31 January 2000 External T.I. 1999-0010965 - EARNOUT CLAUSES AND INELIGIBLE PROPERTY

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues: Whether a earn-out clause will cause the bump under subsections 88(1)(c) and (d) to be disallowed.

Position: Question of fact but if sole purpose is to establish the fair market value of the shares of the subsidiary then generally the earn-out right would not be a property described in subparagraphs 88(1)(c.3)(i) or (ii).

Reasons: The law.

XXXXXXXXXX 1999-001096

Attention: XXXXXXXXXX

January 31, 2000

Dear Sir:

Re: Technical Interpretation Request - Paragraph 88(1)(c.3)

This is in reply to your letter of February 4, 1999 wherein you requested our views as to whether an earn-out clause in a share purchase and sale agreement would represent an "ineligible property", as that term is defined in subparagraph 88(1)(c)(vi) of the Income Tax Act (the "Act").

Specifically, you are concerned that the earn-out clause is a right that would be a property described in subparagraph 88(1)(c.3)(i) or (ii) for the purpose of determining whether the property is an ineligible property. If the earn-out is an ineligible property the bump to the cost base to the parent of non-depreciable capital properties of its subsidiary on the winding-up of the subsidiary under paragraphs 88(1)(c) and (d) of the Act would not be available.

Your request appears to relate to either a proposed transaction or a completed transaction. Confirmation of the income tax consequences of proposed transactions involving specific taxpayers will only be provided in response to a request for an advance income tax ruling. To make such a request the advance income tax ruling must be submitted in accordance with the guidelines set out in Information Circular 70-6R3 (IC-70-6R3) dated December 30, 1996. However, if the situation relates to a completed transaction a request for the Canada Customs and Revenue Agency's views must be made to your local Tax Services Office. We can, however, offer the following comments.

Subparagraph 88(1)(c)(vi) of the Act provides that an increase in the cost base of non-depreciable capital property will not be available with respect to the assets of a subsidiary on its winding-up where any property distributed to the parent on the winding-up or any other property acquired by any person in substitution therefor is acquired by, inter alia, a particular person (other than a specified person) that, at any time during the course of the series of transactions and before control of the subsidiary was last acquired by the parent, was a specified shareholder of the subsidiary.

It is not possible to determine, from the limited facts in your letter, if the earn-out would cause us to conclude that the bump in subsection 88(1) of the Act would be available or not. In order to make such a determination we would require a complete understanding of all the facts and relevant information of the particular fact situation and we are prepared to consider this matter on a rulings basis if the transactions have not yet taken place, otherwise your question should be referred to the appropriate tax service office as described above.

It is, however, our general view, absent any other mitigating factors, that where an earn-out or any similar type of agreement is clearly for the sole purpose of providing a mechanism to determine the fair market value of the shares of the subsidiary (where the fair market value of such shares cannot otherwise be determined), such property would not normally be considered as a property described in either subparagraph 88(1)(c.3)(i) or (ii) of the Act. This would not be the case where an earn-out is used as a mechanism to distribute additional amounts based on the future sale or value of some particular property.

Our comments are provided in accordance with the practice outlined in paragraph 22 of IC-70-6R3.

Yours truly,

for Director
Reorganizations and International Division
Income Tax Rulings Directorate
Policy and Legislation Branch
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