Welch LLP Chartered Professional Accountants Tax Efficient Strategies for Selling a Business Zoran Vranjkovic, CPA, CA, CFP, TEP Senior Tax Manager Welch LLP
Agenda 1. Asset sales 2. Share sales/capital gains exemption 3. Section 84.1 planning 4. Hybrid sale transactions 5. Earnout payments
Bump in cost of assets Asset Sales Purchaser ½ year CCA Goodwill Allocation of purchase price No risk of hidden liabilities
Asset Sales Vendor Recapture No CCA Goodwill Allocation of purchase price Personal tax to extract funds from corporation Greater tax liability
Share Sales Purchaser No bump in cost of assets (other than non-depreciable capital assets) Acquisition of control issues Risk of hidden liabilities
Share Sales Vendor Capital gain Capital gains exemption Tax minimization Tax deferral
Capital Gains Exemption (CGE) $400,000 deduction (offsets $800,000 capital gain) Deduction available to individuals resident in Canada throughout the year Disposition of shares Qualified small business corporation (QSBC) shares at time of disposition Potential tax savings up to $185k - $198k per exemption
CGE Limiting Factors Previous use of deduction Cumulative net investment loss (CNIL) Allowable business investment loss (ABIL) Other capital losses in year
QSBC Shares Basic Conditions Determination Time Test (90% rule) 24 Month Ownership Test Holding Period Asset Test (50% rule)
QSBC Shares Determination Time Test Must be a Canadian-controlled private corporation (CCPC) All or substantially all (90%) of the FMV of the assets at that time attributable to assets that are: a) Used principally (50%) in an active business carried on primarily (50%) in Canada by the particular corporation or a corporation related to it; b) Shares in or indebtedness of one or more small business corporations that are connected with the particular corporation; or c) Assets described in (a) or (b).
QSBC Shares Ownership Period Test Throughout 24 months immediately preceding disposal, share must not have been owned by an unrelated party. Individuals Partnerships Corporations Trusts Exceptions: Shares issued in exchange for other shares Shares issued in exchange for assets of a business Shares issued in exchange for partnership interest (where assets used in business) Shares issued as a stock dividend (provided shares on which dividend declared meet test)
QSBC Shares Holding Period Test Throughout 24 months preceding disposal, at least 50% of corporation s assets must be used in active business Intercorporate shares and debt subject to similar rules Watch for unusual transactions/assets
QSBC Shares Timing Issues 24 month Holding Period Test Watch for new shareholders (Trust/Spouse/Children) Accrual of value Value to date of reorganization can t be shifted Allow time for value to accumulate Consider structure up front Age of children? Cost?
Capital Gains Exemption Alternative Minimum Tax (AMT) Capital gains are a tax preference item Maximum AMT on CGE claim approx. $40k Salary of $265,000 no AMT on full CGE claim AMT credits 7 year carry-forward
Capital Gains Exemption Alternative Minimum Tax (AMT) Annual income required to recover AMT (over 7 years): Salary - $43,500 Interest - $40,000 Capital gains - $355,000 Dividends (eligible) - $193,500 Dividends (non-eligible) - $207,000
Capital Gains Exemption Alternative Minimum Tax (AMT) Plan for recovery of AMT Consider mitigating steps: Crystallize portion of gain prior to sale (straddling December 31) Stagger sale to straddle December 31 Consider OAS clawback impact Worst case portion of capital gain taxed at 5%
Share Sales Sample Scenario X is married 3 minor children Opco value = $4 million
CGE Problematic Structure #1 Sole Shareholder X CGE only available to X No tax efficient mechanism to purify Common shares (FMV - $4M) Opco
CGE Problematic Structure #1 Solution 1. Establish discretionary family trust 2. X freezes value of Common shares ($4 million) 3. Trust subscribes for new Common shares (nominal value) Watch for: 24 month holding period (trust) Enough time for value to accrue to trust?
