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Asset sale vs share sale - what are the tax implications?

Planning your exit now could save you money on taxes further down the line...

If you’re a small business owner in Canada, it’s likely that your business is your most valuable asset. 

Whether you’re in the process of selling or planning your exit strategy, you’ll need to think about the tax implications.

According to the Canadian Federation of Independent Business (CFIB) ‘just 40% of small business owners have a plan for exiting’.

Jacoline Loewen, director at UBS Bank states in The Globe and Mail that ‘entrepreneurs who don’t set down a plan for the sale of their business could miss out on opportunities to cut their tax bill and may even end up increasing their tax liability’.

Taking the time to research your tax procedures can provide you with a strong advantage, especially in the negotiation period.

So what are your options?

Selling your business has two approaches: an asset sale or a share sale.

Asset Sale

In this selling option, the buyer only purchases the assets of the company (tangible and intangible).  Through purchasing assets the buyer can avoid any possible corporate liabilities and  will often negotiate a price  based upon the most desirable tax benefits.

In this type of sale you may encounter recapture income; the difference in price between the proceeds that the buyer received from the asset and the depreciated value. For example, if you sell an asset that is recorded on your books at $1,000 for $1,500, you will then be faced with a recapture income of $500.

Chartered accountant Rob Radloff gives his advice to sellers considering an asset sale in The Globe and Mail, noting that many buyers prefer to buy assets rather than shares because the financial benefit favours them.

He states that business owners should calculate what the tax would be if they 'sold shares versus assets, then … use this number' during negotiations. 

His advice to sellers in the negotiation period is to ‘offer to sell at a slightly reduced price if the buyer agrees to buy shares, or maybe you ask for a bit more if the buyer insists on assets’.

Share Sale

Typically this sale is favoured by sellers; all parts of the incorporated business are sold, including the name of the business.

If your business has been involved in any issues (tax or legal), the buyer will also inherit these. This is why it’s extremely beneficial to be completely honest during the due diligence process.

For example, if there is an audit of your books stating that taxes are due, you will be liable to pay those taxes even if it was prior to you owning the business.

However, on a more positive note, every seller is eligible for a lifetime capital gains exemption. This means that if you bought your shares for $1 and sold them for $10,000, you wouldn't have to pay tax on the sale.

The capital gains exemption only applies to private Canadian-controlled businesses (using at least 90 per cent of their assets) and business owners who have held their shares for at least 24 months prior to the sale.

Radloff believes that sellers should also consider removing certain assets from the company prior to the sale, keeping it ‘pure’ of passive assets.

By removing assets such as investments and real estate from the business he believes that it helps sellers to ‘ensure they stay on the right side of Canada Revenue Agency capital gains exemption rules’Through doing this, it also makes it easier to sell the business as the buyers won’t have to spend on inactive assets.  

Sale Summary

• An asset sale can be used to sell any business, whereas a share sale can only be used to sell an incorporated business.

• If you choose an asset sale you are more in control of what you’re selling and are able to keep certain assets (such as the business name etc.). In a share sale, however, the entire business, including the name is passed on to the new owners.

• In a share sale, the previous liabilities are sold with the rest of the business. It's like selling your business with its history. However,in an asset sale, it is only the assets that are sold.

It’s never too soon to start thinking about your exit. The earlier you prepare the more likely you are to save money.

Both sale methods have tax implications and will differ depending on the business that you want to sell. Ideally, you should seek advice from professionals to determine the best type of business sale for your situation.

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