What to Consider When Buying a Business of a Sole Proprietorship
By: Nizam Shajani, CPA, CA, MBA, Partner
The organizational vehicle of the business you purchase will have tax implications. If you buy a sole proprietorship you normally acquire its assets. This includes its inventory, equipment, leases, customer lists and so on. The purchase price allocated to each asset (or asset group) will determine your cost basis for tax purposes. Depending on the type of assets acquired, a portion of the cost basis can be deducted in current and subsequent periods at various rates against future profits of the business. This future deduction will provide a significant tax shield against future profits. However, the purchase price allocation may also significantly impact the amount of taxes owed by seller.
It is advantageous to have your accountant involved in the negotiation of the purchase agreement as the allocation of the purchase price of the assets can sometimes render a more favorable result to one of the parties given an alternate allocation. To avoid potential problems with the CRA, the parties should negotiate the final purchase price and allocation to be reflected in the purchase agreement. Your accountant can provide valuable advice and assistance in determining an appropriate allocation methodology.
If the proprietor sells its business assets directly to your sole proprietorship or corporation - they can incur capital gains based on the price allocation, as well as recapture triggered that would have immediate tax consequences. The vendor may require a higher selling price to cover the taxes that will be payable, particularly if he or she is forgoing the opportunity to allocate prices to avoid or minimize any taxes payable on the transaction.
Because there are countervailing tax results to the purchaser and the vendor depending on the structuring of the sale of the business, the final sale price and structure is often negotiated to reflect both parties’ interests in terms of what is being enjoyed or given up in a fair manner.
Also, a purchaser does not normally acquire a proprietor’s business related liabilities. The purchase agreement should require the vendor to pay or settle all debts before closing and that they are not assumed by the purchaser unless specifically agreed to. When acquiring assets, it is important to check for any liens or charges on the property acquired and ensure that the vendor otherwise provides good clear title to the assets.
If you acquire business assets and operate as a sole proprietorship that becomes successful you may want to consider moving to a corporate structure. You can incorporate and transfer the assets of your sole proprietorship to the corporation on a tax-free basis. Shares must be received as consideration on the transfer. The rollover is undertaken by filing a T2057 election form.
If you are contemplating the purchase of the assets of a sole proprietorship you should request the following information from the vendor to be reviewed by your accountant:
- Financial statements and tax returns for the last three years
- A list of assets, liabilities, employees and customers
- Copies of leases
- Loan and assets agreements that are being assumed or acquired
- Names of their professional advisors including your lawyer and accountant.
This information is for discussion purposes only and should not be considered professional advice. There is no guarantee or warrant of information on this site and it should be noted that rules and laws change regularly. You should consult a professional before considering implementing or taking any action based on information on this site. Call our team for a consultation before taking any action.