When I was a very young boy we had a small creek in our backyard in North Vancouver. Along with a few of the neighbour boys, I used to carve little wooden canoes and set them to race in the harmless little flow. Sometimes the canoe would be "peopled" with some small bugs we captured to help personify the adventure in miniature.
We also had a rope swing secured to a strong branch on a large evergreen tree at the edge of the creek bank. The creek felt like a canyon to our tiny little bodies, it descending ten or so feet below the level surface of the backyard. If one could run and grab onto the rope swing, our momentum would carry us right over the creek and back into the yard.
The object was to make it back alive while our playmates threw dirt-bombs at us. Dirt-bombs consisted of handfuls of moist soil squished into snowball-like projectiles, which were then thrown at the hapless Tarzan on the swing. Occasionally one of the dirt-bombs would be purposefully laced with a rock just large enough to make its impact memorable.
In all our adventures, if there was one thing we loved even more then our little creek it was big machines and the workmen who operated them. But one week these two passions collided, when a series of heavy machines and dump trucks brought in large storm sewer pipes to close off the creek forever. We watched in mixed fascination and horror as they rather promptly made our canyon of joy a distant memory.
And then it was over. The big machines and the workers were gone. Our creek was somewhere under all that dirt, flowing quietly in the underworld. Our yard had gotten bigger but our fun had gotten smaller.
Sometimes progress comes along and buries your dream.
Speaking of which, today we discuss more proposed tax changes which will significantly impact the after-tax proceeds of the sale of small businesses in 2017 and beyond.
New tax treatment on the sale
of small business assets
The March 22, 2016 federal budget proposed major changes to the taxation of goodwill and other assets categorized technically as eligible capital property (hereafter referred to as ECP). If you are contemplating selling the assets in your business, these changes may significantly increase your tax liability after Dec. 31, 2016.
While business decisions should not be entirely dictated by tax motivations, the tax impact of these changes will be significant. Goodwill, customer lists, quotas, patents and trademarks which are sold at a gain after 2016 will feel the pinch. For many business owners, a significant portion of their business value is attributed to goodwill, which is simply the amount someone is willing to pay you over and above the value of the other assets.
Under the current tax rules, only 50 per cent of the gain on the sale of goodwill is taxable in the corporation at active business income tax rates. The other 50 per cent is non-taxable and is added to your corporation's capital dividend account (CDA) after the end of the corporation's taxation year. A positive CDA balance can be paid out to you, the shareholder, tax-free as a capital dividend.
The 2016 federal budget proposed that a sale of goodwill be treated the same way as a sale of a tangible depreciable asset such as a building or equipment used in your business. Aside from now treating goodwill as a depreciating asset, there is an even more impactful proposal at hand. After 2016 the taxable portion of the sale of goodwill gain will be taxed as passive investment income at higher corporate tax rates and not the lower active business tax rates.
A sale of goodwill under the current rules would be taxed in the corporation at tax rates ranging from approximately 13-16 per cent, depending on the province. After 2016 the sale of goodwill will be subject to a capital gains tax rate which ranges from approximately 25-27 per cent.
The after-tax proceeds may continue to be invested in the corporation and may provide funding for your retirement. However, after the proposed changes in the tax rules take effect, the benefit of the tax deferral is significantly reduced and may negatively impact your retirement planning. (Insert your preferred cuss words here).
Due to the difference in tax rates, some business owners with goodwill may be motivated to sell their business before the end of 2016 in order to take advantage of the current tax treatment.
Next week we will discuss those businesses with goodwill that are not planning to sell and those that are planning to sell but have no imminent offers.
As always, this article is not meant as individualized tax or legal advice. Readers should consult their own tax or legal professionals before proceeding with a strategy.
Mark Ryan is an advisor in Prince George with RBC Wealth Management, Dominion Securities (member CIPF) and can be reached at [email protected] or 250-960-4927.
