How far in advance to plan a business sale: the previous 24 months decide whether you keep the tax break

Summary

Sell the shares of your Canadian company at a profit and a deduction called the lifetime capital gains exemption can wipe out the tax on much of that profit. On shares sold in 2026 it covers $1,275,000 of profit per person.¹ That’s a lifetime total rather than a per-sale one, and once a shareholder has used theirs it’s gone. Profit on shares counts as a capital gain, and only half of a capital gain is taxed to begin with. Top personal rates sit near 50%, so a full exemption is worth roughly $300,000 of tax you never pay.

Your shares have to pass three tests in the Income Tax Act on the day you sell, and the same three apply if you give them away or die owning them. Two of the three look back over the previous 24 months.

1. At the moment of sale, at least 90% of what your company owns by value has to be used in an active business run mainly in Canada. An active business is what the company does to earn money: the equipment, inventory, unpaid customer invoices and the cash it runs on. Investments aren’t active, even though the company owns them. The 90% is how the Canada Revenue Agency (CRA) reads the phrase the Act uses, “all or substantially all”.²
2. For the part of those 24 months when you or a family member owned the shares, more than half the company’s assets had to be in active use at all times.³ The Act says “throughout”, which allows no averaging, so one day below 50% fails the test for the whole period.
3. Over the same 24 months, nobody outside that group of relatives can have owned the shares you’re selling.³ That disqualifies shares issued recently to a spouse, an adult child or a family trust, which is one way owners use each family member’s own exemption.

Where a company holds an investment portfolio or a permanent cash pile, the 24-month clock starts on the day the balance sheet is cleaned up. We’d run all three tests against your actual balance sheet about two years before you think you might sell. Where the exemption at stake is worth less than the fees and delay of protecting it, paying the tax is the better answer.

Three tests, and three different clocks

The exemption attaches to shares you own personally, so it does nothing for an asset sale, where your corporation sells the business itself and earns the profit. Two terms sound alike: the company has to be a small business corporation when you sell, and the shares are what qualify as qualified small business corporation shares.

The first clock is the moment of sale. A small business corporation is a Canadian-controlled private corporation with 90% or more of its asset value in active business use. Canadian-controlled private corporation means a private Canadian company that non-residents and public companies don’t control, individually or between them. The Act asks what would happen if every share they hold were held by one person.⁴ Shares and loans of a connected company, meaning one your company owns a large stake in, also count as active when it is itself a small business corporation, which is how a holding company passes.²

The second clock covers the part of those 24 months when you or a related person held the shares. Across that part, both the more-than-50% active test and the Canadian-controlled private corporation test have to hold at all times.³ Related has a specific meaning in tax law: roughly your spouse, children, parents, siblings and companies any of you control. A friend or an unrelated business partner isn’t related to you.

The third clock is the full 24 months of ownership, and nobody outside that group of relatives can have held the shares during it.³ Two years is our own convention rather than a lead time the CRA publishes, and the extra months are margin.

What counts as an active asset

Both asset tests run on market value, meaning what the assets would fetch in an open sale today rather than what your financial statements record. Every asset lands on one of two sides, active or passive, and goodwill lands on the active side even though a business you built yourself never records it anywhere. Unpaid invoices, work in progress and goodwill are usually enough on their own to clear the 50% test. As such the item left to argue about is cash, and a company that owns little more than its bank account fails far sooner than its statements suggest.

Cash counts as active when the business genuinely needs it to keep running, meaning that taking it out would destabilize operations. The cushion that carries payroll through a slow month counts, and so does a seasonal build-up before a busy period. A balance sitting permanently above what the business needs doesn’t count, and neither does money set aside to buy equipment later. As a working rule we treat about three months of operating costs as the outer edge of what a stable business genuinely needs, which is our own convention rather than anything in the Act. Portfolio investments, term deposits, a rental property not used in the business (e.g. a condo the company rents out) and loans to you all sit on the passive side.

When each shareholder’s shares were issued

Company age is the wrong question. The clock looks at the share’s ownership history, including qualifying ownership by related people, rather than only its time in your hands. When a company issues a brand-new share, the ownership clock starts at the issue date. The law treats the share as having been in a stranger’s hands the instant before, which reaches any share issued in the last few decades.⁵ Three kinds of issuance escape the rule: shares issued in exchange for other shares, shares issued as a dividend rather than paid in cash, and shares issued when 90% or more of an active business’s assets are transferred in.

Someone who was self-employed and incorporated last quarter, transferring the whole business in, therefore holds qualifying shares straight away. The third exception clears the ownership clock, and the asset clock only measures the months the shares have existed in their hands. On the flip side, a thirty-year-old company can have shares issued to a family trust a year ago that can’t qualify for another twelve months. Failing this test for a spouse or an adult child costs twice over, because the rules against splitting income with family members can then tax their gain at the top personal rate.⁶

Getting the surplus out of the operating company

Cleaning up the balance sheet before a sale is called purification. Three routes do most of the work. Two heavier ones, buying active assets or moving the investments into a separate company you own, cost more in fees and months, and we’d work those through with you rather than here.

1. Pay the surplus out to yourself as salary or dividends, which needs nothing set up and avoids the anti-avoidance rules below. The cost is full personal tax now, to protect a capped benefit you may not need.
2. Pay a dividend up to a holding company, i.e. a second company that owns your operating company. The spare cash and investments then sit outside the operating company, where they can’t push it below 50% again. However, section 55(2) of the Income Tax Act can turn that dividend into a capital gain, where paying it and later selling the operating company to an outside buyer are steps in one connected plan.⁷ The Act’s exception for dividends between related companies doesn’t reach a cash dividend at all, so the protection is safe income from the start. Safe income is roughly the after-tax profit the operating company earned while the holding company held its shares, and computing it costs real fees.
3. Have the company repay money it borrowed from you, pay down its supplier bills and top up instalments on tax it actually owes. Doing that shrinks what the company owns without distributing value, so no dividend and no personal tax arise, though the debts it has cap the effect.

If you’re already inside 24 months with a failed asset test, no clever fix exists. The choices are to push the closing date out, to sell the company’s assets instead of your shares and negotiate a higher price to cover the tax, or to sell without the exemption.

How often this changes

Re-run the three tests at every year-end, because they’re running conditions rather than a certificate you earn once. Where they fail, we’d fix it now and keep it fixed, treating a lean operating company as a habit rather than a project. A company cleaned up in 2024 that then banked two strong years can be back below 50% by 2026. Re-run the tests early when shares go to family members, when an unusual receipt lands (e.g. a large insurance settlement), or when investment from non-residents or a public company would give them control. Do the same when a shareholder plans to leave Canada, because leaving triggers a deemed sale of the shares at market value on the day of departure.⁸ All three tests have to be met at that moment, so no time is left to fix anything once the date is set.

Signing a purchase and sale agreement doesn’t by itself break these three tests, even where the buyer is a foreign company that will control yours the moment the deal closes, because the Act sets that agreement aside for these tests alone.⁹

Closing thoughts

Runway here means lead time rather than cash, and what it buys is the ability to sell on your own timetable. An owner whose company already passes can take an offer when it arrives, while one who has to clean up first negotiates against a 24-month clock. Keep the paperwork behind any cleanup as you go: the valuations you relied on, and a directors’ resolution for each dividend or repayment.

How we handle it

We work through the balance sheet at market value with you, and run all three tests across the trailing 24 months, not the current year alone. We check when every shareholder’s shares were issued, and set out the cleanup with the year-end at which we’ll re-test it. Work of that kind sits in our tax planning service, and the same team prepares your company’s return and your personal one, so the two agree.