16 December 2004 External T.I. 2004-0098121E5 - Goodwill sold subject to an earnout agreement

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.

Principal Issues: Goodwill of a business is sold subject to an earnout agreement because the value of the goodwill cannot reasonably be determined at the time of sale. Whether this contingent consideration should be treated as proceeds of disposition pursuant to item E of the definition of "cumulative eligible capital" in subsection 14(5) or whether the cost recovery method can apply to the sale of goodwill, as it may to the sale of shares.

Position: Where the consideration received for eligible capital property is dependent upon the use or production from that property and no amount can be quantified at the time of sale, such consideration is not an eligible capital amount but is taxable as income under paragraph 12(1)(g). The cost recovery method applies only to the sale of shares and not to the sale of goodwill.

Reasons: See the Tax Court of Canada's decision in 289018 Ontario Limited (87 DTC 38, (1987) 1 C.T.C. 2095).

XXXXXXXXXX 2004-009812
Kathryn McCarthy, CA
December 16, 2004

Dear XXXXXXXXXX,

Re: Goodwill sold subject to an earnout agreement

We are writing in response to your e-mail of October 12, 2004, concerning the above noted subject.

You described a sale of the goodwill of a business subject to an earnout agreement because the value of the goodwill could not reasonably be determined at the time of sale. You enquired whether this contingent consideration should be treated as proceeds of disposition pursuant to item E of the definition of "cumulative eligible capital" in subsection 14(5) of the Income Tax Act (the Act). Alternatively, you enquired whether the cost recovery method can apply to the sale of goodwill, as it may to the sale of shares.

Our Comments

Written confirmation of the tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and are the subject matter of an advance ruling request submitted in the manner set out in Information Circular 70-6R5, Advance Income Tax Rulings, dated May 17, 2002. Where the particular transactions are completed, the inquiry should be addressed to the relevant Tax Services Office. We are, however, prepared to provide the following general comments.

Eligible capital amounts may include the sale of goodwill in connection with a business. For example, where the agreement for sale provides that the taxpayer has or may become entitled to receive a fixed sum, that sum is treated as proceeds of disposition pursuant to item E of the definition of "cumulative eligible capital" in subsection 14(5) of the Act. Where a taxpayer has ceased to carry on a business and no longer owns any property of any value that was eligible capital property of the business, the taxpayer may deduct any positive balance of cumulative eligible capital pursuant to paragraph 24(1)(a). This final balance in the pool is referred to as a "terminal allowance" and allows the taxpayer a deduction where there is a subsequent downward adjustment in the proceeds of disposition related to the sale of goodwill.

In a situation where the consideration received for eligible capital property is dependent upon the use or production from that property and no amount can be quantified at the time of sale, such consideration is not an eligible capital amount but is taxable as income under paragraph 12(1)(g). See the Tax Court of Canada's decision in 289018 Ontario Limited (87 DTC 38, (1987) 1 C.T.C. 2095) and Interpretation Bulletin IT-462, Payments Based on Production or Use, for more information. This IT is available on our website at http://www.cra-arc.gc.ca/E/pub/tp/it462/README.html.

The cost recovery method, as described in IT-426R, Shares Sold Subject to an Earnout Agreement, applies only to the sale of shares and not to the sale of goodwill.

We trust our comments will be of assistance to you.

Yours truly,

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