Why do sellers prefer a share sale for tax reasons?

A share sale can suit a seller because it puts the gain in the owner’s hands, where a lifetime deduction may be available, and leaves the company’s own tax position alone. An asset sale works the other way: the company is the seller, so the tax lands in the company first.

The lifetime capital gains deduction

The CRA says an individual who is resident in Canada throughout the year and has a deduction limit available may be able to claim a capital gains deduction against taxable capital gains from the disposition of qualified small business corporation shares. Subsection 110.6(1) of the Income Tax Act defines those shares with a 24-month rule: throughout the 24 months before the sale the shares must not have been owned by anyone other than the individual or a person or partnership related to the individual, and for the part of that time they were so held the company must have been a Canadian-controlled private corporation meeting an asset test. At the time of sale it must also be a small business corporation as the Act defines it.

No recapture inside the company

In an asset sale the company disposes of its own depreciable property, and the CRA says the seller may have a recapture or a terminal loss of capital cost allowance. Under section 13 of the Act, recaptured depreciation is included in income for the year. The owner may be taxed again if money leaves the company as a taxable dividend, which paragraph 82(1)(a) includes in the recipient’s income. In a share sale the company still owns its equipment, so the sale does not itself produce that recapture.

Where the preference runs out

The deduction is not automatic, and a buyer may lean toward assets for reasons covered in why buyers prefer asset purchases for tax reasons. Ask what keeping a share structure would cost on price or terms. Before relying on a share sale, confirm these points:

• Whether the shares meet the definition of qualified small business corporation shares, now and over the preceding 24 months.
• How much of the lifetime limit is already used; the limit is indexed to inflation and the CRA’s Form T657 sets out the calculation.
• Whether part of the price will be paid later, since the CRA says the deduction for a gain brought in from a reserve on qualifying shares is based on the year the shares were disposed of.