Eligible capital property (“ECP”) includes such things as customer lists, franchise rights, licenses, quotas and other intangibles. ECP also includes goodwill, which in general terms is the value of a company beyond the value of its tangible and other specified property.
Initially mentioned in the 2014 Federal Budget, the Federal Government announced in the 2016 Budget that it is replacing the current regime for the taxation of ECP with a new capital cost allowance (“CCA”) class and essentially merging ECP into the depreciable property tax regime. The proposed changes are slated to come into effect on January 1, 2017. The good news is that the new taxation regime for ECP should be much simpler. The bad news is that the taxation of gains realized on a sale of ECP, particularly for Canadian-controlled private corporations (“CCPC”) will be much less favourable.
In basic terms, the current taxation regime is such that on a sale of ECP by a CCPC the gain is included in general income at a rate of 50%. The other 50% is added to the corporation’s capital dividend account, which may be distributed to shareholders via tax-free capital dividends. Using general corporate tax rates in British Columbia, Alberta, Quebec and Ontario, this results in an effective corporate tax rate for gains on the sale of ECP by a CCPC of about 13% (slightly higher in Ontario and Quebec).
The new rules will treat gains on the sale of ECP as investment income (rather than general corporate income), namely capital gains, resulting in an effective corporate tax rate for gains on the sale of ECP by a CCPC in the aforementioned provinces of about 25%. In other words, a CCPC will initially pay almost twice as much tax on a gain from the sale of ECP in 2017 than it will in 2016. A portion of this higher tax under the new rules will be refundable, but in order to obtain a refund the CCPC will have to pay taxable dividends to its shareholders. Consequently, the tax deferral available under the old regime has been effectively eliminated upon the new rules coming into force.
For a corporation that is considering selling goodwill or other ECP in the near future as part of a sale of assets (the issues outlined in this article are inapplicable to share sales), consideration should be given to selling prior to the new rules coming into effect. Should that prove impractical, the corporation could also consider reorganizing in 2016 to crystalize unrealized gains in respect of ECP, in particular goodwill, thereby accelerating tax payable but locking in the lower rate. If it is presently unclear whether it makes sense to reorganize the corporation to crystalize unrealized gains in respect of ECP in 2016, it may be possible to defer the decision for a time yet maintain the ability of the corporation to benefit from the 2016 taxation regime for ECP.