When a purchase or sale of an incorporated business is contemplated, there are two options to consider. The buyer and seller can negotiate a transaction on the assets used to carry on the business of the corporation or they can negotiate a transaction on the shares of the corporation. Whichever option is chosen, income taxes will have a major impact on the price. It is important for both parties to be aware of this effect and to be aware of each party’s tax situation when negotiating. Negotiating power is dependent on this knowledge. Income tax will have an impact on the values of both the assets of the corporation and its shares and will affect the value perspectives of both the purchaser and the seller.
A purchaser will often favour the purchase of assets from the corporation. The fair market values of the assets become their cost to the purchaser and the base for tax depreciation and other write-offs, including the amortization of goodwill purchased. When shares are purchased, the cost values of the assets in the corporation remain unchanged in the corporation at the time of purchase, although losses imbedded in some assets must be realized, because of the acquisition of control of the shares, liabilities, including “hidden” liabilities, of the corporation remain with the corporation and are unaffected by the purchase of shares.
On the other hand, if properly advised, the purchaser might negotiate a price that discounts the value of the shares for the imbedded income taxes in the appreciated values of the assets. This may make a purchase of shares more attractive.
A seller will usually favour the sale of shares of the corporation. On a sale of shares, the future liability for imbedded taxes in the appreciated value of corporate assets remains with the corporation. Also, a capital gain on the sale of shares of a Canadian-controlled private corporation may be eligible for the capital gains exemption of up to $750,000 if the shares meet the tests of qualified small business corporation shares. Even if the shares do not qualify, capital gains are more favourable taxed for an individual in a high tax bracket than the taxable dividend that will usually result from a winding-up of a corporation after its assets have been sold. Even a capital loss on the sale of shares of a small business corporation receives more favourable treatment as an allowable business investment loss.
A sale of corporate assets is only the first of a two-stage procedure. After the first stage, consisting of the sale of assets in the corporation and the payment of liabilities, including the tax liability generated from the sale of assets, the net proceeds from the sale remain in the corporation. At some point, the second stage, possibly involving winding-up the corporation, might be undertaken to distribute the net proceeds to the seller. At this stage, a taxable dividend to the seller shareholder will usually result.
On the other hand, the seller might negotiate a price (and allocation of the price) for the value of the assets in the corporation to make the sale of assets more favourable for the seller. This if often the case if the business income generated by the sale will be taxed in the corporation at small business tax rates, if the sale of the assets will result primarily in capital gains and /or if the capital gains exemption is not available to the shareholders.
These are only a few of the factors that must be considered in determining the values of either the corporate assets or the shares to either the purchaser or the seller. Good tax advice on either side of the transaction for either option is essential both before and during the negotiations. A good result depends on both parties being informed about their tax position and that of the other party. Often, a transaction can be structured that results in a “win-win” situation for both the purchaser and the seller.
If you have any questions regarding the purchase or sale of your business or on any income tax or business issues, do not hesitate incalling Joe Truscott at 905-528-0234 or email Joe at firstname.lastname@example.org.