by Ali Naeem, Counsel
Buying or selling a business is a complex transaction with many tax and legal variables to consider before you start negotiations and close the deal. Although the purchase terms are not solely driven by tax considerations, it can have a significant impact. In this post, I will discuss few key tax considerations for the buyers.
Asset or Share purchase?
There are two basic forms in which a sale and purchase transaction of a business can take place: buying the assets and buying the shares of the business. Buyers usually prefer to buy assets as the buyer does not need to assume the liabilities (contingent or unknown liabilities) of the seller and can choose to buy individual assets that they want.
On the other hand, sellers generally prefer to sell the shares as that can transfer all liabilities associated with the assets and entity as well, and the seller need not worry about the capital gains. Share sales are usually less complex than asset sales.
Depending on the reputation of the business, assets involved, and other factors discussed below, the buyer may choose how he may want to structure the purchase.
Allocating Purchase Price in Asset Sale
The tax implications of the asset purchase model depend on how the purchase price is allocated amongst various assets. Generally, the aggregate purchase price is allocated among the assets by class and fair market value.
The buyer and seller must agree to use the same allocation despite having opposing interests. The buyer might want to allocate as much of the purchase price on assets so that they can claim capital allowance within a short period of time.
Can you deduct the purchase price as an expense at once?
Many small business owners make the mistake of thinking that the total price paid for the assets can be written off within the same year of transaction. Under the tax laws, the cost of assets must be deducted over several years, at different rates depending on the nature or the type of the asset.
As for the seller, the asset sale will result either in a balancing allowance or balancing charge. These are calculated by comparing the tax written down value (TWDV) of the asset to the sales proceeds with respect to that asset. A balancing allowance will arise where the TWDV is more than the sales proceeds while a balancing charge will arise where the TWDV of the asset is less than the sales proceeds. The tax impact for the seller would depend on this.
What if GST is not charged by the Seller?
It happens that the purchaser is concerned that the seller does not charge GST on the asset sale even when the seller is supposed to. GST is a tax that the seller collects and the responsibility is on the seller to charge it on the buyer.
Where, for some reason, the seller did not charge GST on the sale price, the seller is at risk of having the GST being charged by the MIRA should such a business be subject to an audit. The buyer under such circumstances need not worry as the purchase consideration is deemed to have included the GST component.
How can you zero-rate the transaction?
GST law allows you to zero rate the transaction if certain conditions are met. This means that the seller will charge GST at zero percent – effectively the same as not charging GST – on the sale price if those criteria are met- the basic criteria being that both seller and purchaser being registered for GST, and the business is being sold as a going-concern.
Always be sure to check that both the seller and purchaser are registered for GST before closing the transaction should you wish to take advantage of this leeway that’s available.
Due Diligence and Tax Clearance
A proper due diligence review is critical where a share purchase is being considered. The exercise should provide the purchaser with information on the tax compliance history of the company and detail any outstanding tax liabilities.
When you buy shares of the company, you acquire all assets and liabilities of the company. This also means that, if a tax audit finds that there are back taxes of that business a year prior to you owning that business, you will be liable to pay those taxes even if the seller was initially responsible for filing the tax returns. It is therefore, useful to include a clause in your sale and purchase agreement that requires the previous owner to take responsibility for those taxes.
The purchaser, before giving indications of a serious commitment to the transaction, should request from the seller, a tax clearance report from the MIRA. It is a fairly standard procedure to get a tax clearance certificate from MIRA, and be mindful of getting the most recent one from the seller.