Entrepreneurship & Small Business

Buying a small biz, worried about tax liability

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  • Dec 20th, 2017 6:19 pm
Deal Guru
Aug 2, 2010
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crossborderguy wrote:
Dec 19th, 2017 11:34 am
Before this gets side-tracked...

There are a few simple points to remember when it comes to a business purchase:

- Sellers like share sales. (They get the capital gains exemption on the sale.)
- Buyers like asset sales. (Zero risk to the buyer, and a new CCA pool.)

The sale transaction and associated price is always a compromise between the two methods. If there is a risk (like the tax risk you are talking about) then the sale price needs to be adjusted up or down to reflect that risk. If the sellers insist on selling the shares, then decrease your offer.

The next thing you need to figure out is the reassessment exposure if you did acquire the shares. So assuming that $20k/yr is ineligible, and assuming a 13.5% tax rate, that is exposure of $2,700/yr that CRA could hit you with. With interest on the back taxes, let's call it an even $3,000. And assuming CRA assesses 3 years worth of returns, that's a possible $9,000 exposure.
You forgot about the penalties and interest on the penalties. It can be significant.
crossborderguy wrote:
Dec 19th, 2017 11:34 am
So there you go, you've quantified the risk. If the sellers want $200,000 for the business (and you were originally OK with that), you offer $190,000, and put $10k away in a savings account as a contingency fund should CRA reassess. Don't grenade a good deal just because of a possible tax risk. Quantify the exposure first, then make a decision as to whether or not you want to deal with the headache.
It's not so cut and dried as you want to make it seem. Even if the buyer took this approach, the problem is the sellers are not going to accept the discount (which I dare say should likely be way more than you estimate) because they are not looking at it from the point of the view of the buyer who is factoring in possible interest and penalties. The only way to ensure that (and I don't agree this is an advisable approach or even that this company should be purchased by the OP) is to let them know the discount if for the potential tax assessment due to them cheating on their taxes. One is HARDLY going to bring that up!
crossborderguy wrote:
Dec 19th, 2017 11:34 am
Also, if/when you acquire the shares, the tax return will change in terms of shareholders and stuff like that. CRA will see the change in ownership, along with the expense changes. Usually if they see an owner change, they are less concerned about the expense variances, or so we are told. Something to thing about anyway.

Lastly, I don't know what neighbourhood you are from, but most people don't like rats. If you get labelled as one, it is hard to get away from that reputation, especially in a small town. I'd be cautious about listening to some of the advice in this thread.
People who should be ratted on don't like rats. The rest are happy that the culprits got caught. The point you miss about 'listening to some of the advice in this thread' (which obviously is a not so veiled reference to the advice to do the right thing and reporting these fraudsters) is that is being done anonymously and anyone could have reported them, in the town or elsewhere.

I started, bought and sold many businesses in my career. I'd run away from this deal as fast as I can.
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Mar 23, 2008
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mymward wrote:
Dec 18th, 2017 5:52 pm
That's kind of what I'm afraid of - that the accountant will tell me not to touch it. But I haven't taken him the books yet because we haven't signed a letter of intent. It's such an awkward situation though, we live in a small town so our lives are intertwined anyways. And they are seemingly good people who donate lots to charity. I just don't see how they think it's okay to pay their home electricity through the business? Or 100% vehicle expenses on a $60,000 truck that they barely use for business. Even with a notice to reader shouldn't your accountant warn you that's not okay?

I've worked for them for multiple years with the intention of buying the business. This is so disappointing.
You're paying the accountant (at some point) for their advice. Even if their advice isn't what you want to hear, you know what you need to do with it. Failing to listen to them would be foolish.

Given all that, why are you asking for advice from an anonymous Internet forum? If you get a vote of "Go for it!", will that override the advice of your accountant?

