The seller who has spent twenty years building a company and three months negotiating its sale will often spend one afternoon on the tax, usually after the price is agreed, and that is exactly the wrong order. On a $3 million sale, the difference between a well-prepared share sale and an unprepared asset sale can be several hundred thousand dollars, and nearly all of it is decided by things that have to be done before the letter of intent — some of them 24 months before. Tax is not a line item at closing. It is a term of the deal.
Share sale or asset sale: the fork in the road
| Share sale | Asset sale | |
|---|---|---|
| Who sells | The shareholders, personally | The corporation |
| What is taxed | Capital gain on the shares, in the shareholder's hands | Recapture and capital gain inside the corporation, then dividends to get the cash out |
| Lifetime capital gains exemption | Available on qualifying shares, per shareholder | Not available |
| Layers of tax | One | Two (corporate, then personal), partly relieved by the capital dividend account and refundable tax |
| Buyer's view | Inherits all liabilities and the old tax cost of the assets | Picks the assets, leaves the liabilities, gets a stepped-up cost base to depreciate |
| Typical effect on price | Buyer discounts for inherited risk and lost depreciation | Seller asks for more to offset the extra tax |
We cover the non-tax side of the choice in share sale vs asset sale. On the tax side alone, the share sale wins for most owner-managed sellers because of one number.
The lifetime capital gains exemption
The lifetime capital gains exemption shelters up to $1.25 million of capital gain on the sale of qualified small business corporation shares, per individual, over a lifetime (the figure is indexed to inflation again from 2026). A husband and wife who each own shares can each claim it. A family trust that holds shares can allocate the gain to several beneficiaries who each claim it — the reason family trusts are put in place years before a sale. At Ontario's top marginal rate, one exemption is worth roughly $335,000 in tax; multiplying it across a family is where the real planning money sits.
The shares have to qualify, and this is the 24-month problem. Three tests: at the moment of sale, 90% or more of the fair market value of the corporation's assets must be used in an active business carried on primarily in Canada; throughout the 24 months before the sale, more than 50% of the assets must have been so used; and nobody other than the seller or a related person can have owned the shares during those 24 months. A company that has been parking surplus cash, an investment portfolio or a rental property on its balance sheet fails the 90% test on the day of sale and possibly the 50% test for the two years before it. “Purifying” the corporation — moving the passive assets out to a holding company — is routine, but it has to be done in time, and it has its own tax consequences if done badly.
What is left after the exemption
Capital gains are included in income at 50%. The proposed increase to two-thirds was cancelled in March 2025 and is not coming back in the current budget cycle, so a $2 million gain above the exemption produces $1 million of taxable income, taxed at the seller's marginal rate — at the top Ontario bracket, about 26.8% of the gain. Two tools soften that.
The capital gains reserve lets a seller who is paid over time defer the gain and bring in at least one-fifth of it each year over up to five years (ten years for a qualifying transfer of small-business shares to a child). If the buyer pays $3 million over four years, the seller is not taxed on $3 million in year one. The reserve is elected annually and lost if the seller becomes a non-resident, so it needs to be managed rather than assumed.
Alternative minimum tax is the surprise. A large exemption claim in a single year can trigger AMT, because a portion of the sheltered gain is added back for AMT purposes. Since 2024 the AMT rate is 20.5% on adjusted taxable income above the exemption threshold, and a full $1.25 million LCGE claim can produce an AMT bill in the low six figures. It is a prepayment rather than a cost — AMT is recoverable against ordinary tax over the following seven years — but a seller who retires on the sale proceeds and has little income afterwards may never recover it. This is genuinely the most common unpleasant surprise in an otherwise well-planned share sale, and it is the accountant's job to model it before you sign.
Earn-outs, non-competes and the price of allocation
An earn-out — part of the price contingent on future results — is taxed under the cost-recovery method the CRA permits for share sales, provided the earn-out relates to goodwill and runs no more than five years; get the conditions wrong and the contingent payments can be taxed as income rather than capital gain. A payment for a non-competition covenant is ordinary income to the seller unless a joint election is filed to treat it as part of the sale proceeds, which is a form the seller's lawyer should have on the closing agenda and the buyer's lawyer has no reason to volunteer. In an asset sale, how the price is allocated among goodwill, equipment, inventory and real property decides the seller's recapture and the buyer's future deductions, and the parties' interests are opposed on every line; the allocation is negotiated, not filled in afterwards.
