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Purchasing a business in Canada can be a complex yet rewarding endeavor. Whether you are a seasoned entrepreneur or a newcomer to the business world, understanding the legal intricacies is crucial to a successful acquisition. In this article, we will explore key considerations and legal aspects involved in the process of buying a business in Canada. When contemplating the prospect of becoming a business owner in Canada, one must navigate the decision between acquiring an existing business or initiating a new venture. The chosen path significantly impacts the approach to accounting for the purchase of business assets, particularly concerning income tax considerations.

Determining Purchase Structure

In the context of purchasing a business, a predetermined sum is typically paid for the entirety of the enterprise. In certain instances, the sales agreement delineates specific prices for individual assets, assigns a value to the business’s inventory, and, if applicable, designates an amount reasonably associated with goodwill.

When Asset Prices Are Specified

If the sale agreement explicitly outlines prices for individual assets, and these prices are deemed reasonable, they can serve as the basis for calculating the claim for capital cost allowance (CCA).

What Is Capital Cost Allowance (CCA)

When acquiring depreciable assets like buildings, furniture, or equipment for self-employment activities, immediate deduction of the property cost from the net farming or fishing income in the same year is not allowed. Despite this, the wear and potential obsolescence of these assets over time are recognized. To account for this, the Canada Revenue Agency permits the deduction of their cost over several years through a mechanism known as Capital Cost Allowance (CCA). This tax provision enables individuals to spread the deduction of the asset’s cost, acknowledging its gradual loss of value, and thus contributes to a more accurate representation of income over time.

When Asset Prices Are Not Specified

When the contract does not specify individual asset prices, the buyer is tasked with determining a reasonable allocation of the purchase price to each asset, inventory, and, if relevant, goodwill. These allocations should align with the vendor’s reported amounts during the sale.

Fair Market Value (FMV) Allocation

It is imperative to attribute the fair market value (FMV) to each asset, with any remaining portion of the purchase price allocated to goodwill after accounting for the FMV of assets and inventory. This meticulous allocation process is crucial for accurate financial reporting and adherence to taxation regulations.

Asset Classification and CCA Claiming

After determining the values for assets and goodwill, it’s essential to categorize these assets into appropriate classes for claiming Capital Cost Allowance (CCA). Effective January 1, 2017, the eligible capital property system underwent a change, introducing the new CCA Class 14.1 alongside transitional rules. Goodwill and specific intangible properties are no longer classified as eligible capital expenditures; instead, they are now considered depreciable property within the new Class 14.1.

Inventory Valuation and Income Statement Considerations

It is crucial to treat the inventory’s value as a purchase of goods for resale. This value should be factored into the calculation of the cost of goods sold in your income statement as the fiscal year concludes.

GST/HST Implications in Business Acquisition

  • GST/HST Purchase Threshold: In the context of Goods and Services Tax (GST) and Harmonized Sales Tax (HST) considerations, when acquiring a business or a portion thereof, a key criterion is acquiring all or substantially all (at least 90%) of the property deemed essential for conducting the business.
  • Joint Election for GST/HST Exemption: In the event of meeting the specified property acquisition threshold, both the buyer and the vendor have the option to collaboratively elect to exempt the sale from GST/HST liabilities. This election process involves completing Form GST44, known as the “Election Concerning the Acquisition of a Business or Part of a Business.”
  • Conditions for the Election: The joint election to eliminate GST/HST payable on the sale is contingent on the fulfillment of the property acquisition criteria. It is imperative to ensure that the necessary percentage of property is acquired, and the joint election is completed accurately and within the stipulated time frame. This process offers a mechanism for businesses engaged in acquisitions to potentially alleviate the burden of GST/HST obligations, contingent on meeting the specified criteria and completing the requisite election documentation.
  • Limitations on Election Usage: The option to elect for the GST/HST exemption is subject to specific conditions. Notably, this election cannot be utilized if the seller is a registrant, and the buyer is not a registrant, introducing a registration requirement for both parties involved.
  • Requirement to Purchase All or Substantially All Property: A crucial condition for the election’s application is that the buyer must acquire all or substantially all (at least 90%) of the property associated with the business, emphasizing a comprehensive rather than individual asset acquisition approach.
  • Continued Business Operation: The buyer must demonstrate the ability to continue operating the business using the acquired property as per the terms of the sale agreement for the election to be applicable.
  • Timely Filing of Form GST44: To formalize the election, Form GST44 must be filed within a specified timeframe. It is imperative to submit this form on or before the day corresponding to the filing deadline for the GST/HST return of the first reporting period in which GST/HST payment would have been required without the election.
  • Limitations of the Election: While the election can exempt the sale from GST/HST in certain aspects, it does not override obligations in specific scenarios. GST/HST will still be applicable to a taxable supply of a service made by the seller, a taxable supply of property through lease, license, or similar arrangements, and, if the buyer is not a GST/HST registrant, a taxable sale of real property. These limitations highlight the selective nature of the GST/HST exemption even when the election is utilized.

