Buying and Selling a Business
The sale of a business may occur in different contexts. A business owner may sell to a purchaser on the open market, or to key employees all at once or in stages. Alternatively, a transition to family members may occur over time or through inheritance. Each sale scenario requires careful planning to ensure a smooth transition and maximum after-tax sale proceeds.
Asset Sale
An asset sale is often more attractive to the purchaser. Through the sale, the tax value of the business assets can be “stepped-up” to the purchase price, so that the assets can be depreciated anew. The tax treatment of different assets varies, and sale negotiations will generally involve the allocation of the purchase price to assets in different depreciation classes for optimal tax results. The legal risk to the purchaser is typically lower in an asset sale as well, since the purchaser acquires the assets of a business only, and leaves behind unknown or latent risks that may remain in the corporation.
For the vendor, the sale of assets gives rise to varying tax results. The sale of certain assets may give rise to investment income (currently taxed at higher rates in Alberta), part of which is refunded when dividends are paid to the owner/shareholder. The sale of other assets may give rise to active business income (taxed at lower rates). Depending on depreciation history, an asset sale may result in recapture or other income. However, an asset sale may also give rise to capital dividends, which may be paid tax-free to the vendor or other shareholders. Any capital gain on a sale may also be deferred if proceeds are re-invested in eligible small business investments. Because of the tax and other legal consequences of the sale to both purchaser and vendor, an asset sale may attract a higher purchase price, depending on negotiations between purchaser and vendor.
Share Sale
Purchasers are generally wary of a share sale because it is difficult to assess and quantify a corporation’s potential or pending litigation, tax, creditor, and other legal risk at the time of sale. Careful, advance due diligence investigation by the purchaser is generally necessary to identify any latent liabilities of the corporation. This may be less of a concern in a sale to key employees who may be very familiar with the business.
A share sale is typically more attractive to a business owner. A shareholder may be able to claim the lifetime capital gains exemption (approximately $826,000 in 2016) on the sale of shares, depending on the business conducted by the corporation. It may also be possible to multiply the lifetime capital gains exemption among family members, depending on transaction terms, share structure, and whether a family trust is involved. However, the business must be “active”, and passive assets (such as an investment portfolio or excess retained earnings) may disqualify the business for the purposes of the capital gains exemption. Well in advance of sale, it may be prudent or desirable to transfer certain non-qualifying assets to another corporation. Similarly, any property the owner wishes to keep (such as a building) might also be transferred to a new corporation prior to sale. Care must be taken to ensure that such transfers are not taxable. Further, on sale to a third party, to the extent the capital gains exemption is fully utilized or not available, it may be possible to claim a reserve (capital gains deferral) for a period of time, again depending on the terms of the sale.
Depending on the corporate structure, there may be other tax benefits to the owner in a share sale. Certain favourable tax pools of the corporation (such as a capital dividend account balance, refundable dividend tax on hand, amounts in the general rate income pool, or unused capital losses) may be accessed, further reducing tax payable by the vendor. Finally, by selling shares instead of assets, the owner may also avoid recapture on depreciable property, income inclusion on certain intangible property, and GST.
Hybrid Share/Asset Sale
In appropriate circumstances, all the benefits of an asset sale and a share sale may be obtained with proper structuring of a hybrid transaction. While this process is more complex, it may allow the vendor to access the lifetime capital gains exemption (if conditions are met) and other tax benefits, while the purchaser obtains the tax benefits and other advantages of an asset purchase.