Selling a Small Business: Taxes and Capital Gains

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I sold my company last year for $160,000. I originally bought it in 1997 for $90,000. Can you explain the tax consequences? I’ve called the CRA several times but haven’t received a clear answer.

—Peter

The types of taxes you may owe when selling a small business

Sorry you’ve had trouble getting a straightforward response, Peter. Selling a business touches several tax and legal areas, and while the basic ideas are simple, the details can be complex. Apart from GST/HST and payroll-related rules, the most significant issue for most owners is the income tax result of the sale. How that income is taxed depends heavily on whether the business was operated as a sole proprietorship or through a corporation.

What you sell as the owner of an unincorporated business and the tax implications

A sole proprietor typically sells the assets of the business. Those assets can include tangible property such as inventory, equipment and real estate, plus intangible items like goodwill, customer lists and contracts. You can sell individual assets or all of them as a package.

For tax purposes, most asset sales are treated as capital transactions. The taxable amount is generally the difference between the sale proceeds and the adjusted cost base of the assets sold, resulting in a capital gain. Personal tax on capital gains varies with your total income and your province of residence; broadly speaking, this can translate into an effective tax burden in the low-to-moderate range depending on circumstances.

If you previously claimed depreciation (capital cost allowance, or CCA) on sold assets, there can be a recapture. Recapture brings some or all of the previously deducted CCA back into income and is taxed at ordinary income rates rather than the preferential capital gains treatment. Depending on your income level and province, that portion may be taxed at higher marginal rates.

For incorporated businesses, the tax outcome depends on whether the buyer acquired the company’s assets or purchased the company’s shares.

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What about an incorporated business?

If your business was incorporated and the corporation sold assets to a buyer, the corporation recognizes gains or recapture on those assets. The taxable amount in the corporation is the proceeds less the tax cost of the assets. Corporations generally pay tax on that income at corporate rates, and the combined federal and provincial tax on active business income can often fall roughly in the mid-20s percent range, though exact rates depend on province and other factors.

When CCA previously reduced the corporation’s taxable income, an asset sale can trigger recapture, which is reported in corporate income and taxed accordingly. After the corporation pays tax on sale proceeds, any funds distributed to shareholders — for example, as dividends or other withdrawals — create additional personal tax consequences for the owners.

What is the lifetime capital gains exemption (LCGE)?

Selling shares of a qualifying small business corporation may allow you to claim the lifetime capital gains exemption (LCGE). For 2024 the LCGE provides up to $1,016,836 of tax-free capital gain on the sale of qualified small business corporation shares, subject to the specific criteria and limits that apply.

To qualify, the shares must meet several conditions. In general terms, the rules require that at the time of sale the shares be shares of a small business corporation and that the seller (or a related person) owned them. During most of the 24 months before the sale, the corporation must have been a Canadian-controlled private corporation and at least 50% of the fair market value of its assets must have been used principally in an active business carried on primarily in Canada (or be certain shares or debts of connected small business corporations, or a combination of those asset types).

Because the test looks back over the 24 months before a share sale, timing and the corporation’s asset mix can affect eligibility. There are other anti-avoidance and eligibility rules as well, so whether your sale qualifies depends on the full facts.

If you operated as a sole proprietor, you can sometimes transfer a business into a corporation on a tax-deferred basis. That restructuring can, in some cases, make it possible to use the LCGE later, but such rollovers require careful planning to ensure eligibility and to avoid unintended tax consequences.

Given these complexities, selling shares to take advantage of the LCGE is not automatic: it depends on history, ownership, asset composition and other rules.

Why the CRA won’t give definitive tax advice and why professional help matters

The Canada Revenue Agency provides general information but does not normally give personalized tax advice. Even when CRA staff provide factual answers, large or complicated transactions — such as the sale of a business, valuable real estate, or other major assets — benefit from tailored professional advice. An experienced accountant or tax lawyer can assess your specific facts, identify whether you qualify for exemptions like the LCGE, calculate any recapture, and recommend tax-efficient ways to distribute or retain proceeds.

Proactive tax planning before completing a sale is often more effective than trying to resolve tax issues afterward. For a sale of the size you describe, getting professional guidance can help you avoid surprises and preserve more of the value you created in the business.