This article focuses on Canadian Controlled Private Corporations that are considered small businesses. These are corporations that participate in active businesses (not holding companies that only hold investments) and are controlled by Canadian residents.

The information presented has limited relevance to sole proprietorships or partnerships. Today’s article is going to discuss selling assets of a corporation.

We’ll have a look at the impacts of an asset sale versus a share sale, and discuss when selling the assets might be required. We’ll also look at some of the implications of failing to plan your exit.

Exit Planning

Whether we like it or not, small business owners need to go through the exercise of succession planning. 

There are some wonderful tax incentives available that can reward small business owners for the blood, sweat and tears they’ve invested (as well as the risks they took, the sacrifices they made, the jobs they created and the contributions to the economy they made by starting a small business.)

Failure to plan can result in non-optimal tax outcomes. In other words, it can result in paying more tax than the shareholder needs to pay.

When a shareholder dies, the shares need to transition to their inheritors. Ideally, this has been planned out – and perhaps the share transfer even occurred – while the shareholder was alive.  

Failing to have a succession plan results in paying more tax than necessary and adding undue burdens of stress on your executor and inheritors.  If you don’t plan well, your family may be left with little or nothing to show after your lifetime of hard work.

Asset vs Share Sale

In Canada, entrepreneurs have some tax incentives to build and sell their businesses. However, these incentives only relate to the sale of the shares of the corporation. 

They include:

1. The Lifetime Capital Gains Exemption: Up to $1.25 Million is exempt from capital gains tax if the shareholder sells their Qualifying Small Business Corporation shares. (This also applies to fishing and farming properties, but we aren’t discussing that in this article.)
2. The Entrepreneur’s Incentive: This program is not fully rolled-out and may not come to fruition depending on the upcoming Canadian federal election. If it does become law, it will allow for the next $2 Million of capital gains to be included into capital gain tax calculations at a reduced rate of 33%. It is important to note that there are several requirements to be eligible for this program and you need to work with a tax professional to plan this out.
3. The Employee Ownership Trust: This is new to Canada, first being established in 2023.  It provides significant incentives for owners of small businesses to sell the shares of the business to a trust, of which, the employees of the business are the beneficiaries. It provides opportunities for the trust to buy the shares of the company with the company’s own funds through a loan – meaning that the employees do not need to come up with money to make the purchase. This is a far more complex structure and professional advice is definitely required, however, it comes with a possible $10 Million capital gain exemption.

As you can see from these programs, there are a lot of incentives to selling the shares of a corporation over selling the assets. 

Regardless of which method you choose, capital gains tax will play an important role in understanding the underlying tax consequences.

Qualifying Small Business Corporation Shares

There are several conditions that must be met in order for the shares being sold to be considered “Qualifying Small Business Corporation Shares.”

1. You owned the shares when they were sold.
2. For the 24 months prior to the share sale, the corporation was a CCPC (Canadian Controlled Private Corporation) with more than 50% of the assets used in active business, not held in investments or as idle cash.
3. For the past 24 months, nobody else owned the shares sold.

Note that for the purposes of this article, this is a bit of an oversimplification. There are some other possibilities and requirements for shares to be considered Qualifying.

Capital Gains Tax

Capital gains is the difference between the price for which the asset was sold minus the adjusted cost base paid for it originally. The adjusted cost base is the price originally paid for the asset plus any closing costs. 

If the asset was depreciated, the net book value might be lower than the adjusted cost base. In this case, the capital gain would be the difference between the price received and the net book value of the asset. 

If you sell an asset for less than its adjusted cost base or net book value, this constitutes a capital loss. Capital losses can be carried back up to three years, or can be carried forward, to offset capital gains.

Some personal examples of items that regularly generate capital gains include secondary real estate (such as cottages or rental properties), securities (such as stocks, bonds, currencies, or other instruments), other passive investments (such as artwork or collectibles), or other assets (such as equipment, furniture, inventory and the overall value of a business.) 

For most corporations, the assets include fixed assets, such as equipment, and intangible assets, such as systems, processes, trade secrets, patents, and other intellectual property.

When a corporation sells assets, 50% of the Capital Gain is included in its income, and then the corporation is taxed at its regular rate. Note that depending on where the corporation is located, tax rates can vary. The important takeaway is 50% of the Capital Gain is included in income.

If the shares of the corporation are sold, the shareholder includes 50% of the Capital Gain in their income, and then it is taxed at their personal tax rate. When you factor in the possible exemptions, it becomes obvious why a shareholder would prefer a share sale.

However, this isn’t always easy to do…

The Buyer’s Perspective

When considering the acquisition of a business, the purchase of the shares brings along ownership of the business. This brings along responsibility for all the past, present and future actions of the corporation – including any hidden liabilities based on past actions.

For instance, if a corporation is sued for something that happened prior to the change in ownership, the corporation is still responsible for it. The former shareholders will not be affected, but the shareholders who bought the corporation may see their investment damaged.

There is less risk in acquiring the assets of a corporation instead of buying its shares.

(Note that most risk can be mitigated through appropriate systems, policies, procedures and documentation, and, of course, insurance.)

When do you Sell the Assets of the Corporation?

There are situations where an asset sale is necessary or preferred.

A Share Sale is not Possible

This usually happens when there is some kind of entanglement or planning issue that does not allow for the shares to be sold. This could be for a variety of reasons ranging from regulation to corporate by-laws to contracts and other agreements the corporation or its ownership made.

This might also happen if the corporation owns specific assets that cannot be transferred due to agreements related to those assets.  For instance, if the corporation owns a whole life insurance policy on the original shareholder who is the owner/operator of the business, this cannot be transferred to the new shareholders.

Risk Appetite

Another situation where a share sale is not possible is when it’s beyond the risk appetite of the buyer. In other words, the buyer absolutely refuses to assume any liability for the past actions of the corporation.

When there is only one buyer, this may mean that the shareholders of the corporation may have to settle for an asset sale.  This emphasizes the importance of having a larger pool of qualified buyers so you have options.

Note on Pricing

Since buying the assets brings less liability than buying the shares of a business, sometimes, a higher price can be offered. When determining the impact of this higher price, it’s important to factor in the tax implications. 

More money up front might mean less for the shareholders in the end. Be sure to speak with a tax professional if you’re transitioning your business. It’s important to plan ahead and take advantage of the tax measures you’re eligible for.

Only a Segment is Being Sold

If the business needs or wants to continue on an ongoing basis, but sell a segment of the business, an asset sale is required.

In this scenario, the corporation would sell the assets it wishes to divest itself from and then have to pay capital gains tax on the difference between the book value of the assets and the price received for them.

Plan, Plan, Plan

The key takeaway from this article should be that you need to plan your exit. Start well ahead of time so you can mitigate your overall tax liability and ensure you can take advantage of the tax incentives in place for entrepreneurs.

Planning and executing your exit properly could mean saving literally millions of dollars in taxes.  

It could make all the difference for your loved ones.