To capitalize on the best tax strategies for their circumstances, the seller needs the professional guidance of accountants, lawyers and financial advisers.McCay Duff, Humphrey Law and Advanced Planning Group have contributed to this post on the two main tax structures in the sale of a business: 1) the shares of a corporation and 2) the assets of the business. Tax considerations and lead times are different for each option. This information has been updated as of September 7, 2016.
The difference between the cost of the shares and the sale proceeds is a capital gain. By taking advantage of the lifetime capital gain exemption (LCGE) of up to $800,000,* share owners can potentially receive the capital gains tax free. *For dispositions after 2013 of qualified small business corporation shares and qualified farm and fishing property, the lifetime capital gains exemption limit has increased to $800,000. It is indexed to inflation, up to $1 million, for tax years after 2014. The LCGE for 2016 is $824,177.
Advance planning is usually required to ensure:
- shares are of a Canadian-controlled small business corporation;
- shareholder(s) have owned the shares during the 24 months preceding the sale;
- substantially all (at least 90%) of the company’s assets are used in an active business in Canada at the time of sale;
- a minimum of 50% of the company’s assets have been used in active business in the prior 24 months.
Potentially significant tax could be saved by:
- Purifying any excess cash, portfolio investments and investment properties not being used in the active business. Advanced Planning has helped many of our clients achieve this through insurance vehicles.
- Multiplying the capital gain exemption by having your spouse and/or children own shares (through a trust) so each can use their lifetime capital gains exemption. This can be set up through an estate freeze two years prior to the sale; we highly recommend working with your accountant and a tax lawyer as part of your Exit Planning Team.
Negotiating the structure of the purchase can be difficult as the vendor and purchaser have conflicting goals. Vendors want to sell shares for tax-free capital gains; purchasers want to buy assets to get the stepped-up asset values and to avoid liabilities for past business activities. The purchase price is often discounted in a shares sale because the purchaser is losing the tax shield against future earnings.
If you own shares of a small business corporation, set an annual review with your accountant and tax lawyer to continue meeting capital gain exemption requirements. Keep in mind that as shares are deemed to be sold at fair market value on death, appropriate planning may avoid placing a tax burden on your estate.
Purchasers often prefer buying assets, which are recorded at fair market value and amortized over time, accelerating tax savings. The remaining value relates to goodwill, also amortized over time. When the vendor receives proceeds in excess of the “tax cost” (UCC) of the asset, tax will be due. The proceeds need to be allocated to the various assets being sold; some may need to be appraised.
The purchaser may agree to buy some of the assets at the end of December and some at the start of January, splitting the taxable income and capital gains between two years, helping to minimize taxes for the seller. Your accountant and tax lawyer can help you determine if this is of advantage.
The existence of significant eligible capital property (goodwill) can benefit both the seller and purchaser in an asset sale. The purchaser, who can amortize the goodwill, will generally be willing to pay more for assets to offset increased tax costs to the vendor.
The seller may enjoy a small tax savings or a small tax cost and a significant tax deferral or a moderate tax deferral depending on whether or not the sale of eligible capital results in income eligible for the small business deduction.
There are many factors to consider in planning for the sale of a business and structuring it to be tax-effective; we deal with more aspects in Tax Planning Prior to Sale.
Looking for more detailed information on the pros and cons of share or asset transactions?