In the dynamic landscape of business acquisitions, the choice between a share purchase and an asset purchase holds significant implications for both the buyer and the seller. These two distinct approaches form the cornerstone of sale and purchasing strategies, each carrying its own set of advantages, disadvantages, and intricate accounting intricacies. Whether you’re a seasoned entrepreneur looking to expand your business or a curious observer seeking to unravel the complexities of corporate transactions, understanding the fundamental differences between share and asset purchases is essential.
Today we are going to break down and demystify share vs asset purchases and outline the benefits and risks of both in order to help you make empowered business decisions. When looking to buy a business or sell your business you may be asking yourself, what is the difference between a share and an asset purchase/sale, and which is better for me? These are common questions that Lott & Company has dealt with many times over the years, so let’s break it down and walk through both scenarios together.
In a share transaction, the shares of a corporation are purchased by the buyer. A share sale involves the sale of the company with the buyer essentially taking over the business. In a typical share sale, all assets and liabilities remain with the company and transfer to the new owner. In short, you are taking over or selling all aspects of the business. Let’s say for example, company A, a multinational conglomerate, is interested in acquiring your successful chain of retail stores. In this scenario, company A purchases a significant majority of the shares of your retail chain, effectively gaining ownership and control of your chain. In this case, company A becomes the new parent company, and you become the subsidiary under the umbrella of company A’s ownership.
In an asset transaction, the company sells some or all of its business assets (which can include inventory, equipment, buildings, working capital, accounts receivable, intellectual property, contracts, etc.) to a buyer, but the company itself is not sold. In an asset transaction, the seller retains ownership of the company as a legal entity. So let’s imagine that company A, a well-established technology firm, decides to sell a portion of their business that specializes in manufacturing computer components. Now for arguments sake, let’s say you own a startup focused on hardware development and have been looking to break into the market. This could be a strategic opportunity for you to quickly enter the market with an established customer base and operational infrastructure. Now let’s say terms of the transaction are negotiated and you’ve purchased this division of company A, well done! So unlike a share purchase where the entire ownership of company A would change hands, in an asset sale only the designated assets and liabilities associated with the computer component division would be transferred to you. Company A will still retain ownership of its other divisions, assets, and liabilities.
Now that we have addressed the difference between a share vs an asset sale, we need to talk about the tax implications of both a sale vs an asset purchase on both the seller and the buyer. Generally, share sales are preferred by sellers to take advantage of favourable capital gains treatment, while asset sales are preferred by buyers to minimize risk.
In some cases, a hybrid sale – which combines elements of both a share sale and an asset sale to balance risk and tax implications – may be possible.
Let’s look at the common tax considerations with selling a private incorporated business in Canada.
Tax Implications of a Share Sale
A share sale is usually preferred by sellers, as it generally results in a favorable capital gains treatment. If an individual sells their shares in a company, the proceeds ─ in excess of the adjusted cost base of the shares and certain expenses incurred to sell the shares ─ result in a capital gain, which is only 50% taxable.
Additionally, if the shares are considered Qualified Small Business Corporation (QSBC) shares, the seller may be able to shelter all or part of the resulting capital gain from tax by claiming their Lifetime Capital Gains Exemption (LCGE). In 2023, the LCGE for QSBC shares is $971,190.
How to Qualify as QSBC Shares
To qualify as QSBC shares, your Canadian-controlled private corporation must meet three conditions:
- At the time of sale, 90% or more of the fair market value of the corporation’s assets must be used principally in an active business carried on primarily in Canada (either by the corporation or by a related corporation), be shares or debt in a connected small business corporation, or be a combination of both.
- In the 24-month period immediately preceding the sale, more than 50% of the fair market value of the corporation’s assets must have been used principally in an active business carried on primarily in Canada, invested in shares or debt of a qualifying connected corporation, or a combination of both.
- The shares must not have been owned by anyone other than the individual seller or a person or partnership related to the seller during the 24-month period immediately preceding the sale.
A few things to consider when looking to qualify as QSBC, if the shares being sold are owned by a holding company rather than an individual, the capital gains exemption will not be available on the sale of shares unless the shares of the holding company are sold as only individuals can claim the capital gains exemption.
Although not usually the first choice of buyers, there are some factors that might motivate a buyer to pursue a share purchase:
- One factor could be if there is meaningful value in a company’s brand and reputation, and the buyer intends to carry on the same or similar business.
- Another factor could be the tax considerations, such as available tax pools, including non-capital loss carry-forward balances and investment tax credits, that the buyer can use.
However, such considerations generally require that the same or similar business be carried on with a reasonable expectation of profit in order to be claimed by the buyer after acquisition. These motivating factors may only apply in certain situations.
