A common issue for those considering the purchase of a new business is whether to also buy the company’s shares or assets. The vendor is usually motivated to sell the shares because they can use their capital gains exemption on the capital gains of the shares. The problem with buying shares is that the purchaser is then responsible for old liabilities to suppliers, employees or the government (probably the biggest concern), and potentially for previous work. Even more problematic, this liability is unknown in many cases.
Fortunately, there are some measures that can be taken to minimize this risk. In most business purchases, there will be holdbacks of the purchase price for anywhere from six months to a year. In some cases, there’s a vendor take-back, so the purchase price is paid over a number of years. This gives the purchaser the ability to adjust for any potential liabilities that arise.
The liability is enormous when you’re buying shares, but if you set up a new corporation, you have far less liability, as you are then only acquiring the business’ assets. You start your own HST account and your own payroll accounts, and thus don’t assume any liabilities related to past work. In essence, you’re using an old company’s assets to start a new company.
When new business owners consider purchasing shares versus assets, the one thing we advise is: if you buy assets that have increased in value, you can depreciate them at the higher value now for fair market value. You could run into a situation where somebody has a building that they paid $300,000 for 15 years ago and now that building is worth $500,000. On the purchase of these assets, you get to bump up that building to the $500,000 value. When you do a share sale, you don’t get that bump in asset values.
As for HST payments, the rule is that you can file an election on the purchase of assets if you’re acquiring substantially all of the assets to run a business. For CRA, “substantially all” is 90%, so if you acquire 90% or more of a business’ assets, you can elect for HST and not pay HST on the purchase. But let’s say a company has multiple entities under one name and you buy part of it – then you’re not buying substantially all of the business. As a result, you will have to pay HST on the purchase of these assets.
In the end, different purchasers have different needs, but it’s crucial that you understand the tax and liability implications of your options before finalizing a deal.