Optimizing Opportunities provided by Canada's Tax Laws

Neufeld Legal PC: Chris@NeufeldLegal.com - 403-400-4092 / 905-616-8864

BUSINESS ACQUISITION / SALE - SHARE PURCHASE vs. ASSET PURCHASE

Both share-purchase and asset-purchase business acquisitions result in distinctive tax considerations and strategies for each of the purchaser and the vendor. As a general assessment, a share sale is often preferred by vendors due to potential tax advantages, while purchasers often prefer an asset purchase for different reasons. However, there are ways to structure a share deal to benefit both parties, with the final purchase price oftentimes reflecting the concession as between the parties of using one transactional approach over the other.

Share Purchase from the Perspective of the Vendor (Seller)

Sellers typically favour a share sale due to the following potential tax benefits:

A. Lifetime Capital Gains Exemption (LCGE)

  • Benefit: If the shares being sold are "Qualified Small Business Corporation" (QSBC) shares, individual sellers can claim a significant portion of their capital gain tax-free. As of June 25, 2024 (and proposed for dispositions on or after that date in Budget 2024), this limit is $1.25 million. This is a major tax saving for eligible sellers.

  • Conditions for QSBC shares:

    • The shares must be of a Canadian-controlled private corporation (CCPC).

    • At the time of sale, at least 90% of the fair market value of the corporation's assets must be used primarily in an active business carried on mainly in Canada.

    • For the 24 months preceding the sale, more than 50% of the fair market value of the corporation's assets must have been used in an active business in Canada.

    • The shares must not have been owned by anyone other than the individual seller or a person or partnership related to the seller during the 24-month period.

  • Strategy: Purification: If the corporation doesn't meet the 90% active asset test, sellers might "purify" the company by removing passive assets (e.g., selling investments, paying down debt with excess cash) before the sale to qualify for the LCGE.

  • Strategy: Family Trusts: By setting up a family trust, a seller can multiply the LCGE across multiple family members, potentially sheltering a much larger capital gain from tax. This is a complex strategy and requires careful legal and tax advice.

  • Strategy: Intergenerational Transfers: New rules allow certain family business transfers to be treated more like third-party sales, enabling sellers to claim the LCGE when selling to a child or grandchild.

B. Capital Gains Treatment:

  • Benefit: Proceeds from a share sale (above the seller's adjusted cost base) are treated as capital gains, where only 50% of the gain is taxable. This is generally more favourable than the tax treatment for income from an asset sale, which can be subject to corporate tax and then personal tax upon distribution (double taxation).

  • Strategy: Capital Dividend Account (CDA): If the seller corporation has accumulated non-taxable capital gains (e.g., from the sale of assets within the company before the share sale), this amount can be flowed out to the individual shareholder as a tax-free capital dividend through the Capital Dividend Account.

C. Tax Deferral (using a holding company):

  • Benefit: If shares are sold by a holding company, the proceeds can be received tax-free by the holding company. This allows the owner to postpone personal tax on this amount until they choose to withdraw the funds from the holding company.

Share Purchase from the Perspective of the Purchaser (Buyer)

While purchasers generally prefer asset purchases for the ability to "step up" the cost base of assets for future depreciation, there are still tax considerations and potential benefits in a share purchase:

A. Acquisition of Tax Attributes:

  • Benefit: The purchaser acquires the entire corporation, including its existing tax attributes, such as non-capital losses, capital losses, and other tax credits. These can be valuable for offsetting future taxable income.

  • Caveat: Acquisition of Control (AOC) Rules: Be aware that an "acquisition of control" (which generally occurs in a share purchase) can trigger rules that limit the purchaser's ability to utilize the target corporation's pre-acquisition tax attributes (e.g., non-capital losses may be restricted). Careful tax planning and due diligence are crucial here.

B. Continuity and Simplicity:

  • Benefit: A share purchase is often simpler to execute as the legal entity remains the same. There's no need to transfer individual assets, re-negotiate contracts, or obtain new permits. This can save on legal and administrative costs.

  • Tax Impact: This continuity means the tax cost of the assets within the corporation generally remains the same as the vendor's historical tax cost. There's no "step-up" in the tax basis of depreciable assets to their fair market value as there would be in an asset purchase. This is often a disadvantage for the purchaser.

