Canada Small Business Tax Reform 2025: What You Need to Know

The Canadian federal government has proposed significant changes to the tax treatment of capital gains, impacting small businesses across the country. These changes, while still proposals and subject to potential shifts depending on future federal elections, introduce both opportunities and challenges for entrepreneurs. Understanding the details of the Canada small business tax reform is crucial for effective financial planning.

The core of the Canada small business tax reform 2025 revolves around adjustments to the capital gains inclusion rate, the Lifetime Capital Gains Exemption (LCGE), and the introduction of a new Canada Entrepreneurs' Incentive (CEI). These modifications aim to balance revenue generation with support for entrepreneurial activity, but the outcome varies significantly depending on the size and sector of the business.

Understanding the Proposed Changes to Capital Gains Taxation

The most significant proposed change is the increase in the capital gains inclusion rate. This rate determines the portion of a capital gain that is subject to income tax.

Calculate your taxes with our free tax calculator.

Use our IRPF 2024 calculator to quickly calculate your tax refund or the amount you owe.

Calculate >

Capital Gains Inclusion Rate Increase

The proposed legislation, now slated to be effective January 1, 2026, would increase the capital gains inclusion rate from one-half (50%) to two-thirds (66.7%). However, this increase will not apply uniformly. For individuals, the first $250,000 of capital gains in a year will remain subject to the 50% inclusion rate. This threshold provides some relief for smaller transactions. All capital gains realized by corporations and most types of trusts will be subject to new two-thirds inclusion rate.

It is important to note that the effective date delay to January 2026, means that the originally proposed date of June 25th, 2024, is no longer applicable. All capital gains realized before January 1, 2026 will be subject to one-half inclusion rate.

Lifetime Capital Gains Exemption (LCGE) Enhancement

To partially offset the impact of the increased inclusion rate, the government proposed a significant increase to the Lifetime Capital Gains Exemption (LCGE). This exemption allows individuals to exclude a certain amount of capital gains from the sale of qualified small business shares and farm or fishing property from taxation.

LCGE Increase to $1.25 Million

The proposed changes, effective June 25, 2024, increase the LCGE from $1 million to $1.25 million. This means that eligible individuals can now shield a larger portion of their capital gains from the sale of qualifying assets from taxation. Furthermore, the LCGE will be indexed to inflation starting in 2026, ensuring its value keeps pace with the rising cost of living. This was a high priority for many advocacy groups, including the CFIB.

The Canada Entrepreneurs' Incentive (CEI)

The government has also proposed a new incentive, the Canada Entrepreneurs' Incentive (CEI), aimed at further reducing the tax burden on capital gains for certain entrepreneurs.

CEI: Lowering Capital Gains Taxes on Qualifying Shares

The CEI is designed to lower the effective capital gains inclusion rate on the sale of qualifying small business shares. This incentive will be phased in gradually, starting at $400,000 in 2025 and increasing by $400,000 each year until it reaches $2 million in 2029. For qualifying entrepreneurs, this means that only 33.3% of their capital gains (up to the applicable limit) will be subject to income tax, rather than the standard 50% or the proposed 66.7%.

Sector-Specific Eligibility for the CEI

Crucially, the CEI is not available to all business sectors. Businesses in the following sectors are *excluded* from the CEI:

• Finance and Insurance
• Real Estate
• Food and Accommodation (restaurants and hotels)
• Arts, Entertainment, and Recreation
• Professional Corporations (e.g., doctors, lawyers)

This exclusion creates a significant disparity in the tax treatment of different types of businesses, with some sectors facing a considerably higher tax burden on capital gains.

Stacking the Benefits: LCGE and CEI

For business owners in eligible sectors, the LCGE and CEI can be "stacked," providing substantial tax relief. When fully implemented, this combination can significantly reduce the taxable portion of capital gains from the sale of a business.

Impact on Different Business Scenarios

The proposed changes create a complex landscape of winners and losers within the Canadian business community. To illustrate the varying impacts, consider the following scenarios:

Businesses Selling Shares Under $1 Million

Businesses selling shares (or farm/fishing assets) for under $1 million will see no impact from these changes. The existing LCGE already covers this amount.

