The Tax Side of Buying and Selling a Business
The Tax Side of Buying and Selling a Business
By Gabrielle Loren, CGA, Partner
Loren, Nancke & Company
September 1, 2010
When you are looking into buying or selling a business, there are really only two options — to buy/sell the assets of the business or to buy/sell the shares of the company that runs the business. The first is known as an asset sale; the second is a share sale. There are tax advantages to both.
On an asset sale, you would be buying the assets of the business, such as furniture, equipment, accounts receivable, inventory and leasehold improvements. The difference between the fair market value (FMV) of the assets — fair market value being the price an unrelated person would pay for the asset in its present condition — and the price that you pay for these assets is know as “goodwill.”
Here’s an example of the sale price of a small grocery store:
Equipment $ 5,000
Delivery van 2,000
Leasehold improvements 1,000
Total FMV of assets $17,000
Price paid (20,000)
Goodwill purchased $ 3,000
Many clients believe that the entire $20,000 is a write off. This is partially true, as you will be able to write off the entire amount paid — just not at one time. You may have heard the term depreciation — this is a term used to describe deducting the cost of an asset over several years. The Canadian tax system has rules that permit you to deduct the costs of certain assets at various rates. This tax deduction is called capital cost allowance.
Using the above grocery store example, the capital cost allowance on the equipment and leasehold improvements would be 20 per cent per year, while the van would be depreciated at 30 per cent. The goodwill has a more complicated formula but in essence is deducted at around five per cent per year. There are also rules for assets purchased in a year, but at least this gives you an idea of the principles of depreciation.
The advantage of an asset purchase is that you get 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. If you are selling assets, you may be faced with recapture income, which is the difference between the proceeds received from an asset and the depreciated value. 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.
The second option is a share purchase/sell. If an incorporated company operates a business, 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.
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.
However, with the assets come all the liabilities, too. If ABC has been involved in labour, tax or legal issues, you will inherit these, too. For example, if there is an audit of the books of ABC and it is determined that there are taxes due for a year prior to you owning the business; you will be liable to pay those taxes. You may have a clause in your purchase agreement that says the old owner will be responsible for those taxes, but unless they pay voluntarily, you will have to sue to collect your money.
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 resident is eligible for a $500,000 lifetime capital gains exemption so if you bought your shares 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.
With either of the above scenarios, I cannot stress enough how important it is to obtain good legal and accounting advice. The structuring of a purchase or sale of a business can mean the difference between low, average or high taxes, so be sure to consult with your professional adviser before you sign off on a deal.
Gabrielle Loren is a partner with Loren, Nancke & Company who provides accounting and income tax services to individuals, small businesses and corporations. They are located at the International Plaza at Marine Drive and Capilano Road in North Vancouver, BC and can be reached at 604-904-3807 or Gabrielle@LNCo.ca