C
[OP]
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Jan 19, 2014
31 posts
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Canada
Thank you, I appreciate all the advice and opinions. This is exactly the type of discussion I was hoping for.
Deal Guru
Aug 2, 2010
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mymward wrote:
Dec 19th, 2017 2:26 pm
Thank you, I appreciate all the advice and opinions. This is exactly the type of discussion I was hoping for.
Good luck. FYI, don't take my advice as meaning that you shouldn't buy the assets of the company. It's the business sale I wouldn't touch.
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CNeufeld wrote:
Dec 19th, 2017 1:54 pm
You're paying the accountant (at some point) for their advice. Even if their advice isn't what you want to hear, you know what you need to do with it. Failing to listen to them would be foolish.

Given all that, why are you asking for advice from an anonymous Internet forum? If you get a vote of "Go for it!", will that override the advice of your accountant?

C
I think it's great to have this type of dialogue on a forum to get more of a 'world view' on a topic. It provides one with a lot more questions that might have to be asked and possibilities. I applaud the guy for seeking help, no matter where it is from. There are many times where I have sought input on RFD and things were mentioned that I didn't think of. I subscribe to the philosophy of 'You don't know what you don't know'.

I hardly doubt he is simply going to follow what people say on here blindly.
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Mar 23, 2008
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eonibm wrote:
Dec 19th, 2017 2:37 pm
I think it's great to have this type of dialogue on a forum to get more of a 'world view' on a topic. It provides one with a lot more questions that might have to be asked and possibilities. I applaud the guy for seeking help, no matter where it is from. There are many times where I have sought input on RFD and things were mentioned that I didn't think of. I subscribe to the philosophy of 'You don't know what you don't know'.

I hardly doubt he is simply going to follow what people say on here blindly.
You have more faith in humanity than I do... Many people seem to be seeking an answer that agrees with what they want to do, and will go forth blindly. No idea if that's the case here...

C
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CNeufeld wrote:
Dec 19th, 2017 2:51 pm
You have more faith in humanity than I do... Many people seem to be seeking an answer that agrees with what they want to do, and will go forth blindly. No idea if that's the case here...

C
Yes I try to be a very positive optimistic person (I just don't suffer fools easily lol).
Newbie
Jan 18, 2017
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Eonibm we've had our disagreements in the past, and these days I just default to agreeing to disagree. In your world you feel it's acceptable to rat. That's fine, maybe in your world there are no consequences for that. In my neighbourhood, that gets you in a world of hurt. Which is fine too. Like they say, "Do what you gotta do."

And no I didn't forget penalties and interest, it's detailed right in there in my original post, and you even directly quoted it. The tax returns have been filed on time - no filing penalties. All that's at risk is any reassessed back taxes on possible personal expenses that are disallowed. Interest will be applied to any back taxes owing triggered by the reassessment, which is 1% per month to a 12 month maximum. So in our hypothetical: $2,700 balance due at 1% per month = $324 in interest owing. So your net due = $3,024 per year. I recall my ballpark figure being $3,000, so yes, I appear to have understated the interest by $24. Apologies to OP.

And I disagree with your assertion that it "isn't so cut and dried". You can buy the business, or not. Simple. If it's risky, calculate the downside. Mitigate. It's an easy conversation to have: "Hi Seller, I like your offer but I'm concerned about possible tax liability from CRA interpreting things as possibly running some personal expenses through the company, and my being stuck with the results because of the transaction being a share sale. I want to decrease the price by what my accountant calculates the tax risk to be at. What do you think?"

Worst case is the seller says "No", bringing you right back to where you are now. It's just business. I wouldn't walk away from a deal because of the possibility of a nominal CRA reassessment. Instead either:

- Draft the purchase agreement that the seller is responsible for any tax reassessments;

- Do an asset sale, or discount the share sale by the amount of tax exposure;

- Possibly look at a hybrid type of sale (Geranksy case) if you want to get tax lawyers involved;

What I don't recommend is anonymously reporting a small business to CRA in a small town where everyone knows everyone, especially when you don't know 100% of the details of the business. (It's certainly just as possible that the utilities are being run 100% through the company, and then at year-end the accountant pulls out 95% of the expense as a SH loan entry.)

eonibm wrote:
Dec 19th, 2017 1:39 pm
You forgot about the penalties and interest on the penalties. It can be significant.



