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The Sale of Intangibles Tax Planning Opportunities for Professionals

28/09/2016


​​​​​​​​​​​​​​​​​On January 1, 2017 the tax treatment of corporately owned intangible assets such as goodwill, quota, and customer lists, etc. (known in the tax world as cumulative eligible capital or “CEC”) will change. This will, among other things, significantly affect the taxation of the sale of CEC. If you plan to sell CEC in the future you may be able to defer a significant amount of tax by either accelerating a third party sale to 2016 or by structuring an internal transaction which triggers a CEC gain in 2016.

Following is a comparison of the current and new rules:

  • Until 2017, generally, one half the gain on the sale of corporately owned CEC can be paid to a professional corporation’s shareholders tax free. The remaining one-half of the gain is subject to a maximum corporate rate of tax of 26.5%. When the funds are paid from the professional corporation to its individual shareholders they can be subject to individual taxes of up to 45.33%;
  • After 2016, generally, one-half the gain on the sale of corporately owned CEC can be paid to a professional corporation’s shareholders tax free. The remaining one-half of the gain is subject to a maximum corporate rate of tax of 50.17%. When the funds are paid from the corporation to its individual shareholders almost two thirds of the corporate taxes paid will be refunded. As a result, the combined corporate and individual income taxes owing on the withdrawal of the funds from the professional corporation can be very low.

There are two important points to note about the above alternative tax regimes:

  • The tax rate on corporately owned CEC is significantly less in 2016 (26.5%) versus 2017 (50.17%)
  • There is not a material difference between the two tax regimes if the sale proceeds are withdrawn from the corporation soon after the sale of the CEC.

The following calculations illustrate the above points. Assume that a professional corporation has goodwill with a value of $5.0 million and no tax basis.

There is $0.6 million less tax payable immediately (i.e. the difference between “total after tax cash after sale” under each alternative of $4.3 million and $3.7 million) if the CEC is sold in 2016 versus 2017, assuming the funds are retained in the corporation; and

  • There is a negligible difference between the two tax regimes if the funds ar​e withdrawn from the corporation soon after the sale of the CEC.

Sale of Corporate goodwill in 2016 versus 2017

(Amounts rounded for presentation purposes)​​

Trigger sale under existing rules in 2016Actual sale of CEC under new rules after 2016
Assumed corporate proceeds5,000,0005,000,000
Corporate tax paid on actual sale-700,000 -1,300,000
2017 corporate cash remaining, net of tax1,800,0001,200,000
2017 personal cash remaining, net of tax2,500,0002,500,000
Total after-tax cash after sale4,300,0003,700,000
Future tax on withdrawing funds from company-700,000-100,000
​Net after tax cash in personal hands3,600,0003,600,000
​This example assumes that the funds are ultimately withdrawn from the Corporation as a dividend. At the top tax rate there are additional tax savings available by planning this withdrawal carefully.

Planning opportunities

If you are planning to sell your professional business in the near future, it may make sense to accelerate the sale so that it happens in 2016 or to sell your goodwill in 2016 to a related corporation while the current Eligible Capital Property (ECP) rules are still in effect. The benefit of doing so would be that the gain on the sale of ECP may allow for a significant deferral of personal tax that will not be available under the new ECP rules starting in 2017. This planning opportunity will only be available until the end of the year. If you are thinking of selling your business, please speak with your advisor about the possible benefits of this type of planning.

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* Note that examples were based on Ontario tax rates and were rounded for presentation purposes and therefore may be inconsistent with rates discussed in the narrative.
Jim Chagnon, CPA, CA, TEP, is a Partner and Business Advisor in MNP’s Burlington office and a member of the firm’s Professional Services group. Jim works predominantly with owner-managed businesses and professionals. His clients represent a wide range of business se​ctors, including professionals such as medical, dental, legal and pharmacy businesses; technology companies; franchises and the construction industry. Contact Jim at 289.293.2311 or [email protected].​​

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