Goodwill is an intangible asset that arises when there is a sale of an existing business. The Goodwill represents the amount of value that a company’s brand, reputation, customer base, etc. adds to the company’s overall value over and above its identifiable assets. Many businesses have significant goodwill that is not reflected in the financial statements as it is internally generated. When Goodwill is purchased it is considered to be an Eligible Capital Property (ECP).
Currently, ECP is amortized at ¾ of its cost at a rate of 7%/year on Schedule 10 of the T2 Corporate Tax Return. When ECP is sold it is taxed like a capital gain, where the portion of the proceeds that exceed original cost are only taxed at 50% at active business income rates.
Effective January 1, 2017, ECP rules will no longer exist, and balances on Schedule 10 will be transferred to a new CCA class. One of the implications of this change, is that future sales of ECP (or the premium received on a sale of your business) will be subject to recapture and capital gain treatment, including RDTOH. The gain is now going to be taxed as investment income which is a higher tax rate than income from active business.
Consequently, even if you are not planning to sell your business at this point, there is an opportunity to crystallize goodwill value (through a reorganization of the business, and a transfer of goodwill to a new entity) at a low tax rate, creating a Capital Dividend Account (CDA) balance in the process. Such a restructuring may provide an opportunity to access corporate funds at a lower effective tax rate (through CDA), making the prepayment of corporate tax on goodwill value a worthwhile trade-off. Note that it is not necessary for this goodwill value to be shown currently on your financial statements, for this opportunity to exist.
If you feel that your business may have significant internally generated goodwill, please feel free to contact us so that we may assist you with any planning prior to the changes coming into effect in 2017.