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small-business taxes

Matthew Mammola of Ernst & Young suggests business owners who are contemplating selling their assets should begin the process now if they want to beat the deadline, when taxes go up.JENNIFER ROBERTS/The Globe and Mail

Private companies pondering whether to sell their businesses are being forced off the fence becaue of a change in the latest federal budget that would see them pay more tax on a sale starting next year.

The revision is around taxation of intangible assets, such as goodwill and licences, at the time of sale.

Tax experts says the move, which is intended to simplify the tax system, is inspiring some business owners readying for a sale to finally pull the trigger, with a goal of closing the deal before the new tax rules kick in on Jan. 1.

"It's driving a lot of discussion about M&A [mergers and acquisitions]," says Dov Begun, a partner in the tax group at Osler, Hoskin & Harcourt LLP, who works with many entrepreneurs and startups in Canada.

"There are a lot of meetings, a lot of phone calls and a lot of interest" since the change was introduced in the federal budget on March 22, he says.

The clause can be found in the "eligible capital property" section of the budget document, which includes "intangible property such as goodwill and licences, franchises and quotas of indeterminate duration, as well as certain other rights."

The change affects all companies, but has a significant impact on owners of private companies that sell the assets of the business, and not the company shares, says Matthew Mammola, a senior manager at consulting firm Ernst & Young's transaction tax practice.

He said the key difference is that a company selling intangible assets will have them taxed as a capital gain starting in 2017, which attracts a higher tax rate for Canadian-controlled private corporations. Under the current system, those assets are taxed as business income.

For example, today, goodwill gains are taxed as business income at a rate of between about 13 and 15.5 per cent, depending on the province a business operates in, Mr. Mammola says. Starting next year, the rate will range between 25 and 27 per cent, when taxed as a capital gain under the new system.

Put another way, if a company were to sell its goodwill for $5-million, for example, the tax would be about $700,000 in 2016. Under the new system starting in 2017, the tax would be about $1.3-million, or nearly double.

The change could also be an incentive for owners of private companies to sell their shares, instead of the assets. That way, they may also qualify for the lifetime capital gains exemption, which is $824,176 in 2016, which is not possible for an asset sale.

However, that may be more challenging since buyers often prefer asset deals because of certain tax deductions they can't get on a share deal, Mr. Mammola says. Plus, an asset sale is less risky for the buyer.

"If they buy the shares of the company they're inheriting its tax history and any skeletons in the closet that now become theirs," such as litigation, he says.

For business owners thinking of selling their assets, Mr. Mammola recommends they start the process soon if they want it done under the current, more favourable tax system.

That is because it can take up to six months or more to complete a deal.

"A typical transaction can take longer than most people think," Mr. Mammola says. "If they wait until the last couple of months of the year, they could run out of runway."

Mr. Begun at Osler is expecting inquires from potential sellers to pick up over the summer, as the end of the year draws closer.

However, he doesn't expect owners, who had no plan to sell prior to the budget change, to suddenly make a decision to find a buyer.

"It's more for people already in negotiations, with a term sheet, thinking about a sale or who have been approached about a sale – and are thinking about the best way to structure it," Mr. Begun said.

Dino Infanti, a tax partner and national leader at KPMG LLP, says his firm is getting more calls from private companies looking to sell before the end of the year, or to simply better understand the tax implications of staying put for a few more years if they are not ready.

"Where someone has been thinking about selling their business … then it would be useful to have a discussion now to entertain a transaction, before the new tax regime comes into place," Mr. Infanti says.

That said, he also doesn't expect business owners to decide to sell simply to beat the taxman.

"You never do something simply for tax purposes," says Mr. Infanti. "You look at the business deal first and foremost. If there is a deal on the horizon … then there may be some motivation here to accelerate that transaction and consummate it before year end."