What is an asset purchase agreement and how does it work?

An asset purchase agreement is the contract in which a buyer acquires a business’s assets, as listed in the agreement, instead of buying the shares of the company that owns them. It works in two layers. One is legal: who carries which risk. The other is financial: how the price is split, because that split flows into tax. Both need to be settled before closing.

How it allocates risk

BDC calls the representations and warranties the core of the purchase agreement and says it is all about risk allocation. Closing conditions and indemnities are other sections it describes. Read them as a set: what the seller promises is true, what must happen before the deal closes, and who pays if a promise proves wrong. For the section-by-section list, see the key sections of an asset purchase agreement.

How the price is split

Under section 68 of the Income Tax Act, if an amount can reasonably be regarded as being in part the consideration for the disposition of a particular property, for particular services or for a restrictive covenant, the part that can reasonably be regarded as the consideration for each is deemed to be that, irrespective of the form or legal effect of the contract or agreement. A figure in the contract does not by itself settle it. The CRA classes goodwill acquired after 2016 as Class 14.1 property for capital cost allowance.

Sales tax and employees

Under section 167 of the Excise Tax Act, the supplier and recipient of a business or part of a business may make a joint election in prescribed form if, under the agreement, the recipient is acquiring ownership, possession or use of all or substantially all of the property that can reasonably be regarded as necessary to carry it on as a business, except where the supplier is a registrant and the recipient is not. Where the election applies, no tax is payable on a supply of property or service made under the agreement, other than the supplies listed in s.167(1.1). Provincial rules can apply too. In British Columbia, PST applies to the assets that are taxable goods or software, unless a specific exemption applies, and under the Employment Standards Act, if all or part of a business is disposed of, an employee’s employment is deemed continuous and uninterrupted for the purposes of that Act. Check the rules in the province where the business operates.