Can You Use a Company's Tax Losses After Buying Its Shares in Ontario?

Many buyers look at a corporation with years of losses on its books and wonder whether buying the shares lets them use those losses against future profits. It is a reasonable question, but the tax rules around a change of control are stricter than most people expect.

This article explains what happens to a corporation's tax history when you buy its shares, how that compares with buying its assets, and which inherited liabilities you should keep in mind. It is general information, and a lawyer or accountant should look at the actual numbers before you commit.

What a change of control does to the tax year

In a share purchase, you buy the corporation itself. The corporation keeps its history, its contracts and its tax account. But if you acquire control, the tax rules treat that moment as a break. The corporation has a loss restriction event, and its taxation year is deemed to end immediately before that time, with a new year beginning.

A new year therefore begins under your ownership. How the period before the change is reported is worth confirming with an accountant. The deemed year end is not a sign that anything went wrong. It is simply how the Income Tax Act marks the change, and it affects which losses can be used and when.

Which losses survive and which do not

The two main kinds of loss are treated differently after an acquisition of control.

So capital losses sitting in the corporation do not add value for you as a buyer. Business losses may help, but only where the same business continues to operate with a genuine profit motive. If you plan to shut down the old business or change it into something quite different, those losses may be unavailable. Whether a particular plan keeps the business within the rule is a fact-specific question for your tax adviser.

How an asset purchase differs

In an asset purchase, you buy specific property from the corporation rather than the corporation itself. You are not buying its tax history, so there are no losses to inherit or lose. Instead, your tax position starts from the price you pay for each asset.

Where an amount can reasonably be regarded as paid partly for property, partly for services, or for a restrictive covenant such as a non-compete, each part is treated as consideration for that item, whatever the contract says. The buyer is deemed to have acquired each property for the part of the price allocated to it, which sets your cost base. Any part of the price reasonably regarded as paid for a restrictive covenant is treated as an amount the seller received for it. This is why the purchase price allocation deserves real attention in an asset deal.

• Share purchase: you step into the corporation's shoes, with the deemed year end and loss limits described above.
• Asset purchase: you start fresh, with a cost base tied to the price allocated to each asset.

The seller's side: why structure affects the price

Sellers often prefer a share sale, and that preference can show up in negotiation. In an asset sale, the seller corporation pays tax on the sale, and money paid out to the owner afterwards is taxed again in the owner's hands. If the corporation sells depreciable assets for more than their undepreciated capital cost, the negative balance at year end is included in the corporation's income as recaptured depreciation. That is taxed as income, not as a half-taxable capital gain.

For capital gains in general, the taxable portion is one-half of the gain. Certain special dispositions are subject to different rules that can reduce the taxable amount. An individual who sells qualifying small business corporation shares may be able to claim the lifetime capital gains exemption, but a corporation that sells its own business assets cannot. The exemption has conditions, including ownership and asset tests, so a seller should confirm eligibility early rather than assume it.

Inherited liabilities and what to do next

Because the corporation stays the same legal entity in a share deal, its past problems stay with it. Two examples are worth knowing.

• Source deductions: the directors at the time a corporation fails to remit payroll deductions are jointly and severally liable with the corporation, and in a share purchase this liability stays with the corporation as it was. A director may avoid liability by showing the care, diligence and skill a reasonably prudent person would have used, and CRA cannot start an action more than two years after the person last ceased to be a director.
• WSIB: the WSIB does not issue purchase certificates for share capital acquisitions where no assets are disposed, and in share acquisitions the acquirer takes on the seller's liabilities by law. In an asset purchase, by contrast, the buyer is liable for amounts the employer owed under the Act, but a purchase certificate can waive that liability if the seller's account is in good standing.

Employees are another consideration. If a business is sold and an employee keeps working for the new owner, employment is not ended, and the employee's length of service with the seller carries through for vacation, notice and severance. Prior service does not carry over if the employee is rehired by the buyer more than 13 weeks after the earlier of their last day with the seller or the day of the sale.

• Ask for the corporation's tax returns, notices of assessment and a loss schedule.
• Decide whether the business will continue as it is, since that affects business losses.
• Request confirmation of source-deduction remittances and WSIB account status.
• Consider a lien search through ServiceOntario's Access Now for registered security interests against personal property.
• Have a lawyer and accountant compare share and asset structures before signing.

Frequently asked questions