Deal Structures And Taxes When Selling Your Small Business
Mar 26, 2025
Key Takeaways
Structure and tax planning can impact your after-tax proceeds as much as or more than the headline price
The Lifetime Capital Gains Exemption (LCGE) can save Canadian business owners up to $242,000 in taxes per qualified shareholder
Share sales are typically more tax-advantageous for sellers, while asset sales are preferred by buyers
LCGE qualification requires meeting specific criteria for at least 24 months before sale
Provincial tax considerations vary significantly across Canada, affecting optimal deal structures
Cross-border sales to U.S. buyers require additional planning for tax efficiency
Expert Canadian advisors are essential for maximizing after-tax proceeds
"What's your number?"
It's often the first question Canadian business owners ask themselves when contemplating an exit. While the headline sale price matters, what you actually pocket after the deal closes can vary dramatically based on how the deal is structured and the resulting tax implications.
The harsh reality? Many Canadian business owners leave significant money on the table by focusing exclusively on the headline price while neglecting the finer points of deal structure and tax planning. A well-structured $4 million deal can put more cash in your pocket than a poorly structured $5 million transaction.
This comprehensive guide will help you navigate the complex world of deal structures and tax strategies to maximize what you actually take home when selling your Canadian business.
The Basics: Asset Sale vs. Share Sale
The most fundamental decision in any Canadian business sale is whether to structure it as an asset sale or a share sale. This choice has profound implications for both buyers and sellers.
Asset Sale: The Buyer's Preference
In an asset sale, the buyer purchases specific business assets and liabilities rather than the legal entity itself.
How it works:
Buyer selects which assets to purchase and liabilities to assume
Seller retains the corporate entity and any excluded assets/liabilities
Buyer receives a stepped-up tax basis in the acquired assets
Why buyers prefer asset sales:
Clean slate: Avoids inheriting unknown or undisclosed liabilities
Tax advantages: Higher depreciation/amortization deductions through stepped-up basis
Cherry-picking: Can select specific assets and leave unwanted liabilities behind
Avoid problematic contracts: May avoid contracts with change-of-control provisions
Share Sale: The Seller's Preference
In a share sale, the buyer purchases the business entity itself, including all assets and liabilities.
How it works:
Buyer purchases your ownership interest in the company
All assets and liabilities transfer automatically with the entity
The business continues uninterrupted; only ownership changes
Why Canadian sellers prefer share sales:
Lifetime Capital Gains Exemption (LCGE): Potentially exempt up to $971,190 (2023) of capital gains from taxation when selling qualified small business corporation shares
Capital gains treatment: Lower tax rate compared to business income
Simplicity: One transaction transfers everything
Cleaner exit: Typically fewer trailing liabilities for the seller
Real-world example: Sarah sold her engineering firm in Vancouver for $3.2 million. Structured as an asset sale, she netted approximately $2.1 million after taxes. Had she negotiated a share sale and qualified for the LCGE, she would have taken home closer to $2.7 million—a $600,000 difference simply due to the deal structure and available tax exemptions!
Canadian Tax Advantages: The Lifetime Capital Gains Exemption
The Lifetime Capital Gains Exemption (LCGE) is one of the most powerful tax advantages available to Canadian business owners—but qualifying for it requires careful planning.
LCGE Basics
2023 exemption amount: $971,190 of capital gains can be exempt from tax
Application: Applies to qualified small business corporation shares (QSBC)
Per-person benefit: Each shareholder may claim their own LCGE
Potential savings: Up to approximately $242,000 in tax savings per qualified shareholder
Qualifying Criteria for QSBC Status
To qualify for the LCGE, your shares must meet specific criteria:
24-Month Holding Period Test: You must have owned the shares for at least 24 months before the sale
50% Asset Test: Throughout the 24 months 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
90% Asset Test: At the time of sale, at least 90% of the fair market value of the corporation's assets must be used principally in an active business carried on primarily in Canada
Common LCGE disqualifiers:
Excess cash or investments not required in the business
Passive assets like real estate not used in active business
Non-Canadian business operations
Pro tip: Begin "purifying" your company at least 24 months before a potential sale by removing excess cash, investments, and non-business assets that could disqualify you from claiming the LCGE.
