Considering Selling Your Business? Know The Tax Implications
Are you considering selling your business? The sale of your business can be equally as exciting as it can be stressful. It is important that you know the options available to you and the tax implications of different choices. We at DMCL are here to guide you through the options available to you and make sure that you can realize the maximum amount of after-tax value from the sale of your business. There are two possible approaches to selling your business: sale of the shares of the corporation, or the sale of the business assets.
Two Approaches to Selling your Business
- Share Sale
When selling shares any gain will likely be a capital gain, one-half of which will be subject to tax. Depending on the circumstances, the owners of those shares may be able to utilize their Lifetime Capital Gains Exemption (LCGE). The LCGE allows individuals to realize the first approximately $890,000[1] of any gain tax-free on the sale of Qualified Small Business Corporation (QSBC) shares.
To be considered a QSBC and eligible for the LCGE, the company must meet the following criteria:
- The company must be a Canadian-controlled private corporation (CCPC);
- At least 90% of the fair value of the company’s assets must be used in an active business carried out in Canada immediately prior to the sale;
- In the 2 years prior to disposing the shares, the shares must not be owned by anyone other than the seller or a person related to the seller; and
- In the 2 year holding period, the company must be a CCPC and at least 50% of the fair value of the assets must be used in an active business carried out in Canada.
The shares must be held by an individual, a personal trust or partnership. There are also some specific conditions that must be met to ensure the LCGE is available for use. In order to ensure that a company will be meet these criteria, planning should be done well in advance.
2. Asset Sale
Often a buyer will want to structure an acquisition as a purchase of business assets (inventory, equipment, goodwill, etc.) as such a purchase will usually allow them to step-up the cost base of the assets purchased. The benefit to the seller can be increased tax depreciation and/or a reduction in any future gains on a subsequent sale.
The company selling the business assets will have taxable income including the following:
- Recapture of Capital Cost Allowance (CCA) on the sale of depreciable assets
- Capital gains on other capital properties, such as land
- Capital gains on goodwill
The taxes payable will depend on the gains realized and the way in which amounts are distributed to shareholders (repayment of debt, return of capital, bonus, taxable dividends, capital dividends). The nature of each of these types of income will impact how the corporation will be able to pay the after-tax proceeds of the sale to its shareholders. Generally speaking, capital gains realized by the company will enable it to pay capital dividends on the tax-free portion of the capital gains realized. Any other amounts can be distributed as taxable dividends.
Next Steps
Pre-Sale Restructuring
For most business owners, it is wise to start planning for a sale before a buyer has found you. This is because both you and the buyer can maximize the after-tax value generated by the sale by planning in advance to get your business into the best position to sell. Where possible we usually recommend reviewing your circumstances two to three years before sale.
Analysis of Alternatives
As we discussed above, there are generally two ways to sell your business: share sale or asset sale. The tax consequences to both the buyer and seller will usually determine the structure of the sale transaction, the price the buyer will be prepared to pay and the price the seller will need to realize. Included in this analysis is planning for how best to pay out the proceeds from the sale to minimize taxes and maximize the after-tax proceeds from the sale.
How we can help
To learn more, or if you have any questions, please contact your DMCL advisor. We have the experience and knowledge to guide and consult you through the sale of your business.
[1] 2021 LCGE Amount = $892,218. This amount is indexed to inflation each year.