Download Sale of a business - Should I sell the assets or my shares? Recently

Sale of a business - Should I sell the assets or my shares?
Recently, the editor of Private Practice Division News mentioned to me that the "buying and selling of
a business" would make a good topic for my column. She felt it was something that would interest
physiotherapists. Since they're the group that this publication is directed towards, why not.
However, this topic is very complicated and I'm only going to briefly touch on the highlights here. I
would HIGHLY recommend you consult a tax professional to assist you in the selling of your
business.
As you've heard me say many times before, there are two different worlds involved with all matters of
taxation: the incorporated world and the unincorporated world. This applies to the buying and selling
of a business as well.
Selling an unincorporated business is definitely less complex. Basically, if you're buying an
unincorporated business, you're buying the assets of the business. These may or may not include
"Goodwill". Goodwill is a company's reputation, it's good name, it's client base, etc. Goodwill is often
very hard to quantify, and even harder to get somebody to buy. It's only ever realized when a
business is sold. Whatever amount one party is willing to pay another party to buy their business,
above and beyond the fair market value of the assets being purchased, is deemed to be goodwill.
Revenue Canada (now known as Canada Revenue Agency or CRA) treats this excess payment, or
"goodwill", as an asset of the buyer. This asset is known as an "eligible capital expenditure" (ECE)
and 75% of this expenditure can be amortized on the buyer's tax return at a rate of 7% per year, of
the declining balance.
The seller must then claim the proceeds they receive for goodwill as income ("recaptured"
amortization written off in prior years) and/or as a capital gain. These are the main issues that face
the buyer and seller of an unincorporated business.
The buying and selling of an incorporated business can be done in two possible ways.
1) Sell the shares of the business, which gives the buyer control over the net assets of the
corporation. This resulting in either a capital gain or loss to the seller.
2) Sell the assets of the corporation. The proceeds of the sale of the assets would stay within the
corporation after the sale. The shareholders would then pay out the cash as dividends and wind up
the company. Selling the assets will create what's known as a "capital dividend account" within the
corporation. This basically is the NON-TAXABLE part of the capital gain, (1/2 of the gain) on the sale
of each asset, accumulated into this "virtual" account balance (no real money is involved) known as
the capital dividend account. The account balance can then be paid out as a tax-free dividend from
the corporation to its shareholders.
Example: Mr. X & X. Co.,
Mr. X owns all the shares of X Co. Ltd., a Canadian-controlled private corporation. Mr. X has an offer
on the table from a Canadian public company to buy either all the shares of X Co. for $100,000 OR all
the assets of X Co. for $146,000. Assume Mr. X's shares have a cost base of $1000 (paid-up capital)
and are eligible for the $750,000 enhanced capital gains deduction on the sale of qualified small
business corp. shares. Thus, no tax for Mr. X. on sale of X. Co. shares. Mr. X. is in the 48.25%
marginal tax bracket.
X Co. has the following assets:
ASSET
PROCEEDS
COST BASE
Cash
$44,000
$44,000
Land
$10,000
$ 1,000
Buildings
$35,000
$10,000
Equipment
$25,000
$18,000
Goodwill
$32,000
NIL
$146,000
$73,000
Option 1 - Sell shares for $100,000
Proceeds
$100,000
Cost base of shares
$ 1,000
Capital Gain
$ 99,000
Enhanced Capital Gains
$( 99,000)
deduction
Net proceeds from sale of shares
$100,000
Option 2 - Sell all the assets for $146,000, and wind up the corporation
CAP DIV
ASSET
PROCEEDS COST BASE NET CAP GAIN (1/2)
ACCT (1/2)
Cash
$ 44,000
$ 44,000
----Land
$10,000
$ 1,000
$ 4,500
$4,500
Buildings $35,000
Equipment $25,000
Goodwill
$32,000
$146,000
$10,000
$18,000
NIL
$73,000
$12,500
$3,500
$16,000
$36,500
$12,500
$3,500
$16,000
$36,500