Family Multiplication Strategies
With proper advance planning, Canadian business owners can multiply the LCGE benefit across family members:
Estate freeze: Restructure ownership to introduce family members as shareholders while freezing your equity value Family trust: Establish a trust with family members as beneficiaries who can each claim the LCGE Spousal ownership: Ensure both spouses own qualifying shares if both are involved in the business
Real-world example: The Jensen family owned a manufacturing business in Ontario. Through careful planning three years before sale, they implemented an estate freeze and family trust that allowed four family members to each claim the LCGE. When they sold the business for $5.6 million, they saved approximately $850,000 in taxes compared to a single-shareholder structure.
Beyond the LCGE: Other Critical Tax Considerations
While the LCGE is powerful, other tax strategies are equally important for Canadian business owners.
Capital Dividend Account (CDA)
What it is: A notional account that allows Canadian corporations to distribute the tax-free portion of capital gains to shareholders as tax-free dividends.
How it works:
50% of capital gains realized by a corporation are added to the CDA
Amounts in the CDA can be paid to shareholders as tax-free capital dividends
Particularly valuable when selling assets within a corporation
Strategic opportunity: When an asset sale is unavoidable, consider selling assets from within the corporation and using the CDA to distribute proceeds, potentially reducing overall tax burden.
The Section 84.1 Trap
What it is: An anti-avoidance rule that can convert capital gains into dividends when selling shares to a non-arm's length party.
Common scenario to avoid: Selling your shares to a holding company you control and attempting to claim the LCGE could trigger Section 84.1, causing proceeds to be taxed as dividends rather than capital gains.
Real-world example: John attempted to sell his business shares to a holding company he controlled, claiming the LCGE. CRA reassessed the transaction under Section 84.1, resulting in dividend treatment and approximately $180,000 in additional taxes.
Earn-out Structuring in Canada
What it is: A portion of the purchase price is contingent on the business achieving certain performance targets after the sale.
Canadian tax implications:
By default, earnouts may not qualify for capital gains treatment or the LCGE
The "reverse earnout" structure can help maintain capital gains treatment
How a reverse earnout works:
Maximum purchase price established at closing
Portion placed in escrow
Escrow released based on performance targets
Unreleased amounts returned to buyer
Entire amount potentially eligible for capital gains treatment
Pro tip: Have your tax advisor review any earnout structure to ensure it qualifies for the desired tax treatment under Canadian rules.
Working Capital Adjustments: Canadian Considerations
Many Canadian sellers are blindsided by working capital adjustments that can significantly impact final proceeds. Understanding this concept is crucial for accurate financial planning.
What is Working Capital?
Simply put, working capital is the money needed to run day-to-day operations, calculated as:
Working Capital = Current Assets - Current Liabilities
Key components include:
Cash (sometimes excluded)
Accounts receivable
Inventory
Prepaid expenses
Accounts payable
Accrued expenses
HST/GST/PST payable or receivable
How Working Capital Adjustments Work in Canadian Deals
Most purchase agreements include a "normal" or "target" working capital amount the business should have at closing. If actual working capital is:
Higher than target: You receive additional payment
Lower than target: Purchase price is reduced
Canadian-specific considerations:
Tax installments: Can affect working capital calculations
HST/GST/PST: Treatment in working capital can vary by province
Seasonal businesses: Canadian seasonal businesses should ensure working capital calculations account for seasonality
Real-world example: Lisa sold her distribution business in Montreal for $5 million with a target working capital of $800,000 based on historical averages. At closing, actual working capital was $650,000. Result: $150,000 was deducted from her proceeds. Had she understood this mechanism, she could have managed inventory and collections more strategically in the months before closing.
Strategies to Optimize Working Capital Adjustments
Understand the calculation method
How many months are used for the average?
Which accounts are included/excluded?
Are seasonality adjustments considered?
How are HST/GST/PST receivables/payables treated?
Negotiate favorable terms
Push for lower target working capital
Exclude cash from the calculation if possible
Include collar provisions (small variations ignored)
Ensure clear definitions to avoid disputes
Strategically manage working capital pre-closing
Accelerate accounts receivable collection
Optimize inventory levels
Time major purchases and payments strategically
Document unusual fluctuations
Alternative Structures for Canadian Businesses
1. Hybrid Asset/Share Deals
What it is: A transaction structured as both an asset and share sale to optimize tax treatment.
How it works:
Certain assets sold directly
Shares of the corporation sold after asset sale
Can address specific buyer concerns while preserving some LCGE benefits
When it's useful:
Buyer has concerns about specific liabilities
Certain assets have specific tax attributes worth preserving
Some assets may not qualify under QSBC rules
2. "Butterfly" Transactions
What it is: A tax-deferred reorganization that allows for division of corporate assets.
