Share Sale Versus Asset Sale for a CCPC Founder
Northwind Fabrication Ltd. (NFL) is a CCPC owned 80% by Marco and 20% by his brother. Marco's shares have an ACB of $100,000; NFL's fair market value is about $3.2 million. NFL holds land with a $300,000 ACB and $800,000 FMV, equipment with a $200,000 UCC and $600,000 FMV, goodwill, and $100,000 cash. A public company has offered $3.2 million for NFL's assets or $2.9 million for all shares. The asset offer requires NFL to sell the land, equipment, and goodwill and wind up. Marco is 63, wants to retire, and has never used his lifetime capital gains exemption. His brother will follow Marco's decision. NFL has always been a CCPC, and Marco has held his shares for 15 years. The purchaser will not assume liabilities and wants a step-up in asset cost. Marco asks which offer produces more after-tax cash for him and whether his shares qualify for the lifetime exemption.
1. Determine whether Marco's NFL shares qualify as qualified small business corporation shares for the lifetime capital gains exemption. Identify the tests and the facts that could cause failure.
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The shares must meet three main tests. First, NFL must be a CCPC at the time of sale and, generally, the shares must not have been owned by a non-resident or a public corporation. NFL has always been a CCPC and Marco has held his shares for 15 years, so the holding-period test is met.
Second, at the time of sale, the shares must be shares of a CCPC and more than 50% of the fair market value of NFL's assets must be used principally in an active business carried on primarily in Canada. NFL's land, equipment, and goodwill are used in fabrication, which appears to be an active business. The $100,000 cash is only about 3% of the $3.2 million value, so it should not cause the 50% test to fail unless there are unreported investment assets.
Third, the same 50% asset test must generally be met throughout the 24 months before the sale, and the shares must have been owned by the taxpayer throughout that period. Marco has held for 15 years, but the asset mix during the prior 24 months must be confirmed. If NFL held significant excess cash, investments, or redundant land during that period, the test could fail. The land is used in the business on the facts, but that should be documented. If the tests are met, Marco can claim the lifetime capital gains exemption up to the indexed limit for the year of sale, and the exemption can shelter part of his gain. The brother's shares would need the same analysis.
2. Compare the after-tax cash to Marco from the $2.9 million share offer versus the $3.2 million asset offer. Show the main tax layers and conclude which is better for Marco.
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On a share sale, Marco's 80% share of the $2.9 million proceeds is $2.32 million. His ACB is 80% of $100,000, or $80,000, so his capital gain is about $2.24 million. If the lifetime capital gains exemption limit is $1.25 million, the exempt portion is $1.25 million and the taxable gain is about $990,000. At a 50% inclusion rate and roughly 50% combined personal tax, tax is about $247,500, leaving Marco about $2.07 million before any other adjustments. The exemption is the key advantage.
On an asset sale, NFL pays corporate tax first and then distributes after-tax proceeds. The land produces a $500,000 capital gain and about $250,000 taxable at roughly 26.5%, or $66,000. The equipment produces recapture and capital gain; assuming the $200,000 recapture is taxed at the small-business rate and the excess is a capital gain, corporate tax is perhaps $50,000 to $80,000. Goodwill produces a capital gain taxed at the general corporate rate. Assume total corporate tax of about $150,000, leaving about $3.05 million. Marco's 80% share is $2.44 million of dividends. At roughly 47% tax on non-eligible dividends, personal tax is about $1.15 million, leaving about $1.29 million. The asset offer is therefore much worse for Marco despite the higher headline price. The share sale is better unless the purchaser pays a substantially higher asset price to compensate for the lost lifetime exemption and the second layer of tax.
3. The purchaser prefers an asset purchase for the cost step-up. What structures or concessions could close the after-tax gap, and what risks should Marco consider?
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The purchaser's preference is understandable because an asset purchase gives a stepped-up cost for equipment, land, and goodwill, and avoids inheriting NFL's liabilities. Marco should price that benefit. The asset price would need to rise enough to offset the corporate tax, the dividend tax, and the loss of the lifetime capital gains exemption on the shares. On the numbers, the gap is roughly $700,000 to $800,000, so a modest increase from $3.2 million is not enough.
A possible structure is a share sale with a section 338 election, which can give the purchaser a deemed asset sale and cost step-up while Marco sells shares. The election generally causes NFL to be deemed to sell its assets and reacquire them, so NFL bears the corporate tax. The purchaser would need to compensate for that tax, and the election has complex filing and liability consequences. It may not be available or practical if NFL has liabilities or if the purchaser wants a clean asset acquisition.
Alternatively, Marco could negotiate a higher asset price, a holdback for liabilities, or a share sale with representations and warranties, indemnities, and a purchase-price adjustment. He should also consider whether the purchaser will assume NFL's liabilities, whether NFL has unrecorded liabilities, and whether the share sale preserves the lifetime exemption. The recommendation is to compare after-tax cash, not headline price, and to use the asset purchaser's desire for a step-up as leverage to improve the share price.