A Beginner’s Guide to Canadian Entrepreneurs’ Incentive

Canada is home to thousands of small business owners, and the Canadian government keeps introducing various incentives to make it easier for them to do business. Proposed in the Budget 2024, revised in August 2024, and implemented on January 1, 2025, is the New Canadian Entrepreneurs’ Incentive (CEI). The CEI aims to leave more money in the hands of entrepreneurs to encourage them to reinvest in new projects and reduce their financial challenges.

CEI complements initiatives such as the Scientific Research and Experimental Development tax incentive program, the Venture Capital Catalyst Initiative, and the $1.25 billion Lifetime Capital Gain Exemption (LCGE).

How Does Canadian Entrepreneurs’ Incentive Work?

The CEI significantly reduces the capital gain tax for eligible entrepreneurs of qualified businesses. In a typical scenario, individuals include 50% of their capital gain up to $250,000 a year in their taxable income in the year they realize the gain. The CEI reduces the inclusion rate from 50% to 33.33% up to a lifetime maximum of $2 million. This $2 million limit is earned in a phased manner of five years, with $400,000 added annually. This means that a complete lifetime maximum of $2 million will be available in 2029.

Note that the CEI only applies to the capital gain on the sale of qualified businesses.

Example: John purchased a 5% stake in a tech company for $500,000 in 2024 and was actively involved in the business. He met the eligibility criteria for CEI when he sold his shares for $1.5 million in 2027. The capital gain on the sales after adjusting the cost is $1 million.

In 2027, $400,000 has been added for three years in the CEI limit, and he now has a $1.2 million limit.

Taxpayers must report the capital gain in the tax filings within one year following the due date for that tax year to claim the CEI or risk the incentive being denied.

With CEI, John will show a capital gain of $333,300 (33.37% for $1 million) in his 2027 tax filings.

Without CEI, his normal capital gain would be $625,025 (50% on the first $250,000 + $66.67% on $750,000). Note that the new inclusion rate of 66.67% on capital gains above $250,000 (for individuals) will come into effect from January 1, 2026.

However, not every business owner can avail themselves of the CEI.

Is Your Business Eligible for the Canadian Entrepreneurs’ Incentive?

The CEI was specifically intended for entrepreneurs in technology and manufacturing but was later extended to include farming, fishing property, and other qualified small business shares.

However, the CEI excludes businesses that depend on one or more employees’ reputations, knowledge, or skill. The excluded businesses are:

• Professional corporations like lawyers, dentists, physicians
• Consulting, financial, insurance, and real estate services
• Short-term lodging and complementary services
• Food and beverage-related services
• Operating facilities or services relating to cultural, entertainment, and recreational interests
• The purchase, sale, and rental of real property

Do You Qualify for the Canadian Entrepreneurs’ Incentive?

If the business is not on the exclusion list, entrepreneurs may qualify for CEI if they meet the following conditions:

• They must own at least 5% of the company’s voting shares for at least 24 months.
• If the business is a partnership, the entrepreneur must own a 5% interest in the partnership.
• If the business has no shares or is not a partnership, the entrepreneur’s interest must be 5% of the company’s fair market value. 
• They must actively be engaged in the business for any combined three-year period at any time since the company was founded.

Identifying your eligibility for the incentive is not enough. Entrepreneurs should plan business ownership structure and engagement while considering these incentives and make themselves eligible for these incentives.

Moreover, entrepreneurs should comply with specific rules and requirements to make the most of the CEI instead of falling into non-compliance. CEI may not apply in certain situations and could become an anti-tax avoidance transaction. For example, dividends converted into capital gains do not qualify for CEI and could be anti-tax avoidance.

Contact KSSP Partners LLP in Markham to Help You Claim Tax Incentives Offered by the CRA 

Incentives like CEI and LCGE have various layers of eligibility criteria. Ensuring every criterion is met at the point of sale of a business needs meticulous planning with tax experts. At KSSP Partners LLP, our accountants and tax experts can provide services such as tax planning, business structure, and tax filing. To learn more about how KSSP Partners LLP can provide you with the best accounting and tax planning expertise, contact us online, or by telephone at 289-554-5997.