Earn Tax Exemptions on the Sale of your Business by
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
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%
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.