Selling to your employees or your children
Two newer routes change the arithmetic. A sale to an employee ownership trust now carries a $10 million capital gains exemption for the seller, on top of the ordinary rules, and Parliament made the measure permanent in 2026. And since January 2024 a genuine intergenerational transfer to a corporation owned by an adult child or grandchild can be taxed as a capital gain, eligible for the exemption, rather than being recharacterised as a dividend — the trap that made selling to your own children more expensive than selling to a stranger for a generation. Both routes have detailed conditions, immediate and gradual transfer tests, and multi-year hold periods; both reward a seller who starts three years out.
What to do 24 months before you sell
Have the accountant test the shares against the 90% and 50% rules today and purify if needed. Look at whether spouses, children or a family trust should own shares, and what it costs to put them there now versus what it saves. Check that the corporation's tax accounts — the capital dividend account, refundable dividend tax on hand, safe income — are calculated and current, because they decide how cheaply an asset-sale price can be extracted if the buyer refuses shares. Model the AMT. And decide, before the first buyer calls, whether you will sell shares or assets and at what price difference you would switch, because the buyer's first question will be which one, and the answer is worth more than most of the negotiation that follows.
Nothing on this page is tax advice; it is a map of the terrain a seller has to cross. The advice is the part where an accountant puts your balance sheet on it. Get that done before you agree to a price, and the price will be the number you keep.
Common questions
How is the sale of a business taxed in Canada?
It depends on what is sold. In a share sale the shareholders pay capital gains tax on the gain, half of which is included in income, and may shelter up to $1.25 million with the lifetime capital gains exemption. In an asset sale the corporation pays tax on recapture and capital gains, and the shareholders pay again when the proceeds are paid out as dividends.
What is the lifetime capital gains exemption in 2026?
$1.25 million per individual on qualified small business corporation shares, qualified farm property and qualified fishing property, indexed to inflation again from 2026. It is a lifetime limit, so earlier claims reduce what is left. Confirm the current figure with the CRA or your accountant.
What are the conditions for qualified small business corporation shares?
At the time of sale, 90% or more of the fair market value of the corporation's assets must be used in an active business carried on primarily in Canada; for the 24 months before the sale, more than 50% must have been; and the shares must not have been owned by anyone other than the seller or a related person during those 24 months.
Is it better to sell shares or assets for tax purposes?
For a Canadian owner-manager, usually shares, because of the lifetime capital gains exemption and the single layer of tax. Buyers usually prefer assets because they avoid inherited liabilities and get a higher cost base to depreciate. The difference is normally reflected in the price, so you are actually comparing what each structure leaves you after tax at the price the buyer will pay.
What is the capital gains reserve?
Where part of the sale price is payable after the year of sale, the seller can defer part of the capital gain, recognising at least one-fifth each year over up to five years (ten for a qualifying sale of small-business shares to a child). It is claimed annually on the tax return and is lost if the seller becomes a non-resident.
Can the alternative minimum tax apply when I claim the capital gains exemption?
Yes. A large exemption claim in one year can trigger AMT at 20.5% because part of the sheltered gain is added back for AMT purposes. AMT paid is recoverable against regular tax over the following seven years, but a seller with little income after the sale may not recover all of it, so it should be modelled before closing.
How is an earn-out taxed in Canada?
On a share sale, the CRA allows the cost-recovery method where the earn-out relates to goodwill, the contingent period does not exceed five years and other conditions are met, so contingent payments are treated as proceeds and taxed as capital gain when received. If the conditions are not met, the payments can be taxed as income.
Are there special tax rules for selling to employees or family?
Yes. A sale to an employee ownership trust carries an additional $10 million capital gains exemption, now permanent. A genuine intergenerational transfer to a corporation owned by an adult child or grandchild can be taxed as a capital gain, with the lifetime exemption available, instead of as a deemed dividend, provided the strict conditions in effect since 2024 are met.