Thinking of selling your business? Getting prepared for the sale well in advance may help you to save some or all of the taxes otherwise payable on the sale.
If a business owner is able to sell the shares of the corporation through which the business is run, rather than the assets of the business, that business owner may be in a position to take advantage of the capital gains exemption permitted under the Income Tax Act (Canada) to reduce or eliminate the capital gains taxes otherwise payable on the sale of the business. However, some advance planning may be required to take advantage of the capital gains exemption.
Generally, on the sale of shares of a corporation through which the business is carried on, the amount by which the sale price exceeds the price paid for such shares by the business-owner at the time he or she acquired such shares (namely the business owner’s “capital gain”) is taxable at the time of the sale. For example, if upon the setup of a corporation, the business-owner acquires shares in the capital of the corporation for an aggregate of $1.00 and later sells those shares for $100.00, fifty percent the $99.00 capital gain (or $49.50) is generally taxable at the time of the sale of the shares.
There are a few ways the business owner can reduce or offset the tax payable on the sale, including utilizing any unused capital gains exemption available to the business-owner.
The capital gains exemption allows sellers to realize up to $848,252.00 (effective in 2018 and indexed to inflation going forward) of capital gains during his/her lifetime, tax-free on the sale of shares of a Qualified Small Business Corporations (“QSBC”).
In order to qualify as QSBC shares there are a number of complex tests that must be met with respect to (i) the type of assets owned by the corporation, and (ii) the length of time the shares were held by the business owner prior to the sale.
The first test to qualify as QSBC shares requires that at the time of disposition of the shares, such shares be shares of a Small Business Corporation (“SBC”). In order to be a SBC the corporation must be a Canadian Controlled Private Corporation (“CCPC”), of which, all or substantially all of the assets (at least 90%), on a fair market value basis, are used principally in an active business, carried on primarily in Canada (at least 50%) by the corporation or a related corporation.
Once the shares pass this first test, the business owner must pass the second test, which is a holding period test. To meet the holding period test, the shares must be owned by the business owner disposing of such shares (or a related person or partnership of such business-owner) for at least two years prior to the date of the proposed sale.
This two-step test makes it important for the business owner to work with his or her legal and accounting advisors well in advance of any anticipated sale to ensure that the “holding period” test is met, and any excess cash or other assets sitting on the books of the corporation and not being used in the business of the corporation, be extracted from the corporation so that the assets of the corporation meet the “active business assets” test.