TAX PLANNING FOR THE SALE OF A BUSINESS

REFERENCE GUIDE TAX PLANNING FOR THE SALE OF A BUSINESS

Sale Of A Business? Consider The Tax

For business owners in the Burlington, Oakville, Mississauga vicinity, if you own a corporation that carries on an active business, you may be in a position at some point to consider the sale of your business.  Considering the tax implications and planning for the ultimate sale is imperative.

This guide sets out some of the important tax issues that you should consider. For a complete reference guide please refer to the document at the end of the article. 

Share sale vs. Asset sale 

The sale of an incorporated business can be accomplished either through the sale of the corporation’s assets or the sale of shares of the corporation. Either decision requires consideration of many tax and non-tax issues. 

The vendor of an incorporated business would prefer to sell shares, while the purchaser would prefer to buy assets. For the vendor, the tax cost may be less in the case of a share sale. For the purchaser, an asset purchase will result in a greater cost base for the underlying assets of the business, and a greater cost base on which to claim depreciation. 

A non-tax reason that a purchaser would rather purchase assets is the potential liabilities that may exist in the corporation, which would remain if the purchaser acquired the shares of the corporation. By buying the assets of an existing corporation instead, and carrying on the business in a new corporation, the purchaser will only inherit those liabilities that it specifically assumes. 

An asset sale may be subject to taxes which would be payable by the purchaser.

In either case, whether on a sale of shares or assets, there are opportunities for the vendor to minimize tax. 

Minimizing tax on a share sale 

There are several methods to reduce or defer the tax that the vendor will pay on a sale of shares. 

Capital Gains Exemption 

Many sale transactions are structured around the vendor’s ability to claim the capital gains exemption in respect of the disposition of shares of a qualified small business corporation (QSBC shares). 

QSBC share

In order to qualify for the enhanced capital gains exemption, an individual must dispose of a share of a qualified small business corporation or QSBC. A QSBC share of an individual is defined to be a share of the capital stock of a corporation and must meet certain criteria. Please refer to PDF Reference Guide below for all the details. 

Payments from available Tax Pools

Another method of minimizing tax is to remove value from the corporation prior to the sale where the tax cost of the removal is less than the tax cost of the capital gain that would otherwise arise. 

The following are some examples of how this might be accomplished: 

• Shareholder loans 
• Capital dividend account 
• Safe income 

Retiring Allowance 

Another strategy used to defer tax (and, if the deferral is long enough, to save tax) is to have the corporation pay to the vendor(s) a retiring allowance prior to the sale. The payment of a retiring allowance would decrease the value of the corporation and would therefore decrease the purchase price that would be subject to tax. 

Capital Gain Rollover

Under the income tax legislation, an individual can defer all or a portion of a capital gain when the individual disposes of shares of an eligible small business corporation and uses the proceeds to invest in new shares of another eligible small business corporation (sometimes referred to as replacement shares). This deferral is affected by the cost base of the replacement shares being reduced by the amount of the capital gain deferred.

Defer Payment of the Purchase Price

Deferring the payment and receipt of the purchase price is another way to defer tax. Note, however, that to the extent that a vendor agrees to defer the receipt of the purchase price, the vendor is financing the acquisition. In such cases, the vendor should ensure that any unpaid amounts are properly secured. 

Capital gains reserve 

As a general rule, tax is payable when the business is sold, regardless of when the purchase price is paid. In certain circumstances, a reserve may be available to the vendor. The effect of the reserve is to spread out the capital gain over more than one taxation year. 

Rollover for shares 

Subsection 85(1) of the Income Tax Act provides for a rollover when the vendor receives consideration that includes shares of the purchaser (where the purchaser is a corporation). This is a deferral of payment since the vendor would receive no cash until the shares are sold or redeemed. If the vendor receives freely tradable shares of the purchaser corporation, the tax liability would be realized when the vendor sells the shares on the open market (public company) or as the shares are redeemed by the purchaser corporation.

Minimizing tax on an Asset Sale

There are a few methods to reduce the tax that the vendor (in this case, the corporation) will pay on an asset sale. 

• Allocation of Purchase Price 
• Defer Payment of the Purchase 

Conclusion 

There are several tax planning opportunities when you are considering a sale of your business. There may be additional investment and wealth strategies beyond those discussed here, depending on the particular circumstances of the vendor and the purchaser. In all cases, professional legal and accounting advice, as well as proper planning and documentation, are essential.