Sale of Business Considerations - Asset Purchases
As discussed in last week's Knowledge Bureau Report, the June 15th filing deadline for proprietorships is around the corner, and some consideration should be given to the implications of selling a business and encouraging discussion between a business owner and their advisory team.
An earn-out agreement is a purchase and sale agreement in which the ultimate price to be paid is dependant in whole or in part on the economic results the business produces.
Where an earn-out has been negotiated it is not possible at the date of closing of the sale to determine the exact proceeds of disposition the vendor is to account for. For this reason mechanisms must exist to adjust the tax accounting for the disposition as the proceeds become known.
The treatment of an earn-out payment depends of whether it relates to the purchase of assets or the purchase of shares. In this issue we will review the earn-out payment where the purchase of assets is used.
Asset Purchase
The tax treatment of earn out payments that do not qualify under the conditions required for a sale of shares differs because there is a statutory rule in the Income Tax Act that deals with them. This rule normally applies where the payment to be made for assets is based on the gross revenue, net income or production that the assets are to generate.
Where this is the case, the non-variable portion of the proceeds is accounted for in the normal way. Any payment that is based on production or use is treated as business income to the vendor. This is true even where the payment represents part of the capital cost of the property purchased to the vendor.
This treatment does not apply where the purchaser and vendor agree on a fixed price which can be adjusted downwards if revenue, income or production targets are not met. In those cases, the vendor accounts for the sale based on the agreed price. If it turns out that the price is adjusted downwards, an amendment is made to the return(s) on which the disposition was reported.
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