If you are in the initial stage of negotiating the purchase of an incorporated business in British Columbia (B.C.), this is a good time to consider the method you choose to go about the acquisition.
There are two methods to acquire a business: you either buy the desired assets of the company, or you buy the shares of the company. Each method has different business tax consequences for the seller and the purchaser, so knowledge of the different tax treatments can provide the purchaser with room for price negotiation.
A share purchase transaction is relatively straightforward for both parties. The purchaser becomes the new shareholder of the company after the transaction. The tax values of the assets and liabilities of the company are carried forward. If the company continues on in the same line of business, the non-capital losses carry forward can be used in the future by the company. Due to the relative simplicity of a share purchase, legal and accounting fees are lower. The downside of a share purchase is that the buyer becomes responsible for future tax reassessments, past environmental pollution, or any other non-tax legal claims that may be lurking around the corner.
The most significant benefit of a share transaction is for the seller. Assuming that the shares are being sold for a price above the seller’s adjusted cost base, the gain from the sale of shares would be considered capital gains, taxable at only 50% to the seller. Better yet, if the seller has yet to use his/her lifetime capital gains exemption, the first $750,000 of the sale would be completely tax free. Understanding this sizeable tax benefit to the vendor of a share sale, the buyer can negotiate to lower the acquisition cost.
The other way to acquire a business is to buy only the assets the purchaser desires, which could be all or most of the assets of the business. This method requires that all assets being acquired be valued based on the price being acquired in this arm’s length transaction. Any excess of purchase price over the fair market value of tangible assets would be allocated to goodwill. The benefit for the purchaser (assuming an inflationary environment), is that the price being paid would be higher than the current tax values of these assets. The buyer gets to record the acquired assets at the price paid, and therefore gets the benefits of capital cost allowance on the higher “bumped up” asset values. The same benefit also applies where goodwill has been acquired as well. So the bottom line is greater tax deductions available to offset future business income.
For the seller, the sale of assets creates a lot more accounting and legal work. The sale of the assets is by the company, not the shareholder, so gains and losses from the sale must be reported by the company. After that, the after tax proceeds must be distributed and would eventually lead to possible personal tax consequences. At this point, the company may need to be wound up. The bottom line is that sale of assets is not the preferred choice by the seller, so the buyer can expect to pay more if an asset’s purchase is the method used for acquiring the business.
A professional accountant can assist in a number of ways by providing business consulting during the negotiation phase of a business purchase. Firstly, professional accountants are used to calculate the tax savings of one method over the other for the purchaser and/or the seller, the result being the value of the acquisition under a share purchase versus an assets purchase. The accountant will also perform the required due diligence work pertaining to the purchase, so the purchaser has peace of mind, particularly in the case of a share purchase. If the transaction is an asset purchase, the accountant can advise on how to best allocate the purchase price to the assets acquired, for optimal business tax planning.
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Disclaimer: All Rights Reserved for Mew & Company. This blog post is designed to provide information for personal use only. Please consult your professional tax advisor for further information. Mew & Company is not responsible for any legal disputes resulting form the content of this blog post.