Small business owners are not aloof to taxes, from goods and service tax (GST), corporate tax, income tax, and capital gains tax (CGT). While other taxes are related to regular income, capital gain is an income small businesses occasionally earn when they sell an asset or investment for a profit. Capital gain is a windfall gain or an alternate income, so it receives a favourable tax treatment from the Canada Revenue Agency (CRA). In addition, CGT has relevance to small business owners as its calculation differs from other taxes.
What is Capital Gains Tax?
Capital gains tax is charged on making a gain by selling a capital property. Capital property is a stock, bond, real estate, or business you purchased for investment purposes. For instance, a stockbroker who earns money by buying and selling stocks cannot claim gain from stock sale as a capital gain. However, a baker selling stocks for profit can claim the profit as a capital gain.
The correct income classification is essential because only 50% of the capital gain is taxable. The CGT applies when you realize the gain by selling or transferring the asset to another person. There is no tax implication for holding a high-value asset as the capital gain is unrealized.
When Do Small Business Owners Realize Capital Gains?
According to the CRA, a capital gain or loss is realized when the asset is disposed of. For example, an asset can be disposed of by selling it for cash or giving it away to charity, children or relatives. In the second scenario, the asset owner might not receive any money or probably receive a small token, maybe $1. But it is still treated as a sale at the fair market value. As per CRA’s definition, fair market value is the highest price you could get for your property in an open and unrestricted market, where a buyer and seller agree on a price to complete the transaction.
How Does Capital Gains Tax Work?
When a small business owner sells a capital property, the proceeds fall under the capital gain category. You may sell your investments for a profit or a loss and deduct a capital loss from capital gain. While calculating your total taxable income at the end of the tax year, add 50% of the net capital gain. A marginal tax rate applies to your total taxable income, which includes a 50% capital gain for that year.
For instance, Mary is a baker who earned $75,000 in taxable business income. During the year, she sold 100 stocks of A for a profit of $5,000 and her delivery van for a loss of $2,000. At the end of the year, her net capital gain is $3,000 ($5,000-$2,000). Her taxable income is $76,500 ($75,000 + 50% of $3,000).
There could be other scenarios where your capital loss is equal to or greater than capital gain, or there is no gain and only loss. Small business owners can use capital loss to offset capital gain and reduce it to zero. For instance, your capital loss is $5,000, and your capital gain is $1,000. You can bring the capital gain to zero and carry the capital loss back by three years or forward into the future indefinitely.
The CRA has not set any time limit to carry forward the capital loss. But the laws could change. So it is better to consult a tax expert to get a clear picture.
How Can Small Business Owners Calculate Capital Gain Tax
The calculation of capital gains tax has several layers, especially if it is an investment portfolio your business developed over the years. When calculating the capital gain, include the cost incurred to acquire and sell the asset. For instance, if you purchased real estate, add the estate agent’s commission, transfer fee and other charges to the cost of the property. Similarly, deduct the charges you incurred from the property’s sale price.
If the asset is company stocks you purchased over several years at a different price, take the average cost per share after adding commission. Similarly, deduct the commission from the selling price. For instance, John purchased 500 stocks of X Co. for $5,000 in 2020 and another 100 shares of the same company for $700 in 2022. In both instances, he paid a commission of $25 and $10, respectively. As a result, he now sells 100 shares for $20/share.
John’s total cost: $5,000 + $700+$35 = $5,735
Average cost per share: $5,735/600 = $9.56
Capital gain: ($20 – $9.56) x 100 = $1,044
This is just the tip of capital gains tax. The concept runs deep when calculating CGT while selling business or during succession planning. The magnitude of CGT increases when you sell the company you built from a $10,000 investment for $10 million. Here small business owners can take advantage of lifetime capital gain tax exemption.
Understanding the working of capital gain tax is just the beginning. The next and most crucial step is to identify ways and means to save a significant amount in CGT by timing the asset sale correctly. This step needs the expertise and experience of a professional tax consultant, as he/she can help you get the maximum after-tax value of your capital property.
Contact Glenn Graydon Wright LLP in Oakville to Help You With Your Taxation Requirements
At Glenn Graydon Wright LLP, our professional tax consultants can help you conduct a business transaction in a tax-efficient manner and prepare you in advance for upcoming tax liabilities. To learn more about how Glenn Graydon Wright LLP can help you with your tax requirements, call us at 905-845-6633, or connect with us online, to set up an initial consultation.