Allocations of Purchase Price on the Sale of a Business – Be Wary of Section 68
When buying or selling the assets of a business, it is essential to negotiate how the purchase price is allocated, as the allocation carries significant tax implications for both the vendor and the purchaser. The purchase price must be allocated among categories such as inventory, depreciable capital property, eligible capital property (including goodwill, licences, franchises, and concessions), and non-depreciable capital property such as land or partnership interests.
The allocation directly affects the vendor’s income tax, the purchaser’s sales taxes, and the purchaser’s ability to claim future tax deductions through amortization. To understand how to structure an allocation effectively and avoid attracting scrutiny under section 68 of the Income Tax Act, both parties must approach the transaction with careful planning and proper documentation.
Vendor’s Allocation: Tax Implications
Non-Depreciable Capital Property
Vendors typically aim for an allocation that results in the lowest tax payable. Allocating proceeds to non-depreciable capital property, such as land or partnership interests, offers a tax advantage because only 50 percent of the capital gain is included in income.
Inventory and Depreciable Capital Property
In contrast, proceeds allocated to inventory are fully taxable as income. For depreciable capital property, including goodwill under the post-2017 rules, amounts exceeding the undepreciated capital cost (UCC) are fully included in the vendor’s income through recapture.
If the proceeds allocated are lower than the UCC, the vendor may deduct the difference as a loss in the year of the transaction.
Purchaser’s Allocation
Non-Depreciable Capital Property
From the purchaser’s perspective, non-depreciable capital property creates a tax disadvantage because there are no ongoing deductions available to offset income. Some types of non-depreciable capital property, such as land, are also subject to additional taxes, for example, Ontario’s Land Transfer Tax.
Inventory and Depreciable Capital Property
Purchasers tend to prefer allocating more of the purchase price to inventory because its cost is deductible when the inventory is sold. For depreciable capital property, a portion of the total cost of each class may be deducted annually on a declining-balance basis.
Opposing Interests and CRA Review
Because vendors and purchasers have inherently opposing tax interests, the Canada Revenue Agency (CRA) generally accepts mutually agreed-upon allocations when there is clear evidence of bona fide negotiations. Hard bargaining between parties at arm’s length signals legitimacy.
However, where income allocations appear unreasonable or suspicious, section 68 of the Income Tax Act may apply. Section 68 empowers the CRA to disregard the parties’ allocation if:
- The allocation is not reasonable in the circumstances, and
- There is no evidence of bona fide negotiations.
Section 68 also applies to amounts related to services such as consulting services or retiring allowances paid concurrently with asset transfers.
Unexplained cash credits deemed suspicious may be taxed at a flat rate of 60 percent, plus a surcharge of 25 percent and a penalty of 6 percent, bringing the effective rate to 83.25 percent. These amounts cannot be offset by deductions or losses.
Legitimate Red Flags and Indifference
Even legitimate transactions can attract CRA scrutiny. Red flags may arise when one party appears indifferent to the allocation. For example, a vendor may be indifferent if they expect carryovers to expire or if the asset’s cost base is sufficient to avoid income creation.
Despite such scenarios, both parties must remain vigilant. Consistent reporting is critical. A consistent allocation reported by both vendor and purchaser demonstrates hard bargaining and reduces the likelihood of section 68 being invoked.
Protect Yourself Against Section 68
Regardless of whether the allocation favours the vendor or purchaser, bona fide negotiations should always occur and be properly documented, such as through solicitor emails.
For support in structuring an allocation that limits tax exposure and avoids triggering section 68, consult an experienced business lawyer.
Contact Kalfa Law Firm
Kalfa Law Firm can assist you in determining the appropriate allocation of purchase price on the sale of your business’s assets, ensuring your transaction is compliant and defensible in the event of CRA review.
If you are considering selling or purchasing a business, contact us today. Book a Consultation
Related Resources
- Understanding the Tax Implications in Asset Purchases
- Mergers & Acquisitions: What You Need to Know
- Share Purchase vs. Asset Purchase
- Managing Tax Liability in Corporate Transactions
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-Shira Kalfa, BA, JD, Partner and Founder
Shira Kalfa is the founding partner of Kalfa Law Firm. Shira’s practice is focused in corporate-commercial and tax law including corporate reorganizations, corporate restructuring, mergers and acquisitions, commercial financing, secured lending and transactional law. Shira graduated from York University achieving the highest academic accolade of Summa Cum Laude in 2012. She graduated from Western Law in 2015, with a specialization in business law. Shira is licensed to practice by the Law Society of Ontario. She is also a member of the Ontario Bar Association, the Canadian Tax Foundation, Women’s Law Association of Ontario, and the Toronto Jewish Law Society.
© Kalfa Law Firm 2021. Updated July 2026
