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Tax considerations for the purchase or sale of a business


As a business owner, you may have thought about selling your company as part of your long-term financial strategy. A range of motivators, such as retirement planning, new entrepreneurial opportunities, or uncertain market challenges may influence your plans. Despite continued economic uncertainty and changes to interest rates, investors are still buying and selling businesses.  Regardless of the reason, once a sale has become the chosen exit strategy, tax considerations should be at the forefront of any seller's mind.

There are two common methods to sell an incorporated business in Canada ─ the first is the sale of shares of the corporation, while the second is the sale of business assets owned by the corporation. Both share and asset sales result in a number of differing short- and long-term tax implications. But there is also a third less common option that sellers often overlook: the hybrid sale, which combines elements of both a share and an asset sale to balance the tax risks and costs. 

Given that each of these options have different risks, benefits, and tax considerations for both buyer and seller, each method (share, asset, or hybrid) should be carefully weighed before moving forward with a sale or purchase.

Share sale

In a share sale, the current owner sells the shares of the company to a purchaser. This option is often the preferred choice of sellers because of the favourable tax implications.

If an individual sells shares of a company, the proceeds—in excess of the adjusted cost base of the shares, and certain expenses incurred to sell the shares—results in a capital gain, of which only 50% is taxable. Additionally, if these shares represent qualified small business corporation (QSBC) shares, the seller may be able to claim the lifetime capital gains exemption to shelter all or part of the capital gain from tax. This lifetime capital gains exemption for QSBC shares is $971,190 in 2023 and is only available to individuals who are Canadian residents. There is also a $1,000,000 lifetime capital gains exemption in respect of qualified farm or fishing property.

To qualify as QSBC shares, your Canadian-controlled private corporation must, among other things, meet all three of the following conditions:

  • At the time of sale, 90% or more of the fair market value of the corporation's assets must be used principally in an active business carried on primarily in Canada (either by the corporation or by a related corporation), be shares or debt in a connected small business corporation, or be a combination of both.
  • In the 24-month period immediately preceding the sale, more than 50% of the fair market value of the corporation's assets must have been used principally in an active business carried on primarily in Canada, invested in shares or debt of a qualifying connected corporation, or a combination of both.
  • The shares must not have been owned by anyone other than the individual seller or a person or partnership related to the seller during the 24-month period immediately preceding the sale.

If the shares being sold are owned by a holding company rather than an individual, the capital gains exemption will not be available as only individual sellers (and not corporate sellers) can claim the lifetime capital gains exemption.

While many buyers prefer to purchase business assets over shares, there are tax reasons that could motivate a purchaser to prefer a share purchase, most notably acquiring tax attributes of the corporation being sold, such as non-capital losses, and investment tax credit carry-forwards. However, the availability of such attributes requires, amongst other things, that post-acquisition, the same purchased business or a similar business be carried on, with a reasonable expectation of profit. 

As a consequence of a share purchase, the purchaser also inherits any outstanding liabilities of the corporation, including tax and legal liabilities, resulting in a higher level of risk to the buyer. Buyers are encouraged to conduct a rigorous due diligence process to ensure that their purchase doesn't come with unexpected risks. In addition, as part of the negotiation process, buyers should look to incorporate protective clauses for both tax and legal liabilities into the definitive purchase and sale agreement.

Finally, from an economic perspective it is important to keep in mind that a share sale generally results in a lower purchase price than would an asset sale for the same business, given, amongst other things, the greater level of risk inherited by the buyer. 

Asset sale

In an asset sale, the buyer acquires ownership of business assets including, but not limited to, accounts receivable, inventory, equipment, and the business’s goodwill. Buyers tend to prefer this method of purchase, as it allows them to select which business assets to buy and, since liabilities of the business are not generally acquired as part of the asset sale process, it allows the buyer to limit their risk exposure.

Another advantage to buyers of a business asset purchase is the associated increase to market value in the tax cost of the acquired assets. This increased tax cost minimizes the buyer’s tax going forward, as it generally results in a greater tax depreciation which may be used to reduce the buyer’s future taxable income. However, non-income tax considerations such as sales tax and/or land transfer tax must also be carefully reviewed to determine if they apply in a business asset purchase.

From a seller's perspective, a business asset sale is generally less appealing because the seller faces two levels of tax upon an asset sale: first, tax paid by the corporation on the sale of assets (including recaptured depreciation and the potential for capital gains on the business asset sold) and second, tax paid by the owner when the net proceeds are distributed by the corporation to the shareholder.

Net proceeds are generally distributed to individual shareholders as ordinary dividends which are subject to tax at the shareholders’ applicable marginal tax rate. However, where a capital gain was triggered within the distributing corporation, the corporation may be able to pay a capital dividend on the non-taxable portion of capital gains realized on the sale of assets. This capital dividend has the benefit of being tax-free to an individual recipient.

From a negotiation perspective, the purchase price allocation (PPA) embedded in the asset purchase agreement will be of particular importance to both buyers and sellers. The PPA apportions the seller’s proceeds across the business assets sold, which drives the vendor corporation’s taxes payable and after-tax proceeds. Similarly, PPA apportions the buyer’s purchase price across the assets acquired, which drives the tax cost, and future tax depreciation deduction available to the buyer. 

