Fable Friday: His Daughter Was Right

Stan was the kind of guy who did not listen to anyone, particularly his wife or his daughter. His wife Mabel would sometimes become very angry at him when he came home talking about something he had heard from his friends. Whatever the news was, Stan did not hear it unless it came from one of his friends. For example, Mabel had apparently been telling him for awhile that margarine was only one molecule away from being plastic and some people said it was better for you to eat butter. Stan had not really paid any attention. Then, one day he comes home talking about how his friend Bob had to stop eating margarine because of his heart and cholesterol. Stan is talking about this like it is a great revelation! Mabel could just spit.

Now the trouble is with his daughter. Veronica is an accountant and Stan is really proud of her. However that does not mean he has been paying any attention to what she has been saying. Stan had an opportunity to sell his business and he mentioned this to Veronica.

She says, “Dad, you have to get that rental property out of the company before you sell it, if you want to be able to use the capital gain exemption.”

Stan said “Sure, honey I will take care of that before the sale, don’t worry about it. I have everything under control.”

Stan was happy to sell the business and pleased with the price. He sold shares rather than the assets because he knew that with shares he would not have to pay any tax on the sale. He knew that if he sold the assets of the business, that first of all he would have to pay tax inside his corporation on the assets that he sold at a gain. And then he would have to pay tax on all of the money that he would take out of the corporation. He had told the buyer that he was not at all interested in an asset sale- that he wanted to go with the share sale, all the way.

Stan sold the business and reported the gain on his personal tax return as the sale of a Canadian controlled private corporation and claimed his exemption and assumed that was the end of it.

About three months after Stan filed his personal income tax return he got a letter from the Canada Revenue Agency (CRA) asking him for details about the sale of the shares. Stan provided the copy of the purchase and sale agreement as requested. A week or so after that CRA asked for a copy of the financial statements of the company that Stan had sold, and Stan provided that.

Then he got a letter saying that because the company whose shares he had sold had more than 10% of its value coming from rental property, that the share sale did not qualify for the capital gains exemption. Therefore, Stan would have to pay tax on the capital gain.

Stan was amazed. How is that possible, we only have a little bit of rental income so we should be allowed to use some of the exemption? How can CRA disallow the entire sale because we are a few percentage points over 10% of the value coming from income from property? How is that reasonable?

So Stan called Veronica and asked her to take a look at the letter and the calculations. Veronica was very angry. “Christ Dad, didn’t you tell me that you were getting the rental property out of the corporation before you sold it.” We TALKED about this! You told me it was going to be OK! And then what — you just ignored me?

Veronica explained that there was nothing that can be done now about this situation. The corporation did not qualify as a 90% active business because of the rental property. The exemption is no longer available. It is like being pregnant — you are or you are not. You can’t be 10% pregnant any more than you can be 10% eligible for the exemption.

Is it too late for Stan to learn to listen to the people who are trying to help him?

Want to avoid situations like Stan’s? Be in the know with Starting a Successful Business: Stuff You Need to Know. Book and online course available.