Entrepreneurs work hard at building their enterprise – but
most of them want to eventually reap the rewards by selling all or
part of their business. Entrepreneurs may focus on maximizing the
purchase price through negotiation with a prospective purchaser,
which is important. But they may be missing out on some important
tax planning steps that can also have a significant impact on how
much after-tax proceeds they can retain subsequent to the sale.
Recent changes to Canadian tax legislation underline the need to
pay attention to tax planning.
Business owners planning to sell all or a portion of their
business in the near future might want to make that sale happen
sooner rather than later, to avoid a tax bite that is scheduled to
get a lot bigger on January 1, 2017. Even if you aren't
planning on selling, you might do well to reorganize your business
in a way that triggers your gains before January 1, 2017 rather
than after that time, depending on the circumstances.
Owners of CCPCs may be subject to higher tax on the sale of
The upcoming change affects Canadian-Controlled Private
Corporations (CCPCs), which are private Canadian corporations that
are not controlled by non-residents and/or public companies.
Under the new rules, the existing Eligible Capital Property
(ECP) tax regime will be merged into the current depreciable
capital property rules. ECP includes intangibles not otherwise
included in a separate class of depreciable property, such as
trademarks, customer lists and certain licences.
However, for many businesses, the most important aspect of this
change is the fact that ECP also includes goodwill, which is the
entire value of the business that cannot be attributed to other
tangible business assets (net of liabilities) or other intangible
assets that are not separately identifiable. In most instances,
goodwill represents a material amount of the purchase value (i.e.
generally the purchase price in excess of the value of net
identifiable assets). This goodwill may not have a significant tax
cost where it was "internally generated" by the business
(i.e. where the existing goodwill of the business was not purchased
from another business by the entrepreneur). What this can mean is
that all or substantially all of the realized gain from the sale of
goodwill may be subject to income tax on the sale.
These proposed changes are part of Canada's Federal Budget
presented on March 22, 2016.
Currently, only 50% of ECP gains are taxed, and, assuming the
top combined Federal and Ontario corporate income tax rate of
26.5%, results in an effective corporate tax rate on ECP gains of
13.25%. However, as of January 1, 2017, gains on the sale of ECP
will be taxed as ordinary capital gains, so that 50% of the gain
will be subject to a much higher upfront tax rate of 50.17%, which
results in an overall upfront effective corporate tax rate of about
25%, nearly double the current rate.
Steps to consider to avoid higher taxation
So if you're an owner of a CCPC, what are your choices and
what do you need to consider?
How much of your company's value is attributable to
ECP? Consider how much of your company's value is
considered goodwill and other eligible intangibles, and therefore
subject to the higher tax rate after the end of 2016. If not much
of the business value is attributable to ECP, it could be that no
immediate action is necessary.
Sell early? If you are planning to sell the
assets of your business in the near term, think about whether it is
practical to seek out a good offer and complete the purchase before
the end of 2016, to minimize the effects of the changes to the ECP
Crystallize gains now? If you are not planning
to sell your business soon, there may be steps you can take to
crystallize your gains related to ECP. Such steps would be intended
to have those gains taxed at the current rates, reducing the impact
of potential taxes on a sale of the business in the future at the
much higher rates in place after the end of 2016.
Shares versus assets? Since selling the shares
of your company and selling the business assets are treated
differently under Canadian tax legislation, you should consider
whether changes to your corporate structure will help you shelter
more of your capital gains from taxation.
Hybrid transactions – where are we now?
Some transactions, which involve both a sale of shares (to access
capital gains exemptions) and assets, may now be less attractive to
entrepreneurs selling their business. The circumstances of each
case will dictate whether or not this particular type of
transaction continues to have merits going forward.
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.
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Under the Income Tax Act, the Employment Insurance Act, and the Excise Tax Act, a director of a corporation is jointly and severally liable for a corporation's failure to deduct and remit source deductions or GST.
While most are well aware that the sale of a business is generally a complex process, even sophisticated business owners are surprised by just how much cost and effort is required to complete the sale.
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