Two asset tests, not one. At the moment of sale the company must be a small business corporation: Income Tax Act section 248(1) sets that at “all or substantially all” of the fair market value of its assets, which CRA reads as at least 90%. Across the previous 24 months the threshold is lower, more than 50%. Cash, portfolios and idle real estate count against both.
Key takeaways
SECTION 01 OF 10
The exemption attaches to a “qualified small business corporation share”, defined in section 110.6(1). Paragraph (a) is the closing-day snapshot: the share is one that, “at the determination time, is a share of the capital stock of a small business corporation owned by the individual”, that individual’s spouse, or a related partnership.
Paragraph (c) is the history, and it sets a lower number: through those 24 months the company must have been a Canadian-controlled private corporation “more than 50% of the fair market value of the assets of which was attributable to” “assets used principally in an active business carried on primarily in Canada by the corporation or by a corporation related to it”. So the standard is higher on the day of sale than across the two years before it. Treadstone Law’s QSBC share test explainer names neither threshold.
SECTION 02 OF 10
Neither percentage is in the Act. Paragraph (a) borrows the section 248(1) definition: a Canadian-controlled private corporation “all or substantially all of the fair market value of the assets of which at that time is attributable to assets that are” “used principally in an active business carried on primarily in Canada by the particular corporation or by a corporation related to it”.
The numbers are CRA’s. Income Tax Folio S4-F8-C1, at ¶1.15: “For income tax purposes, the term all or substantially all is understood to mean at least 90%, and the terms principally and primarily to mean more than 50%.” A company at 88% has not breached a statutory number; it has fallen outside a published position. The consequence is the same, and there is no partial relief.
SECTION 03 OF 10
The phrase “used principally in an active business carried on primarily in Canada” is three tests in one. The middle one is defined negatively: section 248(1) says an active business, “in relation to any business carried on by a taxpayer resident in Canada, means any business carried on by the taxpayer other than a specified investment business or a personal services business”.
Section 125(7) then defines a specified investment business as one “the principal purpose of which is to derive income (including interest, dividends, rents and royalties) from property”, unless “the corporation employs in the business throughout the year more than 5 full-time employees”. A rental operation run by five people or fewer is a specified investment business, and the property behind it is not an active business asset — the line Treadstone Law draws for active business income.
SECTION 04 OF 10
Cash is neither automatically active nor automatically passive. CRA’s archived bulletin IT-73R6 states that “It is a question of fact whether a property is used principally in an active business”, and gives the example that decides most balance sheets: “If, for example, a corporation carrying on an active business holds term deposits that are not used or connected to its business operations, the term deposits are not property that is incident to or pertains to an active business”.
It reports the Supreme Court of Canada in Ensite as requiring that “The property had to be employed and risked in the business to fulfil a requirement which had to be met in order to do business”, and the converse: “If the withdrawal of the property would have a decidedly destabilizing effect on the corporate operations, the property would generally be considered to be used in the course of carrying on a business”. IT-73R6 is archived and construes these words for the small business deduction: CRA’s reading, not a ruling on any asset test.
SECTION 05 OF 10
Both limbs measure “the fair market value of the assets”. Not book value, and not assets minus liabilities. A company that borrowed to buy a building it does not operate from carries that building at full value inside the test, and the loan does not cancel it.
Goodwill runs the other way. Where the business generates it, it sits on the active side, and in a service company it is often the largest item on the balance sheet — which is why one firm with a large cash balance passes and another with a smaller one fails. Because the test is a ratio, a shrinking business with a static investment account drifts toward the line with nobody buying an investment.
SECTION 06 OF 10
The definition does not stop at the company being sold. Paragraph (c)(ii) also counts “shares of the capital stock or indebtedness of one or more other corporations that were connected” with it. Paragraph (d) then raises the bar: “where, for any particular period of time in the 24-month period ending at the determination time” a connected corporation falls short, its threshold is read up to all or substantially all.
