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The Tax Side of Buying and Selling a Business
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When you are looking into buying or selling a business, there are really only two options:
- To buy or sell the assets of the business
- To buy or sell the shares of the company that run the business
The first is known as an asset sale; the second is a share sale. There are tax advantages to both.
1. Asset Sales
An asset sale is where you buy the assets of a business, such as furniture, equipment, accounts receivable, inventory and leasehold improvements.
An Example
The sale price of a small grocery store can be broken down into:
|
Equipment |
$5,000 |
|
Delivery Van |
$2,000 |
|
Inventory/Stock |
$9,000 |
|
Leasehold Improvements |
$1,000 |
The fair market value (FMV) for these assets is $17,000. This price is the estimated cost that a person would pay for these assets.
The actual price paid by the 3rd party is $20,000. The difference between the price paid and the FMV is known as ‘Goodwill’. In this example the Goodwill purchased would be $3,000.
The Tax Rules
Many business owners make the mistake of thinking that the total price paid for the goods can be written off in one go, however this is not the case. Under the Canadian tax system, the cost of assets must be deducted over several years. This is known as depreciation. The system also requires that difference assets are deducted at different rates. This is known as capital cost allowance.
Using the grocery store example, the capital cost allowance would look like this:
|
Equipment |
20 per cent per year |
|
Delivery Van |
30 per cent per year |
|
Inventory/Stock |
20 per cent per year |
|
Leasehold Improvements |
20 per cent per year |
Note: As Inventory/Stock is written off as part of cost of goods sold it has no depreciation.
Calculating the cost capital allowance of goodwill is quite a complicated formula which varies from business to business, even if they are in the same industry, but, in essence, is deducted at around five per cent per year. There are also rules for assets purchased in a year, but this gives you an idea of the principles of depreciation.
The Advantages of Asset Purchase
The advantage of an asset purchase is that you able to negotiate what price is paid for what assets so that you receive the most desirable tax benefit; you do not inherit any of the liabilities of the existing business and you get to start with a clean set of books.
Recapture Income
Recapture income is the difference between the amount received for an asset and the depreciated value of it. For example, if you sell an asset that is on your books at $2,000 for $2,500, you will be faced with recapture income of $500. This must be reported as income in your end of year accounts.
2. Shares Sales
The second option is a share purchase/sell. If you have an incorporated company, you may wish to consider selling the shares of the business. The advantages of this option are numerous, but there are many pitfalls as well.
The Value of a Name
One benefit is the continuing name of the business. If you are buying ABC Market because ABC has a good name and the name alone is bringing in business, you may wish to consider buying the shares of ABC Market Inc. The share purchase will result in all assets of the business, including the name, being transferred with the shares of the company to you.
The Liabilities
However, with the all assets come liabilities. For example, if there is an audit of the books of ABC Market and it is determined that there are taxes due for a year prior to you owning the business, you as a shareholder will be liable to pay those taxes. It is therefore useful to consider including a clause in your purchase agreement that dictates the old owner of the business will be responsible for those taxes. However unless they pay voluntarily, you will have to sue to collect your money.
Tax Exemptions for Share Sales
On the positive side, if the business you are selling is classified as an active business for tax purposes, you may be able to sell your shares and pay no taxes on the proceeds. Every Canadian resident is eligible for a $750,000 lifetime capital gains exemption; therefore if you bought shares in a business for $1 and sold them for $20,000, you would pay no tax on the sale. The hard part will be to find an unrelated buyer willing to assume the history that comes with the shares of a company.
The Importance of Good Legal and Accounting Advice
Whichever scenario you choose to take, it is always important to seek good legal and accounting advice. Structuring a purchase or sale of a business is a big and complicated task that can mean the difference between paying low, average or high taxes; so be sure to consult with your professional adviser before you sign off on a deal.
About the Author:
Gabrielle Loren
Gabrielle Loren is a Certified General Accountant and partner with Loren, Nancke & Company. She was employed by Revenue Canada Taxation for 8 years; 4 of which were completed in the audit division. Gabrielle started as a home based accounting practice in 1989 with a handful of clients in varying industries. Over the past 20 years this client base has grown in both size and industries and evolved into Loren & Company in 1997 and then to Loren, Nancke & Company in 2007.
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