Generally, buyers are motivated to allocate more of the purchase price to inventory or depreciable property to minimize their future taxable income. In contrast, sellers often seek to minimize the corporation’s taxable income triggered by the business asset sale by allocating purchase price to internally developed assets (like goodwill) with nominal or low tax cost. As such, the PPA is often a key negotiating point in business asset sales and should be clearly documented to ensure consistent tax reporting by both the buyer and seller. The buyer and seller should be mindful that the documented PPA is reasonable in all circumstances as CRA may put forward a challenge.

Practically speaking, given the tax and risk advantages to a buyer associated with a business asset sale, and the fact that a seller forgoes their right to the lifetime capital gains exemption that’s otherwise available upon a share sale, this generally results in a higher purchase, as the parties attempt to make the sellers whole on an after-tax perspective.

Hybrid sales

Less common than a share or asset sale (given their additional complexity), a hybrid sale aims to combine a sale of both shares and specific business assets, with the overall goal of creating an acceptable balance of benefits and tax costs to buyer and seller alike.

There are many ways to structure a hybrid sale, with the best structuring option depending on the specific facts and circumstances, as well as the needs of both buyer and seller. This structuring is further complicated by recent developments in tax case law with regards to the underlying assets of the shares being sold as part of a hybrid deal. As such, careful consideration must be taken from a tax perspective when structuring such a sale.

Selling your business to the next generation (intergenerational business transfers)

In 2021, Bill C-208 legislation was enacted to make it easier for business owners to sell the shares of their corporation to the next generation. Prior to this legislation, it was generally more favorable from a tax perspective to sell to an arm’s length third party than to sell to one’s children due to the application of rules in the Income Tax Act affecting related party transfers of shares. 

As a result of Bill C-208 and amendments to the Income Tax Act, it is now easier to sell the shares of one’s business to a child or grandchild and claim the lifetime capital gains exemption on a portion of the capital gain realized, provided the relevant criteria have been met. Recently announced amendments to the initial legislation included in Bill C-208, which are effective after January 1, 2024, have modified previously enacted legislation. 

In general, the legislation includes provisions stipulating the following requirements:

  • that the shares being sold are shares of a QSBC or shares of a family farm or fishing corporation;
  • that the parents transfer and transition their ownership and managerial involvement in the corporation over a period of time;
  • that the children or grandchildren purchasing the shares of the corporation are at least 18 years of age and that they obtain both legal and factual control of the corporation;
  • that the children or grandchildren taking over the business are actively involved in the management of the corporation subsequent to the transfer of ownership for specified periods of time; and
  • that all parties to the transaction to sign a joint election that will be filed with the CRA in respect of the business transfer.

As with all related party transfers, a proper valuation supporting the transfer amount is recommended. 

In addition to the requirements of Bill C-208, business owners should ensure the sale of their business to the next generation fits within their overall estate planning objectives. Careful consideration needs to be given to one’s overall financial plan before implementing a significant transaction such as selling a business to one’s children. 

Selling your business using an Employee Ownership Trust

New amendments to the Income Tax Act, effective January 1, 2024, will provide business owners with an additional option of selling the shares of their corporation to the existing employees of the business over time, using an Employee Ownership Trust. 

Under the revised legislation, an Employee Ownership Trust will be required to comply with a complex set of rules, including the establishment of a trust that is subject to various control, governance, and other criteria. In addition, only shares of a qualifying business (as defined within the legislation) will be eligible for this type of business transition plan. 

Whether the amendments will create a business transition plan that works in accordance with your objectives will require careful consideration from a tax perspective.

Other considerations

There are many factors to consider when selecting the right method of sale for your business, not least of which is selling price. Prior to moving forward with a sale, consider calculating and comparing the after-tax result of selling company shares versus selling company assets. Not only will this analysis assist in understanding the ramifications of each choice, it also provides you with additional information that may assist with price negotiations.

If you are considering a sale of your business within the next few years, you may also wish to conduct a detailed company review to identify obstacles that could influence either the sale or the tax resulting from that sale. If any potential issues are found, there may be actions you can take now, such as a reorganization or restructuring shareholdings, that will help achieve an optimal tax result in the future.

You should be mindful that the comments above focus on the tax implications to an owner-manager. Where there are additional shareholders involved, such as family members, consideration will need to be given to the tax on split income (TOSI) rules. Where the TOSI rules apply, amounts received by family members may be considered to be split income, with such amounts subject to tax at the highest marginal rate and restrictions on personal tax credits.

The TOSI rules are very complex and are beyond the scope of this article. Owners of private corporations with more than one shareholder, those who are considering a hybrid sale, or those who plan to sell their business to a child or grandchild are especially recommended to seek external guidance to mitigate risk areas and ensure that the business and sale are structured to minimize taxes and optimize after-tax proceeds.

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When it comes time to sell your business, planning and foresight will help you achieve your goals and reduce your overall tax burden. Our Tax and Mergers & Acquisitions Services teams support owners when selling their business. We provide strategic advice before, during, and after the transaction process.

The information in this publication is current as of September 1, 2023.

This publication has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The publication cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact BDO Canada LLP to discuss these matters in the context of your particular circumstances. BDO Canada LLP, its partners, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information in this publication or for any decision based on it.

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