Selling a Business: Prepare for the Tax Hit
20 January 2025: Selling a Business: Prepare for the Tax Hit.
“Capital gains tax will drive down competition, chase away investment: study”
That’s the headline of an article I read this past weekend – an article that all business owners and small real estate investors ought to read.
As it happens, for most of us – those working in the U.S. – this headline represents a bullet we just dodged. But for some of us – specifically our Canadian brokers and Canadian business owners in general – this headline represents reality. The article it leads is a clear explanation of the idiocy of government bureaucrats – or perhaps the willful deception practiced by those bureaucrats – and the ignorance of most of the media.
At noon today in Washington, DC, Donald Trump, a Republican, was inaugurated as the 47th president of the United States. As a result of the November election, he takes office with the Republicans, the conservative party, enjoying majorities in both chambers of the U.S. Congress, where tax law and spending policies are hammered out. From Trump on down, they campaigned on more freedom, smaller government, fewer regulations and lower taxes. Anyone who’s been paying even a modicum of attention knows that, had the other team won, we’d be facing, as promised, less freedom, bigger government, more regulations and higher taxes.
To business owners, business brokers and even business buyers, these election results are significant.
But our Canadian colleagues are not as fortunate. The collapse if the Trudeau government notwithstanding, the Liberals, in power for the last dozen or so years, passed a budget in 2024 that included an increase in the capital gains tax in a grossly misguided effort – one that betrays a bad case of financial illiteracy – to increase the government’s income stream to cover its outrageous spending.
So, what happened? Here’s the lead paragraph posted in True North Wire and authored by Quinn Patrick:
The Liberals’ increased capital gains tax rate will likely hurt the country’s competitiveness globally. A new study finds its effects will reverse “investment, productivity, entrepreneurship, and innovation in Canada.”
The Impact of Capital Gains Taxes
The article is a brilliant explanation of how business owners – and the buyers who become business owners – are going to get clobbered at the sale (in the case of buyers, the eventual sale) of their businesses.
The article goes on to state…
According to research released by the Fraser Institute, increasing the number of Canadians included in the new capital gains tax bracket will ultimately lower the country’s “competitiveness relative to other advanced countries.”
“At a 50% inclusion rate, Canada’s top capital gains tax rate ranked between 17th and 23rd, depending on the province, out of 37 OECD countries,” reads the study [referring to the Organization for Economic and Cooperation and Development].
The newly hiked capital gains tax was part of the Liberals’ 2024 federal budget, requiring Canadians making more than $250,000 in capital gains annually to pay taxes on two-thirds of that profit instead of half.
The Department of Finance said that the $250,000 threshold was created to “ensure this increase in the capital gains inclusion rate is concentrated among the wealthiest, while keeping taxes lower on the middle class.”
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According to the 2024 Budget, the tax should only affect “0.13% of Canadians with an average gross income of $1,411,000 per year (including capital gains) would face higher capital gains taxes as a result” in 2025.
However, the Fraser Institute takes issue with the government’s figure, saying that it misrepresents how far the tax extends. The study noted how capital gains taxes are “incurred infrequently and involve assets purchased decades ago that have significantly appreciated in value.”
“A small business owner selling a business at retirement or a family selling their cottage represents two instances that may occur only once or twice in a lifetime, generating capital gains far exceeding what could be considered a modest income,” reads the study.
Some Math…
“In these cases, the year in which individuals sell their assets—and realize a capital gain—becomes a year in which their income is greatly inflated and not representative of their typical earnings.”
For example, an individual who earns $80,000 per year may take in a capital gain of [$2.4] the year that they decide to sell their [business], which they may have owned for decades. Despite otherwise earning a middle-class income, that individual will have to report earnings of [$2,480,000] that year, meaning that they have well exceeded the $250,000 threshold.
That individual would now be forced to pay higher taxes under the Liberals’ expanded inclusion rate.
The government’s decision to raise the inclusion rate to 66.7% moves Canada up the ranks of between eighth and 13th highest of any OECD country, depending on the province.
“Simply put, Canada now has effectively no capital gains tax advantage over three-quarters of OECD countries,” said study authors Jake Fuss and Grady Munro.
Yes, the article and the study it refers to focus more on the impact on Canada’s global competitiveness. But if you do the math, it’s also a cautionary note to business owners and entrepreneurs. In the example above, an additional $410,000 will now be subject to capital gain taxes at rates that range between 62% and 69% (federal and provincial), depending on the province. That ain’t chump change!
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More from the article…
The study goes on to say that by reversing such actions and lowering the inclusion rate to one-third of the [capital gain], Canada could put itself back on the map in terms of global competitiveness.
“At a 33.3% inclusion rate, Canada’s top capital gains tax rate would rank between 30th and 31st [of the 37 OECD countries]. In other words, every Canadian province would enjoy a lower top capital gains tax rate than the majority of OECD countries,” it said.
Despite Prime Minister Trudeau’s resignation and subsequent proroguing of Parliament, the Canada Revenue Agency confirmed it will continue to administer the Liberals’ increased capital gains tax rate.
The CRA intends to do so even though it hasn’t passed in Parliament. (Italics added.)
The article concludes with the following…
The Fraser Institute projects that entrepreneurs and innovators will be hurt the most by these changes. Additionally, “investors may sell off their share of whatever new technology or business is created.”
“By depressing the level of entrepreneurship and innovation, capital gains taxes ultimately lower technological advancements, employment, and overall economic growth productivity and overall economic growth,” it said.
The study emphasized the importance for the government to recognize that Canadian businesses are also competing with other businesses globally, not just domestically.
The new increase is not only detrimental for higher taxes “relative to what they used to be within Canada, but that it raises Canada’s capital gains taxes relative to other countries towards which capital investments could be redirected.”
However, the authors argue that a reversal of the Liberal’s recent decision “would foster higher rates of economic growth and help boost living standards for Canadians.”
The Bottom Line
A 33.3% inclusion rate – as reference above – would reduce the taxable portion of the gain on our theoretical business which, in turn, would reduce the portion of taxable income to $825,840 from the pre-June 2024 level of $1,240,000 and, more significantly, from $1,654,000 from the new current level (“…even though it hasn’t passed in Parliament.“).
Those of you who’ve followed this blog for any appreciable length of time, probably know that, as business brokers, we believe that the owners/entrepreneurs that we represent DID “build that” (notwithstanding the claim of a recent U.S. president who never worked in the private sector) and as business owners ourselves, we believe that the people who built business and created jobs are FAR more competent in putting their money to good us than tens of thousands of bureaucrats who’ve never made a payroll.
If you have any questions or comments on this topic – or any topic related to business – I’d like to hear from you. Put them in the comments box below. Start the conversation and I’ll get back to you with answers or my own comments. If I get enough on one topic, I’ll address them in a future post or podcast.
I’ll be back with you again next Monday. In the meantime, I hope you have a safe and profitable week.
Joe
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The author is the founder, in 2001, of Worldwide Business Brokers and holds a certification from the International Business Brokers Association (IBBA) as a Certified Business Intermediary (CBI) of which there are fewer than 1,000 in the world. He can be reached at
jo*@Wo*******************.com