Frequently we have clients who want to move their existing
business venture from one company to another. A new company
("Newco") is incorporated with the desired shareholders
(possibly including additional shareholders) with the intention of
selling a few assets to Newco and having Newco continue to operate
the existing business in this new entity. While this may sound
great in theory, it is lacking the transfer of the goodwill. The
goodwill essentially moves when the existing business commences
operations from Newco under the same name. If the existing company
does not receive payment or consideration for this transfer, this
could pose a potential problem for tax purposes.
Goodwill is an intangible asset, and is often not recorded
on the balance sheet of a private company. It is difficult to
measure, as goodwill is the premium that a purchaser will pay over
fair market value (FMV) for the tangible assets of a business, such
as the reputation, customer list and name of the business.
The sale of goodwill results in income to the business. Currently,
this income is 50% taxable (like a capital gain) and is taxed as
active business income. Therefore, the sale of goodwill generally
results in very preferential tax treatment. In Alberta, active
business income is taxed at 14% on any income below the small
business deduction threshold and 25% on any income in excess of the
small business deduction.
The Income Tax Act (ITA) requires taxpayers to transact at FMV. If
no consideration is received on the transfer of goodwill, the ITA
deems the existing operating company to have disposed of the
goodwill at its FMV, resulting in tax.
The good news is, rather than being assessed with this unintended
tax, there are tax-effective ways to transition assets to Newco or
bring an additional shareholder into your existing operating
company.
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.
