Maximizing Tax Benefits: Allocating Purchase Price for a Business Acquisition
Updated: Jun 12
When acquiring a business in Ontario, the allocation of the purchase price between different business assets is crucial to determine the tax implications of the acquisition for both the buyer and the seller. Before the closing can take place, the seller and the buyer must agree on how the purchase price is allocated for the different business assets.
The allocation of purchase price refers to the process of assigning a portion of the purchase price to the different assets being acquired, such as real estate, goodwill, equipment, machinery, inventory, and other tangible and intangible assets. The allocation must be based on the fair market value of each asset at the time of the acquisition. When allocating the proceeds of a sale, it is important to specify whether they are assigned to inventory, depreciable capital (property that generates a capital gain when it is sold), eligible capital property (such as goodwill or licenses), or non-depreciable capital property (such as real estate, which appreciates in value over time).
Generally, wherever there is a tax advantage on one party to the transaction there is a concomitant tax disadvantage on the other party and vice versa. When a business is sold, the buyer and seller may disagree on how to divide the money between different assets. However, if they negotiate and agree on a fair allocation, the Canadian Revenue Agency (CRA) will accept it as legitimate. But, if the CRA suspects that the allocation is not fair or honest, they can use section 68 of the Income Tax Act to investigate. The CRA can set aside the allocation if they find evidence that the negotiations were not conducted honestly or fairly. If the negotiations were conducted fairly and there is no deception, the CRA will accept the allocation. The CRA will also check if the allocation is reasonable for both the buyer and the seller.
The allocation of the purchase price must also comply with the rules set out in the Ontario Business Corporations Act (OBCA). Section 242 of the OBCA requires that the allocation of purchase price must be based on the fair value of the assets being acquired. The fair value must be determined in accordance with generally accepted accounting principles (GAAP) and must be consistent with the valuation principles used for financial reporting purposes.
The seller must report any gain or loss on the sale of the assets on their tax return. Briefly, the gain or loss is calculated by subtracting the adjusted cost base of the assets from the proceeds of the sale. The adjusted cost base is the original cost of the assets plus any expenses incurred to improve or maintain them.
The allocation of purchase price can also have an impact on the goods and services tax/ harmonized sales tax (GST/HST) payable on the sale of the assets. The GST/HST payable on the sale of certain assets, such as real estate, is based on the fair market value of the assets at the time of the sale. Another important tax to take into account is the land transfer tax, which the buyer is required to pay upon acquiring real estate.
The allocation of purchase price between different business assets is a critical consideration when acquiring a business in Ontario. The allocation must be based on the fair market value of the assets being acquired and comply with the rules set out in the OBCA. The allocation can have significant tax implications for both the buyer and the seller, and careful consideration should be given to minimize tax liabilities and maximize the benefits of the acquisition. It is recommended to seek professional advice from an accountant or a business/tax lawyer before finalizing the allocation of purchase price.
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