Tax implications of transferring a business
For a long time, transfers within families were subject to major tax disadvantages compared to selling the business to an outside buyer. “If you bought the shares of a family member through a company, the profit was considered a dividend, whereas it was considered a capital gain if the business owner sold their shares to a company belonging to an outside buyer,” says Steeve Vachon, a partner and tax specialist in business transfers at Raymond Chabot Grant Thornton.
In 2016, Quebec relaxed this rule to make it easier for families to transfer SMEs, under certain conditions. In 2021, the federal government followed suit by adopting Bill C-208, which ensures that most transfers of businesses within a family will be treated like external sales. “Some details of the law’s application still need to be worked out, so it’s not quite settled yet, but it should be before the end of the year,” says Steeve Vachon.
An exemption that pays off
This is important because the combined marginal tax rate on dividends can exceed 40% in Quebec, while only half of the capital gain is taxed, depending on the income level. “The entrepreneur who sells eligible shares can also take advantage of the capital gains deduction (CGD) – editor’s note: also known as the lifetime capital gains exemption (LCGE) – which allows them to avoid paying tax on all or part of their profit,” says Steeve Vachon.
In 2022, the LCGE is capped at $913,630, and at $1 million for fishers and farmers. This means that only half of the amount over these figures will be taxed. This exemption is cumulative, meaning that it can be used multiple times until the maximum amount is reached. Note that the LCGE can be combined with that of other family members when the shares are held in a family trust.
Sell the shares or the assets?
Business owners should also be aware of the difference in tax treatment between the sale of shares and the sale of assets. The sale of shares entitles the seller to the LCGE, avoiding taxation on the recapture of depreciation, not requiring the payment of GST and QST on the sale price, and allowing the taxable capital gain to be spread over several years, among other things. The sale of part or all of the assets does not allow access to the LCGE and generally results in higher taxation for the seller.
“Taxation on the sale of a business involves many fine points and the biggest challenge is the lack of preparation,” says Steeve Vachon. “Entrepreneurs and buyers are prodding about in the dark, which adds to their stress and can lead to costly mistakes.”
“Taxation on the sale of a business involves many fine points and the biggest challenge is the lack of preparation.” — Steeve Vachon