It's not so cut and dried as you want to make it seem. Even if the buyer took this approach, the problem is the sellers are not going to accept the discount (which I dare say should likely be way more than you estimate) because they are not looking at it from the point of the view of the buyer who is factoring in possible interest and penalties. The only way to ensure that (and I don't agree this is an advisable approach or even that this company should be purchased by the OP) is to let them know the discount if for the potential tax assessment due to them cheating on their taxes. One is HARDLY going to bring that up!



People who should be ratted on don't like rats. The rest are happy that the culprits got caught. The point you miss about 'listening to some of the advice in this thread' (which obviously is a not so veiled reference to the advice to do the right thing and reporting these fraudsters) is that is being done anonymously and anyone could have reported them, in the town or elsewhere.

I started, bought and sold many businesses in my career. I'd run away from this deal as fast as I can.
______
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[OP]
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Jan 19, 2014
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crossborderguy wrote:
Dec 19th, 2017 4:03 pm
So in our hypothetical: $2,700 balance due at 1% per month = $324 in interest owing. So your net due = $3,024 per year. I recall my ballpark figure being $3,000, so yes, I appear to have understated the interest by $24. Apologies to OP.

And I disagree with your assertion that it "isn't so cut and dried". You can buy the business, or not. Simple. If it's risky, calculate the downside. Mitigate. It's an easy conversation to have: "Hi Seller, I like your offer but I'm concerned about possible tax liability from CRA interpreting things as possibly running some personal expenses through the company, and my being stuck with the results because of the transaction being a share sale. I want to decrease the price by what my accountant calculates the tax risk to be at. What do you think?"
Cross border guy, that is one thing I had wondered. Would the taxes be assessed at this corporate rate or would there be some sort of personal rate too since the money left the business. If it's just corporate it is less of a concern. I just have no idea.

And yes, in my small town I feel there would be definite consequences for reporting someone.

I appreciate your response and breaking down of options going forward.

I need to talk to my accountant but it's not looking like that's possible till after Christmas. I'm glad to have these other views to mull over.
Deal Addict
Aug 28, 2007
1851 posts
246 upvotes
Calgary
Regardless of tax cheating or anonymity of reporting them to CRA, let's take a step back. You mention it is a professional service business. Selling a professional service business is, in general, very difficult, because the "assets" of the business ride up and down the elevator every day. Not many buyers want to take on the risk of that type of "asset" purchase. Maybe you should count yourself among that number. You could use that as your excuse to walk away from them when the time comes to be buying them out.

Since a share purchase is clearly not wise (as per this thread). Perhaps you may want to leverage your own knowledge of your industry and start your own professional service business when theirs winds down.
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Aug 2, 2010
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crossborderguy wrote:
Dec 19th, 2017 11:34 am
Eonibm we've had our disagreements in the past, and these days I just default to agreeing to disagree. In your world you feel it's acceptable to rat. That's fine, maybe in your world there are no consequences for that. In my neighbourhood, that gets you in a world of hurt. Which is fine too. Like they say, "Do what you gotta do."
Yes I feel it is acceptable to report people who are committing tax fraud while other people work hard, are honest, pay their fair share of taxes (which are higher for everyone because of that) and don't commit fraud, all the while trying to support their families and get through life. I call that being an honourable and respectable member of society. You want to call that being a 'rat' in order to sully those who do the right thing. So be it. I suggest that you are the rat by standing idly by. You obviously have a very different moral, ethical and legal fiber than most people.
crossborderguy wrote:
Dec 19th, 2017 11:34 am
And no I didn't forget penalties and interest, it's detailed right in there in my original post, and you even directly quoted it. The tax returns have been filed on time - no filing penalties. All that's at risk is any reassessed back taxes on possible personal expenses that are disallowed. Interest will be applied to any back taxes owing triggered by the reassessment, which is 1% per month to a 12 month maximum. So in our hypothetical: $2,700 balance due at 1% per month = $324 in interest owing. So your net due = $3,024 per year. I recall my ballpark figure being $3,000, so yes, I appear to have understated the interest by $24. Apologies to OP.

