Canadian Tax and Estate Planning

As a strategic business leader, you may have thought about expanding your business or the appropriate exit strategies. When contemplating to expand or sell, it is important to plan the structure of the transactions to account for the various tax implications. Proper tax planning with your accountant, prior to a purchase or sale can assist in mitigating these implications.

Buying or selling a business can be complex from a tax perspective, but there are also many non-tax factors involved. This article will outline the major tax considerations under the two most common ways to structure an acquisition or divestiture – a share sale or an asset sale.

Share sale

A share sale is where the business owner sells the shares of their corporation directly to a buyer. This is a common option for larger purchases and sales. Detailed due diligence is normally done by the buyer. This can be costly but varies with the deal size, business complexity, and risk tolerance. The tax implications can also vary with each transaction.

Canadian tax considerations for the seller

It can be very advantageous to sell your shares. Shares are typically treated as capital property for Canadian tax purposes. Capital property is eligible for the capital gains treatment, for which only 50 per cent of the gain is taxable. Also, Canadian residents have access to their Lifetime Capital Gains Exemption which can shelter up to $913,630 of capital gains (as of 2022) on the sale of Qualified Small Business Corporation (QSBC) shares.

For the shares of a corporation to qualify as QSBC shares, the following three conditions must all be met at the time of sale:

1. The shares need to be shares of a Small Business Corporation (SBC). An SBC is defined to be a Canadian-Controlled Private Corporation (CCPC) with all or substantially all (at least 90 per cent) of the fair market value (FMV) of its assets used in an active business carried on in Canada, or be shares or debt of a connected SBC, or a combination of both. Connected generally means that the subject corporation owns more than 10 per cent of the issued shares of the other corporation.
2. Throughout the 24 months immediately before the sale, the shares must have been shares of a CCPC where more than 50 per cent of the FMV of its assets is used in an active business carried on in Canada.
3. Throughout the 24 months immediately before the sale, the shares must not have been owned by anyone other than the individual, or persons or partnership related to the individual.

Note that the above conditions focus on the assets of the corporation. Liabilities are not relevant. Further, the conditions are based on the FMV of the assets, which can include off balance sheet items such as goodwill.

A seller can also defer and save taxes by applying the Capital Gains Reserve (CGR). The CGR is available if the proceeds are not received in full, and the remainder is paid in installments over the next few years. The CGR allows the taxpayer to bring taxable capital gains into income in proportionate to when the proceeds are received, over a maximum of five years. For example, when the proceeds are paid evenly over five years, it can be beneficial to the seller as only 20 per cent of the taxable capital gain is taxed each year. For individuals, this will also permit the use of marginal tax rates which can reduce taxes payable.

Canadian tax considerations for the buyer

From the buyer’s perspective, any share acquisition will transfer all of the liabilities of the former corporation to the new owners, including any hidden liabilities. From a tax perspective, the buyer will be inheriting the tax attributes of the corporation, which can include and are not limited to:

• Inheriting the undepreciated capital cost (UCC) pool – This is the remaining tax base of the depreciable assets that can be deducted against taxable income each year. In a share sale, the purchaser does not get to step up the cost bases to their FMV at the time of purchase
• Tax reassessments – The buyer will be liable for any pending or future tax reassessments for which there may be unforeseen taxes payable, interest, and penalties. This can be mitigated through performing due diligence engagements and including indemnity clauses in the purchase and sale agreements

When acquiring the shares of another corporation, buyers need to be aware of how this purchase should be structured. As a general planning tool, setting up a holding corporation and properly capitalizing it before the share purchase can have many benefits, such as being able to withdraw the original investment in a tax-efficient manner.

Acquisition of control

When an unrelated party acquires control of a corporation through a share purchase, this results in an Acquisition of Control (AoC) for Canadian tax purposes. The major tax considerations of an AoC for the corporation are as follows:

• There is a deemed year-end immediately before control is acquired which will create a tax filing requirement for the corporation. A new tax year is then deemed to begin at the time control is acquired.
• Net capital losses cannot be carried forward post AoC.
• Losses from business operations can only be carried forward against income post AoC if:
  • the business with the losses continues to be carried on with a reasonable expectation of profit.
  • the losses are deducted against profits from the same or similar business.
• Assets with accrued losses are written down to FMV at the time of AoC. For example, capital assets that have a UCC balance in excess of the FMV will have deemed to have claimed the excess as additional capital cost allowance (CCA). The deemed claim of CCA can create a situation where additional business losses are created but are restricted in the future.

