Maximizing growth: Tax considerations and key questions for business expansion or acquisition

Growing a business during a turbulent economy comes with many complicated decisions. Whether you’re expanding an existing company or buying a new one, there are a variety of tax considerations to keep in mind.

It’s important to work with a trusted financial advisor throughout this process. Your advisor will help you create a solid purchase and sale agreement and guide you through a myriad of issues including any future environmental complications, important legal and compliance considerations, and Capital Cost Allowance deductions.

What to ask when growing your business

Entrepreneurs are dealing with unique economic challenges as they work to fulfill their ambitions. From sky high inflation, increasing interest rates and a looming recession, buying a business – or expanding an existing company – comes with risks. This is why it’s essential to answer the following questions before moving forward.

Are you expanding or buying a new company?

When making a decision, keep the following considerations in mind:

  • Will you be able to quickly grow a stable customer base? When buying a new business, there’s likely already a customer base. If you’re expanding, it’s vital you understand the market in your new location, as well as the competition. If you choose a saturated area, it may be hard to stand out.
  • Work with your financial advisor to understand the market you’re entering, along with profitability potential. If the new company you’re investing in has a low profit margin, there may be an opportunity to be more efficient with its existing assets in order to increase this margin.
  • Which option is more expensive? Take all aspects into consideration, including your sales cycle, utility bills, real estate expenses, additional insurance, and financing needs.

Where are you locating your business?

Whether expanding or buying a new company, choosing the proper geographic area is essential to your long-term growth. Keep in mind:

  • Business needs. If you sell a service, you may need office space that employees can reasonably commute to if no remote work programs have been put in place. Otherwise, this might not be as important of a consideration. A retailer will need parking space, while a high-end business may prefer to be located next to other high-end retailers.
  • Are renovations or changes necessary? If you’re buying a business or expanding a current location, it’s vital to understand if renovations or any costly changes will be needed in the near future. IE: Will the building need to be expanded to support long-term growth?
  • Different municipalities have different property tax rates. Some towns are actively trying to attract businesses, and may offer a preferential rate, while others, like big cities, are naturally going to be more expensive.

Structuring your purchase – Shares vs. Assets

When deciding on your purchase structure, it’s important to understand how to maximize any tax deductions and decrease your tax burden. A trusted tax and financial advisor, like our team at Zeifmans, can guide you through this process.

When purchasing a business, entrepreneurs can choose from the following structures:

Asset purchases:

Instead of buying the company itself, you’ll be purchasing a business’s tangible and intangible assets, which include real estate, equipment, customer lists, goodwill, etc.

The upside to this structure is that you’ll be starting from scratch, meaning any past debt obligations, tax issues or compliance concerns belonging to the previous asset owner won’t follow you into your new venture.

As you will be purchasing assets for their fair market value at the time of purchase, you will be entitled to a tax write off of the dollar values assigned to each asset over a period of time. Furthermore, if you pay an amount in excess of the fair market value of the assets themselves, this excess would be considered goodwill, which can also be written off over time.

These write-offs, known as “capital cost allowance” provide tax savings over the life of the asset and may even be accelerated in some instances, depending on the asset class to which it belongs, when the asset was purchased, and other factors.

Through CCA deductions, purchasers may be able to claim tax deductions for the depreciation of capital assets that are already owned by the target company being purchased, like buildings or machinery. The CRA allows businesses to recover any lost costs of these assets over their lifespan through CCA. However, unlike with an asset purchase, a share purchase will only yield CCA on capital assets if there is an existing balance in an asset class to depreciate, as the asset values are not bumped up to their fair market value.

The downside to purchasing assets is the amount of work and negotiations needed to complete the transaction. This includes negotiating supplier contracts, employment contracts, leases, loans and more, and can be a complicated, lengthy process.

Share purchases

Unlike an asset purchase, buying shares of a business means you’ll take over the whole company, including any debts, tax issues or compliance considerations. These transactions may require less complex negotiations and can be attractive if an entrepreneur is interested in a business’s tax attributes. For example, if a company takes part in research and development, it may be eligible for the Scientific Research and Experimental Development (SR&ED) tax credit program.

Those choosing a share purchase may be eligible for non-capital losses, which arise from property operations. These can be used against your taxable income, leading to a lower tax burden. However, new owners won’t be eligible for a goodwill deduction in this structure.

It’s also possible to take advantage of interest paid tax deductions during a corporate purchase by taking out a loan to buy the corporation. In this case, the interest will be deductible.

 In share purchases, the due diligence process is especially important. While asset sales will have a fairly straightforward due diligence process, share sales will need a thorough review of all tax considerations, including a deep dive into past tax returns for years within the statute of limitations. Areas of interest include international business activities and transfer pricing for cross-border initiatives. During this process, you’ll be able to ensure there are no outstanding tax liabilities or tax owing to the CRA, such as unpaid income taxes, GST/HST issues, payroll taxes etc.

Understanding the valuation process

During this process, you’ll also want to go through a formal valuation with a trusted financial team, like our experienced advisors at Zeifmans. If a buyer and seller can’t decide on a valuation or purchase price, an earnout may be useful. This allows the buyer to pay part of the purchase price once a financial milestone is met, such as earning $50M two years after closing. In the event of a share purchase, the buyer could also request protection from undisclosed tax liabilities.

Drafting the purchase and sale agreement

This stage of the process can be long and arduous, requiring substantial negotiations. When navigating the purchase and sale agreement (PSA), consider the following:

  • Purchase Price Allocation (PPA). When buying a company, your goal should be to price assets higher if they are likely tax deductible. Keep in mind that the seller will be trying to reduce income on inventory sales in order to take advantage of the CCA  deducted on amortizable property.
  • Using arm’s-length parties in the negotiation process. In this case, the CRA will likely accept a reasonable PPA, especially if there’s proof of price negotiations. When a sale is completed between non-arm’s-length parties, the CRA may scrutinize your PPA if the agency feels it’s unreasonable.
  • Tax-specific When purchasing shares, the PSA should include warranties, indemnities or representations that are specific to taxes. This way, any tax liabilities will be the seller’s responsibility before the sale closes. Ensure you include whether the buyer or seller will be filing pre-closing tax returns.

Navigating growth together

Growing your business is an exciting and often nerve-wracking time. Whether you’re expanding a current company or buying a new one, it’s essential to have a trusted partner by your side. Our team at Zeifmans is skilled at advising entrepreneurs through a number of tax considerations, business expansions and acquisitions. To speak to an experienced advisor, contact us here.