Tax Implications When Selling a Pharmacy
September 12, 2023
To put it mildly, putting up your pharmacy for sale is a big event. For one thing, it can be a complex and even intimidating process. For another, exiting a pharmacy business represents a significant change in your professional and personal life, with all the emotional impact – positive and negative – that goes with that. It is also a (hopefully) huge “liquidity event,” in which you are monetizing the value of the business that you may have spent years building and setting you and your family up for a financially secure future.
There is, however, at least one more way in which selling a pharmacy can be a big event, and it is not anywhere near as pleasant. Selling a business will often require the payment of funds from your pocket to the taxman’s. And if you don’t prepare appropriately, taxes can be a big hit, indeed.
Now, we are not tax accountants. So, consider what we are about to discuss as a general outline, not as tax advice. For that, you should consult a qualified tax specialist, which is something we encourage all our pharmacist-owner clients to do before beginning the sale process.
When you have those conversations with a tax accountant, it helps to be at least generally familiar with the tax consequences of selling a business and the issues to watch out for.
Corporate structure
Multilevel corporate structures and holding personal assets or real estate within a corporation are often used by business owners (and their accountants) to try and minimize taxes. Ironically, those same strategies can create big tax headaches when it comes time to sell.
For many pharmacist-owners, a key factor here is eligibility for the lifetime capital gains exemption (LCGE), which can exempt a shareholder from paying taxes on income up to more than $970,000 realized in a share sale.
But eligibility for the LCGE comes with strict criteria (discussed below), and some corporate structures can make it difficult to meet those. For example:
- An operating company with significant excess cash or investments.
- An operating company with land or buildings as assets.
- An operating company that owns building or land not associated with the pharmacy.
- A holding company that owns an operating company and has other investments.
If those structures might put a business offside of the rules, then the LCGE could be put in jeopardy. “Purifying” a company of non-active assets then may be required, but it can take time. In some cases, an altogether different corporate structure – for instance, a family trust and/or family wealth corporation – can preserve the LCGE and even multiply it across family members. Cost and complexity, however, can be challenges.
Share sale or asset sale?
There are two basic ways to sell a company. The vendor can either sell the equity of the company – its shares – or they can sell the assets of the company, which include things like working capital, equipment, inventory and goodwill.
Usually, a seller will prefer a share sale. It is usually simpler. It also can allow the seller to reap significant tax advantages, especially the LCGE. However, it is typically more expensive to conduct a share sale than an asset sale.
On the other hand, buyers generally prefer asset sales. When they purchase assets and not the company, the buyer is not taking on any of the selling company’s liabilities or any redundant (non-active) assets, and there might even be tax advantages through capital depreciation write-downs.
Which is right for you? That depends on your business and your situation, of course, but most pharmacist-owners will try to do everything they can to maintain the benefit of the LCGE.
Preparing for LCGE
As we noted above, qualifying for the capital gains tax exemption requires meeting some strict criteria. Basically, there are three tests your company must pass:
- Holding period test: The disposed share must have been owned by the shareholder or a related person throughout the 24-month period prior to the disposition.
- Basic asset test: Throughout the two years prior to the sale, the corporation must have been a Canadian-controlled private corporation and more than 50% of the company’s assets had to have been used in an active business carried on primarily in Canada.
- Small Business Corporation (SBC) test: At the time of the sale, at least 90% of the company’s assets must be used in an active business carried on primarily in Canada.
If your company cannot pass those tests and you want to claim the LCGE – well, you and your tax account probably have work to do!
The year-end tax review
Having a year-end discussion with your accountant about your company’s tax standing is something we always recommend. It’s just good tax hygiene. And if you are even beginning to think about selling your pharmacy, those discussions should include what you need to do get your business ready for sale:
- Identify redundant assets
This is an important step towards passing the active asset tests for QSBC status. Do you need to conduct an asset purification? Or perhaps use a different corporate structure to move those assets out of the company? - Get externally prepared financial statements
Do you have any? When you want to sell your business, externally prepared financial statements are the first things a potential buyer will want to see. If you do not have them, then you will be scrambling right out of the gate. Better to get them done every year. - Check corporate tax attributes
Certain tax-relevant corporate accounts (like the RDTOH, PUC and CDA) can have substantial tax impacts at sale, so discuss where they stand with your accountant. - Assess your tax planning needs
If you are the only shareholder and you think the business is worth more than the lifetime capital gains exemption, it might be the right time to discuss alternative strategies like a holding company or an estate freeze. If it’s appropriate, a good accountant can help.
The worst time to start thinking about the tax ramifications of selling your business is when you get an offer. The good news is that with a little preparation and good communication with your tax advisor, you can make the most out of one of the biggest financial events of your life – without losing a big chunk of your wealth to the taxman.
[…] significant. But, importantly for anyone selling a business, the company must meet stringent criteria to qualify for the LCGE. A big one is that more than 50% of assets in the company must be active […]