You might be selling your business because you’re ready to retire, because you want to pass it down to the next generation, or perhaps because you have just moved on and you want to pursue different business opportunities. There are some really key items that you’re going to want to start thinking about.
- Are you structuring your sale through assets or shares?
So goes the old saying, acquire assets, sell shares, with the notion being that it is somewhat more tax beneficial to purchase shares and slightly more tax advantageous for the seller to sell their shares. On the asset side, the rationale for this was that there used to be certain tax factors connected with a company’s goodwill that made it highly favorable for a purchaser to buy those assets; those advantages are no longer as important as they once were.
However, on the selling of shares, this is still very much the case. Because in Canada, there is a provision known as the lifetime capital gains exemption, which allows you to deduct up to $850,000 of the capital gain on the sale of your business. That is the price difference between the adjusted cost base, or the original purchase price of the firm, which is frequently minimal if you founded it yourself, and the real exit price.
If you were able to take full advantage of the lifetime capital gains exemption on the sale of your company, and your company was worth $850,000. In theory, you’d pay no taxes on the sale of it. So that’s the first thing you’ll want to think about when deciding whether to structure the transaction as an asset sale or a share sale. Another factor to consider is that an asset sale tends to be a little bit faster on the transaction side. As a result, there may be less due diligence required. Because when a buyer buys your company’s stock, they also inherit every single obligation that occurs there.
As a result, any obligations that may exist inside your firm will be passed to the buyer. So the buyer is going to be doing more due diligence, it’s going to take longer for them to get through that phase. And the associated fees for the lawyers, the accountants involved will likely be higher.
2) Are your shares eligible for the Lifetime Capital Gains Exemption?
There’s a number of steps that need to be taken to ensure that they are eligible. They need to be considered what are called Qualified Small Business Corporation shares.
So QSBC shares are;
a) They need to be shares in a company that is a Canadian Controlled private company (CCPC).
Essentially, this means that it is controlled by Canadian residents.
b) 90% of the assets inside of your company are active.
Active means in the eyes of the CRA is that they are actually being used to fund the operation of the business.
And this includes cash that needs to be used for things like;
– operating expenses,
– paying staff,
– legal accounting fees
All sorts of normal things that go into making your business operational.
So, if you have surplus cash in your firm that isn’t being used, or if you have other assets, such as real estate, languishing in your functioning company, you may fall short of the 90 percent requirement.
3) Shares need to be held by you or a relative of you for at least the preceding 24 months.
Shares need to be held by you or a relative of you for at least the preceding 24 months.
There’s a considerable amount of thought that should be put into what is the appropriate corporate structure for yourself.
So you may have already set up or been considering setting up a structure that looks a little bit like this;
– 100% of the shares are held by a holding company and then beneath that holding company is yourself, perhaps another business partner or family members who control that holding company.
So this can be a very beneficial structure in the sense that you will be insulating yourself from a fair amount of obligation by being able to transfer cash from the operating business to the holding company via tax-free dividends. And, as a result, the running business is not exposed if a lawsuit is launched against it, which is favorable from a liability standpoint.
However, this creates some tax difficulties. Individuals are eligible for the Lifetime Capital Gains Exemption.
A holding corporation is not included in the definition of an individual.
There are ways for holding companies to take advantage of for somebody who has an operating company holding company structure to take advantage of the lifetime capital gains exemption, but the tests there are more nuanced, they’re a little bit more complex, and they’re harder to satisfy.
4) Inserting a Family Trust
If you want to take advantage of that exemption, one option is to set up what is known as a Family Trust.
Rather than the holding company owning the shares, the operating business would have a family trust own the shares in that operational company.
Beneficiaries might include you, a holding business, or other persons who would receive dividends from the family trust. That can be a method to take advantage of the lifetime capital gains exemption, avoid the holding company issue, and shield oneself from liability.
So, if you’re wondering if it’ll be beneficial for you to take advantage of that exemption, a family trust is a great option. Not all businesses are destined to be sold; certain firms, such as professional corporations or corporations or companies that are too closely linked with the owner-operator himself, are extremely difficult to sell. As a result, this will not be applicable to every single business owner. Of course, many enterprises simply do not reach the point where they can be sold.
Other pieces about the family trust that you’re gonna want to be aware of are that a family trust will also enable you to control the flow of distributions outside of the company. So once the family trust subscribes for shares in the operating company, then the distributions can be made to the different beneficiaries, generally per the trustees’ discretion. So that means that there’s more control, there’s more flexibility over how that occurs.
There are also some opportunities for income splitting, so income splitting in Canada has largely been dispensed with, by virtue of the TOSI, or tax on split income rules that came into effect in 2017. However, there are certain limited opportunities through what’s called the prescribed rate loan strategy, something that to explore in more depth in another video. But in any case, so the final item and perhaps the most exciting item of that a family trust will offer is the multiplication of the lifetime gains capital gains exemption. So if you have beneficiaries who qualify and are against certain important qualifications that need to be met, those beneficiaries can actually shelter the proceeds of the sale of your company. And each beneficiary can make use of his or her lifetime capital gains exemption, so you can potentially multiply instead of having $850,000 of exemption, you could multiply that by a factor of four, perhaps even more.
So, when it comes to selling your firm, they are some of the factors you’ll want to think about at a high level in terms of taxation and responsibility. For most company owners, selling a business is a highly complicated item format. And it’s something you’ll want to surround yourself with good counsel for.
So I encourage you to start thinking early, to reach out to do your research, and to surround yourself with good people who can help you get across the finish line. Hope you have a great day and feel free to reach out at 604 283 8622 or send an email to firstname.lastname@example.org.