Wednesday, September 26, 2012

Exit Planning Can Save Significant Taxes

Maximizing the net proceeds received from the sale of a business is a common goal for many business owners.  This will only be accomplished with enough time to implement an effective strategy for maximizing value and minimizing taxes.
Business owners generally are aware of the $750,000 capital gains exemption that is available on the sale of qualified small business corporation (QSBC) shares.  This can be an extremely valuable tax shield.  In Ontario, this translates into a tax savings of approximately $180,000 at the top combined marginal tax rate on capital gains (i.e. 23.98% for 2012). 
Many business owners assume that this exemption will be available to them.  However, certain conditions must be met in order to qualify.  A cursory summary of these conditions is as follows:
  1. Ownership Test – the shares were owned by the person (or a related party) throughout the 24 months preceding the disposition;
  3. 50% Test – more than 50% of the fair market value of the assets of the business were used principally in an active business carried on primarily in Canada throughout the 24 months preceding the disposition; and
  5. 90% Test – all or substantially all (90%) of the fair market value of the assets were used in the active business at the time of disposition of the shares.
Assets not used in the active business include excess cash, marketable securities and other investments, vacant land, rental properties, shareholder and related party loans, etc.  From a business valuation perspective, assets not used in the active business are considered redundant assets which are valued separately from the business operations.  An independent business valuation will help ascertain whether or not the business satisfies the 50% test and 90% test.
Between 60% and 75% of business owners are planning to exit their businesses within the coming decade. [1]  These business owners must start planning now if they want to maximize the net proceeds ultimately received on exit.  The action items take time to implement and preparation is vital to ensure value is maximized and taxes are minimized.
Some business owners have lost out on the $750,000 capital gains exemption because, when faced with an involuntary sale of their business (i.e. illness, disability, dispute, death, etc.) or an unsolicited offer by a third party, the above noted conditions were not met.  Don’t let this happen to you. 
Implementing strategies to minimize tax on the sale of a business takes time, including being able to take advantage of the $750,000 capital gains exemption.  The 2 year period prior to disposition is critical.  Not qualifying for the capital gains exemption will take nearly $200,000 out of the business owner’s pocket and place it in the hands of the CRA.
Visit us at to learn more about our exit planning process.
[1]  Source: Surveys by the CFIB and the CICA/RBC Business Monitor.

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