Published: March 20, 2020
Last Updated: April 13, 2020
Changes to the Eligible Capital Property Tax Rules: How Canadian Tax Lawyers Can Help you Protect your Hard-Earned Goodwill
Part I: Introduction to New Tax Rules for Goodwill
New tax changes are set to come into force on January 1, 2017 with respect to the income tax treatment of Goodwill. The new tax rules will result in higher taxes on the sale of Goodwill and the inability to defer income from the sale using a corporation.
Business owners should contact our experienced Canadian tax lawyers immediately in order to take advantage of the tax savings offered by the old rules by carrying out a corporate reorganization to take advantage of the favourable old tax rules before the end of the year.
Eligible Capital Property (Goodwill) Taxation
Eligible Capital Property is the tax term for an intangible asset held by a taxpayer. The most common example (and the most important for tax planning purposes) of Eligible Capital Property is Goodwill, or the valuable pre-existing relationships built up through years of doing business with suppliers and customers.
Canadian Income Tax Treatment of Eligible Capital Property (Goodwill)
Historically, Canadian income tax law has by design allowed for preferential tax treatment of Eligible Capital Property. Under the rules currently in force (only until the end of 2016), when Eligible Capital Property is sold for a gain as a part of a discrete transaction, or a complete sale of a business as a going concern, fifty percent (50%) of the gain is taxable as active business income, while the balance is treated akin to the non-taxable portion of a capital gain, meaning it is tax free. The non-taxable proceeds from a sale of Eligible Capital Property or goodwill are tracked in a corporation’s Capital Dividend Account and become available for distribution to the shareholders on a tax-free basis by way of capital dividends.
The previous income tax treatment of the taxable 50% portion of ECP allowed business owners to continue to defer taxes upon the sale of Goodwill through the use of a holding corporation, in some cases indefinitely. As mentioned above the taxable portion was considered Active Business Income, allowing for the income to be taxed in the hands of the corporation at the lower corporate rate.
As a result, the easiest and most tax effective manner of selling a business was by way of a sale of the assets of a corporation, including its goodwill. Doing so would result in half of the proceeds attributable to the sale of the goodwill being non-taxable in the corporation, and then distributed to the shareholder on a tax-free basis through a capital dividend election. The remaining taxable portion, after taxes were paid, could be retained & invested in the corporation without immediate tax consequences.
In Part II of this article we will detail the reasoning behind, as well as the impact of the new changes and how they will greatly affect the taxability of the sale of a business after 2017. As readers will see, careful and thoughtful income tax planning must be undertaken immediately to ensure preferential tax treatment. To find out how our experienced Canadian Tax Lawyers can assist you in diminishing the impact of these changes, please continue to Part II of this Eligible Capital Property tax planning article.
Continue Reading More about Goodwill Taxation Part 2.
"This article provides information of a general nature only. It is only current at the posting date. It is not updated and it may no longer be current. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in the articles. If you have specific legal questions you should consult a lawyer."