The rule change on the taxation of intangible assets for Canadian Private Companies is fast approaching.
The Canadian Federal Budget presented on March 22, 2016 contained proposals which will impact negatively on private companies selling their business on or after January 1, 2017.
This may result in increased pressure for companies currently in negotiation for a sale of their business to conclude the transactions before the end of 2016.
The change stems from the repeal effective January 1, 2017 of the existing Eligible Capital Property tax regime (“ECP”) and its replacement by a new capital cost allowance (“CCA”) class for depreciable capital property. Whilst the new rules will provide similar deductions in calculating income as the existing system there will be a major impact on business owners seeking to sell their business, particularly where the business is operated through a Canadian-controlled private corporation (“CCPC”).
Common examples of EPC include goodwill, customer lists, trademarks, franchise rights, farm quotas and some patents, i.e. intangible assets of a business generally. Under current tax rules, half of the gain resulting from a disposal of ECP is taxable at the low corporate business tax rate, i.e. treated as business income, while the remaining 50% of the gain is included in the CCPC’s capital dividend account and can be distributed tax-free to individual shareholders. This treatment results in gains on disposal of EPC being taxed at a rate of between 13% - 15.5% depending on which province the company operates in.
Under the new system, gains on the disposal of ECP will be subject to tax as regular capital gains (as opposed to business income) and consequently will suffer the higher tax rate applicable to investment income realized by CCPCs. As a result the tax will nearly double, with rates ranging between 25% and 27% depending on the province in which the company operates.
The rule change may make it more attractive for business owners to dispose of the shares in their company rather than have the company sell the business. By doing so they may qualify for the lifetime capital gains exemption ($824,176 in 2016). However in general buyers prefer an asset deal rather than purchasing the shares in an existing company where they end up buying into a company’s tax history and other potential liabilities which may exist in the company.
For business owners currently contemplating a sale of business assets it may make sense to accelerate the process so that it is completed before the end of 2016 and thus be dealt with under the existing EPC regime. By their very nature, deals to dispose of business assets take time and there are effectively only six months left in 2016 in which to close out transactions and benefit from the more benign current EPC regime.
As in all cases however it is important to consider all aspects of a proposed transaction, as tax is not the only important driver in such situations – deals must make sense on other fronts also.