Tax Factor 2016-09

September 19, 2016

Many stacks of books

In this issue, we cover:
Buying a business: four tax considerations for purchasers
Back to school: tax saving opportunities for students
Upcoming HST rate increase in Prince Edward Island


Buying a business: four tax considerations for purchasers

Thinking of buying a business? Many buyers understand that doing their research and ensuring that they pay a fair price for the company or company assets purchased need to be priorities; however, tax considerations for any purchase also require careful thought and planning.

Whether you are looking to purchase your first business or this is only the most recent of your acquisitions, here are a few critical areas that can affect your immediate tax outcomes and long-term business strategy.

Structuring the purchase

As discussed in our previous Tax Factor article, “Tax considerations for the purchase or sale of a business”, there are two primary ways that you can structure the sale of the business: a share sale or an asset sale. Each option has very different tax implications for both buyer and seller, and the right choice is highly dependent on the particular business being purchased, your reasons for purchasing, and your individual situation.

Many purchasers prefer buying assets directly as this allows you to pick and choose which assets you want and which liabilities are acceptable to assume, minimizing your risk while reducing the overall complexity of the transaction. Another advantage of this purchase method is that it allows you to step up the value of the acquired assets as the carrying value of the assets for tax purposes will be fair market value. This will reduce future gains or income when the assets are later sold.

Buying shares has other advantages, and may be a good path forward if the company has a strong reputation and brand. In terms of tax considerations, a share purchase may also allow you to use your lifetime capital gains exemption when you eventually dispose of the shares. A share deal would also be the ideal structure if you are looking to buy a company for its tax attributes, such as non-capital loss and investment tax credit carry-forwards (although restrictions on their use may apply).

If the vendor can claim the capital gains exemption on a share sale and you would rather buy assets, a point of negotiation may be a reduction of the purchase price if you buy shares. In such a situation, you and the vendor will be effectively sharing the tax savings from the exemption.

Depending on the company and situation, you may also want to consider a hybrid sale, which combines elements of both sale types to balance risk, opportunity, and tax burden for you and the seller. In particular, the vendor can benefit from the capital gains exemption and the purchaser can still step up the carrying value of assets purchased.

Due diligence and valuation

Before making a final purchasing decision, you should conduct a due diligence process to avoid any unwanted surprises. Even with reputable companies, there can be unexpected tax or legal liabilities that might affect your purchasing decision—or provide a strong basis to push for a lower purchase price.

The depth and extent of the due diligence required will be dependent on the individual company, and whether you are choosing to purchase company assets, shares, or a combination of both. Generally, the due diligence process for an asset sale will be relatively simple, as buying assets generally means you will not be taking on the risks and liabilities of the original company.

With a share purchase, a more comprehensive due diligence process is required. From a tax perspective, you should examine past tax and information returns for all open years. This should include assessments and any re-assessments, the status of audits by tax authorities, uncertain tax positions taken by the company, any significant or unusual transactions, and income and sales tax compliance both domestically and internationally (as applicable). Depending on the company, you may also wish to look at additional areas like cross-border transfer pricing.

By conducting this process, you can identify any undisclosed tax liabilities prior to purchase and be able to effectively evaluate the quality of tax attributes being acquired. At the same time, it is important to get an objective view on the value of the business through a formal valuation process. BDO’s Transaction Advisory Services team can assist you in this process.

Purchase and Sale Agreement

The Purchase and Sale Agreement (PSA) is a complex document that often requires significant negotiation. There are, however, a few areas and potential tax issues that a buyer should keep in mind.

For the purchase of company assets, purchase price allocation is often a significant negotiating point. As a buyer, you should look to allocate higher values to assets that can be deducted relatively quickly for tax purposes, such as inventory and depreciable property. At the same time, the seller will be motivated to minimize income on the sale of inventory and recapture of capital cost allowance previously deducted on depreciable property.

Courts have indicated that generally the agreed-upon allocation between arm’s length parties will govern the sale. Evidence of real bargaining between arm’s length parties is also proof that the allocation is reasonable and should be accepted by the Canada Revenue Agency. If instead the sale is between non-arm’s length parties, you will need to take extra care to establish a reasonable allocation that will stand up to scrutiny, as re-allocation of the purchase price by tax authorities can result in undesirable tax consequences.

For the purchase of shares, the common practice is for the PSA to include tax-specific representations, warranties, and indemnities. This is to allow a longer time period for claims for breaches of tax-related representations and warranties to ensure that all tax liabilities that exist or may arise pertaining to the period before the sale closes will remain solely with the seller. It is also in your best interest to specify that the seller will be responsible for filing all pre-closing tax and information returns, and that they will make these items available for your review in a timely manner. This allows you to make sure that appropriate returns are filed and are consistent with prior years.

Share purchase cost and tax planning

If purchasing shares, you should also assess the most effective method for paying for those shares as different methods will have different tax results.

