Today’s blog comes to you from my tax partner, Ronald E. Nobrega.
The March 22, 2016 federal budget included a measure to merge the eligible capital property (“ECP”) tax regime under the Income Tax Act (“ITA”) with the ITA’s depreciable property rules. Eligible capital property includes goodwill and certain other intangibles that were not previously included as depreciable property. For the most part these changes are benign, including that the overall tax amortization/depreciation rate is similar, and these changes represent a degree of tax simplification. The budget measure applies after 2016.
However, the proposal has an additional impact on Canadian-controlled private corporations (“CCPCs”) that are selling goodwill or other eligible capital property, typically as part of a sale of a business. In brief, CCPCs are private Canadian corporations that are not controlled by public companies and/or non-residents. On a sale of goodwill (and for this purpose assume the goodwill is self-generated and has not been amortized for tax purposes), 50% of the gain realized is treated as business income and is subject to corporate tax. The other 50% of the gain is included in the corporation’s capital dividend account that can be distributed tax-free to individual resident shareholders. The corporate tax on the 50% taxable portion of the gain is taxed at the usual corporate tax rate of 26.5% (in Ontario). However, after 2016, the goodwill gain will be treated as a capital gain. Again, half of the capital gain is not taxable and would be included in the CCPC’s capital dividend account. However, the taxable portion of the gain would be taxed at a higher tax rate (approximately, 50.1% in Ontario) applicable to investment income earned by CCPCs rather than at the usual corporate tax rate of 26.5%. This additional amount of tax on a CCPC’s investment income is generally refundable where sufficient taxable dividends are paid. Accordingly, a significant tax deferral opportunity exists under the current ECP regime for CCPCs that will be eliminated under the budget measure commencing January 1, 2017. As a result, owners of CCPCs have a strong incentive to complete asset sales before year-end to benefit from this tax-deferral opportunity.
Some owners of CCPCs with significant accrued gains on goodwill or other ECP intangibles are crystallizing these gains in corporate reorganizations to be completed before year-end. Tax is accelerated because of the crystallization transactions, but with the lower tax rate applying.