Tax Implications of Selling a Business in Ontario, Canada

At the time of selling their company, business owners are more interested in knowing how much money they will keep after the sale than what price they will get. Tax can have a huge impact on the proceeds from the sale. Since tax regulations vary among US states and Canadian provinces, we will focus on Ontario in this post.

This post provides some general information about the tax repercussions of selling a business but is not intended to replace professional advice from Lawyers, Accountants and Tax Experts. Business sellers should to seek competent professional advice concerning tax and liability matters when contemplating the sale of their companies.

From a tax perspective, a business owner shall first make a decision about the structure of the sale: Share sale vs. Asset sale:

Share Sale: The company is sold as a whole. The new shareholder becomes the Buyer who takes over the company including both its assets and liabilities. Therefore, all company debts are also transferred to the buyer. Other company stakeholders such as employees, customers, suppliers etc. are not affected since the company remains the same. There is only a change in share ownership.

• Tax implications: As a seller, you pay very little tax on the first $750,000 (as of today). This is a one lifetime tax exemption in Ontario, Canada. if other family members are also shareholders, they might also benefit from this exemption. Caution: Qualifications for this exemption are stringent.  Sellers should verify with their tax expert that they qualify.As a buyer, this option is not favorable from a tax perspective because the goodwill portion of the purchase price cannot be depreciated. Most buyers are very reluctant to purchase shares especially when the business is relatively small.
• Risk implications: The seller of shares sells also liabilities including possible employee liabilities and the buyer inherits these liabilities. From a buyer’s perspective, purchasing the shares could be very risky especially if the business has undisclosed liabilities. While most share purchase agreements will have a special clause stating that the seller should still remain liable for any undisclosed liability or any liability that is the result of an event occurring prior to the sale, it will be still the responsibility of the buyer to face the liability with the option to sue the seller if the seller does not pay for such a liability.

Asset Sale: in this structure, the company only sells its assets such as inventory, equipment, leaseholds, goodwill, name, customer contracts and relationships etc. The buyer creates their own legal entity and does not purchase the existing legal entity. The seller dissolves the existing entity after the sale.

• Tax implications: The seller in this case is not the owner directly but the corporation belonging to the owner is. The corporation will sell its assets and will pay a combination of capital gain and income tax. In Ontario, 50% of capital gains (if these gains qualify as capital gains) are not taxable. In this case, the sale structure will matter for seller. The part of the purchase price allocated to equipment, leaseholds and other tangible assets should not exceed their book value on the balance sheet at the time of closing to avoid any recapture, which would increase the portion of taxable income vs. capital gains. From a Buyer’s perspective, this is the most advantageous structure since the goodwill portion of the purchase price can be amortized over a period of time, which should reduce future taxes for the buyer.
• Risk implications: Since the buyer is only buying the assets, all the liabilities remain with the seller. It’s the seller’s responsibility to pay for all debts including any new liabilities related to the period before the sale that only appear after the sale. For example, the Buyer doesn’t have to worry about a tax audit that happens after the sale and that questions the seller’s accounting  practices prior to the sale (with some exceptions).

While most business sellers prefer to sell shares because of the huge tax advantage they receive from a share sale, most business buyers prefer to buy assets. In practical terms, most transactions for small or very small businesses happen as asset sale. As a business broker, I can still see some small transactions structured as share sale and more specifically in these two circumstances 1.When the seller accepts to finance a part of the translation (as a Vendor Take Back Loan), such a loan can guaranty any undisclosed liability that shall be paid for by the seller and 2. When the business has received a large number of offers and one of the buyers is willing to take the risk because they want the business and they trust the sellers.