It is one thing to know how to bookkeep the transactions a business enters; it is another to take the information the bookkeeping system produces and use it to provide business advice to the owners and managers of a small business.
Most Canadian businesses enter into transactions that are denominated in a currency other than the Canadian dollar. Many enter into such transactions regularly, either by exporting or importing goods and services. Bookkeeping transactions that are denominated in foreign currencies requires an understanding of several principles.
Transactions that are denominated in a foreign currency must be reported in Canadian dollars when Canadian dollar financial reports are prepared.
This reporting involves recording the initial transaction in Canadian dollars using the rate in effect at the time the transaction is entered into.
Where a transaction is settled at a time other than the transaction date a foreign exchange gain or loss may be realized.
A translation gain or loss also arises when a foreign currency denominated account is translated into Canadian dollars in the process of preparing financial reports. A translation gain or loss is unrealized.
While both realized and unrealized gains and losses are reported for financial statement purposes, only realized gains and losses are reflect in income for income tax purposes.
A realized gain or loss may be on either income or capital account for income tax purposes.
As a business grows, it becomes increasingly important to consider the legal structure through which property is owned and profits accrue. The structure has implications for both the taxation of income currently and, in the longer term, for business succession planning, including a sale of the business.
A corporation is often used in the conduct of a business because it provides a limit to the liability of its owners.
A major disadvantage in using a corporation is that income that flows through a corporation is ultimately taxed twice.
A corporation can be used to protect business assets from creditors and to allow dividend income from the corporation to be split with family members.
A partnership is a more or less formal relationship between two or more parties for the conduct of a business. A partnership does not generally provide a limitation to the liability of a partner.
A partnership is not subject to tax; its income is allocated to and taxed in the hands of the partners.
A joint venture arises when two or more parties come together in a common venture, typically a one-off relationship that will terminate on its completion.
A joint venture is not a person either at law or for income tax purposes. Each venturer accounts individually for its share of each revenue and expense.
As an administrative convenience, many joint ventures account as if they were partnerships. However, for income tax purposes, each venturer must decide separately how to claim discretionary deductions related to venture activities. For more detail on complex business structures see our GreenLearning articles: Partnerships and Joint Ventures and Trust Accounting.
Consolidated and combined financial statements are prepared where two or more business entities are under common ownership or control.
The objective in preparing such statements is to reflect what results would have looked like if all inter-entity transactions were eliminated.
Most privately held enterprises can elect not to present consolidated financial statements even if these are required under Accounting Standards for Private Enterprises (ASPE) Generally Accepted Accounting Principles.
One way to grow a business is to purchase a complimentary business or a competitor. A formal process should underlie a purchase transaction to ensure that the appropriate business issues have been addressed.
Purchase transactions can be structured as either a purchase of assets or a purchase of shares.
The vendor typically prefers to sell shares. The purchaser typically prefers to buy assets. Their conflicting priorities are reconciled through the price paid.
On any purchase the purchaser will perform due diligence to ascertain the value of the target’s income and related assets.
Detailed information is generally needed on the makeup and business attributes of the various types of property and, to a lesser extent, liabilities of the target when assets are purchased.
On a share purchase the purchaser needs more detailed information relating to liabilities and the tax cost of the target’s assets.
A business owner may find him- or herself in the position of wanting to sell the business or receiving an unsolicited offer. It is important to understand the process the purchaser goes through in assessing an acquisition.
In assessing the desirability of a business acquisition, a purchaser needs to consider both the external environments in which it operates and its internal systems for strengths, weaknesses and opportunities.
This assessment should identify both risks and opportunities posed to the business by external factors and whether these make an acquisition more or less desirable and, if so, why.
The assessment should lead to a conclusion about the attributes that a target should have together with criteria for evaluating how well a target fits the business environment.
Equally important is an honest assessment of the purchaser’s capabilities to manage any acquisition.
As noted earlier, there are two ways generally that a business is sold: either the assets themselves are sold or the shares of a corporation owning the business assets are sold.
The way in which income tax applies to the sale of assets varies with the nature of the assets sold. The economic gain may be fully taxable or only partially taxable.
There may be planning opportunities to be pursued on the sale of assets, particularly where not all of the sales proceeds are to be received on closing, to defer the amount of tax to be paid.
Where the assets are sold by a corporation, the rate of tax that applies and the creation of a capital dividend account are important planning issues.
There are several strategies that should be explored in planning for the distribution of surplus from a corporation that has sold its business to its shareholders.
Special issues must be considered if shares are to be sold.
In order for a gain to qualify for the capital gains deduction, the vendor must be selling qualifying property. The vendor’s access to the capital gains deduction may be restricted by prior ABIL claims or the existence of a CNIL account.
Two tests – the determination time test and the holding period test – are applied to the fair value of the assets of a corporation in determining whether it is a Qualified Small Business Corporation (QSBC).
The holding period test applies differently in assessing the QSBC status of a holding company.
Where a corporation has assets which put it off-side under either of these tests, it is possible to ‘purify’ it by removing the non-qualifying assets.
There are several techniques that a family can use to multiply access to the capital gains deduction by introducing children and spouses as shareholders.
The issues involved in structuring a business succession arrangement vary depending on whether the succession is to family members, employees or third parties.
With family members, payment terms and the vendors’ access to their capital gains deduction are the major issues to address.
With employees, accessing the capital gains deduction is typically not an issue. Employee stock options are a useful tool in easing the employees into an ownership position.
With a third-party purchaser, the key issues relate to structuring the commercial arrangement during the transition period. The tax treatment of earn-out payments and non-competition payments needs to be understood.
There may be preliminary steps to be taken in order to make a business suitable for succession – whether by sale or by inheritance.
Corporations can generally be merged together without triggering tax.
A division of corporate assets can only be accomplished on a tax-free basis under very limited circumstances. Such a division in contemplation of a sale is typically not tax free.
Property can generally be transferred to a corporation without triggering tax.
Special rules permit a proprietor to incorporate a proprietorship and access his or her capital gains deduction on an immediate sale of the shares of the corporation.
Property generally cannot be distributed from a corporation without triggering tax. Special rules govern the transfer of property to and from a trust. Our GreenLearning article Corporate Tax Integration for Shareholders & Business Owners in Canada is an excellent resource for the tax implications for shareholders and corporations.
We can assist you with advice and reporting as it relates to advanced business issues such as foreign transactions and complex organization structures in Canada. Here at Green Quarter Consulting - Accounting and Bookkeeping Services for Small Businesses in White Rock South Surrey, Vancouver, Langley and Surrey BC, we assist Small Business Owners with analyzing transactions, sources of income and your tax risks and how they relate to your business strategy. Learn more about our Greenstamp CFO Services here.