Changes to the rules related to intangible property were confirmed in the 2016 Federal Canadian Budget earlier this year, and are due to be introduced next year.
However, while the Government’s intention is to simplify the rules in this area, the final legislation could have serious tax consequences for entrepreneurs who sell their business after 31 December 2016.
The Government is following up on proposals first mentioned in the 2014 Federal Budget with draft legislation which would merge the existing Eligible Capital Property (ECP) regime with the depreciable capital property rules.
The new proposals were subjected to a two-month public consultation which concluded on 27 September 2016, and are due to be introduced on 1 January 2017.
How Does This Affect Canadian Business Owners?
At first glance, the new measures, which are largely of a technical nature, would seem fairly innocuous. However, on closer inspection, they have something of a sting in the tail, namely the potential to increase tax on the proceeds of business sales.
At the nub of the issue is how tax will be determined on ECP upon the sale of a Canadian-Controlled Private Corporation (CCPC) once the changes have been introduced.
ECP is generally property of an intangible nature, such as goodwill, customer lists and licences, franchise rights and farm quotas.
Under current rules, when ECP is disposed of, 50% is taxed as active business income and subject to corporate tax. The new rules will instead treat these proceeds as investment income, which is subject to additional tax (refundable upon the distribution of taxable dividends).
The current rules mean it is more advantageous to sell a CCPC as assets rather than shares, and if structured correctly, sellers can defer tax – a commonly-used tax planning technique.
This changes under the new regime.
The proposed changes are particularly pertinent to anyone planning to invest in a new business, or hoping to use these proceeds as retirement income.
How Can Business Owners Prepare For The Change?
Before acting, tax experts are advising CCPC owners to thoroughly examine the structure of their business to ascertain whether they could be affected by these measures.
The main thing to consider here is how much of the company’s worth would be considered as ECP, in particular goodwill.
However, for those likely to be hit by these new tax rules, all is not lost and there are steps that entrepreneurs can take in order to mitigate the incoming changes.
Business owners who are thinking about selling their companies, or are actively planning to, may want to bring these plans forward and ensure that any deal is closed prior to the end of 2016 when the new measures are set to take effect.
For those not planning to sell this year, there are still avenues that could be taken to lessen the tax blow when the time does come to sell the business.
One is to consider realising any gains related to eligible capital property through a corporate restructuring before 1 January 2017.
Another is to consider selling the business in the form of shares rather than assets, as the former may open up more tax planning opportunities.
However, for any business owner worried that they may be adversely affected by the new measures, probably the most crucial first step is to seek advice from a tax professional with specialist knowledge in this area.