Many clients ask the question on whether it makes more sense to incorporate a business or operate as a sole proprietorship. Both ownership structures offer their own unique advantages and disadvantages. Choosing one will involve considering your current situation and your future plans. On the topic of future plans, one very important tax consideration that may impact your decision about incorporating is your exit strategy for the business.
If your exit strategy, or retirement plan is to build a saleable business then it is important to understand that there is a distinct tax advantage to owning an incorporated business, where you can sell the shares of the company, as opposed to the assets.
The sale of Qualified Small Business Corporation Shares (QSBC) generally qualifies for the Lifetime Capital Gains Exemption.
As the seller of the shares, your proceeds in excess of the adjusted cost base and certain selling expenses, results in a capital gain. The capital gain from the sale of property is 50% taxable. For example, if the gain is $500,000 then $250,000 is normally subject to capital gains tax. However, if the shares count as QSBC shares, you can claim a lifetime capital gains exemption to shelter all or part of the gain from tax. This lifetime capital gains exemption for QSBC shares is $883,384 in 2020 and is only available to individuals who are Canadian residents.
So, to have this tax strategy work in your favor, you first need to own shares in an incorporated company, and not be in the situation of selling the assets of a sole proprietorship. This is one of the main advantages of incorporating your company if you have a saleable business!
Next you need to make sure that the shares qualify as QSBC shares. The shares of your Canadian-controlled private corporation generally must meet three conditions:
At the time of sale, 90% or more of the fair market value of the corporation’s assets must be used principally in an active business carried on primarily in Canada (either by the corporation or by a related corporation), be shares or debt in a connected small business corporation, or be a combination of both.
In the 24-month period immediately preceding the sale, more than 50% of the fair market value of the corporation’s assets must have been used principally in an active business carried on primarily in Canada, invested in shares or debt of a qualifying connected corporation, or a combination of both.
The shares must not have been owned by anyone other than the individual seller or a person or partnership related to the seller during the 24-month period immediately preceding the sale.
In conclusion, if your plan is to build value to your business and then sell it as part of your retirement or exit strategy, an incorporated business allows you to sell the shares and shelter that capital gain from taxes. For the right business and the right business owners, this may be the most impactful reason for incorporation.
I hope that this article was helpful - please give us a call if you have any questions related to bookkeeping, & small business finance in general!
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