Factor tax when selling a business

The tax rules associated with selling a business give even experts headaches.

Although each seller’s circumstances are unique, there are some general points to consider.

Shares benefit the seller

The main decision is usually whether to sell shares of the business or its assets; or, in some cases, a combination of both.

“In general, it’s an advantage for a vendor to sell the shares,” says Jim Murdoch, a partner in the Toronto office of Thorsteinssons LLP. “The opposite is generally true for the purchasers. They usually get a better deal out of buying the assets. But you can’t say that 100% of the time.”

A primary benefit of a shares transaction is the potential for each share seller to claim a capital gains tax exemption, especially if the shareholders are related.

“I’ve seen transactions where proper tax planning resulted in accessing six or eight capital gains exemptions for family members,” says Bryan Allendorf, regional tax leader in the Markham, Ont., office of MNP.

Of course, there are certain conditions. One is they must pay fair-market value for the shares. And they need to have held them for at least 24 months prior to sale (although there are a few exceptions).

Also, to be eligible for a capital gains exemption, 50% or more of the firm’s assets have to relate to its active business for two years leading up to the sale.

“Sellers are forced to take out their redundant assets not used in the active business,” says says James Blackwell, managing partner for BDO Canada in Orangeville, Ontario. The number increases to 90% on the day of the sale.

Assets benefit the buyer

A seller is likely to get a higher offer in an asset sale. Why? Purchasers prefer to buy a company’s assets because they can write them off. When they purchase shares, they’re actually “buying the history of the corporation, including all its legal and employee issues,” says Murdoch.

Before considering this option, however, be aware the sale of assets could result in a considerable tax hit due to recaptured depreciation.

A good solution is to negotiate a transaction that brings sellers a certain amount of the sale price in the first year and spreads the rest over a multi-year period. “That reduces how much capital gains they have to use each year and reduces the minimum tax as well,” says Blair Corkum, founder of Corkum & Arsenault in Charlottetown, P.E.I.

Combined benefits

Some sellers opt for a combination share and asset sale.

A Winnipeg entrepreneur in his mid-50s sold off his Toronto professional services firm several years ago for a tidy sum. “I sold it in three parts,” he says, “two of which were asset sales, such as my client list, and a third that was a share sale.”

The share sale occurred because the suitor was buying a lucrative portion of the business that operated out of a shopping mall. “She didn’t want to have to go to the landlord and ask for permission to transfer the lease in case he rejected her,” he says. “She needed control of the company to avoid that.”

Structuring a share or asset sale is no simple matter. Sellers must invest time to figure out the right transactional structure. “They don’t want to get it wrong, because a couple of percentage points in the tax rate can make a huge difference in how much money they can get,” says Jason Safar, a tax partner with PricewaterhouseCoopers in Hamilton, Ontario.

You need to give your tax advisor as much time as possible to help plan the deal.

“I can deal with a week but I like a couple of years,” he says. “Let’s say my base point is the capital gains rate and I’m starting with an effective rate, depending on the province, of some 20%. If you give me a couple of years, maybe I can get that rate down to 5% or 10%.”