Additionally, there is an election to trigger any accrued capital gains on assets immediately before AoC, which can off-set the net capital losses that would otherwise have expired. This results in a bump up on the cost base of the assets post AoC.

For example, a corporation owns land with an adjusted cost base (ACB) of $100,000 has a FMV of $200,000 and it is subject to the AoC rules. If there are $50,000 of expiring net capital losses, we can elect to trigger $50,000 of capital gains on the land, to offset the expiring losses. Ultimately, the land will have a new ACB of $150,000, and there will not be any losses remaining.

Asset sale

Depending on your business strategy, purchasing an entire business may not be necessary. It may be worthwhile to consider only buying the needed assets. Asset sales typically favour the buyer as it limits their liabilities and maintains flexibility by only purchasing the required assets and liabilities.

Canadian tax considerations for the seller

When the assets are sold, it can result in business income and capital gains. The type of income is determined by the type of asset sold (e.g. inventory, accounts receivable, depreciable assets, and non-depreciable assets), and is further determined by the asset’s FMV, UCC, and ACB. Sale of inventory and accounts receivable will be on account of income. Sale of depreciable and non-depreciable assets for proceeds in excess of their ACB will be a capital gain.

Having differing tax treatments for different assets can create a conflict between the buyer and the seller. The seller has an incentive to allocate more proceeds to non-depreciable assets, such as land and goodwill, resulting in capital gains. The seller wants to limit the amount of proceeds allocated to inventory and depreciable assets, which can generate business income and recapture that is fully taxable when they are sold.

Canadian tax considerations for the buyer

The buyer has the opposite incentive as the seller and may want to allocate more proceeds to inventory and depreciable assets. These proceeds become the assets’ new ACBs. For depreciable assets, the ACB is the starting UCC. Thus, a higher proceeds allocation results in higher CCA deductions and lower taxes payable for future periods.

The opposing objectives between the seller and buyer on the purchase price allocation will usually be a point of negotiation in an asset sale. The ultimate asset and purchase sale agreement should clearly document the final agreed upon purchase price allocation.

Common elections available to both the buyer and seller

There are a few common joint elections available that the seller and buyer should keep in mind for an asset sale.

Section 22 election for accounts receivable

This election is for accounts receivable for which there are uncollectible amounts. The election allows for the seller to claim the uncollectible amounts as a deduction in the year of the sale that it otherwise would not be able to claim in the year of sale. It also allows for the buyer to be entitled to claim future deductions for any uncollectible amounts. Without this election, the buyer would have a capital loss on any future uncollectible amounts which can only be deducted against taxable capital gains.

There are three conditions to be met for the election to apply.

1. All or substantially all of the property used in carrying on the business is being sold.
2. The sale agreement must include all of the vendor’s accounts receivable.
3. The purchaser must continue to carry on the business.

Section 167 election for GST/HST

The sale of business assets will be considered a provision of a taxable supply for GST/HST purposes. This usually provides unnecessary cash flow burdens to the purchaser and additional remittance requirements for the vendor. If applicable, the section 167 election will deem GST/HST to not apply on the sale of assets.

There are three conditions to be met for the election to apply.

1. The vendor and purchaser must both GST/HST registrants, or they are both non-registrants, or the vendor is a non-registrant while the buyer is a registrant.
2. All or substantially all of the property used in carrying on the business is being sold to the buyer, to continue carrying on the business of the seller.
3. The seller must be selling the assets of the business that it carried on.

These are some of the common elections that provide benefits to both the seller and buyer. The timing and filing of these elections should be part of the negotiations in an asset sale.

If you have any questions or need further information, please feel free to reach out to the Canadian Tax and Estate Planning group at Fuller Landau.

About the authors

David Liang, CPA is a Manager in our Tax group. He can be reached at 647-417-0372 or dliang@fullerllp.com.

Jason Booth is a Tax Specialist in our Tax group. He can be reached at 647-417-0371 or jbooth@fullerllp.com.