The 2016 Federal Budget released in March contained proposed changes that may impact selling your business in the near future. The proposed changes relate to the current Eligible Capital Property ("ECP") rules and may result in less favourable tax treatment for business owners who sell their businesses after 2016.
What is ECP?
Generally, ECP includes various intangible assets relating to a business, with goodwill and customer lists being common examples.
What happens when ECP is sold?
When a Canadian-controlled private corporation ("CCPC") sells ECP, its effective corporate tax rate on the sales proceeds can be as low as 7% (for an Alberta corporation). Generally, 50 percent of the gain on the sale of ECP is subject to tax as active business income and the remaining 50 percent is included in the corporation's Capital Dividend Account ("CDA") from which tax-free capital dividends can be paid. This is currently more favourable than the result under the proposed rules, where the sale will be treated as a capital gain, with 50 percent of the gain taxed at the investment income tax rate (50.7% in Alberta). The 50 percent non-taxable portion of the capital gain will still be added to the corporation's CDA under the proposed rules.
Current vs. Proposed rules for the sale of ECP
To help illustrate the corporate tax differences under the
current and proposed rules, let us consider an example where Opco,
an Alberta CCPC, sells its ECP for a gain of $500,000. Using the
general corporate tax rate of 27%, Opco will pay taxes of $67,500
($500,000 x 50% x 27%) under the current rules. Under the proposed
rules, the taxable portion of the gain will be taxed at the
investment income tax rate and Opco will pay taxes of $126,750
($500,000 x 50% x 50.7%).
Of this $126,750 of taxes, up to $76,750 can be refunded to Opco
as it pays taxable dividends to its shareholders. However, the
opportunity for tax deferral by delaying the payment of taxable
dividends to shareholders is effectively eliminated due to the
higher corporate taxes paid up front under the proposed rules.
Current vs. Proposed rules for the purchase of ECP
The proposed rules will also affect the tax treatment of ECP acquired by a business. Under the current rules, 75 percent of the cost of ECP is added to a separate pool called Cumulative Eligible Capital ("CEC") which is depreciated at a rate of 7 percent per annum on a declining balance basis.
Under the proposed rules, a new class of depreciable property for Capital Cost Allowance ("CCA") will be introduced. The new rules will add 100 percent of the ECP to a newly introduced class 14.1 having an amortization rate of 5 percent per annum on a declining balance basis.
Transitional rules will transfer December 31, 2016 CEC pool balances to the new CCA Class 14.1. For 10 years, pre-2017 balances will be amortized at the rate of 7 percent per annum on a declining balance basis.
In addition, to simplify the transition for small businesses, small initial balances may be eliminated quickly. A taxpayer will be permitted to deduct as CCA, in respect of expenditures incurred before 2017, the greater of: (i) $500 per year; and (ii) the amount otherwise deductible for that year. This additional allowance will be available for taxation years that end prior to 2027.
What if I am considering selling my business?
If you are considering selling your business, there may be a significant tax advantage to accelerating the sale to occur before January 1, 2017. This of course should be considered in conjunction with various other non-tax factors.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