C. Avoidance of Sales and Property Transfer Taxes:

  • Benefit: Generally, the purchase of shares of a corporation is not subject to GST/HST or provincial sales taxes, unlike an asset purchase where these taxes may apply to the transfer of certain assets (though exemptions can exist for the sale of "substantially all" of a business).

D. Canadian Acquisition Entity (for non-resident purchasers):

  • Strategy: Non-Canadian purchasers often establish a Canadian subsidiary to acquire the shares. This can facilitate interest deductions on financing against the Canadian target's income, create "paid-up capital" in the subsidiary's shares for tax-free repatriation of funds, and in some cases, allow for a "bump" in the tax cost of non-depreciable capital property if the acquisition vehicle subsequently amalgamates with the target.

Key Considerations for Both Purchasers and Vendors as to Share Purchase Transactions

  • Due Diligence: Thorough tax due diligence is paramount in a share purchase, especially for the purchaser, as they inherit all of the corporation's past tax liabilities and history.

  • Negotiation: The tax implications are a significant factor in determining the purchase price. A vendor with access to the LCGE might be willing to accept a slightly lower purchase price in a share sale due to their significant tax savings. Conversely, a purchaser might push for a lower price to offset the lack of a "step-up" in asset basis or to account for assumed liabilities.

  • Professional Advice: Given the complexity of tax laws and the potential for significant tax consequences, it is crucial for both purchasers and vendors to consult with experienced lawyers and accountants to structure the acquisition in the most tax-efficient manner.

Asset Purchase from the Perspective of the Vendor (Seller)

Although vendors typically favour a share sale, where the sale is being undertaken as an asset sale, consideration needs to be given to the following aspect:

A. Purchase Price Allocation The total purchase price for the assets needs to be allocated among the specific assets being sold (e.g., inventory, equipment, real estate, intangible assets like goodwill). This allocation is crucial for both the vendor's and purchaser's tax purposes.

  • Vendor's Goal: The vendor generally wants to allocate the purchase price in a way that minimizes their tax liability. This often means allocating more to assets that result in capital gains (which can be taxed at a lower rate or potentially benefit from exemptions) and less to assets that trigger recaptured depreciation or ordinary income.

  • Negotiation: The allocation is often a key point of negotiation with the buyer, as the purchaser typically prefers to allocate more to depreciable assets to maximize their future tax deductions.

B. Tax Implications This is arguably the most complex and critical aspect for the vendor.

  • Two Levels of Tax (in Corporate Sales): If the vendor is a corporation selling its assets, there are often two layers of tax:

    • Corporate Level: The corporation pays tax on any gains realized from the sale of its assets. This can include:

      • Recaptured Depreciation: If an asset is sold for more than its undepreciated capital cost but less than its original cost, the difference is considered recaptured depreciation and is taxed as ordinary income.

      • Capital Gains: If an asset is sold for more than its original cost, the excess is a capital gain (a portion of which is taxable).

      • Inventory and Accounts Receivable: The sale of these items is generally treated as ordinary business income.

      • Goodwill: Under current Canadian tax rules (since 2017), proceeds allocated to goodwill are generally taxed as capital gains, which can have an impact on the vendor's after-tax proceeds.

    • Shareholder Level: When the net proceeds are distributed from the corporation to its shareholders (e.g., as dividends), the shareholders may face a second level of taxation. However, a portion of capital gains at the corporate level can often be distributed tax-free to shareholders through a "Capital Dividend Account" (CDA).

  • No Lifetime Capital Gains Exemption (LCGE) for Corporations: Unlike a share sale, where individual shareholders might be able to utilize the LCGE to shelter a significant portion of capital gains from tax, the LCGE is not available to corporations selling assets.

  • Sales Tax (GST/HST): In Canada, the sale of assets is generally subject to GST/HST. However, there's an election (Section 167 election) that can be made jointly by the vendor and purchaser to have no GST/HST payable on the sale if all or substantially all of the property necessary to carry on the business is being sold and both parties are GST/HST registrants. This reduces cash flow burden and accounting complexity.

  • PaPayment Terms: If the vendor provides financing (vendor take-back mortgage) or receives proceeds over time, they may be able to defer some of the tax liability by claiming a capital gains reserve.

C. Accounting Treatment:

  • The vendor will derecognize the assets sold from their balance sheet.

