Selling assets in a business normally is not preferred by sellers. In some situations, due to the status of the business like continuing in a loss position or specialty of the business in nature, sellers have no choice but sell the assets in order to attract investors to carry on the business.

Purchase price allocation
In reality, seller and purchaser often spend time in agreeing the allocation of the purchase price. Why? The reason is that the allocation will determine the tax payable for the seller as well as the purchaser. Every single dollar counts. Seller’s ultimate goal is to allocate the purchase price to assets that attract less tax. For example, non-depreciable capital property is ranked the first to consider as 50% of any gain will be included in income. However, purchasers have totally different point of view in allocating the purchase price.

 

Then, what’s the tax impact on the items for sale?
There are two types of properties: non-depreciable property and depreciable property. The tax treatment on each type is different.

Depreciable property
Eligible Capital Property like intangibles (client list, trademark, goodwill, etc.), 50% of economic gains are considered active business income. The recapture is also considered active business income. Sale of goodwill is an eligible capital property as well. The valuation of the business will normally indicate how much is worth in goodwill, which does not have a tax value in the CEC pool. As a result, the disposal will generate recapture or economic gains. However, no reserve can be claimed even if payments for goodwill are made over time.  For other depreciable property, seller will be taxable on recapture. Recaptured depreciation is considered to be active business income for the purposes of the small business deduction.

Non-depreciable property
The disposition of non-depreciable capital property is treated like capital transaction. As a result, a capital gain or capital loss may be realized. If the properties held in a corporation, then taxable capital gains/loss are considered aggregate investment income and the non-taxable Capital gains portion will increase the capital dividend account (CDA), which can be distributed in a tax-free dividend to shareholders. If they are held under sole-proprietorships, it naturally flows through the personal tax capital gain transaction in schedule 3.
For example, if accounts receivable are sold, in most cases, it is sold at discount. Sellers will realize capital losses and only 50% of the capital loss is deductible. However, if a joint election under section 22 is filed, the transaction will be treated as a non-capital transaction. As a result, 100% of losses can be deductible for sellers. Isn’t it great? But there is a condition: 90% of the assets of the seller used in a business carried on in Canada are sold.
Inventories as an example, gain/loss will be treated as active business income. A three-year reserve for unpaid amounts may be available.

HST/GST implication
Generally, in the asset sale of a business, assets like receivable, capital assets will be subject to GST/HST because they are used in a commercial activity is deemed to be a taxable supply when sold or leased. There is a section 167 which can apply to avoid such burden. However, a number of conditions must be satisfied:

  • Both the seller and purchaser are a registrant;
  • The seller is supplying a business or part of a business;
  • The seller established, carried on, or acquired the business or part of a business;
  • Under an agreement, the purchaser is acquiring all or substantially all of the property that is reasonably necessary for the purchaser to carry on the business or part of a business; and
  • A joint election is made by the seller and purchaser.

In many cases, lawyers will help purchaser address this issue in the agreement to ensure a joint election is made by both parties. The Form GST44: Election Concerning the Acquisition of a Business or Part of a Business has to be filed if the purchaser is a registrant. For some transactions, sellers are not aware of such HST implication. Once the issue comes to the surface, it is too late to make any changes.

How much can be distributed
Ultimately, the amount available to distribute to shareholders is critical. The amount can be determined from: Proceeds of Disposition – Liabilities – Corporate Taxes + RDTOH; and the amount distributed to shareholders is subject to personal tax as well. For sole proprietor, the amount is simply determined from: Proceeds of Disposition – Liabilities – Personal Taxes.

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