When selling a business, there are assets like property tied to the business, and as such, it may seem logical to just sell the property. After all, many businesses own the property where their physical storefront operates, be it owned outright or under mortgage(s). However, with careful tax planning based on share sales of qualifying small business shares and the consequent application of the lifetime capital gains exemption, business owners can nullify the tax consequences related to the sale of a business. This planning depends on a few key considerations.
The Tax Outcome of a Sale – Capital Gains and Losses
Upon any sale, the proceeds of what is being sold may be more than what was originally paid, in addition to how much it cost to make that investment; this is what is referred to as a "capital gain".
In the inverse, the proceeds may be less than what was originally paid, in addition to how much it cost to make that investment; this is what is referred to as a "capital loss".
These concepts are important because they have significant tax consequences: capital gains over $250,000 are currently taxed at 50% (with the rate to jump to 66.6% on January 1, 20261), while capital losses are a bit more nuanced. Capital losses, in the year that they are applied to reduce taxable capital gains, will then become net capital losses if there are more capital losses than can be applied to taxable capital gains for that year. These net capital losses then become essentially permanent reserves that can be accessed to offset future (or even past) taxable capital gains. Net capital losses can offset any previous 3 years' taxable capital gains, or indefinitely into the future2.
Essentially, you either pay taxes, reduce your taxes, and/or create a bank of losses to apply against future taxes.
Offsetting Capital Gains – Share Sale and Lifetime Capital Gains Exemption
Rather than selling assets, a potentially more effective way of selling a business, depending on prior business organization planning, would be to sell the shares of the business, rather than the assets. As opposed to selling the assets, selling the shares would transfer not only the assets, but also the liabilities of the transferor to the transferee, which may make winding up a business much less of a hassle in the long run3.
Not all businesses operate under share structures, and typical "mom and pop" shops may operate as sole proprietorships. Businesses that operate under share structures who decide to go through a share sale might find themselves reaping the benefits of the lifetime capital gains exemption. A lifetime capital gains exemption is an exemption on capital gains for a specified amount throughout the lifetime of the individual claiming it4. As of July 31, 2025, the lifetime limit is $1,250,000 for qualifying sales, which, for many small businesses winding up, is essentially a complete shield against taxable capital gains5. This is even more pertinent in times where the capital gains tax rises, as it is planned to in 2026.
The Test to Apply the Lifetime Capital Gains Exemption
The test to qualify for the lifetime capital gains exemption applying following a share sale, while fairly strict, is, at its core, not particularly difficult for small Canadian businesses to meet. Per section 125(7) of the Income Tax Act (the "ITA"), the corporation must be what is known as a "Canadian-controlled private corporation" or "CCPC"6. This is effectively a private Canadian corporation other than a corporation controlled by right or, in effect, by non-residents or public corporations. More specifically, the key trait of a CCPC is that it is not foreign-controlled, meaning 50% or more of the shares must be held by Canadian residents, and it cannot be controlled in effect by non-residents7.
The other part of the test is to determine whether the shares disposed of qualify as qualifying small business corporation, or "QSBC", shares. Per section 110.6(1) and section 248(1) of the ITA, QSBC shares exist, at determination time, when a CCPC has at least 90% of its fair market value of assets attributed to being used mainly in an active business carried on primarily in Canada by the corporation or a related corporation, among two other situations; however, this is the most prevalent amongst CCPCs and thus deserves particular attention8. Otherwise, there is a requirement of continuous ownership by the individual or a related person throughout the prior 2 years, and a requirement of more than 50% fair market value of assets attributed to assets used principally in an active business carried on primarily in Canada by the corporation or related corporation throughout the prior 2 years. The latter requirement may seem redundant, but it exists to prevent businesses from aggressively disposing of passive assets right before a share sale to qualify as disposing of QSBC shares.
As such, one of the more common ways to disqualify a business for QSBC share status and consequently the lifetime capital gains exemption is based on what assets are being used by the business; there needs to be a concerted effort to extract passive assets from the business.
A tax planning lawyer can help with that and explain in more detail all the nuances of these tax designations and the potential benefits and risks. If there is one key message to be imparted, it is that it is never too early to start tax planning.
Footnotes
1. Scotiabank. Everything you need to know about capital gains tax in Canada. https://www.scotiabank.com/ca/en/personal/advice-plus/features/posts.everything-you-need-to-know-about-capital-gains-tax-in-canada.html
2. Canada Revenue Agency. Line 25300- Net capital losses of other years. https://www.canada.ca/en/revenue-agency/services/tax/individuals/topics/about-your-tax-return/tax-return/completing-a-tax-return/deductions-credits-expenses/line-25300-net-capital-losses-other-years.html;Canada Revenue Agency. Definitions for capital gains. https://www.canada.ca/en/revenue-agency/services/tax/individuals/topics/about-your-tax-return/tax-return/completing-a-tax-return/personal-income/line-12700-capital-gains/definitions-capital-gains.html
3. CanadiansMe. Key Considerations Before Selling Your Business: Navigating Asset Sale vs. Share Sale. https://canadiansme.ca/key-considerations-before-selling-your-business-navigating-asset-sale-vs-share-sale/
4. CPA. Claiming the lifetime capital gains exemption on holding company shares. https://www.bccpa.ca/news-events/cpabc-newsroom/2022/november/claiming-the-lifetime-capital-gains-exemption-on-holding-company-shares/
5. BMO. Lifetime Capital Gains Exemption demystified: Strategies for maximizing your gains. https://privatewealth-insights.bmo.com/en/insights/wealth-planning-and-strategy/lifetime-capital-gains-exemption-demystified-strategies-for-maximizing-your-gains/ ; Government of Canada. Line 25400- Capital gains deduction. https://www.canada.ca/en/revenue-agency/services/tax/individuals/topics/about-your-tax-return/tax-return/completing-a-tax-return/deductions-credits-expenses/line-25400-capital-gains-deduction.html
6. Income Tax Act, RSC 1985, c 1 (5th Supp), s 125(7).
7. Government of Canada. Type of corporation. https://www.canada.ca/en/revenue-agency/services/tax/businesses/topics/corporations/type-corporation.html
8. Income Tax Act, RSC 1985, c 1 (5th Supp), s 110.6(1), 248(1); Small Business Corporation (SBC), Practical Law Canada Glossary 2-569-6220.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