And I disagree with your assertion that it "isn't so cut and dried". You can buy the business, or not. Simple. If it's risky, calculate the downside. Mitigate. It's an easy conversation to have: "Hi Seller, I like your offer but I'm concerned about possible tax liability from CRA interpreting things as possibly running some personal expenses through the company, and my being stuck with the results because of the transaction being a share sale. I want to decrease the price by what my accountant calculates the tax risk to be at. What do you think?"
You think the risk can be quantified. It can't really. Where there is smoke there is fire and when you buy a business you also buy all the undisclosed liabilities associated with it. The fact that these people cheat on their taxes, and to such an egregious degree, speaks volumes about what else might be there. You can't quantify the unknown.
crossborderguy wrote:
Dec 19th, 2017 11:34 am
Worst case is the seller says "No", bringing you right back to where you are now. It's just business. I wouldn't walk away from a deal because of the possibility of a nominal CRA reassessment. Instead either:

- Draft the purchase agreement that the seller is responsible for any tax reassessments;
An analogy is possession is 9/10th's of the law. A purchase agreement making the seller have to guarantee any tax reassessments is not going to do much good if they simply won't pay up. You have to sue and have to get judgement. That might be hte easy part. However, they still won't pay. Then you try to execute on their assets but either can't find them or they aren't readily seizable and all you end up doing is being able to file a writ on their property and eventually get paid when they sell it. That could be years into the future. All the while the lawsuit costs you a lot of money, you have to borrow to pay the tax reassessments (that end up being much higher than you imagined in your wildest nightmares) and you are farther down the hole. All the while your business suffers because you don't have the financial resources to keep aflot as a result of having to pay the penalties, interest and court costs.

Yes it sounds so easy and simple to just put it in the agreement as you say. What you don't seem to grasp is that that realizing on that agreement can be very complicated, costly and time consuming.
crossborderguy wrote:
Dec 19th, 2017 11:34 am
- Do an asset sale, or discount the share sale by the amount of tax exposure;
I said don't buy the business. I never said don't buy the assets. They don't carry the liability. As for discounting the share sale, scroll back a few lines for why that still has a lot of risk.
crossborderguy wrote:
Dec 19th, 2017 11:34 am
- Possibly look at a hybrid type of sale (Geranksy case) if you want to get tax lawyers involved;
That can get very complicated, costly and also involves risk
crossborderguy wrote:
Dec 19th, 2017 11:34 am
What I don't recommend is anonymously reporting a small business to CRA in a small town where everyone knows everyone, especially when you don't know 100% of the details of the business. (It's certainly just as possible that the utilities are being run 100% through the company, and then at year-end the accountant pulls out 95% of the expense as a SH loan entry.)
I do. So what if someone else reports it other than the OP? That suddenly means they are going to point the figure at the OP? Hardly? Fact is they aren't going to know one way or another no matter who points the figure. Hell, I'll do it if the OP pm's me the details! As for the possibility that the accountant reverses and reconciles all these expenses these people are putting through it seems the OP knows that is not happening. Also there is really no reason for them to put them through the business in the first place only to be reversed later. Anyway, if that far fetched scenario you are now trying to suggest is occurring then fine, the anonymous tip will not have an effect. No mess no spill.

Crossborderguy: People like you who stand idly by while tax fraud is being committed are part of the problem, not the solution.
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Aug 2, 2010
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mymward wrote:
Dec 19th, 2017 5:27 pm
And yes, in my small town I feel there would be definite consequences for reporting someone.
Ridiculous. If that is the case you better pray that no one else ever does because everyone will point the finger at you! That's why it makes no sense.
Deal Addict
Feb 25, 2007
1158 posts
576 upvotes
Ottawa
mymward wrote:
Dec 18th, 2017 7:28 am
Owners are really pushing for share sale. Business is professional service so not a lot of actual assets either
mrmcwn wrote:
Dec 18th, 2017 1:35 pm
Owners almost always prefer share deals. Buyers almost always prefer asset deals. There are reasons for this. [...]
If you feel there is substantial risk in a share deal, it should be reflected in the price.
Jermyzy wrote:
Dec 18th, 2017 6:52 pm
[In case of an asset sale,] they can assign a larger value for the good will if they believe there is additional value to the company not reflected in tangible business assets.
crossborderguy wrote:
Dec 19th, 2017 11:34 am
Figure out is the reassessment exposure if you did acquire the shares.
I vaguely recall seeing a couple of small business sale agreements that in the legal boilerplate included protective clauses on the previous owner remaining responsible for any later-identified tax liabilities, amounts owing to former/current employees (or somesuch), plus of course a non-compete clause. Of course, that assumes that you could collect. I found this brief mention from 2011: https://www.theglobeandmail.com/globe-i ... le4179628/

