2 June 1989 Income Tax Severed Letter 5-7633 - Source of income for purposes of subsection 126(1) of the Income Tax Act

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.

Dear Sirs:

This is in reply to your letter of March 3, 1989 wherein you requested our opinion as to whether the consideration to be received by your client with respect to a non-competition agreement would be considered foreign source income for purposes of subsection 126(1) of the Act in the following situation:

• 1. Your client is considering whether to sell the shares of a U.S. subsidiary corporation to an arm's length purchaser. The sale will take place in the U.S..
• 2. The purchaser has requested that your client enter into an agreement not to compete with the subsidiary or other persons related to the purchaser in any business similar to that of the subsidiary carried on in the U.S. for a fixed number of years. Your client will receive consideration for entering into such agreement.
• 3. Your client will realize a capital gain on the disposition of the shares of the U.S. subsidiary. Such capital gain will be subject to tax under the U.S. Internal Revenue Code.

As the sale of the shares of the subsidiary will take place in the U.S., it is your opinion that the capital gain to be realized therefrom will be U.S. source income for purposes of subsection 126(1) of the Act. You requested our opinion as to whether the consideration received with respect to the non-competition agreement would also be considered U.S. source income for purposes of that subsection.

The situation outlined in your letter involves actual contemplated transactions which should be the subject of an advance income tax ruling, as assurance concerning the tax consequences of contemplated transactions can only be given in the context of an advance income tax ruling. The procedures for requesting an advance income tax ruling are outlined in Information Circular 70-6R, dated December 18, 1978, and the related Special Release thereto. However, we are offering the following general comments.

We agree with your interpretation of section 42 of the Act with respect to the tax treatment of the consideration to be received with respect to the non-competition agreement. As described in paragraph 6 of Interpretation Bulletin IT-330, the consideration would be required to be included in computing your client's proceeds of disposition of the shares of the U.S. subsidiary. However, whether the disposition of the shares of the U.S. subsidiary would give rise to a foreign source capital gain is a question of fact. Since the shares of the U.S. subsidiary will not be sold through a securities or stock exchange, other factors, such as the place where negotiations and execution of the agreement took place, location of the shares, place of payment and any relevant provisions in the governing corporation statutes, would have to be considered in order to establish the place where the sale occurs. As we do not have all the facts of your particular situation, we are unable to offer any opinion as to whether the sale of the shares of the U.S. subsidiary will give rise to a U.S. source capital gain.

It is, however, our view that, provided

• 1) the capital gain on the sale of the shares of the U.S. subsidiary is from a U.S. source,
• 2) the non-competition agreement will be executed in the U.S., and
• 3) the application of the non-competition agreement is restricted to U.S. territories,

the consideration to be received with respect to the non-competition agreement would likely be considered to be from a U.S. source for purposes of subsection 126(1) of the Act.

The foregoing comments are not rulings and in accordance with the guidelines explained in Information Circular 70-6R, are not binding on the Department.