How it works:
Corporate assets divided between two or more corporations
Can separate qualifying assets from non-qualifying assets
Potentially preserve LCGE qualification for a portion of the business
Complexity factor: High - requires specialized tax advisors and careful planning
3. Management Buyouts with Vendor Take-backs
What it is: The management team purchases the business with seller financing.
Canadian tax advantages:
Potential to claim LCGE upfront
Spread taxable income over multiple years through prescribed interest rate loans
Maintain economic interest in the business while triggering sale
Real-world example: Alex sold his manufacturing business to his management team for $4.5 million. He structured a vendor take-back loan at the prescribed interest rate, claimed the LCGE on the initial sale, and spread the remaining taxable income over 7 years, significantly reducing his overall tax burden while facilitating succession to his management team.
Provincial Considerations Across Canada
Tax implications vary significantly across Canadian provinces, affecting optimal deal structures.
Ontario
Highest combined tax rates on ineligible dividends (approximately 47%)
Strong emphasis on LCGE planning
Active technology incentive programs that may create valuable tax assets
Quebec
Unique tax environment with provincial investment incentives
Additional compliance requirements for share transactions
Special considerations for French language obligations in transaction documents
British Columbia
Lower corporate tax rates can affect asset vs. share sale calculations
Real estate transfer considerations for transactions involving property
Property transfer tax implications for share sales involving significant real estate
Alberta
No provincial sales tax simplifies asset transfers
Lower personal tax rates can affect overall tax planning
Resource-based businesses have industry-specific considerations
Pro tip: Always involve advisors familiar with your specific province's tax regime when planning a business exit.
Cross-Border Considerations: Selling to American Buyers
With many Canadian businesses selling to U.S. buyers, special considerations apply.
Key Cross-Border Considerations
Currency exchange risk
Consider exchange rate hedging for deferred payments
Explore CAD vs. USD pricing strategies
Understand tax treatment of foreign exchange gains/losses
Section 116 Certificates
Required for non-resident disposition of taxable Canadian property
Buyer may withhold 25% of purchase price without certificate
Process can take 6+ months, affecting deal timing
Treaty-based planning
Canada-U.S. Tax Treaty may provide planning opportunities
Consider treaty-protected shares status
Understand withholding tax implications
Earn-out complications
Different earn-out rules between countries
Consider tax treatment in both jurisdictions
May require specialized structure
Real-world example: A Canadian software company was selling to a U.S. buyer with a significant earnout component. By establishing a special purpose Canadian holding company and utilizing specific Canada-U.S. Tax Treaty provisions, they structured the earnout to receive capital gains treatment in Canada while meeting U.S. tax objectives for the buyer, saving approximately $300,000 in taxes.
Assemble Your Canadian A-Team: Essential Advisors
The complexity of Canadian deal structures and tax considerations makes professional guidance non-negotiable. Here's the advisory team you'll need:
1. M&A Tax Specialist
Look for:
Experience with LCGE planning
Cross-border transaction expertise if relevant
Industry-specific knowledge
Track record of tax-efficient deal structures
Typical cost: $15,000-$75,000+ depending on transaction complexity
2. Transaction Attorney
Look for:
Experience with businesses in your size range
Industry-specific knowledge
M&A specialty (not your general business attorney)
Provincial bar membership where your business operates
Typical cost: $20,000-$75,000+ depending on transaction complexity
3. Investment Banker/Business Broker
Look for:
Experience in your industry and deal size
Track record of maximizing after-tax proceeds, not just headline price
Canadian market knowledge
Cross-border experience if selling to foreign buyers
Typical cost: Success fee of 3-10% of transaction value (varies by deal size)
4. Chartered Business Valuator (CBV)
Look for:
Professional CBV designation
Experience in your industry
Understanding of LCGE valuation requirements
Litigation experience if valuation disputes are possible
Typical cost: $10,000-$30,000+ for comprehensive valuation
Pro tip: Start assembling this team 1-2 years before your planned exit to maximize planning opportunities. The cost of good advice will be dwarfed by the tax savings and deal improvement they facilitate.