It is important to keep in mind that a share sale will often result in a lower selling price versus an asset sale for the same business. Through a share purchase, the purchaser also acquires any outstanding known and unknown liabilities, including tax and legal liabilities, which opens up the buyer to a higher level of risk. When considering buying through a share purchase, buyers are encouraged to conduct a rigorous due diligence process to ensure their purchase doesn’t come with unexpected skeletons in the closet. Protective clauses for tax and legal liabilities may also be added to the purchase and sale agreement as a standard part of a share sale.
In addition to liabilities, a buyer also inherits the existing tax cost of any acquired assets, which limits the amount of depreciation available to them in the future. When compared to an asset sale ─ which allows a buyer to increase the tax cost of acquired assets to their current market value ─ the tax disadvantages of a share sale for a buyer can be significant, particularly for a capital intensive business.
It is important for a seller to weigh the tax benefits of a share sale against the overall selling price. A good exercise is to calculate and compare the after-tax result of selling company shares versus selling company assets. For larger companies and more complex deals, the capital gains tax advantages may become less important relative to maximizing purchase price and available corporate tax deferral opportunities.
Tax Implications of an Asset Sale
With an asset sale, the buyer purchases ownership of a company’s assets such as inventory, equipment, and accounts receivable and they aren’t responsible for any liabilities associated with the existing business – other than those they deliberately elect to assume. In other words, this purchase method lets the buyer pick and choose which assets to buy and which liabilities, if any, to assume, which in turn limits their risk.
Also, in an asset sale, unlike in a share sale, a buyer can increase the tax cost of any depreciable property to its current market value. This ‘step-up’ of the tax base of the acquired assets decreases a buyer’s future tax burden, as it allows for greater deductions of capital cost allowance (CCA). However, sales tax and land transfer tax may be applicable on the purchase of assets.
Income tax considerations can make asset sales a less appealing approach from a seller’s perspective. Sellers face two levels of tax upon an asset sale:
- Tax paid by the corporation on the sale of assets with an accrued gain
- And tax paid by the owner when the net proceeds are withdrawn from the company.
After the sale of assets at the corporate level, the net proceeds are generally distributed to you, the owner, as dividends, which are subject to tax at your applicable marginal tax rate. However, where there is a gain in the value of assets over their original cost, the corporation may be able to pay capital dividends on the non-taxable portion of capital gains realized on the sale of assets, which has the benefit of being tax-free to the recipient individual.
Further, how the purchase price is allocated across specific assets plays an important role in an asset sale. This will dictate your taxes payable and after-tax proceeds as the vendor. The purchase price is often a key negotiation point in asset sales, and should be agreed upon and stipulated in the purchase and sale agreement.
Buyers are generally motivated to allocate more of the purchase price to inventory or depreciable property in order to benefit from higher tax depreciation claims going forward. On the other hand, sellers want to minimize income on the sale of inventory and recapture capital cost allowance previously deducted on depreciable property.
Depending on the unique circumstances of the business and transaction, a hybrid sale may be an effective way to bridge the tax objectives of seller and buyer. By combining the sale of both shares and specific business assets, the seller may be able to utilize their LCGE while the buyer partially increases the tax cost of purchased assets. Let’s start with a basic example, for instance a seller sells their shares to a buyer for a gain in order to claim the LCGE. The seller then sells business assets with an accrued gain through an asset sale, which allows the buyer to have a stepped-up cost basis in those assets. The buyer then consolidates both the shares and the individual assets through a reorganization.
Note: The actual steps involved in a hybrid sale are considerably more complex, and there are a number of provisions within the Income Tax Act that can affect a hybrid transaction. To avoid any negative tax consequences, it’s important to consult with an expert and consider all possible tax and business implications before moving forward.
When making business decisions such as whether to sell or purchase a business, there is a lot to consider from tax implications to the type of sale. When deciding on the optimal sale method for your business it is best to consider every factor and have a clear understanding of the tax implications well in advance. If you are considering selling your business within the next few years, it’s a good idea to conduct a detailed company review in order to uncover any potential obstacles or opportunities that might pop up. There may be actions you can take now—such as a reorganization or restructuring of shareholdings—to help you achieve an optimal result in the future.
Lott & Company is committed to helping you
The team at Lott & Company are here to support you. If it’s time to sell your business, planning and foresight will help you achieve your goals and reduce your overall tax burden. If you are interested in purchasing a business, we can help you navigate and make the best decisions based on your objectives. We can provide strategic advice before, during, and after a transaction to ensure the sale is structured and executed in a way that meets your personal objectives and maximizes your tax position.