INFocus: Tax considerations when purchasing a businessDate: July, 2012
When a purchaser evaluates a target business for potential acquisition, there are various commercial and financial considerations that will be reviewed as part of the evaluation process. During this review, the purchaser should also evaluate relevant tax implications when analyzing the target’s business.
The following are some of the tax-related considerations that should be reviewed and evaluated when investigating a business for purchase.
Benefits for the purchase of assets
Buying the assets of a target business (as opposed to the shares of the target corporation in which the assets reside) allows the purchaser some benefits. These include:
- Avoid acquiring the undisclosed tax (and other) liabilities that may exist in the target corporation;
- Buying only the specific business assets that the purchaser wants to acquire;
- Benefitting from a ‘step-up’ in tax basis of the acquired assets, thereby allowing the purchaser to claim higher tax depreciation on the assets where allowed; and
- Dealing with only one vendor (as opposed to multiple shareholders).
Benefits for the purchase of shares
Buying the shares of a target corporation that houses a business may allow the purchaser to negotiate a reduced purchase price for the business, if the vendor can benefit from the capital gains exemption on the sale of their shares. It might also be possible to increase the tax cost of the non-depreciable capital assets within the purchased company after the acquisition if the purchase is structured properly.
Allocation of the purchase price on an asset purchase
The agreed upon allocation of the purchase price on an asset purchase will determine the vendor’s taxable income, arising from the assets sold, and will determine the purchaser’s ability to expense the purchase price based on the tax nature of the assets purchased. As a result, a purchaser of assets will generally want to allocate as much of the purchase price as possible to assets that can be depreciated quickly for tax purposes (as opposed to assets that cannot be depreciated for tax purposes, or assets that depreciate slowly). This desire is at odds with the wishes of the vendor, as this type of allocation will generally result in a larger amount of taxable income (and subsequently tax) being realized by the vendor on the sale. For this reason, the allocation of the purchase price on a bulk asset sale is often a point of negotiation.
Tax due diligence
When a target company’s shares are being purchased, it is necessary to consider the scope of tax due diligence procedures to be performed on the target. Performing these procedures allows the purchaser to gain a level of understanding over the unrecorded tax liabilities within the target company, as well as to understand the tax attributes of the company that is being purchased. The results of the tax due diligence procedures often become a negotiation factor with the vendor for the price to be paid for the shares of the business.
Use of a holding company
If purchasing a target corporation’s shares, consider using a holding company to make the acquisition. The holding company can borrow the funds required to make the share acquisition. The loan can then be repaid by the holding company with income that has only been subject to corporate tax (and not personal tax). This would result in the loan being repaid more quickly than if an individual purchaser had borrowed the funds. Furthermore, after the share purchase, the holding company and the purchased corporation can amalgamate to form one entity, thereby making the interest on the loan deductible from the operating income of the business.
Although the above list is far from exhaustive, it illustrates the various implications that a business purchaser should examine when considering making an acquisition. Although not all tax issues related to the purchase of a business should “wag the dog,” a prudent purchaser will review all relevant tax considerations
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