Disclaimer: Business owners may not be able to eliminate all taxes when selling a business. This article focuses on practical, lawful strategies to help reduce or manage tax exposure while staying fully compliant with Canadian tax rules.
So you want to avoid paying taxes when selling your business. While you may want to ignore this expense entirely, don’t. You will receive a hefty fine, especially without a proper legal structure.
But can one legally avoid these taxes?
The short answer is that you cannot completely avoid all taxes in Canada after selling your business. But with smart planning and with different tax maneuvers, such as the Lifetime Capital Gains Exemption (LCGE) and additional estate planning, you can legitimately minimize your taxes.
In this blog, we will explore how business sales are taxed in Canada, unpack the LCGE, outline various legal tax minimization techniques, and address some misconceptions about tax avoidance.
Let’s get started.
TL;DR: How to Avoid Paying Taxes When Selling a Business
While taxes can’t be completely avoided, there are four practical strategies to help you minimize them:
- Use the Lifetime Capital Gains Exemption.
- Sell the business as a share sale.
- Hold shares through a family trust.
- Purify your business.
How Business Sales Are Taxed in Canada
If you’re planning to sell your business in Canada, you will either structure it as an asset or a share sale.
Both have different tax implications, so let’s discuss them:
Asset Sale
For asset sales, you can sell your business’s assets, whether tangible or intangible, like real estate or your trademark name. The resulting income is taxed before distributing the proceeds to your shareholders.
Double taxation is a primary issue with this method, as you must pay tax on capital gains when you sell your assets.
The after-tax proceeds are then distributed to your shareholders as dividends, which are typically taxed again at a personal level, minimizing your overall returns.
Asset recapture is another factor to consider when calculating taxes on depreciating assets, such as computers and other machinery. If you sell a depreciating asset at a profit, you must recapture and include it as part of your fully taxable business income.
For example, let’s say you purchased a machine for $150,000, it depreciated by $30,000, and you sold it for $180,000. The $30,000 is treated as Capital Cost Allowance (CCA) recapture and must be taxed as part of your business income.
Another drawback is that this method allows buyers to cherry-pick assets, leaving sellers with unwanted liabilities, such as debts and lawsuits.
Share Sale
Instead of selling your business in parts, as seen in the asset share, you can sell your ownership shares. The company remains intact because the buyer acquires your assets and liabilities.
Here is where the seller wins from a tax perspective. If your business’s shares qualify for the Small Business Corporation Shares (QSBCs), you may claim the LCGE on the resulting capital gain, reducing your taxes on the sale.
Nevertheless, finding a buyer may be difficult because they must assume your potential liabilities, including historical taxes and legal liabilities. Therefore, they may ask you to reduce your price or negotiate it to alleviate some of the inherited liabilities.
Asset Sale Vs. Share Sale
Here is a side-by-side comparison of asset and share sales:
| Description | Asset Sale | Share Sale |
| Tax Impact | Double taxation: Seller pays tax after the sale. Shareholder dividends are then taxed individually. | One taxation after the sale. |
| Tax Exemptions | Not available | Exemption is available if the seller qualifies for the LCGE. |
| Buyer Preference | Buyers prefer this because they can cherry-pick the assets. | Not favorable to buyers because they purchase the whole business (assets and liabilities). |
| Seller Preference | Not favorable to sellers due to double taxation. | Favorable to sellers since they can sell the business as a unit. Sellers may also qualify for a tax exemption, reducing their tax liability. |
| Business Flexibility | Sellers are allowed to keep their business and repurpose it. | Buyer assumes complete ownership of the business. |
| Depreciation Recapture | Buyer assumes complete ownership of the business. | Not applicable |
What Is Capital Gains Tax?
Capital gains tax is the income tax you pay if you sell an asset at a higher price than its original purchase price. The profit you get is your capital gain.
For example, if you bought an asset three years ago and sold it at a $1,000 profit, that is your capital gain and must be taxed.
So, what happens when you get a loss? This is called a capital gains loss, which arises when you sell an asset or stock at a price below its original purchase price. From a tax perspective, you can use your capital loss to offset the capital gains tax you owe.
