How are you taxed when you sell a small business?

I will focus on the income tax implications of the sale. The tax treatment will vary depending upon whether your business was a sole proprietorship or a corporation. 

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

When a sole proprietor sells their business, they are selling the assets of their unincorporated company. Assets can include intangible items like goodwill or clients, as well as tangible items like inventory or machinery. You may sell some or all of the assets. 

The sale is generally taxable as a capital gain based on the difference between the proceeds and the cost of the assets, with personal tax ranging from 0% to 27%, depending upon your other sources of income and your province of residence. 

If you have claimed depreciation on the assets, there may be a recapture with past depreciation (capital cost allowance) brought into income and generally taxable at rates ranging from 0% to 55% depending upon your income and province. 

When an incorporated business owner sells their business, the tax treatment depends upon whether it is an asset sale or a share sale, Peter. 

What about for the owner of an incorporated business?

When you sell the assets of your business, your corporation sells them, yet you own the corporation. You may sell some or all the assets. Generally, the proceeds minus the cost amount is taxable as a capital gain, with corporate tax in the 25% range payable on the income depending on your province. If you claim depreciation of these assets, there may be a recapture with past depreciation (a.k.a. capital cost allowance) brought into corporate income. And taxable at rates tend to be between 9% and 31%, depending upon location and other factors.

The initial tax implications upon selling assets of an incorporated business are corporate tax implications, Peter. The shareholder then has personal tax payable to the extent they wish to withdraw money from the corporation afterward. 

What is lifetime capital gains exemption?

When you sell the shares of a business, you are giving up ownership of the corporation. The sale of the shares may qualify for the lifetime capital gains exemption (LCGE). The LCGE allows a tax-free capital gain of up to $1,016,836 for 2024 on the sale of qualified small business corporation shares. 

A small business corporation is defined as a Canadian-controlled private corporation in which all or most (90% or more) of the fair market value of its assets are used mainly in an active business carried on primarily in Canada by the corporation or by a related corporation; are shares or debts of connected corporations that were small business corporations; or are a combination of these two types of assets. 

According to the Canada Revenue Agency (CRA), the following conditions must be met for the sale to qualify:

• “at the time of sale, it was a share of the capital stock of a small business corporation, and it was owned by you, your spouse or common-law partner, or a partnership of which you were a member

• “throughout that part of the 24 months immediately before the share was disposed of, while the share was owned by you, a partnership of which you were a member, or a person related to you, it was a share of a Canadian-controlled private corporation and more than 50% of the fair market value of the assets of the corporation were:
  • “used mainly in an active business carried on primarily in Canada by the Canadian-controlled private corporation, or by a related corporation
  • “certain shares or debts of connected corporations
  • “or a combination of these two types of assets

• “and throughout the 24 months immediately before the share was disposed of, no one owned the share other than you, a partnership of which you were a member, or a person related to you”

It bears mentioning that a sole proprietor can transfer their sole proprietorship into a corporation on a tax-deferred basis. So, a sole proprietor may be able to benefit from the lifetime capital gains exemption by restructuring their business, as well as some of the other potential benefits of incorporation. 

Other complexities may reduce the eligibility for a tax-free capital gain on the sale of your business if it was incorporated and you sold the shares, Peter. But hopefully the above information reinforces why there is no easy answer to the tax implications of the sale. There are a lot of considerations. 

Why the CRA doesn’t give tax advice

It bears mentioning that CRA does not generally give tax advice. They can provide general information, but even then, taxpayers should be very careful about relying on the accuracy of answers from the CRA. Professional advice can be beneficial, especially for a large transaction like the sale of a business, real estate, or other valuable asset. Proactive tax planning before a transaction instead of retroactive tax reporting afterwards may also help a taxpayer to save tax.

Read more about personal income taxes in Canada:

• Tax implications of making transfers between registered accounts
• How to calculate the taxable amount for a cashed-in whole life insurance policy
• Can you file multiple years of income taxes together in Canada?
• Canada’s income tax brackets for 2023, plus the maximum tax you’ll pay based on income

About Jason Heath, CFP

Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto. He does not sell any financial products whatsoever.

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