The ECP Transitional Rules and Internally Generated Goodwill

When a taxpayer has disposed of eligible capital property (ECP) in the calendar year 2016 but the gain is to be reported in the taxation year that straddles January 1, 2017, the transitional rules surrounding the repeal and replacement of the ECP regime essentially provide the taxpayer with a choice between reporting the gain as a capital gain and reporting it as business income. TI 2016-0669721C6 (November 29, 2016) appears to highlight one key exception: the choice does not apply to many gains on internally generated goodwill, and thus these gains must be reported as capital gains. However, few gains may fall into this category, and in those few situations the TI's reasoning seems to suggest that the gain is not taxable in any way.

Under subparagraph 13(38)(d)(ii), a taxpayer with a taxation year that straddles January 1, 2017, who would have had an income inclusion under paragraph 14(1)(b) if the taxation year had ended immediately before January 1, 2017, will be deemed to have received a capital gain equal to twice the amount that would have been included under paragraph 14(1)(b). However, subparagraph 13(38)(d)(iii) allows the taxpayer to elect to report the income inclusion as business income instead of a capital gain. In the TI, the CRA notes that the preamble to subsection 13(38) requires the taxpayer to have made, before 2017, an eligible capital expenditure (ECE) in respect of a business operating on January 1, 2017. Therefore, if the taxpayer's only intangible property is goodwill generated internally, the election will not be available.

At least for corporate taxpayers, it seems unlikely that there would have been no ECEs before 2017; for example, there would have been incorporation costs. Thus, the TI describes quite a narrow situation.

Further, the TI's reasoning appears to lead to a questionable conclusion. If we accept the CRA's argument that the preamble to subsection 13(38) does not apply on the ECP disposition, it does not affect only the one subparagraph. If the preamble is not satisfied, the whole subsection does not apply, including the requirement to report a capital gain (subparagraph 13(38)(d)(ii)). Further, because subsection 14(1) has been repealed as of the time the taxpayer is filing the tax return for the year, there is no business income inclusion; the taxpayer reports no gain of any type on the ECP disposition. It seems unlikely that this was the legislator's intention. Indeed, it is clear that such an interpretation will not stand up to a textual, contextual, and purposive analysis of the provision.

Hamza Benqassmi
KPMG LLP, Montreal

Canadian Tax Focus
Volume 7, Number 2, May 2017
©2017, Canadian Tax Foundation