The most important FINANCIAL planning you should do before you sell your business in Canada – get it ready for selling by purifying it

 Importance of becoming a QSBC

In Canada, the Lifetime Capital Gains Exemption (LCGE) provides a significant tax benefit to business owners who qualify. Professional corporations, such as those owned by business owners or other regulated professionals, should aim to take advantage of this exemption. However, to be eligible, the corporation must meet the criteria of being a QSBC – Qualified Small Business Corp.

If you’re a small business owner it’s important for you to understand the tax benefits and eligibility criteria for Qualified Small Business Corporations (QSBCs). Being a QSBC offers significant advantages, including access to the Lifetime Capital Gains Exemption (LCGE) and potential tax savings on income earned inside your corp. Lifetime Capital Gain Exemption, though seemingly simple and attractive, is subject to complex tax rules.

How to qualify as a QSBC

To qualify as a QSBC and use the LCGE, a corporation must meet the following criteria:

1. Canadian Controlled: The corporation must be Canadian-controlled, meaning that at least 50% of the corporation’s shares must be held by Canadian residents or other Canadian-controlled corporations.

2. Active Business: The corporation must primarily carry on an active business in Canada, which excludes certain investment, rental, and passive income activities.

3. Asset Test: The corporation’s assets should consist of assets used in an active business (90%), with some exclusions for non-qualifying assets. This ensures that the corporation is primarily engaged in business activities and isn’t just being used to hold investments. 90% of the business’ assets need to consist of active assets for a 24-month period prior the date you sell your business.

Where most people fail 

This is where many Canadian small business owners looking to sell their business (and their current advisor and accountant) fail in their planning. Business owners who want to take advantage of the Lifetime Capital Gains Exemption when they sell should start the purification process years before they sell in order to qualify for the LCGE and be as tax-efficient as possible.

The last thing you want as a business owner is to sell your business and be forced to hastily purify it in order to try to save around $250,000 in tax!

Before proceeding with the purification process, you should speak to an accountant who specializes in working with business owners and who is familiar with the eligibility requirements for the Lifetime Capital Gains Exemption. As of 2023, the exemption limit is $971,190 (indexed annually) of gains. A good accountant will ensure that your professional corporation qualifies for the exemption and that you meet the necessary ownership and operational criteria (Asset test above). You’ll want to start this process AT LEAST 3 years before you sell your business because of the 24-month rule.

The best way to purify your corporation 

And the best way once you get started typically involves transferring assets to a holding company and/or family trust.

Purifying a professional corporation in Canada to qualify for the Lifetime Capital Gains Exemption is a strategic step that can result in significant tax savings for business owners. However, it is a complex process that requires careful planning and professional guidance. By understanding the eligibility requirements, identifying non-qualifying assets, and following the steps outlined in this post, you can position your professional corporation to take full advantage of the Lifetime Capital Gains Exemption and minimize the tax you pay.