Selling a business can be rewarding, but improper tax planning can make the process extremely challenging. That’s why planning a business sale ahead of time is essential. Doing this offers several benefits, including taking advantage of certain tax breaks and exemptions, minimizing capital gains taxes, and reducing unexpected liabilities that come with selling a business in Canada.
Like most countries, Canadian businesses are taxed on their profits. Yes, the government wants its half, and there is no easy way around it. But with proper knowledge, you can avoid certain risks and find opportunities that would otherwise be missed.
This article will provide a helpful breakdown of these tax considerations, but before we begin, let's talk about the importance of understanding a share or asset sale.
A share sale means you are selling the shares to a new owner. Therefore, the new owner is responsible for its liabilities. It is typically the quickest and easiest way to transfer ownership but will cost the buyer more as they need to pay a premium for the shares. Usually, a share sale is more tax-efficient for a seller, because you can take advantage of a capital gain exemption.
An asset sale, on the other hand, involves the transfer of ownership of each asset to the new owner. An asset sale can be more time-consuming, and it often favors the buyer. Individual shareholders cannot claim LCGE (we'll get to this later), and you may need to pay a second layer of tax on distributed proceedings.
The most important tax implications when selling a business
Below are five of the most important tax implications to consider when selling the business. These will help you sell your business on a tax-efficient basis.
Capital Gains Tax
The profit you make on a disposed asset (like a building or equipment), also known as capital gains, gets taxed. It's the most common tax consideration that every business owner should prepare for. If you sell an asset for more than you bought it for, you'll pay tax on that gain you made.
Capital gains tax calculators are available to estimate how much one has to pay. However, factors like a business's value and income levels also go into play.
Lifetime Capital Gains Exemption
Also known as LCGE, lifetime capital gains exemption is a way to avoid paying hefty CGT taxes on all or part of the profit you've earned from a disposed asset. It also has a cumulative lifetime limit, which means you can apply for the tax relief multiple times until you reach your capped limit. It also applies to farming and fishing businesses.
If you've sold Qualified Small Business Corporation Shares, it's possible that your profits can be eligible for a tax-free gain of $913,630. However, there's a lot of paperwork that comes with this exemption.
This tax exemption is only applicable to share sales, and you need to be an eligble small business corporation. This means that at least 90% of your business's assets have been used in a trading business in Canada. Also, you cannot exceed $50 million in asset value during the 24 months approaching your business sale.
Selling a business that is structured as a corporation will experience different tax implications, but also opportunities. How much corporation tax you'll pay will depend on your income and which territory you trade in. Generally, the federal tax rate on corporations is 38%, which can be reduced to 28% with a tax abatement.
If the business you are selling offers goods and services in Canada, GST/HST may be added to the total selling price. It is possible to avoid GST/HST, but you'll need to hash this out in negotiations with the buyer. Again, the amount (if any) depends on the value of the company and the buyer’s tax residency. It's important to comply with GST/GST regulations, so we encourage you to hire a professional accountant.
Some businesses are a one-person operation. If you are one of them, hats off to you. But most companies have more than one employee. And you guessed it; all employment taxes must be paid upon the sale of the business. Failing to do so will make you accountable for the initial sum and any additional penalties.
What is the most tax efficient way to sell a business?
Here are the most tax-efficient ways to sell your business:
- Sell to a family member or charitable organization: One of the most tax efficient ways to sell a business is to sell to a charitable organization or a family member. Doing this can save you from paying capital sales tax on the entire sale.
- Sell through a share sale: Another way to reduce tax on a business sale is by selling shares as opposed to assets. In a share sale, the buyer only pays capital gains tax on the sold shares. Share sale taxes are calculated as follows: The sale price is deducted from the purchase price to give you the net profits. Finally, the net profit x 50% equals the taxable amount or capital gains tax.
- Lifetime Capital Gains Exemption (LCGE): You may be eligible for Capital Gains Tax Exemption up to $971,190 if you've sold QSBCS or you own a farming or fishing business. It is an excellent incentive for reducing tax on sale of a business. Remember that not all businesses are eligible for this exemption as the program is quite complex. If you need help determining whether or not you qualify, check with a professional tax specialist.
Do you get taxed for selling a business?
