Our clients often ask us this question when they are looking to purchase or sell the ownership interests in a company “should I purchase/sell the shares of a company or the assets?”
Generally speaking, when selling a business, the preferred deal structure is to sell the shares of the company over the assets. However, if you are buying a business your preference will typically be to purchase the assets of the company and here is why.
When selling the shares of a corporation, capital gains taxes may be incurred on the sale of those shares. Under the Income Tax Act these capital gains receive beneficial tax treatment when compared to other sources of income.
On the other hand, in the case of an asset sale, the resulting tax consequences compared to a share sale are typically higher. This is mainly due to the fact that there is a level of taxation first within the corporation and then the resulting after-tax proceeds are distributed to the shareholders in the form of dividends which attract a higher tax rate than that of capital gains. This higher taxation will not always be the case but it is generally what we see in most circumstances.
On top of the differing taxation rates, the sale of shares for businesses may also receive more favourable treatment in situations where the shares are classified as Qualified Small Business Corporation Shares (“QSBC Shares”).
When the sale of a company’s shares qualify as QSBC Shares they are eligible for a one-time Capital Gains Exemption (“CGE”) that effectively provides a shareholder with tax free income related to the sale of the company. For 2022, the maximum amount of tax free income available is $913,630 with this amount subject to an annual indexing to inflation.
In addition to the above, a further possible benefit that is available is the deferral of the taxes owing on the capital gains in situations where the proceeds relating to the sale of shares is received over a period of time. There is no similar deferral mechanism available with the sale of assets.
This tax deferral opportunity is referred to in tax jargon as a Capital Gains Reserve. The Capital Gains Reserve can be utilized when the shares of a company are being sold and the payments are received by the seller over a period of time (i.e. installments). Given this, the sale of shares can benefit by spreading the tax liability over a potentially five-year period. When determining the potential benefit of the Capital Gains Reserve, it is important to consult a professional to ensure the deferral is optimized but also that the benefit of the deferral outweighs the potential risk of collection of the purchase price proceeds that are also being deferred.
Sale of Assets
When you sell the assets of a company, the purchaser will be able to restate the values of the assets purchased to the current price paid for these assets (often referred to as a tax ‘bump up’ in asset values). As a result, this restatement provides a benefit in situations where the purchase price of the assets being acquired is higher than the existing accounting and tax values and/or when there are assets acquired (i.e. goodwill, customer lists, etc.) that don’t even have an existing accounting or tax value (i.e. internally generated intangible assets brand, customer relationships etc.).
Depending on the assets acquired and whether these assets can be depreciated for tax purposes, the higher asset value paid for by the purchaser will result in larger tax deductions enjoyed by the buyer in the future. In contrast, structuring a transaction through the purchase of shares instead of an asset purchase results in the purchaser assuming the same cost basis for the assets as the seller, resulting in lower future tax deductions when compared to the sale of assets, as the ‘tax bump up’ in value is generally not available in a share transaction.
When you sell the shares of a company, the purchaser assumes all of the assets and liabilities (including contingent liabilities). However, if you sell the assets of a company, the purchaser has the ability to pick and choose what assets to buy and does not assume any liabilities. This approach is similar to the “cherry picking” term as the purchaser will only purchase the assets that fit with his or her objectives and plans, while leaving the remaining unwanted assets and liabilities for the seller to deal with. The other risk to a purchaser in buying the shares is that they might acquire hidden or unknown tax or other liabilities. While the legal agreements for a share sale will attempt to mitigate against this risk, the purchaser will be left to deal with the liabilities and attempt to recover any losses incurred as a result of the unknown issues.
The last consideration relates to what we would refer to as the “cleanliness” of the transaction since the sale of shares do tend to be “cleaner” and less complicated. This factor is somewhat tied to the point above in that a share sale encompasses everything related to the business being sold. Any contracts or agreements of the corporation and all of the employees would generally seamlessly transition under a share sale situation. Conversely, in an asset sale, any legal agreements of the business being sold will need to be transitioned over to the acquiring company. Similarly, the employees of the existing business will need to be terminated from the existing corporation and re-hired by the new company. These are all items that can be adequately addressed but they can create additional complexity in what may already be a complex transaction.
Ultimately, the decision to sell assets or shares will be determined through negotiation. In our experience, we see most transactions structured as a share transaction given the significant tax benefits available to the vendor noted above. However, if a purchaser requests that the sale be structured as an asset deal, the seller would typically ask for a higher selling price as compensation for not being able to take advantage of the various benefits and tax opportunities available. Either way, we highly recommend business owners consult with a tax and/or M&A professional to ensure that the ultimate decision considers all of the factors relevant to their specific situation.