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While a sole proprietor is the simplest form of a business structure, there are considerations when selling such a business to minimize tax. As the sale of a sole proprietorship is a taxable event, it would be advantageous to include your accountant in negotiations from the onset.
A proper valuation of the assets that are being sold will help provide a basis for allocation within the sales price. Allocation is important as it usually renders competing tax results for both the vendor and the purchaser. For example, a high valuation on an asset class that has a large capital cost allowance (or depreciation) rate may be sought by the purchaser – however this may result in recapture of the tax deductions taken in previous years for the seller.
Depending on the nature of the assets, there may be a need for an expert valuation or a formal appraisal. The valuation of land and buildings, specialized equipment and intangibles such as goodwill, patents and customer lists can be a challenge for any proprietor particularly if he or she has been in business for an extended period of time. Often non-compete clauses or restrictive covenants are required by the purchaser and there is value allocable to these agreements that can be subject to certain immediate tax consequences. In many cases reliable valuation assistance can be obtained from your accounting advisor for these purposes.
Under certain circumstances it is possible to defer or minimize the payment of taxes on the sale of a sole proprietorship. For example, a proprietor may consider incorporating and rolling the business into the corporation on a tax deferred basis and selling the shares of the corporation. If the shares meet certain requirements, a lifetime Capital Gains Deduction may be available to eliminate taxes on capital gains of up to $800,000 (plus inflation since 2014). Alternately, the corporation could sell the existing business directly and pay tax at the corporate level and invest the funds to achieve a deferral of tax until ultimately distributed to the shareholder.
Another tax deferral strategy is to acquire a replacement property to defer the gain on sale of the proprietorship’s assets further into the future. Capital gains tax can be deferred over a period of up to five years if the purchaser makes purchase price installments over this period. Also, a tax election is available to defer recaptured Capital Cost Allowance (CCA) which is taxed 100% as income, by combining all of the depreciable property of various CCA classes into a single class.
While there are nuances to every deal, the ultimate goal should consider tax implications for each side. Understanding the after tax cash received when selling your sole proprietorship will help you in your negotiations and facilitate decisions on selling the business.
This information is for discussion purposes only and should not be considered professional advice. There is no guarantee or warrant of information on this site and it should be noted that rules and laws change regularly. You should consult a professional before considering implementing or taking any action based on information on this site. Call our team for a consultation before taking any action. © 2021 Shajani LLP.
Shajani LLP is a CPA Calgary, Edmonton and Red Deer firm and provides Accountant, Bookkeeping, Tax Advice and Tax Planning services.