Businesses Selling Shares Between $1 Million and $2.25 Million

Businesses in this range will generally benefit from the increased LCGE, starting June 25, 2024. The higher exemption limit will shield a greater portion of their capital gains from taxation.

Businesses in Eligible Sectors Selling Shares Under $6.25 Million (2029)

Over time, and particularly by 2029 when the CEI is fully phased in, businesses in eligible sectors selling shares for under $6.25 million will see a significant reduction in their tax liability compared to the pre-2024 rules. This is due to the combined effect of the increased LCGE and the CEI.

Businesses Selling Shares Over $6.25 Million (2029) or Over Lower Levels (2026-2029)

Businesses selling for amounts exceeding the combined limits of the LCGE and CEI will experience a higher tax burden, particularly due to the increased capital gains inclusion rate on the portion of the gain exceeding these limits.

Businesses in *Excluded* Sectors Selling Shares Above $2.25 Million

Businesses in sectors not eligible for the CEI (restaurants, hotels, arts, entertainment, finance, real estate, professional corporations) will face a higher tax burden on capital gains above $2.25 million. They will benefit from the increased LCGE but will not receive the additional relief provided by the CEI.

Investments and Properties Held Within a Corporation

Capital gains on investments or other properties held within a corporation will be subject to the increased inclusion rate of 66.7% starting in January 2026, with no $250,000 allowance. This represents a significant increase in the tax liability compared to the previous 50% inclusion rate.

Example Calculation: Sale of a Business for $2 Million

The below provides a breakdown of the changes.

Pre-Budget:

• $1M LCGE
• $1M at 50% inclusion = $500K

RESULT: Owner would pay income tax on $500K

July 2024:

• $1.25M LCGE @ 0% inclusion = $0
• $750K at 50% inclusion = $375K

RESULT: Owner would pay income tax on $375K

July 2027:

• $1.25M* LCGE = $0
• $750K at 33.3% inclusion (CEI) = $250K

RESULT: Owner would pay income tax on $250K if eligible for CEI

*Does not account for indexation of the LCGE as of 2026.

Comparative Table: Taxable Capital Gains

The following table provides a breakdown of the taxable capital gains at varying levels of sale, and by year, considering the changes.

The following table summarizes the taxable capital gains on property and investments held within a corporation:

Other Key Tax Changes for 2025

In addition to the capital gains changes, there are some other changes business owners should be aware of:

Transitioning to Online Mail

The Canada Revenue Agency (CRA) is transitioning to online mail as the default method for most business correspondence, starting in spring 2025. Businesses registered for My Business Account, or those with authorized representatives using Represent a Client, will receive notices and updates online instead of by paper mail. It's crucial to ensure your email address is up-to-date in My Business Account to receive notifications.

Trust Reporting - Bare Trusts

For the 2024 tax year, the CRA will not require bare trusts to file a T3 Income Tax and Information Return, including Schedule 15, unless specifically requested. Other affected trusts, however, are still required to file.

Canada Pension Plan (CPP) Changes

The Year's Maximum Pensionable Earnings (YMPE) and the Year's Additional Maximum Pensionable Earnings (YAMPE) are increasing in 2025, impacting CPP contributions.

Short-Term Rentals

New rules require short-term rentals to comply with local and provincial laws to claim deductions. This applies regardless of whether the rental is provided by a business or an individual.

Electronic Filing of Information Returns

There will be changes to the electronic filing of information returns starting in January 2025, including updates to the T619 form and restrictions on submitting multiple return types in a single submission.

Conclusion: Navigating the New Tax Landscape

The Canada small business tax reform 2025 presents a complex set of changes with significant implications for Canadian entrepreneurs. While some businesses will benefit from the increased LCGE and the CEI, others, particularly those in excluded sectors or with substantial investments held within their corporations, will face a higher tax burden. It is crucial for business owners to understand these changes, and seek professional advice where appropriate, to optimize their financial strategies. The delay in the increase to the capital gains inclusion rate provides a window of opportunity for planning, but proactive measures are essential.

What steps will you take to prepare your business for these upcoming tax changes?

If you want to know other articles similar to Canada Small Business Tax Reform 2025: What You Need to Knowy ou can visit the category Tax Planning and Optimization.