Capital Gains Tax Rate in Canada
Canada uses a 50% capital gains inclusion rate to determine how much of your gain is added to your taxable income for all capital gains. For example, if your capital gains for the year are $200,000, 50% of this amount is added to your taxable income and taxed at the marginal rate.
However, the government has now announced an increase from one-half to two-thirds for capital gains over $250,000.
The Lifetime Capital Gains Exemption Explained
The Lifetime Capital Gains Exemption (LCGE) allows you to shield up to $1.25 million in capital gains realized on the sale of Qualified Small Business Corporation Shares (QSBCS). This exemption minimizes your tax liability when selling your ownership shares.
It’s important to note that the LCGE is a cumulative lifetime limit, meaning you can use it until you reach the maximum limit.
The eligibility criteria include:
- Residency: The Seller must be a Canadian resident for the entire year in which they require the exemption.
- Ownership Timeline: You must have owned your business shares for at least 24 months before selling them.
- Active Business Test: More than 50% of your shares must have been used in an active business in Canada within the 24-month timeline. This means that the majority of the assets and the business are active and in Canada.
Common Mistakes Sellers Make that Disqualify Them from LCGE
While it may seem straightforward, many people miss out on this exemption because they don’t know the eligibility criteria. Others are unaware of this exemption and therefore don’t apply it, even though they qualify.
Here are some of the mistakes sellers make:
- Failing the Active Business Test: The active business test requires owners to use more than 50% of their assets to run the business. The main problem is that some sellers have numerous passive assets that disqualify them from LCGE.
- Not Planning Early: Most people wait until the last minute to conduct tax and estate planning, or rush the sales process. This disqualifies them from LCGE, especially if they have owned the shares for less than 24 months.
- Using the Wrong Sale Structure: Business owners miss out on this exemption because they sell their assets rather than their ownership interests. Remember, LCGE applies to share sales, not asset sales.
- Poor Record Keeping: Lack of proper documentation may disqualify you from the LCGE. You must have sufficient records illustrating your Canadian residency status throughout the year in which you require the exemption.
Legal Tax Minimization Strategies to Consider
Selling a business in Canada triggers the capital gains tax, especially if you sell it at a profit. However, with the right solutions, you can avoid this tax or minimize it.
Consider the following strategies:
1. Leverage the Lifetime Capital Gains Exemption
As a business owner, this exemption shields you up to $1.25 million of your capital gains, provided you’re eligible.
You must have an active business, be a Canadian resident throughout the year in which you are seeking exemption, and must have owned your business shares for at least 24 months to ensure eligibility.
With this exemption, you can minimize your taxes legally until you reach the maximum limit.
2. Structure the Sale As a Share Sale
Business sales in Canada are taxed as either an asset or a share sale. Asset sales suit buyers because they allow them to choose specific assets. As for the seller, they are left with the liabilities and incur double taxes.
As such, you need to structure your sale as a share sale to enjoy the LCGE, which applies only to share sales. However, if the buyer insists on the asset sale, you can calculate your total taxes after the asset sale and include this figure when selling your assets to alleviate the capital gains tax.
3. Use a Family Trust to Multiply the LCGE
If your business valuation is high, you may increase the LCGE available by involving your family.
Create a family trust to hold some of the shares. This allows you to potentially allocate capital gains to your children and spouse upon selling your business, including shares held by the trust. Each beneficiary in the trust can use their own LCGE limit to minimize the taxes.
It’s important to note that this strategy is complex because your family members must meet different ownership criteria, such as age and QSBCS eligibility. Therefore, hire a tax and compliance expert to help you properly structure the family trust.
4. Purify the Business Before the Sale
Eliminate most of your passive assets to ensure you have sufficient active assets for the LCGE qualification. This involves transferring some of the assets to a holding company, paying dividends, or restructuring your liabilities.
One thing to note is that the purification process should happen years before the sale. Doing this a week or a month before the sale may trigger legal problems, especially when moving assets.
But do these strategies really work? These strategies work, but only when they’re structured correctly and timed right. In fact, some strategies require planning 18–24 months ahead, not scrambling at the last minute.
At JS CPA Strategic Solutions, we partner with companies and founders preparing to exit their businesses to prepare for business valuation, due diligence, or buyer negotiations. This includes pre-sale tax structuring and LCGE optimization and end-to-end M&A advisory, so that you don’t leave money on the table.