A second rule stops the same value being counted twice. Under section 110.6(15)(b), “the fair market value of an asset of a particular corporation that is a share of the capital stock or indebtedness of another corporation with which the particular corporation is connected shall be deemed to be nil”, confined by the Act to the connected corporation’s own status. Treadstone Law’s holdco versus opco comparison puts it practically: passive investments held inside the operating company are what create the problem.
SECTION 07 OF 10
A policy on the owner’s life, owned by the company, is an asset for this test, but it is valued by statute rather than by appraisal. Section 110.6(15) applies to both definitions, and its paragraph (a) provides that “the fair market value of the life insurance policy shall, at any time before the death of the insured, be deemed to be its cash surrender value”.
A permanent policy with a large death benefit and a small surrender value therefore counts at the small number while the insured is alive; after death, proceeds used to redeem the insured’s shares within 24 months are deemed not to exceed that same value. Treadstone Law’s note on corporate-owned life insurance covers the capital dividend account and non-deductible premiums but not this rule, so it is cited for what it does cover.
SECTION 08 OF 10
The routes are not exotic. Treadstone Law’s answer on non-active assets and purification names three: paying surplus out as dividends, retiring debt with it, or moving the non-active assets into a holding company for shares. Each carries a statutory constraint. A dividend to a corporate shareholder is normally deductible under section 112(1), but section 55(2) can recharacterise it where the dividend “exceeds the amount of the income earned or realized by any corporation” contributing to the gain, deeming it “to be a gain of the dividend recipient, for the year in which the dividend was received, from the disposition of a capital property”.
Moving property rather than cash is usually done under section 85(1), marginal note Transfer of property to corporation by shareholders, on a joint election. Taking the asset out to the owner personally is the route that misfires: section 15(1) provides that where a benefit is conferred on a shareholder, “the amount or value of the benefit is to be included in computing the income of the shareholder” — the two-sided cost in Treadstone Law’s piece on shareholder benefits. Its article on safe income notes the dividend route only arises where the selling shareholder is itself a corporation.
SECTION 09 OF 10
Paragraph (a) can move quickly, because it is measured at a single moment. Paragraph (c) cannot, because it is measured throughout a period that has already happened. Clearing the balance sheet the month before closing can make a company a small business corporation on the day of sale and still leave the 24-month limb unmet. The share then fails on that limb alone.
Treadstone Law’s list of the mistakes that cost owners the exemption puts accumulated passive assets first and says the fix needs time, because the tests look back. Its illustrative pre-sale purification case study — a greenhouse business whose corporation also owned the land, reorganised so the land moved to a holding company and was leased back at market rent — puts that step alone at roughly ten weeks. The holding-period limb and the paragraph (b) ownership condition are covered in the 24-month rule that decides your capital gains exemption.
SECTION 10 OF 10
It makes the share a qualified small business corporation share. The deduction is claimed by the individual under section 110.6(2.1), capped by that person’s gains limits. CRA’s Capital Gains guide states the ceiling as “Under proposed changes, for 2025, the LCGE is $1,250,000 for dispositions of qualifying property.” It is indexed, and CRA labels it proposed — read it for the year of the disposition.
One neighbouring trap. The section 248(1) definition contains a twelve-month grace, expressly confined: it applies “including, for the purpose of paragraph 39(1)(c), a corporation that was at any time in the 12 months preceding that time a small business corporation”. Paragraph 39(1)(c) is the business investment loss rule, so a company that stopped qualifying last month cannot borrow it here. Boundaries: this is the federal Act, the percentages are CRA positions, and Quebec’s provincial statute is not described here.
At least 90 per cent. The Act itself just says “all or substantially all,” but CRA’s published position reads that as at least 90% at the determination time — a lower, more-than-50% threshold applies only to the separate 24-month look-back test.
Not on its own. The closing-day test can be met quickly, but the 24-month test is measured throughout a period that has already happened, so clearing passive assets right before closing can make the company qualify on the day of sale while still failing the 24-month limb.
No. The test measures the fair market value of the corporation’s assets, not its net worth, so a building bought with borrowed money still counts at its full value in the test and the outstanding loan does not net it out.
Sources
