Whether the referenced property is restricted to property that was sold (pp. 9:9-10)
[T]he the inclusion of the definite article “the” suggests as a contextual matter that the reference to property in paragraph 12(l)(g) is to the property that was sold. This is arguably supported by the Tax Court’s reasoning in 289018 that paragraph 12(l)(g) applied because the property sold had a direct relationship with the source of the payment. ...
[T]he predecessor provision to paragraph 12(l)(g) was introduced in response to a case in early Canadian tax jurisprudence that found that income from a royalty that was carved out (retained) by the vendor on the sale of a resource property was on capital account to the vendor because it arose from the sale of a capital asset. [fn 37: Spooner (1933), 1 DTC 258 (PC): CRA document 9, June 1988.] ...
[S]ince an earnout on a sale of shares is generally not a form of income right retained by a vendor in connection with a sale of capital property, it follows that earnouts on share sales should generally not attract the application of paragraph 12(l)(g) when that provision is read purposively. ...
However…it is notable that paragraph 12(l)(g) is not stated to be limited to circumstances in which property is sold, notwithstanding the fact that the original impetus for the provision came from a case involving the retention of a royalty in connection with a sale of property….
Partnership interests are property under scheme of Act (p. 9: 10)
[S]ince the Act treats a partnership interest as a separate capital property, and dispositions of such interests are taxed to the partner as a sale of capital property and not as though the partner sold a right to the partnership’s assets … it would be more appropriate for paragraph 12(l)(g) to generally not apply to dispositions of partnership interests for the same reasons discussed above, in the context of share sales.
Potential treatment of earnout as substituted property (p. 9: 12)
[T]here can be a denial of the bump where property distributed on the amalgamation or winding up of a target entity or property, other than specified property, acquired in substitution therefor (“substituted property”) was acquired by one or more “specified shareholders” [fn 51: [F]or the purposes of the bump denial rules, in very general terms, each shareholder’s interest in the target is aggregated to form a notional shareholder, such that if a group of persons who collectively own 10 percent or more of the shares of the target (before it is acquired by the parent) acquire the target’s property or substituted property, the bump can be denied.] of the target entity as part of the series that included the windup or amalgamation. Substituted property includes property that, at any time after the acquisition of control of the target entity, derives more than 10 percent of its fair market value from the property distributed to the parent.
An earnout could be interpreted as deriving more than 10 percent of its value from the property of a target entity, depending on its terms. However, the CRA has opined favourably with respect to this issue. In the CRA’s view, if the sole purpose of the earnout is to establish the fair market value of the shares of the subsidiary on closing, then the earnout will not normally be substituted property. [fn 52: 1999-0010965] However, this favourable view would not apply if the earnout were used as a mechanism to distribute additional amounts from the future sale or value of some particular property.
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