Your Pre-Sale Canadian Deal Structure Checklist
Use this checklist to ensure you're addressing key deal structure and tax considerations before going to market:
24+ Months Before Sale
☐ Review QSBC status and address any disqualifying factors
☐ Consider implementing estate freeze or family trust if multiple LCGE claims are possible
☐ Begin purifying company of non-active business assets
☐ Review corporate structure for tax efficiency
☐ Consider U.S. tax implications if cross-border sale is possible
12-24 Months Before Sale
☐ Obtain preliminary valuation from Chartered Business Valuator
☐ Verify 24-month holding period tracking for LCGE
☐ Ensure 50% asset test for LCGE is maintained
☐ Review shareholder agreements and articles for restrictions
☐ Develop working capital optimization strategy
6-12 Months Before Sale
☐ Model tax implications of different deal structures
☐ Develop strategy for Harmonized Sales Tax (HST) or GST/PST
☐ Review customer/vendor contracts for assignability issues
☐ Prepare for representation and warranty negotiations
☐ Consider tax planning for post-sale proceeds
3-6 Months Before Sale
☐ Create preferred deal structure outline
☐ Prepare for working capital negotiations
☐ Finalize LCGE qualification analysis
☐ Develop negotiation strategy for earnout structure
☐ Prepare for due diligence on tax matters
During LOI Negotiations
☐ Ensure deal structure is clearly specified as asset or share sale
☐ Negotiate working capital definition and target
☐ Address HST/GST/PST treatment
☐ Define earnout calculation methods if applicable
☐ Outline indemnification caps, baskets, and escrow terms
Case Study: The $1.7 Million Structure Difference for a Canadian Business
To illustrate the impact of deal structure and tax planning, consider this real-world Canadian example (with names changed):
The Business: Manufacturing company in southwestern Ontario with $7.5 million revenue, $1.4 million EBITDA
Seller: Robert, 59, and his wife Susan, 57, each owned 50% of the shares for 15 years, with plans to retire after sale
Initial Offer: $5.6 million (4× EBITDA), structured as asset purchase with $4.8 million cash at closing, $800,000 earnout
Potential Tax Impact (Without Planning):
Federal/provincial taxes on asset sale: approximately $1.9 million
Net proceeds: approximately $2.9 million cash at closing plus potential earnout
Strategic Restructuring: Working with Canadian advisors, Robert and Susan implemented several strategies:
Converted to share sale and qualified for LCGE
Each spouse claimed full LCGE exemption (approximately $1.94 million combined)
Obtained capital gains treatment on remaining proceeds
Reduced tax burden by approximately $950,000
Implemented estate freeze two years prior
Added two adult children as shareholders
Each child claimed LCGE on portion of gain
Additional tax savings of approximately $400,000
Restructured earnout as reverse earnout
Qualified for capital gains treatment
Established clear, achievable metrics
Included protection against buyer actions that could negatively impact earnout
Optimized working capital provisions
Negotiated seasonal adjustment to working capital target
Excluded HST receivables from calculations
Secured $175,000 more at closing through improved working capital management
Final Result:
Same headline price: $5.6 million
Tax savings through LCGE planning: approximately $1.35 million
Additional proceeds from working capital adjustment: $175,000
Improved earnout structure with higher probability of achievement
Improved after-tax proceeds by approximately $1.7 million
Key Takeaway: For Canadian business owners, the difference between a good and great deal often comes down to structure, LCGE qualification, and provincial tax planning—not headline price. With proper planning and negotiation, Robert and Susan significantly increased their after-tax proceeds without changing the nominal purchase price.
Key Takeaways: Maximizing Your After-Tax Proceeds in Canada
LCGE is a game-changer – qualifying for this exemption can save hundreds of thousands in taxes
Start tax planning early – many powerful strategies require implementation 24+ months before sale
Structure matters as much as price – how you sell can impact your proceeds as much as what you sell for
Provincial considerations matter – tax implications vary significantly across Canada
Focus on after-tax proceeds – a higher price tag doesn't always mean more money in your pocket
Pay attention to working capital – this frequently overlooked detail can significantly impact your final payout
Assemble expert Canadian advisors – the right team will pay for themselves many times over through improved structure and tax savings
Remember that every Canadian business sale is unique, and strategies must be tailored to your specific situation, including provincial tax considerations. The most successful exits come from combining thoughtful advance planning with skilled negotiation and expert guidance from advisors familiar with Canadian tax law. By focusing on deal structure and tax implications—not just the headline price—you'll maximize what matters most: the amount you actually take home after the sale.
