A change to the treatment of eligible capital property (ECP) for Canadian-controlled private corporations (CCPCs) could have a significant impact on business owners planning a sale of their business in the next year. That is, of course, unless they act now to take advantage of the existing tax rules.
Before we explore these changes, let’s first explain ECP. The Income Tax Act defines ECP as “Any property, a part of the consideration for the disposition of which would, if disposed of, be an eligible capital amount in respect of a business.” Examples of ECP include goodwill, customer lists, licenses, patents or trademarks, or costs related to reorganizations, amalgamation and incorporation.
According to Canada Revenue Agency, the new tax rules change the existing ECP treatment such that “Property that was ECP will be depreciable property and expenditures and receipts that were accounted for under the ECP rules will be accounted for under the rules for depreciable property and capital property.”
What this means is that under changes set to take effect on January 1st, 2017, the existing ECP regime will be replaced by a new depreciable asset class. Currently, only 50 per cent of a gain on the sale of ECP is taxed at regular corporate rates. For CCPCs with less than $500,000 of taxable income, that rate is 15 per cent. The existing rules are in effect until the end of the year, at which time gains on the disposition of ECP will be taxed at much higher corporate tax rates that apply to passive income such as capital gains.
For example, if a CCPC sold its business today and $100,000 of the proceeds were allocated to the sale of its goodwill—assuming its income for the year was less than $500,000—the CCPC would be taxed at the small business tax rate of 15 per cent on half of the gain, or $7,500. The sale of the same business, assuming the same allocation, next year would give rise to a tax bill of $26,000, as the gain on the sale of the ECP in that case will be treated as a capital gain; in effect, the tax deferral previously enjoyed would be eliminated.
If you are contemplating the sale of your business in the near future, you may consider crystallizing gains in ECP before the end of the year. You will prepay tax at lower corporate rates, while also capturing a deferral that can be used to create a tax-friendly cost base for when you ultimately sell the business.
It’s a simple strategy that, in the right circumstance, could help defer tens of thousands of dollars (or more) of tax on the sale of a business.
Armando Iannuzzi, Partner