Catching a Lopsided Price Allocation Before a Business Sale Closed

The situation

Niloufar and Valentina had run their machine shop in St. Catharines for 27 years. Niloufar had worked as a real estate agent early in her career before moving into the business full time to handle quoting, billing and client relationships. Valentina, a millwright by trade, ran the shop floor and kept the machinery running long past what most operators would have replaced it. Between them they had built a small operation with long-standing commercial clients, a shop full of machinery bought and rebuilt over decades, and a modest inventory of stock materials and parts.

By their mid-sixties, they were ready to retire. Neither of their two adult children wanted to take over the shop, so they had spent the better part of a year quietly looking for a buyer through their accountant's network before Gabriela, who ran a larger fabrication operation nearby, made an offer. Gabriela wanted to add their equipment and client list to her own business, and after a few months of back-and-forth the two sides agreed to a sale price of roughly $800,000 for the corporation's business assets.

The deal was structured as an asset sale rather than a sale of shares in the corporation — Gabriela's accountant had recommended this because it let her buy specific assets and start claiming depreciation on them from a fresh, higher value, rather than inheriting the corporation's history, and any of its liabilities, along with its shares. Niloufar and Valentina were comfortable with an asset sale in principle; it was the structure their accountant had also expected going in. What they had not yet focused on, because it had not yet been put in front of them in dollar figures, was how that $800,000 price would be split among the different things they were actually selling.

What the review found

When Gabriela's lawyer sent over the first draft of the asset purchase agreement, it included a schedule allocating the $800,000 purchase price across three categories: roughly $600,000 to machinery and equipment, $150,000 to goodwill, and $50,000 to inventory on hand at closing.

On paper this looked like a technical detail, but our review flagged it as the single most consequential number in the entire agreement for Niloufar and Valentina's tax bill. Under the Income Tax Act, a business sold as assets does not get taxed on one lump sum. Each category of asset has its own tax treatment, and the buyer and seller are expected to agree on the same allocation and report it consistently, because the Canada Revenue Agency can challenge a split that looks artificial or that the two sides report differently.

Equipment is depreciable property. Over the years, Niloufar and Valentina's corporation had claimed capital cost allowance — the annual tax deduction available for wear and tear on business equipment — bringing the undepreciated capital cost of their machinery down to roughly $60,000, even though much of it was still working and worth far more. When depreciable equipment sells for more than its undepreciated capital cost, the difference is recapture: past depreciation deductions get added back into income and taxed in full, the same as ordinary business income, up to the equipment's original cost. Goodwill, by contrast, is treated as capital property. When it is sold, only half of the gain is included in taxable income, at the more favourable capital gains rate.

That difference in tax treatment is exactly why buyers and sellers often want opposite allocations on the same purchase price. Gabriela's accountant wanted more of the price attached to equipment, because it let her start claiming larger depreciation deductions sooner on the assets she was acquiring. For Niloufar and Valentina, the same shift meant a much larger share of their sale proceeds would be taxed as fully taxable recapture income instead of a capital gain taxed on only half its value. Based on an independent valuation of the shop's machinery and its client relationships, a fair allocation looked closer to $480,000 for equipment and $270,000 for goodwill — a difference of about $120,000 sitting in the wrong column of the buyer's draft schedule.

What we did

1. Reviewed the draft schedule against the underlying asset values. Before advising Niloufar and Valentina on anything else in the agreement, we set the proposed allocation next to what the equipment, goodwill and inventory were actually worth, and identified the gap between the buyer's preferred split and a defensible one.
2. Explained the recapture exposure in plain terms. We walked the couple through why an allocation that looked like a minor drafting choice would, if signed as written, convert roughly $120,000 of their proceeds from capital gain treatment into fully taxable recapture income — money they would not get back once the deal closed.
3. Coordinated with their accountant on supporting values. Rather than simply asserting a different number, we worked from their accountant's valuation of the machinery and a reasoned estimate of goodwill based on the shop's client contracts and history, so the renegotiated allocation had a documented basis if the Canada Revenue Agency ever asked either side to justify it.
4. Negotiated the schedule with the buyer's lawyer before signing. We raised the allocation directly with Gabriela's lawyer, proposing a revised split — roughly $480,000 to equipment, $270,000 to goodwill, and $50,000 to inventory — supported by the valuation. Because the deal had not yet been signed, this was a negotiation over numbers on a page rather than a dispute over money already paid.
5. Built the agreed allocation into the closing documents. Once both sides accepted the revised schedule, we made sure the final asset purchase agreement, the closing statement of adjustments and the tax election documents all reflected the same figures, so Niloufar and Valentina's and Gabriela's tax filings would match and stand up to scrutiny.

The outcome

The sale closed on schedule with the corrected allocation in place. Gabriela still received a workable depreciation base on the equipment she bought, just not one built by quietly shifting value away from her sellers. Niloufar and Valentina retired having sold their business at the price they had negotiated, with roughly $120,000 of that price taxed as a capital gain rather than as fully taxed recapture income — the outcome a fair allocation should have produced in the first place.

Because the issue was caught while the agreement was still a draft, there was no dispute to resolve, no reassessment to fight and no amended return to file. The correction cost nothing beyond the time it took to compare a number on a schedule to what the underlying assets were actually worth, and a short negotiation between the two lawyers before anyone signed anything. That is often the difference between a tax problem and a tax bill: whether someone reads the allocation schedule before the signatures go on, or after. Niloufar later said the number on the original schedule had not struck her as unusual at all — it was just a line in a long document, and nothing about it looked like a mistake until it was explained.

What you can learn from this