Book a no-obligation call to start working on an exit plan for your business.
Misconceptions About Avoiding Taxes When Selling a Business
Most business owners have numerous misconceptions about how to avoid taxes when selling a business.
Let’s look at the most common ones:
- You Can Hide Income by Calling it a Gift: Some business owners assume that you can receive the capital gains as a gift or in cash to avoid paying taxes. However, this is not possible because the Canada Revenue Agency (CRA) will request and demand extensive supporting documentation and an audit trail. Omitting this amount can trigger hefty fines or even jail time.
- Everyone Automatically Qualifies for the LCGE: Another misconception is that you automatically qualify for the LCGE if you sell your ownership shares. However, LCGE has strict rules. You must meet the active business test and ownership criteria, among other eligibility requirements. Failing either of the requirements disqualifies you for the exemption.
- Asset Sales Have Lower Taxes: Some business owners assume that selling assets triggers lower taxes. However, this is false. Asset sales are subject to double taxation. You pay tax on the sale proceeds, and then pay it again at a personal level when distributing dividends to shareholders. Therefore, it’s important to determine whether the proceeds should be taken as salary or dividends to minimize the overall tax liability.
- You Can Sell Your Business and Depart: Another misconception is that you can sell your business and leave Canada to avoid paying taxes. Canada has a departure tax. It assumes you sold your business at fair market value and may be subject to capital gain to tax.
When Professional Tax Planning Becomes Essential
Corporate tax planning is mandatory when selling a business in Canada, especially if you want to qualify for the LCGE.
Here are situations where professional tax planning is required:
- Purification Period: Hire an expert before any potential sale to help you clear out passive assets. This prevents you from violating any regulations when transferring assets between corporations.
- LCGE Eligibility: You will require a professional tax planner, especially with the active business test, to help you qualify for this exemption.
- Structuring the Share Sale: A professional tax expert will advise on the share sales and help you structure your sale to ensure LCGE compliance. Additionally, they can help you structure a hybrid transaction that combines asset and share sales while minimizing your tax liability.
- Creation of Family Trust: Hire an expert tax planner to help you create a family trust and ensure you follow all the requirements to ensure your family qualifies for the LCGE. This will help you minimize your taxes, especially if your business is worth a significant amount.
Frequently Asked Questions
Let’s explore some of the frequently asked questions on ways people can avoid taxes when selling a business:
Can You Completely Avoid Paying Taxes When Selling a Business in Canada?
No. You cannot completely avoid paying taxes when selling a business in Canada because the accrued profits are subject to the capital gain tax.
However, you can minimize the taxes by using different legally approved strategies, such as the Life Capital Gains Exemption (LCGE).
Are Offshore Tax Strategies Legal for Business Sales?
Yes. Offshore tax strategies can be legal, but they often are closely scrutinized by CRA to ensure they meet the applicable laws and reporting requirements:
- The business complies fully with home and offshore legal regulations.
- As a business owner, you report all income, assets, and transactions to tax authorities.
- You don’t illegally evade taxes.
Does Reinvesting Sale Proceeds Eliminate Sales Taxes?
No. Reinvesting sale proceeds doesn’t automatically eliminate sales taxes because Canada treats the sale as a taxable event as soon as the gain is achieved, irrespective of where you put the money afterwards.
When Should I Start Tax Planning to Minimize Taxes on My Business Sale?
Start tax planning at least 30+ months before your business sale to ensure compliance, especially if you want an exemption.
Conclusion
You cannot completely avoid all taxes when selling your business, but numerous legal strategies can help you minimize your taxes. The LCGE is one of the best strategies because it shields you from up to $1.25 million in capital gains. However, you must be eligible to qualify for this exemption.
That’s why you should hire an experienced tax and compliance expert to ensure compliance with LCGE eligibility. The planner will also provide other legal tax-minimization techniques and help you structure your business sale.
At JS CPA Strategic Solutions, we offer both strategic M&A advisory and integrated tax planning to ensure nothing slips through the cracks. We offer CFO-level advisory services to optimize financial performance and help you secure the best possible deal on the sale.
Schedule a personalized call to discover how to avoid paying taxes without exposing yourself to potential legal liability.