This website uses cookies. By continuing to use this website you are agreeing to our use of cookies as described in our privacy policy.

Executive Summaries Jan 12, 2023

Avoid and Prevent the Risk of Tax Litigation in Business Succession

Whether we are talking about more "traditional" succession through family members, succession by one or more key employees, or by a third party, the issues in terms of litigation are the same.

The transaction can be structured in different ways, either through a sale of shares or assets. Thus, the sale of shares may have certain advantages for the seller, who may benefit from a capital gains deduction on the sale of its shares or multiplication of this deduction in the case of a trust holding the business. In the case of a third party, the transaction may rather lead to a sale of assets where the third party does not want to carry on with the past of the business, since it has no knowledge of the business for a long enough time to understand the nature of the issues.

Clarify Representations and Warranties

The best way to indemnify and protect the purchaser in the case of a share or an asset transfer is to ensure that the representations and warranties are clearly and rigorously drafted, with the necessary adjustments to be made in light of a share or asset transfer. Generally speaking, representations and warranties are subject to a maintenance period corresponding to the time following the closing, during which a loss must be compensated. After the expiration of such a period, the seller will not compensate any loss, even if it results from inaccurate representation and warranty.

The seller's representations and warranties concerning a corporation's taxes will generally remain in full force and effect for the purchaser's benefit for a period of 90 days following the expiration of the period during which tax authorities are authorized to reassess the corporation again. Consideration should be given, where applicable, to waivers given by the corporation, audits or investigations relating to fraud or misrepresentation, and any relevant factors that may affect the statutory time limits.

In general, the minimum tax representations shall be as follows:

  • the corporation has filed all tax returns;
  • the corporation has paid all taxes and has made its deductions, withholdings or collections of income of all amounts which it was required to deduct, withhold, collect and remit;
  • the corporation has no outstanding indebtedness, liabilities or obligations related to any tax not due and incurred in the ordinary course of its business since the end of the last fiscal period;
  • there are no assessments, reassessments, actions, suits or legal proceedings pending or, to the knowledge of the purchaser, threatened against the corporation in connection with taxes;
  • the corporation has not filed any waiver of statute of limitations with respect to any taxable year under the applicable tax laws.

Concerning the minimum representations concerning litigation, the purchaser must state the litigation in progress and any potential risk of litigation under the various laws, particularly with the environment, operating permits, laws concerning francization, trademarks or patents, to name but a few.

The Importance of Due Diligence

The careful drafting of representations and warranties should uphold the importance of conducting proper due diligence on every level. Thus, it is the purchaser's responsibility to research the corporation's tax, commercial and litigation history. For example, have there been problems with tax collection, have guarantees been given to the tax authorities because of bad behaviour, and are payment agreements still in place that are not being respected?

The purchaser shall determine if the financial records have been properly maintained and if certain tax attributes have been properly assessed, i.e., the depreciation value of certain assets, the value of the inventory, etc. The buyer shall also verify if there have been any transactions on shares, such as exchanges, rollovers, choices that have been made in the past.

Of course, it is important to keep all the books and records of the corporation if the transaction involves a share transfer. Although the new owners may not have the same knowledge as the previous owners, tax authorities make no difference when they audit the corporation for past years. Therefore, it is also necessary to foresee the seller collaborating with the purchaser to answer the tax authorities' questions. An indemnification clause shall also be included. The same comment should apply to current or potential litigation.

You should also not hesitate to consult the professionals already involved in the business, as they can guide the new owner in case of an audit by the tax authorities or pending litigation.

Finally, the purchaser shall also consider whether there is a shareholders' agreement, personal guarantees given by the former shareholders and whether new warranties will have to be put in place. In the case of an asset transfer, personal guarantees may relate to the acquisition of certain assets that are part of the transfer. These items may also be subject to representations and warranties, and it will be important to make the necessary changes to avoid future litigation.

We invite you to contact our tax litigation team for any questions regarding business acquisitions.

Stay on the lookout!

Subscribe to our communications and benefit from our market knowledge to identify new business opportunities, learn about innovative best practices and receive the latest developments. Discover our exclusive thought leadership and events.