If you are thinking of selling your Canadian private corporation, it’s important to carefully consider the tax implications of how the transaction is structured.
(abridged and updated from a 2021 Insight)
There are two primary methods of selling a Canadian private corporation: a share sale and an asset sale. Generally, share sales are preferred by sellers to take advantage of favourable capital gains treatment, while asset sales are preferred by buyers to minimize risk.
In some cases, a hybrid sale—combining elements of both a share sale and an asset sale to balance risk and tax implications—may be possible.
While every transaction is unique, below is an overview of some of the most common tax considerations associated with selling a Canadian private corporation:
In a share sale, an individual (or individuals) sells their shares of a private corporation directly to a buyer. A share sale involves the sale of the company itself, with the buyer essentially taking over the business. In a typical share sale, all assets and liabilities remain with the company and transfer to the new owner.
A share sale is usually preferred by sellers, as it generally results in a favorable capital gains treatment. If an individual sells their shares in a company, the proceeds ─ in excess of the adjusted cost base of the shares and certain expenses incurred to sell the shares ─ result in a capital gain, which is only 50% taxable.
Additionally, if the shares are considered Qualified Small Business Corporation (QSBC) shares, the seller may be able to shelter all or part of the resulting capital gain from tax by claiming their Lifetime Capital Gains Exemption (LCGE). In 2022, the LCGE for QSBC shares was $913,630.
That said, a share sale will often result in a lower selling price versus an asset sale for the same business. This is due to the fact that share sales generally represent increased future tax liabilities and higher levels of risk to buyers.
It is important for a seller to weigh the tax benefits of a share sale against the overall selling price. A good exercise is to calculate and compare the after-tax result of selling company shares versus selling company assets. For larger companies and more complex deals, the capital gains tax advantages may become less important relative to maximizing purchase price and available corporate tax deferral opportunities.
In an asset sale, a company sells some or all of its business assets (which can include inventory, equipment, buildings, working capital, A/R, intellectual property, contracts, etc.) to a buyer, but the company itself is not sold. In an asset sale, the seller retains ownership of the company as a legal entity.
One of the key disadvantages of selling a business through an asset sale is that ─ since the company is party to the transaction ─ the individual seller can’t claim any of their available LCGE.
An asset sale may also result in a double tax hit to a seller. In an asset sale, proceeds are transferred from the buyer to the business, which must pay corporate tax on any accrued gains and settle any outstanding liabilities before distributing the net proceeds (usually as a dividend) to the seller as a shareholder. The dividend would then be subject to tax at the seller’s personal marginal tax rate.
If a buyer insists on an asset sale, a seller should request a higher purchase price to compensate for the increased tax burden.
How the purchase price is allocated across specific assets plays an important role in an asset sale. Buyers are generally motivated to allocate more of the purchase price to inventory or depreciable property in order to benefit from higher tax depreciation claims going forward. On the other hand, sellers want to minimize income on the sale of inventory and recapture capital cost allowance previously deducted on depreciable property. Negotiations between an asset sale versus a share sale generally result in the purchase price allocation set somewhere in the middle, essentially with the value of the seller’s lost LCGE split between the two parties.
Depending on the unique circumstances of the business and transaction, a hybrid sale may be an effective way to bridge the tax objectives of seller and buyer. By combining the sale of both shares and specific business assets, the seller may be able to utilize their LCGE while the buyer partially increases the tax cost of purchased assets.
Note: The actual steps involved in a hybrid sale are considerably complex, and there are a number of provisions within the Income Tax Act that can affect a hybrid transaction. To avoid any negative tax consequences, it’s important to consult with an expert and consider all possible tax and business implications before moving forward.
S+C Partners is committed to helping you
If it’s time to sell your business, let our expert advisors guide you through the process. We can provide strategic advice before, during and after a transaction to ensure the sale is structured and executed in a way that meets your personal objectives and maximizes your tax position.
Please call us at 905-821-9215 or email us at firstname.lastname@example.org if you have any questions or require any assistance.
Looking for more information on tax planning in Canada? Explore our comprehensive tax services.
Read our most recent Insights.