April 14, 2023
When you’re considering selling a pharmacy, good accounting matters – a lot. During negotiations, any prospective buyer is going to take a hard look at your pharmacy’s books. If they don’t like what they see, it could very well lower the price they are willing to pay or scupper the deal entirely.
In previous articles, we’ve discussed some of the major accounting mistakes we have seen pharmacist-owners make over our many years working as business transaction advisors. In this blog, we’ll focus on a doozy: holding too many non-active assets within the company.
Non-active (or redundant) assets can take several forms. Sometimes they are hard assets, like land and buildings, or even “company” cars. They can also come in the form of cash or investments like stocks and bonds. Generally, if an asset is not directly related to the operation of the business, then it’s non-active.
Many pharmacist-owners believe that keeping these non-active or “redundant” assets within their operating company helps protect them from tax consequences. But when it comes time to sell their pharmacy, they are almost always proven wrong.
The lifetime capital gains tax exemption (LCGTE) is a big deal. Basically, it allows any Canadian to realize a capital gain of about $971,190 (as of 2023) without paying tax. In most cases, a pharmacist-owner will seek a share sale of their business, meaning that they sell ownership of the company rather than just the stuff the company owns (an asset sale). When they do, they can potentially keep a good chunk of the sale proceeds tax-free, thanks to the LCGTE.
But … there’s a big “but.”
To claim the exemption in a share sale, your company’s shares must meet the criteria for a Qualified Small Business Corporation (QSBC) under the Income Tax Act. And one of those criteria is that at least 50% of the assets in your company must be “active” – things like receivables, inventory, equipment, business property and goodwill.
Assets like cash (that is over and above what is needed to run the company) and marketable securities might not count as active, however. If they exceed half of the company’s total assets, then it is not a QSBC and you cannot claim the LCGTE in a share sale.
Even worse, potentially, is that active assets within the corporation can never fall below the 50% threshold at any time during the two years before you sell the company, if you want to get the capital gains tax exemption.
And then, when the sale actually takes place, 90% of the company’s assets must be active to qualify as a QSBC.
When they realize that non-active assets exceed the 50% threshold, a pharmacist-owner might scramble to offload them to themselves or to another corporation. That might help them qualify for the LCGTE when they sell, but it could result in a big tax hit even if the “sale” is really only a transfer of ownership. That’s because the authorities could decide that the transfer triggers a capital gain, possibly putting you on the hook to pay taxes.
There are ways to mitigate the tax consequences of so-called “asset purification,” but they can get quite complicated and take time. We always recommend consulting a highly qualified tax accountant if you find yourself in this situation.
There’s a reason most corporate names have a “limited” at the end of them: it means its assets – and its liabilities – are limited to the company. But let’s say you hold a lot of cash or investments or your car or your property within the company and then the company gets sued or goes bankrupt. If that happens, all the company’s assets are vulnerable to legal judgment or to creditors.
The best “solution” to the problem of non-active assets in a corporation is simple: Don’t put them there in the first place! If it’s too late for that, then there are ways to “purify” your company’s assets to reduce liability risk and support a tax-efficient sale of its shares, as we noted above.
However, there are two things to bear in mind if you find your pharmacy business is facing an asset challenge. First, getting redundant assets out of a business the right way can be a very complicated undertaking from a tax perspective, so you should consider working closely with an expert tax accountant. And second, these strategies can take time to implement – the qualifying period for a capital gains tax-exempt share sale extends for two years.
So our advice, if you have to fix your company’s asset mix, is to start well before you hope to sell a pharmacy business. Work with a qualified advisor to identify non-active (redundant) assets, and then get the help you need to “purify” them in a tax-efficient way.
As with most accounting challenges when you are hoping to sell your pharmacy, the time to address your company’s asset mix is right now. Ignoring the problem could end up costing you hundreds of thousands of dollars and turning the sale of your pharmacy business into a disaster. So, contact us today!