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Frequently we have clients who want to move their existing business venture from one company to another. A new company (“Newco”) is incorporated with the desired shareholders (possibly including additional shareholders) with the intention of selling a few assets to Newco and having Newco continue to operate the existing business in this new entity. While this may sound great in theory, it is lacking the transfer of the goodwill. The goodwill essentially moves when the existing business commences operations from Newco under the same name. If the existing company does not receive payment or consideration for this transfer, this could pose a potential problem for tax purposes.
Goodwill is an intangible asset, and is often not recorded on the balance sheet of a private company. It is difficult to measure, as goodwill is the premium that a purchaser will pay over fair market value (FMV) for the tangible assets of a business, such as the reputation, customer list and name of the business.
The sale of goodwill results in income to the business. Currently, this income is 50% taxable (like a capital gain) and is taxed as active business income. Therefore, the sale of goodwill generally results in very preferential tax treatment. In Alberta, active business income is taxed at 14% on any income below the small business deduction threshold and 25% on any income in excess of the small business deduction.
The Income Tax Act (ITA) requires taxpayers to transact at FMV. If no consideration is received on the transfer of goodwill, the ITA deems the existing operating company to have disposed of the goodwill at its FMV, resulting in tax.
The good news is, rather than being assessed with this unintended tax, there are tax-effective ways to transition assets to Newco or bring an additional shareholder into your existing operating company.
Related Topics:Goodwill; Valuations
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