  • Any accumulated depreciation related to those assets will be removed.

  • A gain or loss on the sale of assets will be recognized in the income statement, calculated as the sale proceeds minus the net book value (cost less accumulated depreciation) of the assets sold.

D. Specificity of Assets: Being Sold In an asset purchase, the vendor explicitly lists and transfers only the assets the purchaser wants. This means:

  • Retained Assets: The vendor retains ownership of any assets not included in the purchase agreement.

  • Transfer of Ownership: Legal transfer of each asset (e.g., deeds for real estate, bills of sale for equipment, assignment agreements for contracts) is required, which can be more complex and involve more paperwork than a share sale.

E. Liabilities: A major advantage for the purchaser in an asset purchase transaction is that they generally do not assume the vendor's liabilities, unless explicitly agreed upon. From the vendor's perspective, this means they typically remain responsible for most pre-existing liabilities of the business.

  • Assumption of Specific Liabilities: The purchaser might agree to assume certain liabilities (e.g., future obligations under contracts). The value attributed to these assumed liabilities can impact the vendor's proceeds for tax purposes.

  • Indemnification: The purchaser may require the vendor to provide indemnities for certain liabilities or breaches of warranties, even after the sale closes.

F. Employees: The sale of assets often means that employees of the selling business do not automatically transfer to the purchaser.

  • Termination Costs: The vendor may be responsible for terminating employees not hired by the purchaser, which can incur significant costs (e.g., severance pay, notice periods).

  • Negotiation: Employee considerations are often a point of negotiation, with the purchaser potentially requesting the vendor to manage employee transitions or share in related costs.

G. Contracts, Permits, and Licenses: These typically do not automatically transfer in an asset sale.

  • Assignment/Consent: The vendor will need to obtain consent from third parties (e.g., landlords, suppliers, customers) to assign contracts to the buyer. This can be time-consuming and sometimes costly.

  • New Permits/Licenses: The purchaser will likely need to apply for new permits and licenses in their own name.

Asset Purchase from the Perspective of the Purchaser (Buyer)

Purchasers generally prefer asset purchases for the ability to "step up" the cost base of assets for future depreciation, together with other advantages that are realizable from an asset purchase transcation, there remain other considerations and potential risks.

A. Potential Tax Benefits:

  • Basis Step-Up: In many asset purchases, the purchaser can "step up" the tax basis of the acquired assets to their fair market value. This means the purchaser can depreciate or amortize the assets based on this higher value, leading to increased tax deductions in the future and potentially lowering taxable income. This can be particularly advantageous for businesses with highly depreciated assets.

  • Goodwill Amortization: If the purchase price exceeds the fair market value of the tangible assets, the difference can often be allocated to "goodwill" (intangible assets like brand reputation, customer relationships). This goodwill can typically be amortized for tax purposes over a period of years, providing further tax deductions.

B. Flexibility in Deal Structure and Financing: An asset purchase arrangement tends to offer more flexibility in how the transaction is structured and financed. The purchaser can negotiate terms based on the specific assets being acquired, potentially aligning the financing more closely with their financial capabilities. Asset-based financing, where the acquired assets serve as collateral, can be a viable option.

C. Selective Acquisition of Assets: Where the vendor is prepared to retain certain assets, and sell only selective assets that are being sought by the purchaser (e.g., equipment, inventory, intellectual property, customer lists, real estate), the acquisition can be effectively tailored to more precisely align with the purchaser's strategic goals.

D. Control over Assumed Liabilities: Unlike a share purchase transaction where the purchaser inherits all of the target corporation's liabilities (known and unknown), an asset purchase transaction enables the purchaser to specifically choose which liabilities, if any, they will assume. This significantly reduces the risk of inheriting unforeseen debts, legal disputes, environmental issues, or other contingent liabilities

E. Avoidance of Shareholder Disputes: Since the purchaser is not acquiring shares, an asset purchase transaction typically avoid issues related to minority shareholders who might refuse to sell their shares in a share purchase transaction.

For knowledgeable and experienced tax law representation for transactional tax matters and tax planning, contact tax lawyer Christopher R. Neufeld at Chris@NeufeldLegal.com or call 403-400-4092 (Calgary, Alberta) / 905-616-8864 (Toronto, Ontario).

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