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Buying a Business
Expert: L. Roy Cummings
David asked:
My question is about how to allocate a purchasing amount to goodwill, leasehold improvement and equipment. At the moment, I'm looking at buying the assets of an existing coin-operated laundromat in the Vancouver area. But, since the washers and dryers are 10 years old, I think I should replace them with new equipment in 5-10 years. The current book value of that equipment is estimated at less than $20K (original value was about $85K), which is not enough to be depreciated for new equipment in the future. So, I'd like to know up to what amount (out of total purchase price $159K) could be allocated for the equipment on the contract. And, is the depreciation amount (or expense?) considered taxable income? Lastly, what implication does the allocated amount on each of these (goodwill, equipment and leasehold) have tax-wise should I consider selling this biz after 10 years?
L. Roy Cummings answered:
Firstly, if you are buying the shares of a corporation currently carrying on the business, you do not have any choices; you are stuck with the corporation's historic amounts.
Assuming you are buying the assets, it is usually desirable to tend to allot the purchase price (within reason) as much as possible to the assets which are depreciable most quickly.
In this case, the general rates are:
Laundry equipment: 20% per year, reducing balance method.
Leasehold improvements: usually 5 to 10 years (amortized over the actual lease term and one renewal option), straight-line method.
Goodwill: 2/3 of cost is amortized at 7% reducing balance method (equivalent of about 4Ѕ%).
Presumably after 10 years, all the assets will have been written off. If they are sold for more than the depreciated balances, the recovery (called recapture) is taxable income.
In your case, to assign value to the equipment, consider that, if new, it would cost more than $85,000, the original cost, and the useful life is still 5 years or more. Accordingly, a reasonable value may be up to say Ѕ of the current replacement cost (e.g. 50% of $120,000 = $60,000).
The current book value is not relevant.
The amount to be recaptured on sale can be reduced or avoided when new assets are acquired as the old ones are disposed of. If the whole business is sold, the sale price is allotted to the assets and the excess over the undepreciated values is taxed as income. If the sale price exceeds your original cost, that portion of the gains is taxed at 2/3 of the regular business tax rate on goodwill and 2/3 as a capital gain at higher tax rates on equipment or leaseholds.
On the purchase of a business, it is desirable for the purchaser and vendor to agree on the allocation of the values, usually noted in the sale agreement.
Provincial Sales Tax will be payable by the purchaser on the values attributed to equipment.
Goods and Services Sales Tax can be avoided on the purchase by the purchaser and vendor making a joint election, and accordingly, is not an issue.
About the author
L. Roy Cummings is a general partner with Nordahl, Craig, Cummings & Gares, dealing with owner-managed businesses in greater Vancouver. He has been a Chartered Accountant for over 30 years. He may be contacted by email: lrc@nordahl.bc.ca, facsimile: 604-736-4280, or telephone: 604-736-2571.