When selling a business, choosing between a share sale and an asset sale involves complex tax and strategic considerations. Here are the main differences, the importance of purification for the QSBS (Qualified Small Business Share) exemption, and considerations regarding the Alternative Minimum Tax (AMT):
1. Share Sale
In a share sale, the seller transfers ownership of the corporation by selling their shares to the buyer. The business's entire structure, including assets, liabilities, and contracts, remains intact under new ownership.
Pros of a Share Sale
Tax Benefits for the Seller:
If the shares qualify as Qualified Small Business Shares (QSBS), the seller may be eligible for the Lifetime Capital Gains Exemption (LCGE). This is a significant tax advantage under Canadian tax law that allows individuals to exclude a certain amount of capital gains from taxation (currently over $971,190 for 2024). This can reduce or even eliminate the taxes payable on the sale.
To qualify as QSBS, the company must meet strict criteria, including that at least 90% of its assets are actively used in the business.
Simplicity for the Seller:
A share sale transfers ownership of the entire business, including its liabilities and ongoing contracts. This means the seller generally walks away with fewer residual obligations.
Continuity for the Buyer:
Employees, supplier contracts, and customer relationships are transferred automatically with the sale. This makes the transition smoother for both parties.
Cons of a Share Sale
Liabilities Transfer to the Buyer:
The buyer assumes all past and future liabilities of the business. This includes tax liabilities, legal risks, and potential lawsuits. As a result, buyers may discount the purchase price to offset these risks.
Preparation for QSBS Qualification (Purification):
If the company holds non-active business assets, such as excess cash or investments, these must be removed or "purified" to meet QSBS requirements. For instance, surplus cash can be distributed as dividends or used for legitimate business expenses before the sale.
Potential for Alternative Minimum Tax (AMT):
When the LCGE is claimed, the seller may trigger AMT. AMT is a parallel tax calculation designed to ensure high-income earners pay a minimum level of tax, even if they benefit from certain exemptions or deductions. Although AMT is often recoverable in future years, it can strain short-term cash flow.
2. Asset Sale
In an asset sale, the buyer purchases specific assets of the business rather than the corporation's shares. Assets might include equipment, real estate, inventory, intellectual property, or goodwill. The corporation retains any liabilities not expressly transferred.
Pros of an Asset Sale
Buyer's Preference:
Buyers prefer asset purchases because they can "cherry-pick" the assets they want while avoiding liabilities and unwanted obligations.
Tax Benefits for the Buyer:
The buyer can allocate the purchase price to different assets for tax purposes. For example:
Physical assets like equipment can be depreciated over time, reducing taxable income.
Intangible assets like goodwill may be amortized for tax benefits.
Flexibility:
The buyer and seller can negotiate which assets are included, giving both parties flexibility in structuring the transaction.
Cons of an Asset Sale
Double Taxation for the Seller:
The corporation selling the assets must pay tax on any gains realized from the sale. If the remaining proceeds are distributed to the shareholders, they may be taxed again as dividends. This "double tax" reduces the seller's net proceeds.
Complexity:
An asset sale requires valuing and transferring individual assets. This can involve significant legal, tax, and administrative work.
Continuity Challenges:
Contracts, licenses, and agreements may not automatically transfer to the buyer. This could require renegotiation with third parties, potentially disrupting the business.
3. Purification for QSBS Exemption
What is QSBS?
QSBS stands for Qualified Small Business Shares, a designation under Canadian tax law that offers tax benefits on the sale of shares in a private company. To qualify:
The company must be a Canadian-Controlled Private Corporation (CCPC).
At least 90% of its assets must be actively used in the business (e.g., equipment, inventory, or goodwill) at the time of sale.
For at least 24 months before the sale, at least 50% of the company’s assets must have been used in an active business.
What is Purification?
If the business holds non-active assets, such as excess cash or investments, it may not qualify for QSBS. Purification involves reorganizing the business to remove or reduce these assets. This can include:
Paying out excess cash to shareholders as dividends.
Transferring investments to a holding company.
Using funds for active business purposes, such as acquiring equipment or repaying business debt.
Why is Purification Important?
Without purification, the seller might lose the ability to claim the LCGE, potentially resulting in significantly higher taxes on the sale.
4. Alternative Minimum Tax (AMT)
What is AMT?
The AMT is a parallel tax system that ensures individuals pay a minimum level of tax, even if they benefit from deductions or exemptions like the LCGE.
How Does AMT Work?
When a taxpayer claims the LCGE, AMT rules may apply. The AMT calculates taxable income by adding back certain deductions, potentially resulting in additional taxes. However, AMT is often recoverable in future years when the taxpayer’s regular tax liability exceeds the AMT threshold.
Strategies to Mitigate AMT:
Plan to spread the gain over multiple years, if possible.
Offset the gain with other income that is not subject to preferential treatment.
Engage in detailed pre-sale tax planning with an advisor.
Summary and Strategic Considerations
Share Sale: Ideal for sellers seeking tax efficiency, particularly if QSBS criteria are met. However, preparation is required to ensure qualification, and AMT implications must be managed.
Asset Sale: Preferred by buyers due to reduced liability risks and tax benefits. However, it can lead to double taxation for the seller and requires a detailed negotiation of assets.
Recommendation: Engage a tax advisor or CPA early in the process to evaluate the specific circumstances of your sale. They can help navigate purification, AMT considerations, and ensure the sale is structured to maximize benefits while mitigating risks.