CGE Problematic Structure #1 Solution X Family Holdco Common shares X Trust may sell Opco shares X and family may access CGE Surplus funds may accumulate in Holdco Family Trust Opco Common shares (nominal) Preferred shares ($4M)
CGE Problematic Structure #2 Purification X Family X Trust may sell Holdco/Amalco shares X and family may access CGE No tax efficient purification of Holdco or Opco Family Trust #1 Holdco Common shares ($4M) Common shares ($4M) Opco
CGE Problematic Structure #2 Solution 1. Establish new discretionary family trust 2. Holdco & Opco amalgamated 3. Old trust freezes value of Common shares ($4 million) 4. New trust subscribes for new Common shares (nominal value) Watch for: 24 month holding period (new trust) Enough time for value to accrue to new trust?
CGE Problematic Structure #2 Solution X and X Family Common shares Holdco Family Trust #1 Preferred shares ($4M) Family Trust #2 Common shares (nominal) New Opco Trusts may sell New Opco shares X and family may access CGE Surplus funds may accumulate in Holdco
CGE Problematic Structure #3 Business Real Estate X Family X Family Trust Holdco Purchaser may not want real estate Vendor may not want to sell real estate Difficult to spin out real estate prior to sale of Opco May preclude use of CGE Business Opco Real Estate
CGE Problematic Structure #3 Solution 1. Create a new corporation to purchase real estate in first place; or 2. Take steps to spin out real estate into separate corporation: Can t be in contemplation of sale Valuation Cost Land transfer tax
CGE Problematic Structure #3 Solution X Family X May sell Opco and/or Business Realco May sell one corporation and retain other Both corporations shares may qualify for CGE May facilitate succession planning Opco Business Family Trust Business Realco Real Estate Holdco
CGE Problematic Structure #4 Foreign Activity X Family X Family Trust Holdco Is Opco s business primarily (50%) carried on in Canada? Same issue if use a foreign subsidiary May preclude use of CGE Canadian Business Opco Foreign Business
CGE Problematic Structure #4 Solution X Family X May sell Opco and/or Foreign Opco Shares of Opco may qualify for CGE Shares of Foreign Opco will not qualify for CGE Best to set up initially Opco Canadian Business Family Trust Foreign Opco Foreign Business Holdco
Section 84.1 Planning Provision of Income Tax Act Anti-surplus stripping rules Planning combines section 84.1, RDTOH and CDA to provide tax deferral No advance planning required Consider where CGE not available and/or large capital gain
Section 84.1 Planning Example Assume: - $10 million capital gain on sale - No capital gains exemption Without planning: - $7,500,000 after-tax funds - All held personally With planning: - $8,750,000 after-tax funds (½ personally; ½ in holding company) - Tax deferral of $1.25 million
Section 84.1 Planning Example Purcha ser Vendor Common shares Common shares Cash ($4.375 million) Holdco Opco Cash ($4.375 million)
Hybrid Sale Transactions Combination of asset and share sale Purchaser advantages of asset purchase Vendor advantages of share sale Many variations depending on specific circumstances Common characteristics: Vendor sells shares of Target corporation to purchaser Target corporation sells assets to purchaser
Earnout Payments Share Sale Option #1 Determine value of earnout at time of sale How to determine? Additional amounts received fully taxable Capital loss only carry back up to three years Option #2 Cost recovery method Capital gains treatment Amounts received reduce ACB of shares Amounts received in excess of ACB of shares capital gain Based on amounts determinable
Earnout Payments Share Sale Conditions for Cost Recovery Method Arm s length capital transaction Due to difficulty in valuing underlying goodwill Ends no later than 5 years after end of corporation s tax year in which disposition occurred Notify CRA Vendor is Canadian resident
Earnout Payments Goodwill Purchase price adjustments fully taxable per s. 12(1)(g) Guaranteed minimum: Cumulative eligible capital treatment Consider limiting upside in exchange for higher minimum? Consider reverse earnout: Sets maximum Repayment by vendor if targets not met Issue of determining FMV up front
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