More broadly, like others I would take a hard look why buy the shares at all, especially if it's a professional services business that has few "actual" assets, in a small town. Yes, the owners would like a nice fat capital gain, but on what? What is the genuine business equity they have bought up? Why couldn't you just start a similar business when they close down? Will anyone else be in a hurry to pay them anything in excess of the value of tangible assets they have accumulated? There's a nice solid feeling to "I helped build this business and then I bought it" and "we sold the business to the young guy", but is it really better than "he learned how to do it from ..., and I think bought some of their equipment when they retired."
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Jan 18, 2017
97 posts
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Mymward, if there was a reassessment, it would be at the corporate tax level for your purposes. If CRA wanted to further pursue a personal income inclusion (Based on the facts you've given, I can't say whether they would or wouldn't) CRA would be chasing the sellers for that amount, not you. (You weren't a shareholder or director at the time the personal expenses were paid.)

All the questions you're asking are part of your due diligence. The sellers should be expecting you to ask these types of questions. Anyone else (as this thread has shown) would be asking the same things - It is automatic whenever there is a share sale. So don't feel that asking the hard questions is an unreasonable thing to do. And your "get out of jail" card is just play dumb and blame your accountant: "Sorry to bug you with this but my accountant says I'm supposed to ask you about this and this and this and this. I don't even know what that means, but he says I should bring it up" etc. That way the accountant is the bad guy asking the hard questions and not you.

mymward wrote:
Dec 19th, 2017 5:27 pm
Cross border guy, that is one thing I had wondered. Would the taxes be assessed at this corporate rate or would there be some sort of personal rate too since the money left the business. If it's just corporate it is less of a concern. I just have no idea.

And yes, in my small town I feel there would be definite consequences for reporting someone.

I appreciate your response and breaking down of options going forward.

I need to talk to my accountant but it's not looking like that's possible till after Christmas. I'm glad to have these other views to mull over.
______
Canadian & US tax guy
Deal Guru
Aug 2, 2010
14017 posts
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Here 'n There
houska wrote:
Dec 19th, 2017 10:47 pm
I vaguely recall seeing a couple of small business sale agreements that in the legal boilerplate included protective clauses on the previous owner remaining responsible for any later-identified tax liabilities, amounts owing to former/current employees (or somesuch), plus of course a non-compete clause. Of course, that assumes that you could collect. I found this brief mention from 2011: https://www.theglobeandmail.com/globe-i ... le4179628/

More broadly, like others I would take a hard look why buy the shares at all, especially if it's a professional services business that has few "actual" assets, in a small town. Yes, the owners would like a nice fat capital gain, but on what? What is the genuine business equity they have bought up? Why couldn't you just start a similar business when they close down? Will anyone else be in a hurry to pay them anything in excess of the value of tangible assets they have accumulated? There's a nice solid feeling to "I helped build this business and then I bought it" and "we sold the business to the young guy", but is it really better than "he learned how to do it from ..., and I think bought some of their equipment when they retired."
Right on. I too thought that a better option might just be for the OP to use the money he would invest in the business to start his own business. We don't know what type of business it is but if these people want to get out of the business they just might end up closing it down anyway. The OP seems to understand the business and so would have a head start compared to someone starting a similar business blindly. I would just tell these people that I only want to buy certain assets at this price and tell them that if that is not acceptable I will start my own business.

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