5 June 1990 Ministerial Letter 74678 F - Sale of Business - Amount Paid-Future Obligation

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.

SUBJECT: Sale of Business-Amount Paid-Future Obligations

We are replying to your memorandum of January 26, 1990 concerning a situation where revenue is received in advance of the performance of services by a business and the business is subsequently sold.

24(1) 

In relation to the above situation, you suggest that there is confusion concerning the effect of subsection 20(24).  In this regard, subsection 20(24) would, if a joint election had been made, allow the vendor to deduct the payment to the purchaser in respect of       24(1)  made and would require the purchaser to include the payment in income under paragraph 12(1)(a).  On the other hand, you suggest that the same result should occur if subsection 20(24) did not exist.  However, since paragraph 20(24)(b) would deem the payment to be income to the purchaser under paragraph 12(1)(a) if an election had been made, it would appear that this result may not occur where no election under subsection 20(24) has been made.

In view of the foregoing, our opinion has been requested on the situation provided to us as well as on the intent of subsection 20(24).

Our Comments

Before commenting on your scenario, we note that, in our view, there is nothing in the wording of paragraph 20(24)(b) which would deem a payment to a purchaser to be on account of capital in the event that the joint election under subsection 20(24) is not filed.  In any case where a joint election is not made, it is a question of fact whether the transaction is on account of capital or of income.

With respect to the above scenario, it is our view that the nature of the payment in the hands of the purchaser involves a finding of fact.  However, the fact that the payment is received in conjunction with the acquisition of the business as a going concern is an indication that the payment is likely on account of capital. On the basis that this is the case, it would not be brought into income under paragraph 12(1)(a).  Consistent with these comments, it is also our view that the purchaser would not be allowed to deduct any costs incurred in connection with the capital obligation.

Insofar as the vendor is concerned, it is also our view that the nature of the payment made also involves a finding of fact. However, as with the purchaser, the fact that it was made in conjunction with the sale of the business indicates that it would probably be on account of capital.  Assuming the payment is of a capital nature, it would follow that the vendor could not deduct it without making an election under subsection 20(24).

We note that, in an appropriate case, the sale of a business as a going concern may be on account of income to the vendor, the purchaser, or both.  An example would be where one of the parties is in the business of buying and selling the particular kind of business.

The sale of a business as a going concern can be contrasted with the more common situation where the making of a payment and the receipt thereof would be on account of income.  For example, a taxpayer (A) receives amounts in advance from customers and in an ongoing relationship engages another person (B) to provide;services to them.  A periodically pays 8 in advance and no subsection 20(24) election is made.  A remains primarily liable to its customers for services.  In this type of situation, it is our view that A must include the amounts received from its customers in income pursuant to paragraph 12(1)(a) while the actual payments to 8 would be in the nature of deductible expenses that are subject to the provisions of subsection 18(9). It is also our view that 8 would be required to include amounts received from A in its income under paragraph 12(1)(a).

With respect to the intent of subsection 20(24), it appears that its main purpose is to provide certainty of income treatment in cases where the transaction may be viewed as being on account of capital.  This would then permit the vendor and the purchaser to negotiate an appropriate price taking into account tax consequences the certainty of which is known to each party.

We agree with you that the results of a valid subsection 20(24) election merely reflect economic reality.  The election permits the appropriate tax consequences to flow from that reality regardless of the characterization of the transaction as being on account of income or of capital.

for DirectorBusiness and General DivisionSpecialty Rulings DirectorateLegislative and Intergovernmental Affairs Branch