The short answer is yes. However, the amount of tax deducted will depend on numerous factors, including the province, business value, and the amount of time you have owned it.
How much tax will I pay on the sale of my business?
The following factors will play an important role in how much tax you pay on the sale of your business:
- The value of your business: The higher your businesss value, the more tax you can expect to pay.
- Age of the business: In Canada, new businesses are not likely to qualify for certain tax breaks. To benefit from certain business sale tax incentives like LCGE, the Canadian government requires that companies are active for a minimum of 24 months, apart from other eligiblity criteria.
- Your level of income: The more you make, the more you pay. Your personal tax bracket plays a big role when determining how much tax on a business sale needs to be paid. It can range from 15% to 33%, depending on the total income for the year.
How do I avoid Capital Gains Tax when selling my business?
On top of the suggestions mentioned above, here are some other methods to avoid Capital Gains Tax when selling a business in Canada:
- Sell your business to a holding company: If your business is owned through a holding company, you may avoid capital gains tax by selling the holding company. As opposed to paying capital gains tax on the assets, the holding company only gets taxed on the profits from the sale.
- Sell to an Employee Stock Ownership Plan (ESOP): This type of retirement plan allows employees to become owners of the company. If selling to an ESOP, limited company capital gains tax may be avoided altogether.
- Donate your business: Donating your business is a great way to avoid capital gains tax. Donating to a qualified charity deducts the business's fair market value from your income.
- Incorporate the business: Incorporating a business is another way to save tax on selling a business in Canada. Doing so allows you to defeat capital gains tax on the sale. Selling shares in a corporation is not considered capital gains by Canada Revenue Agency.
- Utilize a deferred sales agreement: A deferred sales agreement contract allows you to sell the business but hold off on the capital gains tax liability until a later date. Although this method does not exempt you from paying capital gains tax when selling a business, it gives you more time if you are concerned about tax liability.
Is there an exemption from capital gains taxes on the sale of a small business?
Yes. LCGE, or Lifetime Capital Gains Exception, is geared toward small businesses. To qualify, you have to meet specifc criteria. If these criteria are met, you can qualify for LCGE and not have to pay a capital gains tax on the first $971,190.
How are capital gains calculated when selling a business?
When selling a business in Canada, the business's adjusted cost base (ACB) is subtracted from the sale price. The adjusted cost base is the initial purchase price of the company plus any capital improvements that have been added over the years.
A capital gains tax calculator is an easy way to determine precisely how much you have to pay. For example, if you sell your business for $500,000 and the ACB is $200,000, your capital gains are $300,000. The tax on that $300,000 will be calculated based on your income and current capital gains tax rates.
Does putting my earnings in a money shelter help me avoid capital gains tax?
If you want to avoid capital gains tax when selling a business in Canada, putting your earnings in a tax shelter is a great option. It essentially protects your investments from taxes.
RRSP is one of the most popular ways to avoid or reduce capital gains tax. Profits made when contributing to a Registered Retirement Savings Plan will not be taxed. In addition, qualifying RRSP contributions can be used to reduce the amount of tax owed at the end of the year. However, if funds need to be withdrawn from the plan, you will be taxed at the full marginal rate.
TFSA is another option to avoid capital gains tax in Canada. Tax free saving accounts allow an individual to contribute a certain sum each year without being taxed. As of 2023, the sum is $6,500. You can withdraw the money from a TFSA without penalty at any time, but you cannot contribute more than the allotted amount each year.
Lastly, RESP is another alternative to avoid capital gains tax when selling a business. We all want our children to be financially prepared when they grow up. Investing in their education through a registered education savings plan is a great way to avoid capital gains tax and ensure they get the education they deserve.
When the money is taken out, it will be taxed. However, the tax rate will be less since most students have a lower income rate.
The bottom line: tax on selling a business
When selling a business in Canada, tax implications are one of the most important aspects to consider. Proper planning can reduce tax liabilities and increase the amount of money you pocket once the deal is done.
Getting professional advice from a certified tax advisor, appraising your business's value, cleaning up any financial loose ends, and marketing it correctly will ensure you get top dollar for your business.
Be sure to read our selling a business guide for comprehensive guidance on the selling process.
When you're ready, you can advertise your business for sale with us, and find the right buyer for your business.