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From a purely financial perspective, the maximum selling price is the obvious goal. However, of greater importance is the amount that the seller will actually pocket after the tax man takes his share.
Ideally the sale will be structured as an all cash offer, however more often than not there is other consideration provided by way of vendor financing and/or an equity stake in the purchaser. These are often desired by the purchaser to provide bridge financing, reduce risk and to align the goals of the vendor with that of their own.
A fixed price is most desired by the vendor but may give way to one partly dependent on the future earnings of the business (i.e. an earn-out clause) as that is really what the purchaser is buying.
One of the earliest and most significant decisions regarding the sale of the business will be whether it is structured as an asset or share sale (or a hybrid of the two). Both have their pros and cons from a business, legal and tax perspective with vendors normally favouring share sales and purchasers favouring asset sales.
Regardless of the breakdown of the consideration provided or whether the transaction is structured as a share or an asset sale, the Income Tax Act (the “Act”) contains numerous tips and traps to enhance the after tax proceeds and restrict them. That being said, the earlier a business owner plans for a future sale, the more tips that can be accessed and the fewer traps that may be applicable.
In terms of tax tips, the $750,000 lifetime capital gains exemption (“LCGE”) is number one when it comes to the sale of owner-managed businesses. The LCGE is one of the main tax reasons vendors prefer share sales over asset sales since it has the potential to reduce income taxes by as much as $170,000 for every individual shareholder. Even if the transaction is structured as an asset sale, the LCGE may still be taken advantage of prior to the sale. The goal in this case being to crystallize the tax free growth in the company shares to date in order to lessen future income taxes triggered on the deemed disposition of the shares at death. As you will read below, only shares in qualified small business corporations (“QSBC”) are eligible for the LCGE, so timing is crucial when taking advantage of this significant tax break.
Access to the LCGE depends on whether the corporation is a QSBC at the time of the disposition. The qualification is dependent on both a test of the assets of the company and the length of share ownership. Simply put, you or someone related to you must have owned the shares for at least 24 months (subject to a few exceptions). In the 24 months preceding the sale more than 50% of the company’s assets must have been used in an active business operating in Canada, with this threshold increasing to 90% at the moment of sale. Just prior to an asset sale the corporation may be considered a QSBC. When the transaction closes and the business assets are replaced with cash, the company is no longer a QSBC and access to the LCGE may be lost forever. This is why timing is everything and proper tax planning is crucial with any business sale, regardless of its form.
With share sales, pre-sale planning or restructuring is often required just prior to the sale to ensure that the 90% threshold is met by moving excess cash and/or passive assets to the individual shareholders or their holding companies. Depending on the specific situation, the planning may result in triggering some additional income tax early or hopefully, achieve additional income tax deferral.
Aside from the significant tax savings associated with utilizing the LCGE, the Act also offers a number of significant tax deferral opportunities.
When vendor financing is provided, part of the taxable gain may be spread out over multiple taxation years by accessing the capital gains reserve. For shares taken back in the purchasing company as partial consideration, the associated gain may be deferred until those shares are actually disposed of and cash is in hand. For proceeds to be received subject to an earn-out clause, the associated gain may be deferred until the actual proceeds become determinable.
Some tax tips are even more straightforward. With the last set of federal corporate income tax rate cuts being introduced in 2012, a simple push back of the closing date on an asset sale from the latter part of this year to the early part of next year may enhance the after tax proceeds. Staggering an asset sale over a taxation year-end may also enhance the after tax proceeds where the proceeds will be taxed in multiple years at the lower corporate tax rate on taxable income up to $500,000 in most provinces.
The bottom line is that the sale of a business is a significant and complicated transaction, where timely advice and planning is crucial to ensure business owners maximize the amount that actually hits their pockets. At MNP, we have professional advisors that specialize in everything related to the sale of owner-managed businesses from our Valuations and Appraisal Services team, to our Corporate Finance group that brings buyers and sellers together, Tax Specialists who provide the pre-sale tax planning all the way down to the Assurance Professionals who bring it all together. Contact your local MNP Tax advisor and we will put the right team together to ensure you extract the maximum value from the sale of your business.
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