One area to consider is structuring an interest deduction. For many takeovers, a common method is to borrow money to buy the target corporation. In this situation, the interest will be deductible. However, there are situations where you may want the acquisition debt and the assets of the target corporation to be in the same corporation so that the interest can be deducted directly from the business income. To achieve this, it is recommended that you set up a new corporation, use this new corporation to borrow funds and buy the target corporation shares, and then subsequently merge both corporations through a vertical amalgamation or wind-up of the target corporation. As part of the amalgamation or wind-up process, it may also be possible to bump the cost of non-depreciable property.

Similarly, if you as an individual buy shares from an arm’s length party, you can transfer these shares to a new corporation and take back debt as consideration. As above, if the new corporation is then combined with the target corporation either through a vertical amalgamation or wind-up, it may be possible to bump the cost of the target company’s non-depreciable assets. Essentially, this allows you to convert tax cost to debt and withdraw future earnings as tax-free debt repayments. You should note that this planning may not work where you buy shares from a non-arm’s length party. Further planning may be required for these purchases.

While tax considerations should not be the only factor when deciding how and when to purchase a business, careful attention to these issues—as well as the balance of tax benefits between buyer and seller—can have a significant impact on outcomes. For support in assessing, valuing, and planning for the purchase of a business, please talk to your BDO advisor.

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Back to school: tax saving opportunities for students

September is here and a new school year has begun. As fresh-faced college and university students concentrate on opening their minds to higher learning, they (and often their parents) have been busy opening their wallets for the funds needed to pay for tuition, residence, textbooks, computers, and other student-related expenditures.

The high cost of post-secondary education in Canada means that students (and parents) may need to think somewhat creatively about how to accumulate the funds needed to pay for school. Fortunately, it does appear that the federal government has recognized the load being placed on Canadian families to finance post-secondary education, and in response, it has made available a number of deductions and non-refundable tax credits for post-secondary students in order to decrease their overall tax burden.

In this article, we will take a look at several of the tax saving opportunities available to students that may assist in offsetting some of the high costs of post-secondary education.

Moving expenses

There are special rules that may allow students to deduct moving expenses related to a move that is made for the purpose of attending a post-secondary educational institution full-time. Note that the Canada Revenue Agency (CRA) considers a full-time student to be one who is registered in a program at a post-secondary school level (i.e. at a college, university, or other educational institution) and during a particular semester, the number of courses that the student is taking is at least 60% of the normal course load for the program in which the student is enrolled.

If your child is moving more than 40 kilometres away from home to attend college or university full-time, they may be able to deduct the expenses they incur to move against any taxable scholarships, bursaries, and research grants that they include in their income. You should be aware, however, that this deduction is often limited since scholarships and bursaries are frequently exempt from tax, and research grants can be reduced by research expenses.

A student may also be eligible to deduct moving expenses if they move a distance greater than 40 kilometres for employment, such as for a co-op placement or a summer job. In this case, eligible moving expenses may only be deducted against income earned in the year from that employment source. Generally, moving expenses that cannot be deducted in the year incurred may be carried forward to apply against taxable scholarship and research grants or employment income in a future tax year, depending on the type of moving expense (i.e. moving for education or moving for work). However, students are generally not permitted to deduct moving expenses carried forward against employment income earned from an unrelated job they started after completing their studies.

If your child will be moving away from home to attend college or university, to take a co-op placement or to otherwise commence employment, speak to your BDO advisor to determine whether the related moving expenses are deductible.

Tuition and education tax credits

A federal non-refundable tax credit equal to 15% (in 2016) of eligible tuition fees may be claimed by a student, provided that the student is enrolled at a qualifying educational institution in Canada and that the total costs paid to such an institution exceed $100. Generally, a qualified educational institution includes a university or college. Other educational institutions may qualify if they provide educational courses at a post-secondary level. Tuition fees paid in respect of courses taken either on-line or via correspondence may also qualify for the tuition credit. Your child may also be able to claim a similar provincial income tax credit, the amount of which will vary depending on the province that your child resides in. Your BDO advisor will be able to tell you whether the educational institution your child is enrolled in qualifies for the purpose of this credit, and what the total federal and provincial claim amount will be.

There are two additional federal non-refundable tax credits related to post-secondary education. The education and textbook tax credits (collectively referred to here as “education tax credits”) are meant to provide income tax relief to students by referencing the number of months that the student is enrolled either full-time in a qualifying educational program or part-time in a specified educational program at a designated educational institution. For each month that the student is able to claim the education amount, they can also claim the textbook amount. For 2016, the combined total of the federal amount that may be claimed by full-time students is $465 per month, while the total for part-time students is $140 per month. Each respective amount is multiplied by the number of months for which they qualify as either a full-time or part-time student.

Any unused amounts in respect of your child’s tuition and education tax credits may be carried forward to future years. It is also possible to transfer up to the equivalent of $5,000 in current year tuition and education amounts to a spouse or common-law partner, or to a parent or grandparent, subject to certain requirements and limitations. Note that the amount allowed to be transferred for provincial purposes may differ from the federal limit of $5,000.

