OverviewAssets vs. Shares – How to decide?What’s the big deal about allocation clauses?Where are the forms?How can they pay tax if they’re not getting any money?Let’s reduce the purchase price with consulting agreements!Now that all this money is in the company …
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Purchase and Sale of Assets
Purchaser IssuesSelection of assets and liabilitiesTax basis = Purchase price allocated to asset
Future deductions
Vendor IssuesIncome
Recapture / Terminal LossReserves
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Purchase and Sale of Shares
Purchaser IssuesInherit tax and other liabilitiesInherit tax cost of assets
Limited opportunity to set up cost base
Vendor IssuesOne level of taxCapital gains treatment$750,000 capital gains exemption
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Tax Factors Influencing StructureTax Status of
TargetShareholders of TargetPurchaser
Tax RatesVendorPurchaserShareholders of Target
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Tax Factors Influencing StructureIncome Generated from Sale of Assets
Ordinary IncomePropertyBusiness
Capital gains (or capital gains equivalent)
Tax CostACB of Target shares to shareholders of TargetAssets of Target that are subject of sale
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Tax Factors Influencing StructureTax Attributes of Assets in hands of Purchaser
Will CCA rates change?Goodwill
Assets in Target not to be part of saleCan they be removed on tax effective basis?
Safe Income in TargetAllow for tax-deferred distribution to Holdco
Liabilities for Tax
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Tax Factors Influencing StructureAvailability of Deferral
Vendor Shareholders – Share SaleVendor Corporation – Asset Sale
Losses in Vendor CorporationExistenceNatureCarry forward on share sale?
$750,000 Capital Gains Exemptionhow many?
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Due DiligenceFinancial Statements
Consolidated versus entity basisWhat are you given?
Balance SheetIncome StatementStatement of Changes in Financial PositionNotes
Complete picture?Source of tax information – T2Minute book
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Due DiligenceT2 and notices of assessment and reassessment
look at Sch 1 – reconciliation of accounting income to taxaggressive treatment of income or expense – risk of reassessment?
Tax Rate of TargetSBD?M+P?
Tax Rate of ShareholdersTax Accounts
CDARDTOHGRIP
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Due Diligence
LossesNon capital losses
businessproperty
Net capital lossesCarryforward periods
Other CarryforwardsCharitable donationITC's
Foreign AffiliatesExistenceStatus
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Due DiligenceValuations
Any?Tax elections (e.g. T2057)
Assets: Tax Cost vs. Book Value vs. FMVPST, GST, HSTLTTShares of Target to shareholders
ACBPUC$750,000 Capital gains exemption?
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SELLER COBalance Sheet as at December 31, 2010
Assets
Cash 18,575
Accounts Receivable 183,560
Prepaid Expenses 171,330
Inventory 248,048
Shares of Subsidiaries 6
Land 500,000
Fixed Assets 815,274 $1,936,793
Liabilities
Accounts Payable 115,991
Long Term Debt 248,571
Due to Shareholder 173,311
Shareholders’ Equity
Stated Capital 45,000
Retained Earnings 1,353,920 $1,936,793
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Depreciation vs. CCA
Accounting concept Financial Statement
Cost net of depreciationEstimated useful lifeAsset by asset basisMandatory deduction
Tax conceptStatutory rates and classesClass by class basisBusiness by business basisDiscretionary deduction
not claim in loss year
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Depreciable Capital Property
Only year end balances countNo doubling up for deductions not claimedRecapture and terminal loss
Property to class?Replacement property?
Half-year rulesPro-rateChange in classes
VENDOR PURCHASER
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Categorize Assets from a Tax Perspective
Accounts ReceivableInventoryNon-depreciable capital propertyDepreciable capital propertyEligible capital property
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Software in DevelopmentCategorization of asset for tax purposes
InventoryEligible capital propertyDepreciable capital property
SignificanceInclusion rateReserves only if depreciable capital property
Conclusion: Eligible capital property
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Allocation of Purchase Price
Mutual
Vendor’s interest and Purchaser’s interest mutually exclusive
Trade-offs?
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TENSION!!!!
