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The Impact of Pending ECP Tax Changes on a Business Sale

In recent years, business owners have had the ability to defer a significant portion of their tax bill by structuring the sale of their business as an “asset deal”, leaving the proceeds in the inactive company and investing the funds. However, the 2016 Federal Budget included proposed changes to the eligible capital property (“ECP”) rules that could have a significant impact on this strategy, as we will discuss in this article.

Two general approaches can be taken in the sale of an incorporated business:
1.  A sale of the shares of the company or
2.  A sale of business assets of the company.

Historically, purchasers have generally preferred to purchase assets (allows for the future amortization of tangible and intangible assets based on fair market values and reduced liability exposure) while sellers have generally preferred to sell shares (lower tax rate on capital gains and the potential to shelter sale proceeds from tax by the use of the shareholders’ capital gains exemption).

Asset sales often include a portion of the purchase price allocated to ECP, which is an intangible right or benefit that assists the business in earning income, and often includes such items as goodwill, licenses or franchise rights.

► Under the “Old Rules” in effect prior to the 2016 Federal Budget, a sale of goodwill as part of an asset sale resulted in 50% of the proceeds subject to tax as active business income. The other 50% of the proceeds was available for tax-free distribution to the shareholders as a capital dividend. Assuming that not all of sale proceeds from the asset sale were immediately required by the shareholders, a significant tax deferral opportunity was available in retaining the proceeds in the now stripped-down (as the business assets were sold in the transaction) company. Consequently, structuring the transaction as an asset deal often provided the seller with greater after-tax proceeds while also providing the purchaser with the benefits mentioned above (even though the common wisdom has been that a share sale was preferable to the seller).

► Under the “New Rules” proposed in the 2016 Federal Budget, which are effective January 1, 2017, a sale of goodwill as part of an asset sale will now be taxed similar to the disposition of depreciable property, resulting potentially in recapture and a capital gain subject to refundable tax for Canadian controlled private corporations. This means that the sale of goodwill under the New Rules will no longer benefit from the deferral opportunities that were available under the Old Rules. Here is an example, whereby $2 million of goodwill is sold as part of an asset transaction under both the Old Rules and the New Rules:

ECP Table

• The total after-tax cash remaining in the company is $236,700 lower under the New Rules, which significantly reduces the deferral opportunity (assuming the small business deduction is not accessed under the Old Rules); and

• It is only after the proceeds are paid to the shareholders, via dividends, that the company is able to utilize the dividend refund, which then allows for the total after-tax cash to shareholder to be fairly comparable.

We believe that the likely consequences of the New Rules will be:
• Sellers will most likely revert to share sales as their preferred business sale structure; and
• If a share sale is not agreeable, sellers will push purchasers to increase the price on the asset transactions so that they share in a portion of the tax benefit that the purchaser will enjoy under the asset sale structure.

However, if an asset sale that allows for the deferral opportunity under the Old Rules is the preferred approach for the business owner, they should contact Catalyst so that we can explore:
• Expediting the business sale process with the goal of closing the transaction in 2016; or
• Realizing the gain on goodwill through a crystallization-type transaction prior to January 1, 2017.

Carl Scholz, CPA, CA, TEP and David Laycraft, P.Ag., MBA, CMC, CBV, CF are partners with The Catalyst Group. Catalyst is a full-service accounting, tax, wealth and business advisory firm working in partnership with clients to meet their needs with customized professional services.

Carl has over twenty years experience advising private companies and their shareholders in tax planning, structuring and purchase / sale matters. Carl can be contacted at (403) 750-7693 or This email address is being protected from spambots. You need JavaScript enabled to view it..

David has twenty years of diversified experience serving private emerging and middle market businesses, and regularly assists clients in identifying, measuring, growing and realizing business value. David can be contacted at (403) 750-7685 or This email address is being protected from spambots. You need JavaScript enabled to view it..

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