Key considerations when selling your business
Selling your business is a lot like selling a house: you need to prepare it for sale. But while most houses need only a week or two of work and a fresh coat of paint, it could easily take years to get a business ready to go on the market. If you think you may wish to sell your business within the next two to five years, now is the time to start the planning process.
Preparing Your Business for Sale
Many owners express surprise at the mention of a five-year timeline. Missteps early in the process can have costly tax ramifications later.
One key consideration is determining whether your business has the right structure to encourage a sale. Before moving forward, you should also determine whether you are aiming for an asset sale or a share sale. These two sale types have different impacts for the buyer and seller.
Considerations for a Share Sale
A share sale—in which you transfer the shares of the corporation—is often the most advantageous for the seller. One reason for this is the opportunity to reduce your tax burden by using your capital gains exemption on the sale of qualified small business shares. If the exemption is not available (for example, if you have already used your exemption, or if your business does not qualify), having the value of the corporation including retained earnings taxed as capital gain can still provide tax savings when compared to an asset sale.
Considerations for an Asset Sale
In contrast, an asset sale—in which you sell ownership of a company’s assets, such as inventory, equipment, and accounts receivable—is often the most desirable approach for the purchaser and their risk is lower as the business’s legal or tax issues generally remain with the seller. The assets that they purchase will also have a full tax cost, as opposed to the current carrying value as in a share purchase. This stepped-up cost (equal to their current market value) minimizes future income or gains.
When to Consider a Hybrid Sale
Given the balance of needs and tax considerations between buyer and seller, coming to an agreement can be difficult. One solution is a hybrid sale, which combines elements of both asset and share sales to deliver benefits to both parties. Such planning can effectively balance the needs of both buyer and seller and usually corporate restructuring is required prior to a sale.
Making the Most from the Capital Gains Exemption
If you are a Canadian resident and shares of your business count as qualified small business corporation (QSBC) shares, you may be able to claim a lifetime capital gains exemption to shelter all or part of the gain from tax. The current limit is in excess of $848,000 and adjusted annually for inflation. To qualify as QSBC shares, your business must meet three specific conditions. The first is the determination time test; the second condition is the holding period asset test; and the final condition is the 24-month ownership test.
There are many ways to optimize your tax outcomes on the sale of your business, and it’s definitely not something you should take on alone.
Scott Conner is a Tax Partner at BDO Canada LLP. With over 15 years of experience as CPA, CA specializing in Canadian income tax, Scott helps a variety of individuals and private companies pay the least amount of tax possible with great tax planning strategies. He also specializes in planning for estates, trusts, and non-resident dispositions of real estate.