Selling a book when incorporated vs. unincorporated

What happens when you sell an incorporated book versus an unincorporated book?

Asset vs. share debate

Where there is no corporation, the thing being sold is the goodwill associated with the client list (an asset). You’ll want to consider:

Seller’s preference. Where the business is run through a corporation, the seller usually prefers to sell the shares. Doing so gives rise to a capital gain and the potential to protect some or all of that gain with the lifetime capital gains exemption (LCGE), as well as the sharing of the gain and LCGE with other shareholders.
Buyer’s preference. A buyer typically prefers to buy the client list, rather than acquiring the corporation itself. While either route would be a capital transaction (leading to either a capital gain or eligible capital property, ECP), acquiring the shares would bring with it exposure to any corporate liabilities. For MFDA commissions redirected to a corporation, it’s unclear what rights the corporation may actually have to sell.

In a share sale, the seller may realize a capital gain on the amount paid above the shares’ ACB. Only half of capital gains are taxable. Where payments are made over time, a capital gains reserve may be allowed for up to five years, with at least 20% of the gain having to be taken into income each year.

If the shares qualify for the LCGE, up to $824,176 of gains (for 2016, indexed annually) may be protected from taxation. To qualify, the corporation must be a CCPC and must meet two capital tests:

In the two years prior to the disposition, at least 50% of the assets must be earning active business income (ABI).
On the date of disposition, at least 90% of the assets must be earning ABI (based on CRA practice).

On the buyer side, the purchase price will form the ACB of the acquired shares. This is the base upon which the buyer will calculate the capital gain (and possibly LCGE) when she later disposes of the shares.

Sale of goodwill/client list

New regime

The 2016 Federal Budget will replace the eligible capital property (ECP) tax regime with a capital cost allowance class (for details, see advisor.ca/ECP). There is a transitional period, so we’ll still discuss the legacy ECP regime, but be aware that new rules are coming in 2017.

The sale of goodwill related to a client list falls under the category of ECP (see “New regime”). The amount paid is called the eligible capital expenditure, 75% of which is credited to an account called the cumulative eligible capital (CEC) pool.

For a buyer, annual amortization of 7% may be claimed based on the balance in the CEC pool, which then reduces the pool accordingly. As compared to buying shares, the buyer will wish to consider whether this regular annual deduction is more or less preferred to capital gains treatment (and potential LCGE) on a future share sale.

Where a seller is selling all goodwill and has not previously claimed any ECP-related deductions, 75% of the amount received for the ECP is deducted from the CEC pool. This creates a negative balance in the CEC pool, two thirds of which is taken into the seller’s income. Where the seller has claimed past amortization out of the CEC pool, the tax calculation on disposition is more complex; discuss the transaction with a tax advisor.

There are important differences between capital property and ECP. There is no equivalent to a capital gains reserve in the ECP regime, for example, meaning that the seller must pay the tax on the full terminal allowance in the year of closing.

Read the rest of this series:

Part 1: Tax and legal considerations when selling your book

Part 2: Finding the right buyer for your book

Part 3: Getting the best price for your book

Part 4: Tax issues with selling your book

Part 5: Incorporation issues when selling your book

Part 6: Can advisors incorporate?