How are you taxed when you sell a small business?

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I recently sold my company last year for $160,000 and purchased it for $90,000 in 1997. Can you please help me with the tax on this? I have called CRA many times and no one knows this simple process. —Peter

The types of taxes you owe when selling a small business

Sorry you have been having trouble getting an answer, Peter. I think one reason is the process may seem simple, but it is not necessarily straightforward. Selling a business has tax and legal implications. The tax implications can include GST/HST sales tax, payroll tax and other taxes. 

I will focus on the income tax implications of the sale. The tax treatment will vary depending upon whether your business was a sole proprietorship or a corporation. 

What you can sell as the owner of an unincorporated business and the tax implications

When a sole proprietor sells their business, they are selling the assets of their unincorporated business. Assets can include intangible items like goodwill or clients, as well as tangible items like inventory or machinery. You may sell some or all of the assets. 

The sale is generally taxable as a capital gain based on the difference between the proceeds and the cost of the assets, with personal tax ranging from 0% to 27% depending upon your other sources of income and your province of residence. 

If you have claimed depreciation on the assets, there may be a recapture with past depreciation (capital cost allowance) brought into income and generally taxable at rates ranging from 0% to 54% depending upon your income and province. 

When an incorporated business owner sells their business, the tax treatment depends upon whether it is an asset sale or a share sale, Peter. 

What about for the owner of an incorporated business?

When you sell the assets of a business, your corporation is selling assets to a purchaser, and you continue to own the corporation afterwards. You may sell some or all of the assets. 

The proceeds less the cost is generally taxable as a capital gain, with corporate tax in the 25% range payable on the income. If you have claimed depreciation on these assets, there may be a recapture with past depreciation (capital cost allowance) brought into corporate income and generally taxable at rates between about 10% and 30% depending upon the province and other factors.

The initial tax implications upon selling assets of an incorporated business are corporate tax implications, Peter. The shareholder then has personal tax payable to the extent they wish to withdraw money from the corporation afterwards. 

What is lifetime capital gains exemption?

When you sell the shares of a business, you are giving up ownership of the corporation. The sale of the shares may qualify for the lifetime capital gains exemption (LCGE). The LCGE allows a tax-free capital gain of up to $913,630 on the sale of qualified small business corporation shares. 

A small business corporation is defined as a Canadian-controlled private corporation in which all or most (90% or more) of the fair market value of its assets are used mainly in an active business carried on primarily in Canada by the corporation or by a related corporation; are shares or debts of connected corporations that were small business corporations; or are a combination of these two types of assets. 

According to the Canada Revenue Agency (CRA), the following conditions must be met for the sale to qualify:

• “at the time of sale, it was a share of the capital stock of a small business corporation, and it was owned by you, your spouse or common-law partner, or a partnership of which you were a member

• “throughout that part of the 24 months immediately before the share was disposed of, while the share was owned by you, a partnership of which you were a member, or a person related to you, it was a share of a Canadian-controlled private corporation and more than 50% of the fair market value of the assets of the corporation were:
  • “used mainly in an active business carried on primarily in Canada by the Canadian-controlled private corporation, or by a related corporation
  • “certain shares or debts of connected corporations
  • “or a combination of these two types of assets

• “and throughout the 24 months immediately before the share was disposed of, no one owned the share other than you, a partnership of which you were a member, or a person related to you”

It bears mentioning that a sole proprietor can transfer their sole proprietorship into a corporation on a tax deferred basis. So, a sole proprietor may be able to benefit from the lifetime capital gains exemption by restructuring their business, as well as some of the other potential benefits of incorporation. 

There are other complexities that may reduce your eligibility for a tax-free capital gain on the sale of your business if it was incorporated and you sold the shares, Peter. But hopefully all of the above information reinforces why there is no easy answer to the tax implications of the sale. There are a lot of considerations. 

Why the CRA doesn’t give tax advice

I think it bears mentioning that CRA does not generally give tax advice to taxpayers. They can provide general information, but even then, taxpayers should be very careful about relying on the accuracy of CRA’s answers. Professional advice can be beneficial, especially for a large transaction like the sale of a business, real estate, or other valuable asset. Proactive tax planning before a transaction instead of retroactive tax reporting afterwards may also help a taxpayer to save tax.

Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto, Ontario. He does not sell any financial products whatsoever.

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