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Last time, we reviewed valuation and negotiation. This article will discuss issues that can affect the tax treatment of a book sale for one or both parties.

The legal nature of parties involved in the transfer of an advisory practice is one of the central determinants of the transaction’s tax outcome. It comes down to clarifying whether the parties are employees, self-employed or incorporated.

Employees

From the selling side, amounts received by an employee are taxed at the person’s marginal tax bracket. Those amounts are generally taxable in the year received, without the ability to defer recognition or to take a reserve or a portion into income in a future year. This applies to a payment received from a succeeding advisor/buyer for making a recommendation to clients to continue with the successor, including any portion received under a non-competition agreement (also known as a restrictive covenant).

The amount of the non-competition payments and their timing (e.g., if extending past the year of closing) must be reasonable.

If the buyer is an employee, few tax deductions are available, and specifically, no deduction is allowed for payments made to acquire another advisor’s clientele. As well, for tax purposes, an employee cannot generally acquire capital property for which annual depreciation might otherwise be claimed. Similarly, acquiring a client list as goodwill does not qualify as eligible capital property, for which annual amortization charges might otherwise be claimed.

Finally, if the buyer has borrowed funds to assist in the purchase, any interest charges will not be deductible.

Much of this summary reflects the Supreme Court of Canada’s 2004 ruling in Gifford (see “Relevant cases”).

Self-employed

A self-employed taxpayer is not subject to the same tax treatment as an employee. Payments made and amounts received will generally fall under the rules applicable to the earning of business or property income.

Advisory practices are capital in nature, so a self-employed buyer cannot claim a current deduction; nor must the seller/receiver generally record a current income inclusion. The payments are instead under the eligible capital property regime, allowing a buyer to claim amortization. A seller is entitled to “capital-gains-like” treatment in the year of sale (see “New regime”).

Relevant cases

Gifford v. the Queen, 2004 SCC 15

Gifford and Bentley were financial advisors employed with Midland Walwyn in North Bay, Ont. In 1995, Bentley (who was departing the practice) agreed to provide a written endorsement of Gifford to his clients, supported by a 30-month restrictive covenant. Gifford borrowed the funds for the agreed price of $100,000.

Gifford subsequently claimed deductions for depreciation and interest. Those deductions were denied, and the appeals eventually made their way to the Supreme Court.

The court held that the payment for the accumulated goodwill and the agreement for Bentley not to compete were made to create an enduring benefit for Gifford. This amounted to a payment on account of capital, and the Income Tax Act (ITA) s. 8(1)(f)(v) prevents an employee deduction from being made for such an expense. Furthermore, interest payments therefore would be a payment on account of capital, and are expressly denied deductibility under s. 8(1)(f)(v).

Morrissette v. the Queen, 2006 TCC 284 (translated from French)

Morrissette was an advisor with Laurentian Bank Securities (LBS). In October 2002, LBS advised Morrissette that it was terminating his employment. A payment of $20,000 was made at that time, with a further $5,000 to be paid six months later as a “final payment—sale of clientele” if LBS had retained 75% of the assets under management.

The court found that Morrissette was indeed an employee, and that the $20,000 was severance pay, not a capital gain as Morrissette had claimed. The court referred to Gifford in discussing the $5,000 payment, determining that this amount was “in respect of a certain right of [Morrissette] in his clientele.” Note that this case proceeded under the informal procedure, and is therefore not binding on any court.

Desmarais v. the Queen, 2006 TCC 417

Desmarais accepted a $350,000 payment from Valeurs mobilières Desjardins (VMD) to move from Nesbitt Burns. He took on the role of branch manager, overseeing 24 advisors. A
colleague joined him, and was making ongoing payments as a commission split to acquire the clientele of Desmarais.

Desmarais claimed the payment as a capital gain, was reassessed by CRA and appealed to the court. The court determined that the VMD payment was an incentive to sign the employment contract, and taxable as income pursuant to ITA s.6(3).

Bouchard v. The Queen, 2008 TCC 462

These were three appeals involving a couple, Danielle and Jacques Bouchard, and their daughter Jacinthe. The couple retired as advisors from National Bank Financial (NBF), receiving in part what was described as “retiring allowances.”

The central issue was whether the payments were capital or employment income. The reasons are quite detailed, but the court arrived at the conclusion that all amounts at issue were employment income.

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 (this article): Tax issues with selling your book

Doug Carroll, JD, LLM (Tax), CFP, TEP, is Practice Lead — Tax, Estate & Financial Planning at Meridian.

Originally published in Advisor's Edge Report

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