Many buyers of a business understand that doing their research to ensure they pay a fair price for the business needs to be a priority. Tax considerations for the purchase of a business should form an integral part of this process.
Structuring the purchase
If you are buying assets, you usually gain a few advantages including:
- Selecting which assets you want;
- Minimizing your risk; and
- Reducing complexity of the transaction.
If you are buying shares:
- This helps ensure you are purchasing the entire business; however,
- The tax cost of the assets within the corporation are not increased.
Depending on the target business and the situation, you may also want to consider a hybrid transaction. In particular, the vendor can benefit from the capital gains exemption and the purchaser can still increase the tax cost of some of the assets purchased.
Before making a final purchase decision, it is always advisable to conduct a due diligence process to avoid any unwanted surprises.
The depth and extent of the due diligence required will be dependent on the business, and whether you are choosing to purchase company assets, shares, or a combination of both.
With a share purchase, you should always be able to identify potential undisclosed tax liabilities prior to purchase and be able to effectively evaluate the quality of tax attributes being acquired.
Purchase and Sale Agreement
Price allocation is a very important consideration for both the purchaser and the vendor when buying business assets. As a buyer, you should look to allocate higher values to assets that can be deducted relatively quickly for tax purposes, such as inventory and depreciable property.
The Canadian courts have generally indicated that the agreed-upon purchase price allocation between arm’s-length parties will govern the allocation of the purchase price for tax purposes. Evidence of real bargaining between arm’s-length parties is also proof that the allocation is reasonable and should be accepted by the Canada Revenue Agency (CRA). Note that the CRA has the power to re-allocate proceeds if they are of the view that the initial purchase price allocation is not reasonable.
Share purchase cost and tax planning
One area to consider is structuring how the purchase is financed to maximize the use of tax deductions on interest paid. To achieve this, common practice is to set up a new corporation to purchase the target corporation with borrowed funds. Then the new company and the target corporation can be merged on a tax-deferred basis. As part of this merger, it may also be possible to increase the tax cost of non-depreciable property of the target company from the tax cost of the assets at the time of acquisition to their fair market value at the time of the acquisition.
Using a new corporation to purchase the target also allows you to convert tax cost to debt and withdraw future earnings as tax-free debt repayments. You should note that this planning will likely not work where you buy shares from a non-arm’s-length party.
The decision to purchase a company should not be made lightly and careful attention to tax issues can have a significant impact on your outcome.
You may also be interested in this related article ~ Getting your business ready to sell ~ BDO’s Scott Conner
Scott Conner is a Tax Partner at BDO Canada LLP. With over 15 years of experience as CPA, CA specializing in Canadian income tax, Scott helps a variety of individuals and private companies pay the least amount of tax possible with great tax planning strategies. He also specializes in planning for estates, trusts, and non-resident dispositions of real estate.