Changes Coming in 2017 That May Significantly Affect the Tax on the Sale of Your Business
In its March 2016 Federal Budget, the Liberal government made some key changes to tax legislation that will affect the after-tax proceeds that business owners can retain from the sale of their business assets (as opposed to the sale of shares of their business corporation). These changes come into effect on January 1, 2017. Here, we explore the changes and what they may mean for you.
The new tax rules affect Canadian-Controlled Private Corporations (CCPCs); specifically, rules surrounding Eligible Capital Property (ECP). ECP includes intangibles such as trademarks, customer lists, licenses, franchise rights, and most importantly, goodwill.
Why is this important? Well, for many business owners, goodwill is one of the biggest assets they have to sell. Goodwill is the intangible value of your business, often associated with brand recognition, reputation with customers and employees, and patents or proprietary technology.
Right now, 50% of the proceeds of the sale of goodwill are subject to tax as active business income, while the other 50% is available for tax-free distribution to shareholders as a capital dividend. If the proceeds from an asset sale are partly distributed to individual shareholders and partly retained in a personal holding company, this can result in a significant tax deferral of personal income taxes.
With the new rules, the seller no longer has the ability to take advantage of this tax deferral. Gains on the disposition of goodwill will be taxed as investment income in the form of capital gains. This means that, as of January 1, 2017, the effective tax rate of approximately 6.5 – 9% that is currently applied to a goodwill gain will be increased to an effective tax rate of approximately 25 – 27% on that same goodwill, depending on your province.
What does this mean for your business?
If you are considering selling all or some of your business, you may want to move quickly to make the sale happen before the new changes come into effect. Alternatively, if your sale happens after January 1, 2017, it may affect how you structure the deal with potential buyers.
There are two ways to structure a business sale transaction: an asset sale or a share sale. Generally, purchasers tend to prefer asset transactions. They offer more flexibility in terms of retaining employees and they carry less risk because the buyer can pick and choose which assets and liabilities he or she will take on. Under share sales, all assets and liabilities remain part of the company. Share sales can be more appealing to a seller because they offer a lower tax rate on capital gains, and they offer the potential to shelter a portion of the proceeds from tax via the shareholders’ lifetime capital gains exemption.
With the new rule in place, sellers will be even more motivated toward share sales. Purchasers who wish to proceed with an asset sale may have to compensate the seller for the additional tax costs associated with that deal. Likewise, sellers may become more selective when considering competing offers.
If you are considering a full or partial sale of your business after the rules change, here are some other things to consider:
- Review your corporate structure. Changes to your business structure may allow you to shelter some of your capital gains from tax should you decide to sell after the legislation takes effect.
- Take steps to crystallize your gains related to ECP. You may be able to have some of those gains taxed at the current rates, which will reduce the impact of potential taxes on a sale that takes place after January 1, 2017.
As with any business transaction, a sale is complex and requires careful planning—perhaps even more so with the changes ahead. This article is intended to give you some basic information; a tax professional can provide detailed information and offer advice on how to move forward. GGFL has a group of experienced tax professionals who would be happy to discuss your business sale with you.