Recently, the federal government passed legislation that will eliminate the federal education and textbook tax credits, effective January 1, 2017. As a consequence, 2016 will be the final year for which these federal education tax credits may be claimed. That being said, the carry-forward rules will continue to apply such that any unused education tax credits that arise prior to 2017 will remain available to be claimed in 2017 and subsequent years. Rest assured, however, that no changes were made to the federal tuition credit.

While the similar provincial tax credits remain unaffected by the federal change, Ontario residents should take note that the Ontario government has decided to discontinue not only its education credit but also its tuition credit during 2017. In 2017, Ontario students will be able to claim the provincial tuition tax credit for eligible tuition paid in respect of studies up to and including September 4, 2017, and would be able to claim the education tax credit for months of study before September 2017. The eligible portion of 2017 tax credits would continue to be transferable to a qualifying family member. Note, however, only tax filers who are resident in Ontario on December 31, 2017, and have unused Ontario tuition and education tax credits available for carry-forward, would be permitted to claim the credits in future years.

One further point to consider—students in full-time attendance at a college or university outside of Canada, including on-line courses, may also qualify for the tuition and education tax credits. If your child will be attending a post-secondary school outside of Canada, consult your BDO advisor about whether they may be entitled to claim these credits.

Credit for student loan interest paid

It may be inevitable that, even with their savings and parental support, your child may end up needing to incur some student debt as a means to help subsidize their university or college expenses. If your child receives financial assistance from one of the federally or provincially government-sponsored programs, the interest paid on those loans could qualify for a tax credit when calculating both federal and provincial income taxes. Only interest on loans extended under government-sponsored programs will qualify for this credit. Also, while the credit is not transferable, any unused portions can be carried forward for up to five years.

Note that interest paid on a loan other than a qualifying student loan, or interest on a student loan that has been otherwise combined with another kind of loan, can’t be claimed. Furthermore, if an existing qualifying student loan has been renegotiated with a bank or other financial institution, or has otherwise been included in an arrangement to consolidate your child’s loans, the interest paid on the resulting “new” loan will also fail to qualify for this credit. If you have questions about whether the interest on your child’s student loans will qualify for this credit, speak to your BDO advisor.

Public transit pass credit

For those students who will be using public transit to travel to and from classes, the cost of their monthly passes (or passes of longer duration) will be eligible for a federal non-refundable tax credit. Cost-per-trip electronic payment cards may also qualify under certain conditions. Essentially, in order to qualify, a pass must entitle the holder to an unlimited amount of travel within a limited time frame. You should note that this credit can be claimed by your child, or by you if your child is dependent on you and under the age of 19.

If this credit is claimed, you or your child should keep expired transit passes. While copies of expired passes are not required to be submitted when filing a tax return, the CRA can request to see them as proof of a claim. Typically, an expired transit pass will be enough to support a claim if it explicitly states the duration and validity period of the pass or card, and clearly indicates the name of the issuer, the amount paid and the identity of the rider. If transit passes do not contain all of the above information, other forms of documentation can be submitted with the passes, including receipts, cancelled cheques or credit card statements, to support a claim for this credit.

Cash flow 101: debits and credits

As a freshman college or university student, your child is going to learn a whole lot more than just what is taught in class. Learning to budget cash inflows against cash outflows is one of those lessons that students can’t help but learn quickly. Funding post-secondary education can be a costly endeavour. However, if properly claimed, the tax breaks specifically targeted to compensate students can help relieve some of the financial burden of post-secondary education by getting some more money back to your child.

If you have a child enrolled in university or college, speak to your BDO advisor for information on the tax credits your child may be eligible to claim on their income tax return.

EDUCATION ASSISTANCE

As parents, it is only natural that you would want to try to assist your child in meeting the financial obligations of post-secondary education. You are likely already familiar with, and possibly have already made use of, the Registered Education Savings Plan (RESP). Beyond RESPs, however, there are several other ways that you can get extra cash into your child’s hands without the added hindrance of a hefty tax bill. If you have a child 18 or older and enrolled in university or college, speak to your BDO advisor for ways you can help your child pay for their post-secondary education. For additional guidance with respect to RESPs, please read our Tax Bulletin titled RESPs: Saving for Your Child’s Education.

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Upcoming HST rate increase in Prince Edward Island

Effective October 1, 2016, the government of Prince Edward Island (PEI) is set to increase their Harmonized Sales Tax (HST) rate to 15%. Take note that the HST rate increase will impact every GST/HST registrant doing business in PEI, as the new rate increase will apply on most supplies made to PEI as well as on taxable expenses incurred there. With the recent HST rate change in Newfoundland and Labrador and New Brunswick, as well as the upcoming change in PEI, it is important to ensure that modifications and programming changes are made to your accounting systems and business processes. See our Tax Alert for more information on the HST rate changes.


The information in this publication is current as of September 1, 2016.

This publication has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The publication cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact BDO Canada LLP to discuss these matters in the context of your particular circumstances. BDO Canada LLP, its partners, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information in this publication or for any decision based on it.

BDO Canada LLP, a Canadian limited liability partnership, is a member of BDO International Limited, a UK company limited by guarantee, and forms part of the international BDO network of independent member firms. BDO is the brand name for the BDO network and for each of the BDO Member Firms.