Saving Capital Gains Tax
The Canadian government provides private companies with a huge tax incentive that should always be considered when selling a private company.
Shareholders can enjoy a capital gains exemption on the sale of shares of a “qualified small business corporation”. For 2014, the lifetime exemption is $800,000 per person. This represents a cash savings of about $156,000 in Alberta on a share sale, and may be a savings of over $200,000 as compared to an asset sale.
The tax savings is even more dramatic if the corporation has a value of higher than $800,000 and has several shareholders, or if the capital gains exemption can be multiplied with other family members through the use of a discretionary family trust.
Unfortunately, the capital gains exemption is often not available because the corporate structure does not allow for it, even though the business owner relied on sound legal advice at the time the structure was set up. In addition, if the business has certain types of assets, the shares of the corporation may not qualify for the exemption.
Assets as common as inter-corporate receivables can effectively eradicate this valuable tax incentive.
While the capital gains exemption is a generous concession provided by the government, the rules for qualifying are tremendously complex, and it is all too easy to fall offside. Prudent business owners seek advice from a tax lawyer or tax accountant at least 2 years before a sale to implement any corporate reorganizations that may be required to make the capital gains exemption available.
Another reason the capital gains exemption may not be available is if the transaction is an asset sale as opposed to a share sale. Buyers often prefer to buy assets to take advantage of tax pools that may be available and to avoid hidden liabilities.
The “asset versus share sale” decision should be discussed at an early part of the negotiation, with the involvement of a tax lawyer.
For example, suppose a business is valued at $2 million. The sellers may pay tax of $300,000 on an asset sale, for example, but not pay any tax at all on a properly structured share sale. Clearly, this is a substantial amount of money, and should play into the negotiation of the purchase price. Alternatively, a transaction can often be structured to allow the seller to obtain the capital gains exemption through a share sale while providing the buyer with the benefit of future tax deductions in respect of assets.
The capital gains exemption is one of the more important aspects of tax planning for shareholders of private companies. Consulting with a tax advisor at the earliest possible stage is a wise investment.
Invitation for Discussion:
If you would like to discuss the capital gains exemption or any tax matter, please do not hesitate to contact one of the lawyers in the Tax & Estate Planning group at Shea Nerland LLP.
Note that the foregoing is for general discussion purposes only and should not be construed as legal advice to any one person or company. If the issues discussed herein affect you or your company, you are encouraged to seek proper legal advice.
 This assumes, among other things, the capital gain would be subject to the top marginal tax rate of 39% and that alternative minimum tax does not apply. Tax on an asset sale will depend on variety of factors, including the tax attributes of the corporation and whether sale proceeds are paid out to the individual shareholder.
 A discretionary family trust is a common structuring device for shareholders of private companies and will be discussed in another blog.
 See note 1 above.
 These types of “hybrid sales” require the acquiescence of both parties, in addition to competent tax advice.