Just like their own business-owning clients, advisors looking to sell their book of business would do well to work with experts.
“The sale of a book of business can have different implications depending on the nature of the business and the structure of the sale,” said Wilmot George Jr., director, tax and estate planning, Toronto-based Mackenzie Financial Services Inc. “So, it’s critical for [advisors] to work with the accountants and lawyers to confirm implications and to determine the most appropriate option.”
George spoke at the 12th annual Institute of Advanced Financial Planners (IAFP) Symposium in Calgary on Monday.
The tax implications of a sale depends on a number of factors, such as whether the buyer and seller are employees, sole proprietors or incorporated, or if the payment is made as a lump sum or is based on future commissions.
For example, if the seller of a book of business is an employee of a firm, he or she would be fully taxed on the proceeds received as employment income, said George. For an employee-purchaser, it is important to note that the client list — which is considered an asset as it represents the good will of the business — is not tax deductible as an expense under the Income Tax Act.
On the other hand, for sellers who are sole proprietors, the client list will generally be considered eligible capital property, which is taxed like a capital gain. However, George said sellers would only receive this type of tax treatment if the price were set in advance. In cases where the price is based on future production, such as future commissions, the payment amount would be fully taxable when received.
“For this reason, vendors could be best served by fixing their sales price in advance to insure capital gains tax treatment, even if the payments will be received over time,” said George.
Non-compete agreements are also considered an asset in the sale of an advisor business. These agreements are fully taxable unless the seller files a special election under the Income Tax Act, which would allow for it to be treated as a capital gain. For a sole-proprietor advisor buying a business, the non-compete agreement and client list would not be fully deductible at the time of purchase, said George, but would be amortized over time at a rate of 7% per year.
Depending on the outcome of a review by the federal government’s Provincial-Territorial Councils of Ministers of Securities Regulation, advisors may be able to incorporate their businesses in the future, which would have an impact on their taxes at the time of the sale of their practices.
Currently, only the insurance industry allows advisors to incorporate, said George, whereas under the rules of the Investment Industry Regulatory Organization of Canada (IIROC) and the Mutual Fund Dealers Association of Canada (MFDA) corporations cannot be registered, and therefore cannot conduct securities related activity. Under the MFDA rules, advisors, except for in Alberta, can redirect commissions to a non-registered corporation and be taxed corporately. However, George said there is debate as to the effectiveness of this model.
Should advisors be allowed to incorporate their businesses, the seller can take up to $800,000 in capital gains tax-free because of the capital gains exemption, so long as the shares qualify. A non-compete agreement would still be fully taxable unless the seller applied for an exemption.
In the case of a purchaser buying shares of an incorporated advisor practice, the cost-base of the shares would be adjusted meaning the buyer’s capital gain on the business would be reduced in the event of a future sale.