Tax Implications of a Share Sale
An asset vs share sale is a complex tax scenario to address. Let’s start with a share sale first. A share sale is essentially a purchase of the entire business. The buyer acquires the shares of the company which owns the business and assets. When the shares transfer to a purchaser, the outgoing owner resigns their position as president/director and the new owner is appointed to the corporation.
Tax Implications to Sellers:
Sellers has two key objectives when disposing of the shares of a corporation:
- To minimize tax on disposal
- To defer tax
Tax minimization:
The seller can minimize the tax through:
- If shares have a high adjusted cost base (ACB), the tax on gain can be minimized.
- If corporation’s shares are qualified small business corporation (QSBC) shares, a portion of capital gain can be sheltered from tax using the capital gains exemption. If seller corporation is a Canadian-controlled private corporation (CCPC) of which over 90 percent of its assets are active within the business at the time of individual is claiming the exemption and is an individual who has held the corporation shares for at least 24 months prior to sale the gain from the sale of the shares are exempt from Lifetime capital gain exemption (LCGE). In 2023, LCGE exemption limit for small business owner is $971,190 which only half of the realized capital gain is taxable.
- Generally, a share sale results in a capital gain to the seller with 50% inclusion rate, rather than the ordinary business income that results when selling of the assets.
Tax Deferral:
In a share sale, tax deferral can be achieved through two key methods:
- Paragraph 40(1)(a)(iii) of the Income Tax Act (ITA) allows deferring capital gain on the sale of the shares for a maximum of 5 years, provided certain conditions are met.
- If shares are being sold by a holding company, dividend can be paid from the target company to be sold and received tax free dividend by holding company.
Holding company allows the owner to postpone personal tax on this amount. The non-taxable portion of the capital gain accumulates in a tax pool called Capital Dividend Account (CDA). The seller can work with their accountant on the timing of when the CDA balance should be paid to the seller.
Tax Implications to Purchaser:
Key implications to the purchaser in a share sale include:
- Canadian-controlled private corporation (CCPC) status may be lost under an agreement of purchase and sale. CCPC status can be maintained from certain ITA provisions throughout the taxation year.
- In a share purchase transaction, the full purchase price is added to the purchaser’s actual cost based of the shares. Since shares are a non-depreciable property, no tax deduction is available in future years against the income of the purchase associated with the cost of the shares. The buyer will be able to regain its actual cost base on a subsequent disposition of the shares.
- The assets being acquired through the share purchase will inherit the tax cost of the seller and can only continue to claim tax deduction based on the existing tax cost of the assets inside the corporation. There is no “bump up” of the assets to their fair market value in a share sale.
- The liabilities of the target company are acquired along with the shares. A significant amount of tax due diligence is required in a share transaction versus an asset sale since purchase is acquiring the target’s tax history.
Tax Implications of an Asset Sale
In an asset sale, the purchaser buys some or all assets of the corporation and the seller retains the legal ownership of the corporation. Assets can include intellectual property rights or contracts, equipment, building, inventory, working capital etc.
Tax Implications to Sellers:
Asset sale generally results in a higher tax liability for the seller due to adjustment on recapturing previously taken depreciation on assets, sale of inventory at market value resulting in active income and possibly capital gains.
Purchase Price Allocation on assets could be different between the buyer and the seller. For ex. on land vs building. Sellers prefer to record the assets at a higher value on land and maximize the capital gain and minimize the recapture of depreciation on building, whereas the purchasers prefer to record the higher value on building to maximize future depreciation.
Tax Implications to Purchaser:
During asset sales, tax implication on the sale of particular type of assets can have both capital gain and business income. The type of assets sold such as accounts receivable and inventory will be on accounts of income. Sale of depreciable and non-depreciable assets for proceeds more than their ACB will result in capital gain.
Hybrid Sales
Hybrid transaction generally involves combination of both an asset and share sale in order to achieve some or all of the benefits of both structures. This can help bridge the competing interests of the seller and purchaser.
Payment Considerations
Cash transaction is a simple type of consideration in business transaction. Cash settlement involves the full payment being made at the time of closing. Cash transaction is low risk to sellers as cash is received upfront but can be riskier for the buyer if the business does not perform as expected.
For this reason, many business sale transactions get structured with both upfront and delayed payment timings. A certain amount of cash is paid on closing, and remaining is held back by issuing a Promissory note, payable over a number of years, at times contingent on pre-agreed performance metrics (revenue, profit, client retention, etc.).
Promissory notes protect the buyer against deficiency in working capital that was not paid off prior to closing. Generally, Promissory notes require a written agreement where both parties agree on a variable or certain fixed amount to pay to the seller at a later date or over a period of time. Interest rates may apply at prevalent commercial rates.
Parting Thoughts
Buyer and seller are involved in a variety of complex negotiations during the sale of the business. When assessing a potential transaction as either buyer or seller, it is important to consider the type of consideration and associated risk with each transaction to evaluate properly and the economic value being exchanged.
In share sale, common share sale planning techniques includes the assets bump, accessing adjusted cost base, capital gain reserve and capital gains deferral on eligible small business investment.
In asset sale, few common joint elections are available for both the seller and buyer:
Account receivable – Section 22
This election is more beneficial when there are with large amount on uncollectable amounts on accounts receivable. This election allows for sellers to claim the uncollectible amount deduction in the year of sales otherwise it will not table to claim the year of sales. On the other hand, buyer may lose the future uncollectible amount if they don’t elect this section. So, it’s beneficial for buyer to claim future deduction on any uncollectible amount on account receivable. There are certain conditions required to elect this section as purchaser must continue to the business, property used in carrying business is being sold and sale agreement must include all of the vendor’s account receivable.
GST/HST on sales of assets – Section 167
This election helps to avoid the GST/HST charge on the sale of assets. This usually reduces the cash flow burden and less complexity on the accounting. To elect under s167, there are certain conditions to meet as both the seller and purchaser must be registered for GST/HST. The seller must be selling the assets of the business which is carried on and all property used in carrying on the business is being sold to the buyer to continue carrying on the business of seller.
Need Help?
We know this can all be quite technical and confusing. If you are in the process of buying or selling a business, and need guidance on asset v/s share sale considerations, reach out to us using this link and we will be happy to get on a call to discuss!
