The new capital gains tax rules and selling your pharmacy
September 14, 2024
Since the federal government came out with it’s Budget in April, we have been fielding plenty of calls about how the new rules governing capital gains taxes affect pharmacist-owners considering putting up their pharmacy for sale. In the wake of the announcement, there was widespread fear and confusion about what the changes mean—not surprisingly, perhaps, because the rules are complex and for a few weeks some details about how they will be applied were unclear.
There could still be more changes to come, technically, but with the release of new legislative proposals and clarifications over the summer, tax experts have enough information to figure out the impact. Of course, few pharmacist-owners are tax experts, and you kind of need to be one to make sense of it all in any given situation.
I am not an expert, either, so let me emphasize that what I will discuss here should not be taken as tax advice. Anyone wondering about how the new capital gains tax rules apply to them and the sale of their business should consult a qualified accountant with expertise and years of experience in business sale transactions, ideally with pharmacies.
Luckily for EVCOR (and, dare I say it, you), we have one of those individuals at our disposal: Mike Stannix, a Canadian and international tax expert at Accelerate LLP in Edmonton. I have worked with Mike for years, and he recently (and graciously) shared his capital gains tax wisdom with Pharmacy Edge on one of their podcast. Much of what we talk about here is an updated distillation of Mike’s perspectives, but again, it is not intended as tax advice. For that, speak to a specialized tax advisor.
The capital gains inclusion rate
The headline development is an increase in the capital gains inclusion rate from 50% to two-thirds. Note that this is not, as some post-Budget chatter claimed, a change in the capital gains tax rate, but rather in the portion of a capital gain that may have to be included in income and taxed as such. (Just to be ultra-clear, a capital gain is an increase in a capital asset’s value—property, shares or a business, for example—from the time you began to hold it to the time you sold it.)
By way of illustration, here’s a simple example. Let’s say Person X paid $100,000 for an asset two years ago and sold it for $200,000 before June 25, 2024 (the date at which the new inclusion rate came into effect). X’s capital gain on the sale was $100,000. At the old 50% inclusion rate, X would include $50,000 in their taxable income for the year in which it was sold. For simplicity’s sake, let’s say X pays the top income tax rate that year—it can vary by province, but we’ll say 50%—so capital gains tax of $25,000 would be owing.
Now let’s say X sold the asset today. At the new two-thirds inclusion rate, $66,667 of the capital gain would be taxable as income. At a 50% tax rate, that means X would have to pay $33,333 in capital gains tax—$8,333 more than if they had sold the asset before June 25.
The $250,000 exemption
Sounds like bad news for business sellers, but again, it’s complicated. One of the breaks in the Budget is that the first $250,000 in capital gains realized by an individual—for instance, shares in a business that our hypothetical Person X owns personally—are included at the old 50% rate, not the new two-thirds rate. So, in the above example, X’s capital gain of $100,000 could be included for taxation purposes at the 50% rate, meaning no change in capital gains tax owing.
This exemption may or may not have an impact for pharmacist-owners when they sell, depending on their corporate structure. That’s because if the business shares are held by a holding company (whose shares are held by the pharmacist-owner), then the $250,000 exemption would not apply.
Another simplistic illustration: Pharmacist Y, who owns her pharmacy shares directly, sells the business for $2 million after buying it for $1 million. Capital gain: $1 million. Of that, $250,000 is included at 50%, while the remainder is included at two-thirds. The total capital gains tax at a 50% income tax rate would come out to $62,500 + $250,000 = $312,500.
Pharmacist Z, meanwhile, has the same capital gain after selling his pharmacy, but owns it through a holding company, so the $250,000 exemption does not apply. The total capital gains tax at a two-thirds inclusion rate (assuming the same income tax rate) would be $333,333. In short, Pharmacist Z would pay $20,000-plus more tax than Pharmacist Y just because of corporate structure.
Of course, these are hypothetical examples, but it may be well worth a pharmacist-owner’s time to consult their tax advisor about the optimal corporate structure to respond to these changes.
The Lifetime Capital Gains Exemption
The government allows every individual in Canada to claim an exemption for qualifying capital gains once in their lifetime. Before the 2024 Budget, the total exemption that could be claimed was just over $1 million. To offset the impact of the changes to the inclusion rate, however, the government is raising the Lifetime Capital Gains Exemption (LCGE) limit to $1.25 million.
That’s significant. But, importantly for anyone selling a business, the company must meet stringent criteria to qualify for the LCGE. A big one is that more than 50% of assets in the company must be active (i.e., directly related to business operations) for two years before the sale; another is that more than 90% of the assets have to be active at the time of the sale.
Effectively, the lifetime capital gains tax exemption has become potentially more important to pharmacist-owners when they sell. It is both more “valuable,” because of the higher exemption limit, and leads to more “savings,” because of the higher capital gains inclusion rate. So, if your goal is to take advantage of your LCGE (and perhaps the LCGE of family members as well) when you sell, then you must ensure that your business is structured in such a way that it qualifies—another issue to discuss with your tax advisor.
The Canadian Entrepreneurs’ Incentive
The Budget announced an additional potential capital gains tax break for entrepreneurs that would eventually reduce the inclusion rate to one-third on a lifetime maximum of $2 million in qualifying capital gains. When combined with the LCGE, the Canadian Entrepreneur’s Incentive could mean that an individual who sells a business will get exemptions or reductions in tax on up to $3.25 million in capital gains.
However, there are a few provisos. One is that the incentive will be phased in at $400,000 per year until it reaches the maximum of $2 million. Also, the CEI comes with its own set of criteria, and it applies only to certain industries.
So it’s something to keep an eye on—and, yes, to discuss with your tax advisor.
Talk to Your Expert
As you might have guessed by now, the overriding message here is to talk to a qualified tax professional about what changes to the capital gains inclusion rate might mean to you and your tax situation when and if you decide to sell your pharmacy. Also, remember that tax policy is always a shifting landscape, so you should have those conversations often.
They should include subjects like figuring out whether your business qualifies you for the LCGE, understanding the varying tax effects of your corporate structure, and ensuring that you are taking advantage of capital gains deductions (for instance, by keeping close track of capital improvements, which can reduce your capital gain when you sell). There may also be the potential impact of the alternative minimum tax (AMT) calculation to consider—a subject far too broad and complicated to get into here.
As it stands, the new rules around capital gains seem to be something of a mixed bag for entrepreneurs, including pharmacist-owners. And since every pharmacy (and pharmacist-owner) is different, they will be affected differently by the new rules. But whatever your own situation, frank, focused discussion with a qualified tax professional about the potential impact of selling your business, even if that is years away, could save you plenty of anxiety—and lots of money—down the road.
Max Beairsto B.Sc. Pharm, MBA, CVA – is a pharmacist, valuation analyst and the president of EVCOR. EVCOR is a Canadian business valuation and boutique M&A firm that focuses on valuations and the sale advisory of independent pharmacies. Over the last 19 years through his company, he has been actively involved in hundreds of valuation assessments and consultations.
