Tax efficiency on a business sale is relatively straightforward for incorporated advisors. For others, more strategy is required.courtneyk/iStockPhoto / Getty Images
With tax-filing season well underway, most advisors are busy helping clients optimize their annual tax strategy. But for those who own a practice, this time of year is also a great reminder to plan for your financial future, especially when you’re considering selling your book of business.
For incorporated advisors, tax efficiency on a sale is relatively straightforward. Provided most of your corporation’s income comes from active business earnings, you may qualify for the lifetime capital gains exemption (LCGE), which allows you to shelter capital gains from taxes. The LCGE limit is set to increase to $1.25-million for sales as of June 25, 2024, making incorporation an attractive structure for tax planning.
Currently, only mutual fund-licensed advisors can incorporate, although the Canadian Investment Regulatory Organization (CIRO) published a position paper last year that may open up incorporation to all mutual fund and investment dealer representatives. But what if your business is not incorporated? Fortunately, there are still strategies to reduce your tax burden upon a sale. Here are three common approaches:
1. Spread payments in multiple tax years
By structuring the sale as an instalment sale with payments received over two to 10 years, advisors can reduce their marginal tax rate by spreading the consideration over multiple years. This strategy lowers the tax impact in any single year but comes with the risk that the buyer may default on future payments.
2. Utilize a Section 85 rollover
Unincorporated advisors may be able to transfer their business assets, including goodwill, to a newly formed corporation on a tax-deferred basis under Section 85 of the Income Tax Act. That can create a more favourable tax structure when selling to an incorporated buyer. (There are restrictions depending on local securities legislation.)
Here’s how it works:
- You roll your practice into a corporation in exchange for shares.
- You must hold these shares for at least two years before selling.
- If the corporation meets the qualified small business corporation criteria, you may be able to claim the LCGE on the sale, reducing or eliminating taxes on capital gains.
This method allows for tax deferral and potential exemption benefits, but it requires careful planning and carries payment risk if the business doesn’t perform as expected during the holding period.
There are other proactive steps you can take to further reduce the payment and price risk of receiving shares in a corporation (versus cash). For example, you could enter into an option agreement to sell the shares back to the corporation (or its shareholders), which may mitigate the risk that the shares become less valuable over the two-year holding period.
3. Income splitting with family members
If family members work in your practice, you may be able to allocate a portion of the sale proceeds to them, effectively reducing your family’s overall tax burden. This approach aligns with income-splitting rules in which reasonable compensation can be paid to family members actively involved in the business.
However, Canada’s tax on split income rules could limit the benefits of this strategy. If the Canada Revenue Agency deems the income isn’t tied to meaningful involvement in the business, higher tax rates may apply. A tax professional can help ensure compliance.
Start planning early
No matter your approach, planning well in advance – ideally two to five years before the intended sale of your book – is important for finding an optimal tax structure. Planning well ahead of time can ensure the deal aligns with your financial goals while minimizing unnecessary tax exposure.
So, as you navigate tax season for your clients, take a moment to consider your long-term financial strategy. Whether your practice is incorporated or not, proactive planning can save you a significant tax bill when it comes time to sell.
Joe Millott is founder and principal of Acquatio, a Toronto-based company that specializes in wealth management mergers and acquisitions.