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Earn Tax Exemptions on the Sale of your Business by Planning Ahead

So, you’re interested in saving money?  What about protecting the money you already have? It can be tricky trying to do both if you’re planning on selling your business. Fortunately, planning ahead today can help you protect up to half a million dollars two years from now from being taxed.

How can this be? Simple. All business owners may qualify to have the first $750,000 from the sale of their business tax-free. This is accomplished by an exemption to the capital gains tax, which applies to the first $750,000, earned from the sale of a Canadian small business corporation. You have to report the capital gain and the offsetting exemption in the year that you sell your company’s shares.  Most importantly, you and your corporation must meet certain criteria to be eligible for the exemption.

Here’s how: first, share ownership. Your company’s shares cannot have been owned by anyone other than you or an immediate relative in the 24 months preceding the sale. If shares are exchanged as a result of a merger, this is considered as substituted shares, so they still qualify.

The second requirement, throughout the 24 months preceding the sale of the shares, more than 50% of the fair market value of your company’s assets must come from any combination of active business assets and shares or debts of connected small business corporations. Examples of active business assets are items such as capital assets, inventory or accounts receivable; all of which are used to generic active income for the company. An example of a connected corporation is one in which your company owns at least 10% or a corporation that is controlled by you or a related party.

The third requirement is fair market value at the time of the sale. At least 90% of the fair market value of your company’s assets must come from any combination of active business assets and shares or debts of connected small business corporations.

The Rules for Holding Companies

In the event that a parent holding company is being sold, both the parent company and its subsidiary must each meet the 50% asset test described above. Additionally at all times in the 24-month holding period, one of either company must meet the 90% asset test. What does this all mean? Here’s an example. If ABC Holdings is the parent company of ABC Elevator, in that case both ABC Holdings and ABC Elevator must each meet the 50% fair market value test in the 24 months preceding the sale and one of the corporations must meet the 90% test.

Helping Your Company Meet the Requirements

There are some easy steps that can be taken, such as removing non-active business assets, such as shareholder loans etc…from your company so that the percentage of active business increases. This process is called purifying your company. Needless to say, such moves need to be taken well in advance of selling in order to meet the 50% level that is required for 24 months.

You can also purify your company immediately prior to the sale in order to meet the 90% test, which would unfortunately, generally result in taxes for you or your company.

Assessing Fair Market Value

It is important to note that both the 50% and 90% tests are based on the fair market value of your company’s assets. Therefore, it may be necessary for you to obtain an accurate fair market evaluation. Good starting points for this are your company’s financial statements as they represent the net book value of your company’s assets.  However, adjustments for differences between book value and market value need to be analyzed in order to get to the fair market value of your company.

Also, a value should be assigned to your company’s goodwill, which is likely not on your company’s books. The value of goodwill can sometimes be difficult to estimate since goodwill is an intangible item. Example? How much is your company’s name and reputation worth? In any event, where an amount is assigned to goodwill, someone must be willing to pay for it. There are different ways to determine the value of your business, so it is always best to retain the services of a Certified Business Valuator.

Constant vigilance is paramount in ensuring that your company’s assets over time do not drop below the 50% level in the 24 month required period. This will ensure that when you are ready to sell, you will meet the requirement for the capital gains exemption and ensure your first $750,000 remains tax-free!

Cara Orzech is with Shimmerman Penn LLP. She specializes in strategic planning and compliance for personal and corporate taxation.

Shimmerman Penn LLP is a vibrant Toronto firm of Chartered Accountants and Business Advisors, established for over 25 years.  Their clients are wide ranging, including – owner-managed companies, professional partnerships, small to mid-sized public companies, and not-for-profit organizations, to name but a few.  Shimmerman Penn is a member firm of Nexia International, a worldwide network of independent accounting and consulting firms with over 300 offices in 98 countries.
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