Non-depreciable capital propertyDepreciable capital property
Little or no recaptureEligible capital propertyDepreciable capital propertyInventory
InventoryDepreciable capital property – high rate CCAEligible capital propertyDepreciable capital property – low rate CCACapital property
Vendor’s Preference
Purchaser’s Preference
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Acceptance by CRAOpposing InterestsCRA generally acceptsS.68
Not reasonable in circumstancesNo evidence of hard bargaining in negotiationsSham, subterfugeProperty and Services
AgreementDetailed allocation
ScheduleProcess to determine
Covenant to file consistently
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Accounts Receivable
Sale $10,000Income inclusion – 12(1)(b)
Income inclusion notwithstanding the fact that the amount or any part of it is not due until a subsequent year
All or a portion is not collectableDoubtful debt reserves – 20(1)(1)Bad debt deduction - 20(1)(p)
Subsequent yearIncome inclusion - 12(1)(d)
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Accounts Receivable
Year 1
Income $10,00020(1)(1) 10,000Net 00
Year 2
12(1)(d) $10,00020(1)(1) 10,000Net 00
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Sale of Accounts ReceivableVendor
Income inclusionInclude doubtful debt of previous year
No reserveCapital loss
PurchaserNo reserve in future years
Year 212(1)(d) $10,00020(1)(1) 0
Net 10,000
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Accounts Receivable Solution
Section 22 ElectionJoint
ConditionsVendor carries on businessPurchaser proposes to carry on businessAll or substantially all of assets of business
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Accounts Receivable
Sub 2Sub1 Business and AR Sub 1
Parent
Parent transfers Sub 1’s business to Sub 234
Accounts Receivable, cont’d
ConditionsVendor carries on the businessPurchaser (Parent) proposes to carry on the businessSection 22 election not available
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Accounts Receivable
US Parent
Canadian Sub
Canadian Vendor
Machinery and Equipment
Inventory and AR
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Accounts Receivable, cont’d
ConditionsAll or substantially all of the assets of the vendor
Section 22 election not available
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Accounts Receivable, cont’d
All accounts receivable of business?
Transportation CompanyTrucking business, courier businessSelling trucking business
Separate business
Who bears risk if election not available?
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Deferrals
ReservesAmount due after end of yearDemand note?
StrategyTerm of promissory noteAmount of down payment
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Sale of Land: Cash and Mortgage
Land – capital propertyPurchase price allocated to land: $4.5 millionCost:$250,000Capital gain: $4.25 millionConsideration:
$500,000 cash, $4 million mortgage,
interest onlyprincipal in 5 years
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Tax in Year of Sale
Proceeds 4,500,000Less: ACB 250,000Capital Gain 4,250,000
Taxable capital gain 2,125,000
Tax (48.7%)** 1,034,875
** a portion of tax is refundable on payment of dividends
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Tax in Year of Sale Proceeds 4,500,000Less: ACB 250,000Capital Gain 4,250,000Reserve 3,400,000Gain 850,000
Taxable capital gain 425,000
Tax (48.7%)** 206,975
Cash Remaining = $293,025
** a portion of tax is refundable on payment of dividends
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Tax in Year 2 Reserve 3,400,000Less: Reserve 2,550,000
Gain 850,000
Taxable capital gain 425,000
Tax (48.7%)** 206,975
Cash Remaining = $86,050
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Tax in Year 3 Reserve 2,550,000Less: Reserve 1,700,000
Gain 850,000
Taxable capital gain 425,000
Tax (48.7%)** 206,975
Cash Remaining = <$120,925>
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Tax in Year 4 Reserve 1,700,000Less: Reserve 850,000
Gain 850,000
Taxable capital gain 425,000
Tax (48.7%)** 206,975
Cash Remaining = <$327,900>
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Tax in Year 5 Reserve 850,000Less: Reserve 000
Gain 850,000
Taxable capital gain 425,000
Tax (48.7%)** 206,975
Cash Remaining = 4,172,100
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Consulting AgreementPurchase deduct payments provided reasonable
services provided, etc.
Income inclusion at full ratesDeferralEarned income for RRSP
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Foresbec
A
B
Purchaser
A sells shares of B for $3.96 million; cash $2.010 and note 1.95
Purchaser’s owner becomes B’s president
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ForesbecMajor disagreement between Purchaser’s shareholder and A’s presidentPurchaser’s shares in B acquired by A: price was equal to cash of $1,750,000 unpaid purchase price and waiver of other amountsContract provided that B would enter into contract for services with Purchaser’s President for $150,000 to be paid over 3 years
Signed by A, B, not PurchaserB deducted payment
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Foresbec
TCC, FCADeduction in computing income denied
guarantee of paymentenable to purchase sharesno services
Ss.15(1) benefit since B paid part of purchase price for purchase of shares by AStatute-barred years openPenalties
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Let’s reduce the purchase price
Separate agreementsConsiderationReasonablePigs get fat, hogs get slaughtered
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Distribution of After-Tax Proceeds
Repayment of shareholder loans
Return of paid-up capital
Capital dividend
Taxable dividend
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