Business Assets Sale and Purchase: Tax Implications
If you are looking to purchase a new business in Ontario or sell your existing business, there are vast considerations that must be contemplated and negotiated. In Part 1, we discussed the fundamental elements in a purchase and sale agreement. In the following article, we will look at the tax implications and liability concerns related to the sale and purchase of business assets
Selling Assets of a Business- GST/HST Tax Implications
The sale of personal property assets used in a commercial activity is subject to GST/HST when sold or leased. However, there are certain provisions set out in the Excise Tax Act that would prevent GST/HST from applying to an asset sale provided the conditions below are met:
The purchaser (recipient) and the vendor (supplier) can jointly make this election if they meet all of the following conditions:
- The supplier makes a supply of a business or part of it that was established or carried on by the supplier, or that was established or carried on by another person and acquired by the supplier.
- Under the agreement for the supply, the recipient acquires ownership, possession, or use of all, or substantially all, of the property necessary for the recipient to be capable of carrying on the business or part as a business.
- One of the following situation applies:
- The supplier and the recipient are both registrants
- The supplier and the recipient are both non-registrants
- The supplier is a non-registrant and the recipient is a registrant.
Even if you to file the election, GST/HST will still apply to the taxable supply of a service made by the seller; the taxable supply of property made by way of lease, licence, or similar arrangement; and where the buyer is not a registrant, the taxable sale of real property.
Note, goodwill is not subject to GST/HST if a part of the consideration for the supply can reasonably be attributed to the goodwill of the business.
Selling Shares of a Business-Tax Advantages and Liabilities
There are a number of tax advantages that a seller enjoys when he sells the shares of a corporation. Among these are the capital gains exemption, which reduces the amount of tax the seller will pay on the proceeds; and limited liability, which protects the seller from any liability attached to the corporation.
1. Capital Gains Exemption: From a tax perspective, it is far more beneficial for a seller to sell the shares of a small business rather than its assets if certain conditions are met. If the vendor corporation is a Canadian Controlled Private Corporation (CCPC) of which over 90 percent of its income is attributed to Active Business Income (ABI), the gain from the sale of the shares are exempt from taxation pursuant to the Lifetime Capital Gains Exemption (LCGE) of Qualified Small Business Shares (QSBC). The Lifetime Capital Gains Exemption allows a business owner an exemption of up to $892,218 (2021) on the sale of qualifying shares.
For example, if you sell shares of a qualifying business for $600,000, you will pay no tax on this income since the value falls under the exemption limit of $892,218. If you sell shares for more than the correct exemption limit, you will pay tax on the difference between your sale price and the $892,218 exemption.
Aside from the Principal Residence Exemption on the proceeds of the sale of one’s principal residence, the Lifetime Capital Gains Exemption is the only other capital gains exemption available to taxpayers in Canada.
Few people know about the LCGE, which happens to be an excellent tax planning and tax saving tool. For more information about the LCGE, read Lifetime Capital Gains Exemption.
2. Limited Liability
In addition to the Lifetime Capital Gains Exemption, a seller who sells shares of a business or corporation enjoys the benefit of limited liability. Shares of a private corporation that has been active in the marketplace are usually saddled with liability. As long as the seller holds onto the shares, his or her liability will continue to exist and accrue. By selling the shares of a corporation, the seller effectively transfers all of its liability along with the sale. The seller can walk away from the business and be secure that an old liability wont rear its ugly head months or even years later.
Purchasing Assets and Shares of a Business: Tax Implications and Liabilities
While there are tax advantages for the owner who sells his business’ shares, often the purchaser will not want to assume the liability of the entire corporation and all of its history in the marketplace. A purchaser, then, is better off purchasing the assets of a business instead of its shares.
The assets of a business are usually the physical assets, inventory, equipment, fixtures, products, and intellectual property, such as its name, website, trademarks, trade names, and goodwill, such as client lists.
An asset transfer occurs when all of the assets of a business are stripped from a corporation and ownership is transferred to the purchaser. The buyer then takes the assets and dumps them into a new vehicle—either a sole proprietorship, partnership or corporation—which belongs to the purchaser. This is called an asset purchase or asset transfer.
Put simply, the buyer wants the assets and goodwill of a business but not the liability of the corporation that operated the business using those assets.
However, there are times when it is better for a buyer to purchase the shares of a business rather than its assets. This is the case when the undepreciated capital cost (UCC) of the assets (carry forward of the depreciation) is nearly NIL. This eliminates a substantial deduction for the business, which essentially increases the business’ taxable income. In this circumstance, the purchaser will prefer the shares of the business because they hope the business will grow and they can one day enjoy the Lifetime Capital Gains Exemption on a sale.
The value of the undepreciated capital cost potentially poses a problem for the seller as well. If the assets are sold over and above the undepreciated capital cost (UCC), recapture comes into play. Recapture is a tax penalty that the CRA levies whenever assets are sold for more than its UCC. The CRA will levy tax on the difference in value between the business’ most recent UCC, as stated in its corporate return, and the value of the sale. For example, if the business indicates a machine’s UCC to be $30,000 and the machine was sold for $50,000, then the business will be subject to a recapture of capital cost allowance (CCA) of $20,000.
The buying and selling of your business’s assets and/or shares have many tax implications that need to be considered before an agreement of purchase and sale is signed. Consult a tax lawyer at Kalfa Law before you purchase or sell the assets or shares of a business. We have both tax and corporate law experience, which allows us to anticipate the tax benefits and liabilities pertaining to a sale or purchase of shares or assets.
Section 167 of the Excise Tax Act is a relieving provision that can prevent GST/HST from applying to the asset sale. It can be used if all of the following conditions are met:
- If the vendor is a registrant, the purchaser must also be a registrant;
- The vendor is supplying a business or part of a business;
- The vendor established, carried on, or acquired the business or part of a business;
- Under an agreement, the purchaser is acquiring all or substantially all of the property that is reasonably necessary for the purchaser to carry on the business or part of a business; and
- A joint election is made by the vendor and purchaser.
There are many factors to take into consideration when deciding whether to structure a transaction as a share sale or an asset sale. However, it is far more beneficial from a tax perspective for a business owner to sell shares of a small business rather than its assets if the conditions for the lifetime capital gains exemption are met. You will not have to pay tax on any capital gains up to the exemption limit.
A business owner who sells shares of a corporation enjoys the benefit of limited liability. A corporation that has been active in the marketplace is usually saddled with liability. By selling the shares of the corporation, the seller effectively transfers all of its liability along with the sale to the buyer.
Felix Ng, Associate Corporate Counsel
© Kalfa Law 2021