Taxes on Buying or Selling a Business
Whether you are buying or selling a business it is important you understand the consequences of both sides for tax purposes. The biggest factor of how your taxes are affected resides in your purchase agreement. You need to consult with your legal counsel to ensure your agreement will get the tax treatements as discussed in this article. In general there are 2 ways you can buy or sell a business, it is either a share sale or an asset sale.
Share Sale Scenario
Under this method the vendor sells the shares of their company and the buyer acquires these shares from the vendor directly. That means all the assets and liabilities including the bank accounts, debts, equipment will become the property of the buyer. Let me caveat that point, everything on the balance sheet has not changed hands, technically the company stays the same as it is. It is the company itself that has changed ownership. For example, if the company owned some equipment then the title of that equipment is still the same company. The owners of such company is what changes.
This is important to understand because from the buyer's perspective if there are unwanted items owned or owed by the company then the buyer has effectively taken responsibility for those too. If the company owed tax money to the Canada Revenue Agency, then unfortunately it becomes the issue of the buyer.
The biggest thing for the vendor is the ability to use Lifetime Capital Gains Exemptions on shares sale of a qualified small business. This is a very technicaly term which you need to discuss with your accountant on whether this applies to you. If you are a qualified small business, then that means the capital gain on the first $750,000 during your life time on a share sale will be tax free.
From the buyer's perspective, if you are financing the transaction then you need to be careful with share purchases. Remember if you are buying shares, then the ownership of the specific assets owned by the company has not changed hands. That means if you are financing then the interest expense tied to this financing is tied to you personally, and not the company. You will not be able to deduct interest expense on your financing. In addition, as the purchase price is tied to you personally, and is not part of the company, then the company is not adding that purchase price onto its balance sheet, which ultimately means you can't write off the purchase price value as a business expense either.
Asset Sale Scenario
The asset sale is where the vendor is putting selective assets from the business up for sale. Such assets may include things not on the balance sheet such as goodwill, customer lists, or schematics. The vendor is therefore not represented as a person (shareholders), rather it is the corporation itself that is selling the assets. The buyer is usually represented as a corporation that is newly created and owned by the buyer. The creation of such corporation is done for the purpose of acquiring the business assets. For example, the vendor, a corporation, is selling all its equipment and customer lists, then the buyer corporation is assuming the ownership title of the equipment.
From the buyer's perspective you still need to know whether the equipment is free and clear of any liens or debts because such liens may not be attached to the company but rather attached to the equipment itself. Therefore, just because you are buying assets does not necessarily mean you may be free of any unwanted liabilities. Another positive is that while under the share purchase the buyer cannot write off the value of the purchase price, under the asset purchase the value of the purchase price is attached to specified assets and is also being acquired by your buying corporation. This means your corporation which ultimately buys the assets, and is ultimately the continuing operating business subsequent to the sale will be able to write off the value of the purchase price as a depreciation expense over time. How fast you write off this value will depend on what type of assets you are buying. It's important to consult with your professional accountant to ensure you are maximize the faster depreciating assets and minimizing the slower depreciating assets. Goodwill is a slower depreciating asset for tax purposes.
The vendor is going to lose the ability to use lifetime capital gains exemptions on this type of sale because a major stipulation on using this tax exemption is that the deal be structured as a share sale. With that said, therefore, the vendor's corporation will bear taxes for selling the assets it owned. Each asset you are selling will bear a different tax burden, therefore, It is important you discuss with your accountant on how each asset you are selling will effect you. In some cases we have seen the vendor walk away with zero corporate taxes from the sale of its assets because of the way the purchase agreement was structured and advanced planning with us, the accountant. While goodwill is a slow depreciating asset for the buyer, it is also a good corporate tax treatment for the vendor. Depending on how goodwill is structured, it may get similar treatment as capital gains, which means only half the amount is taxed.
Which is better for who?
Obviously it is most beneficial for the buyer to go with asset purchase, and for the vendor to go with share sale.
With that said, as you can see the way a business is structured in its sale will create competing tax issues for each party. Where there is a gain for the seller (such as getting capital gains exemption) then there is a loss for the buyer (such as not being able to write off the purchase price). This is almost always true no matter how you structure the deal and the CRA intended for this to happen. This is why it's important to understand both sides of the tax consequences. A knowledgeable prospective buyer should factor into their purchase offer the tax consequences. Likewise a knowledgeable prospective vendor should factor into their offer acceptance what the net tax consequence is to both yourself and the corporation.
Keep in mind it is not always true that a buyer should do asset purchase, and the vendor should do a share sale. As discussed in this article, in some extraordinary cases, and with advanced planning with the accountant and legal counsel, both the buyer and the vendor can achieve a simultaneous minimizing tax solution in their purchase agreement.
-Wilson Wong, CA