The 2016 federal budget plans to eliminate the current system for taxing eligible capital property (ECP) and treat these assets in the same way as depreciable capital property beginning in 2017. Given these proposed changes (note: at the time of writing, the legislation to enact the budget measures has not received royal assent), business owners looking to sell ECP may be able to achieve a tax benefit before the end of the calendar year.
What is ECP?
Eligible capital property includes an extensive list of property, including: goodwill, customer lists, farming quotas, as well as certain licenses, franchises, trademarks and copyrights. Check with a professional tax advisor to determine if your business has ECP.
Where the value of the ECP in your business is significant, the proposed changes would have a negative impact on the ability to defer taxes on the sale of these assets.
Consider a business with ECP worth $1M (that has a negligible cost basis). Suppose that the combined federal and provincial general corporate tax rate is 25 percent. The chart below shows the corporate tax impact should the company sell its ECP under the current system and based on the proposed changes.
Example: Tax Treatment of Eligible Capital Property
As illustrated in the chart, if you sell the ECP assets of your business and you do not need to extract all of the proceeds from the sale immediately, starting in 2017 you would have fewer after-tax dollars in the company to invest until funds are ultimately distributed from the corporation. This is because the effective corporate tax rate on these assets under the existing system is currently only one half of the general corporate tax rate. Note that under both tax regimes, there will be no change to the addition to the capital dividend account.
For business owners contemplating a sale in the near future of ECP with a significant value, you may consider closing the sale before the end of 2016 to take advantage of the current tax regime.
If you are not willing or able to sell before the end of the calendar year, you may wish to consider strategies that could trigger the gains on the ECP this year (i.e., prepay the tax today) to reduce the amount subject to tax in the future under the new regime.
As always, please consult with your professional tax and legal advisors to review the facts of your situation and determine if there is an opportunity for you to benefit before 2016 ends