Should I incorporate before selling my business?

A sole proprietor selling a business is selling assets, because there are no shares to sell. That means asset-sale treatment: inventory taxed as income, recapture on equipment, a gain on goodwill, and no access to the lifetime capital gains exemption, which applies to shares of a qualifying corporation. Incorporating changes what is available — but only if it is done far enough ahead.

What incorporating can unlock

Once the business is in a corporation, a future buyer may be willing to purchase shares rather than assets. A share sale can, where the qualified small business corporation conditions are met, allow the exemption to shelter part of the gain. Incorporation may also allow income splitting within the limits of the split-income rules, deferral of personal tax on profits left in the company, and access to the small business deduction on active business income. It also provides limited liability, which matters independently of tax.

Why late incorporation usually fails the tests

The exemption depends on tests that look backwards, including a holding-period test and an asset test measured over the twenty-four months before the sale. Shares issued when you incorporate immediately before a sale generally will not satisfy the holding period, though specific rules can deem the period met in certain rollover situations. Assume that incorporating with a buyer already at the table is unlikely to produce exemption access, and confirm with an advisor rather than hoping.

The costs on the other side of the ledger

• Transferring the business into a corporation is a disposition; a section 85 rollover is generally needed to defer the tax, and that election has its own conditions and filing deadlines.
• Corporations file their own returns, keep minute books, and carry ongoing accounting and legal costs.
• Contracts, licences, leases, permits and bank arrangements may need consent to be assigned to the new company.
• Payroll, GST/HST and provincial registrations must be redone in the corporation’s name.
• Federal and provincial incorporation differ on residency requirements for directors and on extra-provincial registration, so the jurisdiction choice matters.

How to approach the decision

Treat incorporation as a multi-year decision rather than a pre-sale manoeuvre. If a sale is three or more years away, model the after-tax outcome of incorporating now against staying as a proprietorship, including the ongoing costs. If a sale is imminent, focus instead on the levers that still work: negotiating the purchase price allocation, using a reserve where proceeds are deferred, and choosing the closing date. An accountant can run both scenarios on your actual numbers in a short engagement.