What is purchase price allocation, and who decides it?

In a share sale there is one asset, so allocation barely arises. In an asset sale the buyer is acquiring a basket of different things, each with its own tax treatment. The agreement of purchase and sale sets out how the price is divided across that basket. That schedule is not administrative housekeeping — it often moves more money than the last round of price negotiation did.

Why the split changes the tax for both sides

For the seller, amounts allocated to inventory generally produce fully taxable business income. Amounts allocated to depreciable property can trigger recapture of capital cost allowance, also generally taxed as income, and a capital gain above original cost. Amounts allocated to goodwill fall under their own rules and are often more favourable. For the buyer, the allocation sets the starting cost of each asset, which determines future depreciation deductions and the eventual gain when the buyer sells. Inventory is typically deducted soonest; goodwill is written off slowly.

The interests are usually opposed

• Sellers commonly prefer more allocated to goodwill and less to depreciable property and inventory.
• Buyers commonly prefer more allocated to fast-deducting assets such as inventory and equipment.
• Amounts allocated to a non-competition or other restrictive covenant have specific rules and can be treated unfavourably without the right elections.
• Real property allocations can attract provincial land transfer tax, which some parties overlook.
• GST/HST applies differently across asset classes, which is a further reason the split matters.

The CRA is not bound by an unreasonable split

An allocation agreed between arm’s-length parties carries real weight, because genuinely opposed commercial interests tend to produce a fair result. But the CRA can reallocate where the stated amounts do not reasonably reflect fair market value, and it can do so for one party without matching adjustments landing where you expect. Support significant allocations with evidence — appraisals for real property and equipment, inventory counts, and a defensible valuation of goodwill. Non-arm’s-length deals get closer scrutiny.

Practical handling in the agreement

Set the allocation out in a schedule, and add a covenant that both parties will file consistently with it. Deal with what happens if the CRA challenges the split, including cooperation on any appeal. Agree how post-closing adjustments to the price, such as a working capital true-up, will be allocated. Have both accountants review the schedule before signing, because it is difficult to renegotiate afterwards.