Proposed Changes to Eligible Capital Property Regime
Volume No. 14-13
“we expect that the changes will eliminate an important tax deferral.”
Eligible capital property (“ECP”), for income tax purposes, includes intangible property such as goodwill and certain licenses, franchises and quotas, as well as certain other rights. Under the current tax rules with respect to the treatment of the purchase and sale, these types of assets are separate and distinct from the depreciable property rules. For example, the sale of corporate goodwill is currently 50% taxable at business tax rates, resulting in an effective tax rate on goodwill gains of 13% in B.C. (some variation by province). If goodwill was treated like depreciable property, the effective rate on the gain from its sale would be approximately 23% in B.C. In both cases, the tax free 50% of the gain can be paid out of a company tax free as a capital dividend.
In the 2014 Federal budget, the government announced that it would begin consultations aimed at removing the existing ECP rules and treat ECP as a new class of depreciable property, presumably, subject to the same rules that are currently used for depreciable assets.
The government stated that this change is intended to simplify and reduce the tax compliance costs for businesses. Although no proposed legislation has been released, we expect that any changes will eliminate an important tax deferral that a corporate vendor of ECP can currently realize in certain circumstances (particularly where goodwill is sold).
Under the existing rules, 50% of gains arising from the sale of goodwill by a Canadian Controlled Private Corporation (“CCPC”) is taxed as active business income (“ABI”) to the CCPC. We expect that any new measures will likely cause the 50% taxable portion of such gains to be taxed as investment income, at a higher corporate tax rate than ABI for CCPC’s. Since the difference in the tax rates between ABI and investment income is largely equalized once personal tax is paid on the distribution out of the CCPC, the potential increase in the effective corporate tax rate represents a lost deferral rather than an absolute tax cost.
For example, assume a CCPC sells goodwill, that has no cost base, for $10M. Under the current rules $5M of the gain would be subject to tax as active business income to the vendor , giving rise to $1.3M of tax at the corporate level (using BC rates). Under the anticipated rules $5M of the gain will likely be taxed as investment income to the vendor, giving rise to approximately $2.3M  of tax at the corporate level.
In this example, the new ECP regime would eliminate a tax deferral of approximately $1M ($1.3M vs, $2.3M) which would otherwise be available to the corporation.
With potential changes to the taxation of ECP on the horizon, corporate vendors of goodwill may wish to seek tax advice with respect to how the anticipated new rules may apply to their situation.
 Assumes the small business limit has been otherwise consumed and therefore the full income is subject to the top corporate rate on active business income in BC for 2014 of 26.0%.
 Assumes corporate tax rate on investment income in BC for 2014 of 45.7%.
TAX TIP OF THE WEEK is provided as a free service to clients and friends of the Tax Specialist Group member firms. The Tax Specialist Group is a national affiliation of firms who specialize in providing tax consulting services to other professionals, businesses and high net worth individuals on Canadian and international tax matters and tax disputes.
The material provided in Tax Tip of the Week is believed to be accurate and reliable as of the date it is written. Tax laws are complex and are subject to frequent change. Professional advice should always be sought before implementing any tax planning arrangements. Neither the Tax Specialist Group nor any member firm can accept any liability for the tax consequences that may result from acting based on the contents hereof.
TAX TIP is provided as a free service to clients and friends of Cadesky Tax.
The material provided in Tax Tip is believed to be accurate and reliable as of the date of posting. Tax laws are complex and are subject to frequent change. Professional advice should always be sought before implementing any tax planning arrangements. Cadesky Tax cannot accept any liability for the tax consequences that may result from acting based on the contents hereof.
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