Business Acquisition through Share Purchase

An alternative avenue for acquiring an existing business is through the purchase of a corporation’s shares. This method does not alter the cost basis of the business’s assets. Given that a corporation functions as a distinct legal entity with the ability to hold property in its name, a change in share ownership does not impact the tax values of the assets owned by the corporation. Typically, the acquisition of a corporation’s shares is not subject to Goods and Services Tax (GST) or Harmonized Sales Tax (HST).

Importance of Legal Representation

Legal representation is essential when considering a business purchase in Canada due to the intricate legal landscape involved. Whether deciding between acquiring an existing business or starting anew, legal experts provide crucial guidance in navigating complexities, especially concerning income tax considerations. They play a pivotal role in negotiating comprehensive purchase agreements, addressing changes in Capital Cost Allowance (CCA) systems post-January 1, 2017, and understanding the nuanced GST/HST implications in acquisitions. Legal professionals are instrumental in ensuring eligibility for joint elections, compliance with filing requirements, and navigating limitations on election usage. In the realm of business acquisition through share purchases, legal representation becomes indispensable to navigate tax implications and ensure a smooth transfer without affecting the cost basis of business assets. In essence, legal guidance safeguards all parties, ensures compliance with evolving tax regulations, and contributes to the overall success of the acquisition.

Conclusion

In summary, acquiring a business in Canada involves navigating a complex legal landscape, and whether opting for an existing business or a new venture, understanding legal intricacies is crucial. Key considerations include determining the purchase structure, handling specified or unspecified asset prices, fair market value allocation, and the complexities of Capital Cost Allowance (CCA) and asset classification. The intricate realm of GST/HST implications, with its joint elections, limitations, and filing requirements, underscores the necessity for legal expertise. Additionally, the alternative avenue of business acquisition through share purchase presents its own set of legal considerations. Ultimately, legal representation is essential to ensure compliance with evolving tax regulations, protect the interests of all parties involved, and contribute to the success of the acquisition.

At Kozyrev Law, we specialize in providing comprehensive legal services tailored to the intricate landscape of business acquisitions in Canada. Our team guides clients through critical considerations, from determining optimal purchase structures to navigating Capital Cost Allowance complexities and GST/HST implications. With a commitment to precision, we assist in fair market value allocations, meticulous asset classifications, and ensure adherence to evolving tax regulations. Our expertise extends to joint elections, limitations, and filing requirements, offering invaluable support throughout the acquisition process. Whether pursuing an existing business or exploring share purchases, Kozyrev Law is dedicated to safeguarding our clients’ interests and contributing to the success of their business endeavors.

Note: The information presented in this article is not intended to constitute legal advice. It is recommended to refer to official government publications and guidelines for accurate and up-to-date information. For obtaining legal advice tailored to the specific circumstances of your case, it is advised to consult with a qualified professional.

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