CHAPTER EIGHTEEN

1. CHAPTER EIGHTEEN • Business Acquisitions and Divestitures – Tax-Deferred Sales • I.Tax-Deferred Sales and Acquisitions • II. Sale of a Closely Held Corporation

2. I. Tax-Deferred Sales and Acquisitions • A tax-deferred sale is distinguished from a taxable sale by the nature of the payment received for the property. • A taxable sale involves the payment of cash, or a deferred payment of cash secured by notes bearing interest. • A tax-deferred sale involves payment in the form of shares issued by the purchasing corporation.

3. There are three basic reasons that a vendor may be prepared to accept a greater risk by receiving shares rather than cash or other secure assets: • The vendor wants to participate in the continued growth of the business. • The vendor simply wants to enhance its after-tax return on investment. • The purchaser may not have sufficient cash to make the acquisition, or perhaps no other acceptable buyers are present.

4. When arranging a tax-deferred sale of a corporate business, one must utilize the special provisions of the Act that are designed to provide tax relief when corporations are reorganized.

5. When arranging the tax-deferred sale of a business, the following alternative courses of action are available: • A sale of assets by one corporation to another at an elected transfer price for tax purposes equal to the assets’ tax values. • A sale of the corporation’s shares to a corporate purchaser at an elected transfer price equal to the tax value of the shares. • An amalgamation of two or more corporations. • A reorganization of share capital.

6. Sale of Assets • A tax-deferred sale can be achieved by arranging for the vendor corporation to sell individual assets to the buyer corporation at a price for tax purposes equal to the assets’ cost amount. • This can be done even though the actual selling price for legal purposes is equal to the assets’ FMV. • The vendor achieves a tax deferral and the potential for increased returns, but also assumes an additional risk by accepting shares of the purchaser corporation as payment.

7. The major advantage of this form of purchase is that the purchase can be achieved with a minimum of cash and debt, because of the requirement that shares be issued as part of the payment terms. • A major disadvantage to the purchaser is that the cost base of the assets acquired is deemed to be equal to the transfer price elected for tax purposes rather than to the assets’ FMV.

8. Sale of Shares • A vendor that wishes to sell a business by selling the shares of the vendor corporation rather than assets can obtain a tax deferral by using the same elective provisions as for an asset sale. • For both the vendor and the purchaser, the advantages and disadvantages of a tax-deferred sale of shares are similar to those for a tax-deferred sale of assets.

9. To utilize the election to transfer shares at their tax values, both the purchaser and the vendor must formalize their intentions by signing a tax agreement. • While this is not a problem when there are few shareholders, it may be difficult when there are many shareholders, and virtually impossible when the corporation being sold is a public corporation. • The parties can overcome this problem by using a less formal tax-deferred method of selling shares, referred to as a share-for-share exchange.

10. A share-for-share exchange has been made when a purchasing corporation acquires the shares of another corporation and the payments consist entirely of shares issued by the purchaser. • In these circumstances, and provided that certain other conditions are met, each separate vendor is entitled to declare that its shares have been sold at their cost amount, thereby deferring tax on the sale.

11. The share-for-share exchange is not so attractive for the purchaser. • The purchaser’s ACB of the shares acquired in a share-for-share exchange is equal to the lesser of the shares’ paid-up capital or their FMV. • As the acquired shares’ paid-up capital is normally lower than FMV, the result is that the purchaser’s cost for tax purposes is lower than the market value of the shares. • This may result in additional taxes if the shares are subsequently sold.

12. Amalgamation • The amalgamation process combines a share sale with an asset sale, in that the shareholders of the former corporations exchange their shares for shares of the new corporation, and all of the former corporations transfer their assets to the new corporation. • This type of business combination automatically results in a tax-deferred exchange of shares and assets.

13. Share Reorganization • A tax-deferred sale of a business can also be achieved by a reorganization of share capital. • The existing shareholder would convert common shares with a certain FMV and cost into fixed-value preferred shares of the same value. • The purchaser would then acquire newly issued common shares for a nominal value. • This method involves considerable risk for the existing shareholder, as the opportunity to realize the value of the preferred shares depends entirely on the continued success of the vendor corporation.

14. Conclusion • All tax-deferred acquisitions involving a share sale, an asset sale, an amalgamation, or a share reorganization have similar results for both vendor and purchaser. • The vendor defers tax on the sale by accepting payment, in whole or in part, in the form of the purchaser’s shares; in doing so, that vendor incurs greater risk. • The purchaser assumes the disadvantage of a lower cost base for the assets acquired, but is also able to issue shares as payment for the acquisition, which reduces the related cash and debt requirements.

15. Because so many options exist, both tax-deferred and fully taxable, there is considerable flexibility in structuring a business divestiture and acquisition. • The choice of method will depend on the needs of the vendor and purchaser in the given circumstances. • Because the best form of transaction for a particular situation is not always obvious, the decision-making process must involve examining each of the alternatives in terms of both its immediate and its long-term impact.

16. II. Sale of a Closely Held Corporation • A closely held corporation has either a single shareholder or a relatively small number of shareholders so that the relationship between the shareholders and the corporation is very close. • Special circumstances may exist that affect the manner in which the business is ultimately sold, whether the sale is to independent third parties or to related family members.

17. Often, but not always, a closely held corporation will have the following features, which will affect any later sale of the business: • The corporation that houses the business has, in addition to the business assets, a number of investment assets that are not related to the operation of the business. • The owner of the business is usually under greater pressure to sell the business to immediate family members of the next generation, or to senior managers or other employees who have given long service to the business. • The business of a closely help corporation is often sold in response to the owner’s wish to retire.

18. Sale to Third Parties • The sale of a business to third parties may involve negotiations with a number of potential buyers, each of which faces a different financial situation, and each of which has a different reason for making the acquisition.

19. Sale to Family Members • The sale and purchase of a business within a family unit has all of the fundamental aspects of a sale to third parties. • In most cases, the vendor in a family transaction is prepared to given preferential terms that will ensure a successful acquisition by the purchaser.

20. The sale of a family business to children may appear unnecessary considering that on the death of the parent, the business will likely pass to the children as a succession gift. • However, a parent may want to sell a family business to children well before an estate transfer because: • An early transfer may minimize the tax liability that would otherwise occur on the death of the original owner. • The early transfer of a family business from one generation to another provides an orderly succession and a continuity of management responsibility.

21. The sale of a business to family members is often motivated by personal factors, which in turn influence the form of the transaction. • A sale to a third party must result in the best possible security for the vendor so that he/she can ultimately realize the full value of the business. • In a sale to children, however, the vendor is less concerned about security; this means that the deferral and minimization of tax may be the primary concern when the method of transaction is being chosen.