With fall around the corner and looming tax changes, certain private companies – Canadian-controlled Private Corporations (generally, private corporations that are controlled by Canadian residents, referred to herein as CCPCs) – may begin to feel pressure to quickly start and/or complete asset sale transactions. On March 22, 2016, the federal Finance Minister released the 2016 Federal budget. The budget includes new measures that will impact tax payable on sales of eligible capital property (ECP), such as goodwill and other intangibles. The impact of these changes will largely be borne by sellers. The date for implementing these measures is January 1, 2017.
Current and proposed tax rules: from ECP to CCA
The current rules provide a tax advantage that benefits CCPCs that sell ECP in an asset sale. Generally, 50% of the gain from the sale of ECP is taxed as active business income instead of as taxable capital gains. The tax rate on active business income is favourable relative to the rate on taxable capital gains realized by a CCPC because those capital gains are subject to an additional refundable tax that is only refunded upon the payment of dividends. The other 50% of the proceeds can be distributed tax-free to shareholders as capital dividends.
The incoming changes will repeal the ECP regime. In its place, a new capital cost allowance (CCA) class, Class 14.1, will be introduced. Class 14.1 will capture goodwill and other property that would previously have qualified as ECP under the current rules. In accordance with the CCA regime, gains from the sale of CCPCs’ assets belonging to Class 14.1 will be taxed as capital gains and thus subject to investment income tax rates, which include the additional refundable tax. This treatment will apply for any sale occurring after December 31, 2016. CCPCs with tax years ending in 2017 will have the option to elect to have the old rules apply to any sale of ECP that occurs prior to January 1, 2017.
Projected implications for private company M&A
So what does this all mean for CCPCs? In the short term, if ECP comprises a large proportion of a particular company’s value, it may be worthwhile for that company to take advantage of the current rules and to quickly complete a sale transaction before the new rules are implemented, though the practical difficulty is that many sale transactions take several months to complete. Sellers should carefully weigh the benefits of the tax treatment under the current rules against the challenges of an abbreviated sale process.
The author would like to thank Samantha Sarkozi, summer student, for her assistance in preparing this legal update.
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