- Purification means bringing non-active assets, such as surplus cash and investments, below the levels the share tests require.
- The 90% test applies only at the time of sale, but the more-than-50% test must be met throughout the 24 months before the sale.
- Moving money out of a company can create tax problems of its own, so plan the steps with a tax advisor before you act.
Many owners leave profits inside the company over the years. That cash and those investments can cause trouble when you sell, because shares in a company holding too many passive assets may not qualify for the lifetime capital gains exemption.
Fixing this is often called purification. This article explains the idea, the timing rules, and the traps to discuss with a lawyer or accountant before you try it.
What purification means
To qualify, the company's assets must be mostly used in an active business. A small business corporation is a Canadian-controlled private corporation in which 90% or more of the fair market value of the assets is used mainly in an active business carried on primarily in Canada, is shares or debts of connected small business corporations, or is a combination of these.
A company holding too much cash or investments that are not used in the active business must bring its non-active assets below the thresholds, at the right times, for the shares to qualify.
Timing is the whole game
| Test | Timing |
|---|---|
| 90% test | Applies only at the time of sale |
| More-than-50% test | Must be met throughout the 24 months before the sale |
This means you cannot wait until closing day and assume everything is fixed. A company that dipped below the 50% line during the 24 months may have a problem even if it looks clean at closing. The 24-month holding period also applies, so the share must not have been owned by anyone other than you or a related person or partnership during that time.
Ways owners approach it
The usual goal is to reduce non-active assets or increase active ones. Owners and advisors commonly look at options such as paying out surplus, repaying debt or moving surplus into a separate holding company. Which option fits depends on your company, your tax position and the timing, and each can carry its own tax cost.
Payments between related companies, in particular, can raise anti-avoidance and other tax issues. Do not move money simply because a general guide mentions it. Get tax advice on the specific steps and the order in which they happen.
Traps to watch
- New shares: shares issued after June 13, 1988 are deemed to have been owned by an unrelated person before issue, so the 24-month clock starts at issue, with exceptions for shares issued in exchange for other shares, for all or substantially all the assets of an active business, or as a stock dividend.
- Unpaid dividends: the deduction can be denied where a significant part of the gain can reasonably be attributed to dividends not being paid, or being paid at less than 90% of the average annual rate of return.
- Sales to your own company: where you sell shares to a corporation you do not deal with at arm's length and the corporations become connected, non-share consideration above the greater of paid-up capital and adjusted cost base is deemed a dividend, and the exemption cannot shelter that amount.
- Alternative minimum tax: a large gain sheltered by the exemption can trigger it, and it is calculated on Form T691.
If you plan to sell to your adult children, special rules can change the s. 84.1 result, but they require conditions and a joint election.
What to do next
- Prepare a current balance sheet at fair market value, separating active assets from cash and investments.
- Review the last 24 months of the company's asset mix, not just today's.
- Map out the steps, their order and their tax cost with a lawyer or accountant before moving any money.
- Build the timeline backward from your target closing date.
- Confirm that the sale structure does not trigger the related-company dividend rule.
Frequently asked questions
Is there a single approved way to purify a company?
The official rules set the tests and their timing, not a list of methods. The right approach depends on your facts, so get tax advice on each step.
If I fix my assets just before closing, will that be enough?
Not necessarily. The 90% test applies at the time of sale, but the more-than-50% test must be met throughout the 24 months before the sale. Starting early gives you more room.
Does the exemption apply to the whole gain?
It is capped. For 2025 and for dispositions after June 24, 2024, the limit is $1,250,000 of gains, a maximum deduction of $625,000. Earlier claims reduce what is left.
What if the shares do not qualify?
Only one-half of a capital gain is taxable, but without the deduction the gain is taxed at your marginal rates. An accountant can estimate the difference for you.
Sources
- CRA – Line 25400 Capital gains deduction — canada.ca
- Income Tax Act, s. 110.6 — Justice Laws (federal)
- CRA Guide T4037, Capital Gains – 2025 — canada.ca
- Income Tax Act, s. 38 — Justice Laws (federal)
- CRA – Tax rates and income brackets (2025) — canada.ca
- Income Tax Act, s. 84.1(1) — Justice Laws (federal)
- CRA – New for 2025 for capital gains — canada.ca
Links go to official government, court and regulator pages. The law changes — confirm you are reading the current version.
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