Whether you’re thinking of buying or selling a business, it’s essential to consider their tax implications. Here, we’ve broken down key information to help you navigate the complexities of business transactions and optimize tax outcomes.
Buying and Selling
These are the two main options for buying or selling a business, each with its own tax advantages.
- An Asset Sale – To buy or sell the assets of the business.
- A Share Sale – To buy or sell the shares of the company that runs the business.
1. Asset Sales
An asset sale is where you buy the assets of a business. This includes furniture, equipment, accounts receivable, inventory, and leasehold improvements.
An Example
The sale price of a small grocery store can be broken down into:
- Equipment: $5,000
- Delivery Van: $2,000
- Inventory/Stock: $9,000
- Leasehold Improvements: $1,000
The fair market value (FMV) for these assets is $17,000. This price is the estimated cost someone would pay for these assets.
The actual price paid by the 3rd party is $20,000. The difference between the price paid and the FMV is known as ‘goodwill.’ In this example, the goodwill purchased would be $3,000.
Tax Rules
Many business owners make the mistake of thinking the total price paid can be written off in one go. But, this isn’t the case. Under the Canadian tax system, the cost of assets must be deducted over several years. This is known as depreciation. The system also requires that different assets be deducted at different rates. This is known as capital cost allowance (CCA).
Using the grocery store example from above, the CCA would look like this:
- Equipment: 20 percent per year
- Delivery Van: 30 percent per year
- Inventory/Stock: 20 percent per year
- Leasehold Improvements: 20 percent per year
Note: As inventory/stock is written off as part of the cost of goods sold, there’s no depreciation.
Calculating the CCA of goodwill is quite a complicated formula which varies from business to business, even if they’re in the same industry. Generally speaking, it’s deducted at around five percent per year. There are rules for assets purchased in a year, but this gives you an idea of the principles of depreciation.
Advantages of Asset Purchase
The advantage of an asset purchase is that you can negotiate the price of assets so you receive the most desirable tax benefit. You don’t inherit any of the liabilities of the existing business, and you get to start with a clean set of books.
Recapture Income
Recapture income is the difference between the amount received for an asset and its depreciated value. For example, if you sell an asset on your books at $2,000 for $2,500, you’ll have a recapture income of $500. This must be reported as income in your end-of-year accounts.
2. Shares Sales
The second option is a share purchase or sale. You might consider selling your business shares if you have an incorporated company. Here are some advantages and disadvantages of this option.
Value of a Name
One benefit is the continuing name of the business. If you’re buying ABC Market because it has a good reputation and the name generates business, you may consider buying some shares. The share purchase will result in all business assets, including the name, being transferred to you with the company’s shares.
Liabilities
However, all assets come with liabilities. For example, if there’s an audit of ABC Market’s books and it’s determined that there are taxes due from the year before your ownership, you, as a shareholder, will be liable to pay. So, it’s useful to consider including a clause in your purchase agreement that dictates the old owner responsible for those taxes. But, you’ll have to sue to collect your money unless they pay voluntarily.
Tax Exemptions for Share Sales
On the positive side, if the business you’re 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 Canadian resident is eligible for a $750,000 lifetime capital gains exemption. So, if you bought shares in a business for $1 and sold them for $20,000, you’d 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.
The Importance of Good Legal and Accounting Advice
Whatever path you choose, seeking good legal and accounting advice is always important. Structuring a business’s purchase or sale can be complicated and can mean the difference between paying high, average, or low taxes. Be sure to consult with your professional advisor before you sign off on a deal.
Small Business BC is Here to Help
SBBC is a non-profit resource centre for BC-based small businesses. Whatever your idea of success is, we’re here to provide holistic support and resources at every step of the journey. Check out our range of business webinars, on-demand E-Learning Education, our Talk to an Expert Advisories, or browse our business articles.