23 October 2002 Internal T.I. 2002-0164607 - CONTINGENT LIABILITIES-SALE OF BUSINESS

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 CCRA.

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

Principal Issues: Tax Consequences arising from sale of business where part of the consideration includes the assumption of contingent liabilities

Position: Vendor's proceeds includes fair market value of contingent liability assumed by purchaser; Purchaser's cost of assets would not include contingent liability until contingency is met.

Reasons: Consistent with prior opinions.

		October 23, 2002

	Surrey TC/Burnaby-Fraser TSO	HEADQUARTERS
	Jennifer Adams	Wayne Antle, CGA
	Research and Knowledge Centre	(613) 957-2102
	9755 King George Highway
	Surrey, BC  V3T 5E1
		2002-016460

Assumption of Contingent Liabilities on Purchase of a Business

This is further to your email of September 24, 2002, requesting a copy of our response to Question 9 at the 1998 Tax Executives Institute ("TEI") conference concerning the tax implications when contingent liabilities are assumed as part of the consideration paid on the purchase of a business.

Specifically, Question 9 stated:

Would Revenue Canada confirm the following views where a business is sold and contingent liabilities of the vendor are assumed by the purchaser as part of the consideration paid for the business assets?

Where the purchaser assumes contingent liabilities, e.g., warranty reserves, as consideration for assets (i.e., the amount of other consideration is less than what would otherwise have been received by the vendors had the contingent liabilities not been assumed by the purchaser), we believe that the following results arise:

? The reduction in the amount of other consideration received by the vendor as a result of the assumption of the contingent liabilities by the purchaser is treated as a payment by the vendor in satisfaction of the contingent liability;

? The vendor's proceeds of disposition will include the amount of contingent liabilities assumed;

? The purchaser's cost of assets, likewise, includes the amount of liabilities assumed; and

? Any subsequent payments made by the purchaser in excess of the amount of the contingent liabilities initially assumed are treated in accordance with the nature of the contingent liability.

In a situation where the contingent liabilities are assumed as part of an ongoing business, e.g., unidentified future severance payments, and not as consideration for any of the assets (i.e., the amount of other consideration received by the vendor is not affected by the assumption), we believe the following results arise:

? The vendor is not considered to have made any payment in respect of the contingent liabilities;

? The vendor's proceeds of disposition do not include any amount in respect of the contingent liabilities assumed;

? The purchaser's cost of the assets does not include any amount in respect of the contingent liabilities; and

? Any subsequent payments made by the purchaser in respect of the contingent liabilities is treated in accordance with the nature of the contingent liabilities.

Our response to this question was that the issue was under consideration. We have, however, adopted the following general position on this issue.

When a business is sold and the purchaser assumes contingent liabilities as part of the consideration for the business, it is our view that the vendor's proceeds of disposition would include the fair market value of the contingent liability assumed by the purchaser. However, the cost of the asset to the purchaser would not include the contingent liability until the contingency has been met, pursuant to paragraph 18(1)(e) of the Income Tax Act (the "Act"). Our position on the application of paragraph 18(1)(e) to the cost of assets is consistent with existing jurisprudence as expressed in a line of cases including that of Lawrence H. Mandel v. the Queen (80 DTC 6148) heard by the Supreme Court. When the purchaser pays the contingent liability, the amount would be added to the cost of the assets acquired.

However, the tax consequences arising from the sale of a business where part of the consideration included the assumption of contingent liabilities can only be conclusively determined after reviewing all of the facts and documentation including the purchase and sale agreements, the fair market value of the business assets, and the relationship between the purchaser and vendor.

We trust that our comments will be of assistance.

John Oulton, CA
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
Policy and Legislation Branch
- 2 -