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:
1. Whether capital gain exemption available in subsequent where cost recovery method described in IT-426 is used?
2. Treatment where taxpayer chooses not to use the cost recovery method?
Position TAKEN:
1. Taxpayer would be entitled to capital gains exemption to the extent permited by subsection 110.6(2.1).
2. Amounts received and\or receivable plus the FMV of the earnout rights would be included in proceeds of disposition and a reserve allowed under subparagraph 40(1)(a)(iii). Each year's earnout rights would be considered a separate capital property.
Reasons FOR POSITION TAKEN:
Previous correspondance.
940343
XXXXXXXXXX W.P. Guglich
Attention: XXXXXXXXXX
August 4, 1994
Dear Sirs:
Re: Technical Interpretation of IT-426
This is in reply to your letter of January 26, 1994 wherein you requested our views regarding the reporting of gains on a sale in 1994 of "qualified small business corporation shares".
You described a situation where an individual has in 1994 disposed of shares that are qualified small business corporation shares. A portion of the proceeds that are to be received are determined pursuant to an earn-out clause in the agreement. The earn-out agreement meets the conditions for using the cost recovery method as set out in IT-426. Shares of a public corporation will be received pursuant to the earn-out agreement provided that the earn-out conditions are met.
In your letter you have outlined what appears to be an actual fact situation related either to a past transaction or to an actual proposed transaction. If the situation described relates to an actual transaction which has already been implemented, the review of such transactions falls within the responsibility of District Taxation Offices and it is the practice of this Department not to comment on such transactions when the identities of the taxpayers are not known. If, however, the situation described relates to an actual proposed transaction, it should be the subject of an advance income tax ruling. However, we can provide you with the following general comments which we hope will be of assistance.
A.Where the taxpayer uses the cost recovery method to report the gain the taxpayer would be entitled to the capital gains deduction on qualified small business corporation shares as the proceeds become determinable in later years to the extent permitted by subsection 110.6(2.1) of the Income Tax Act (the "Act").
B.Where the taxpayer chooses not to use the cost recovery method and has instead reported the estimated total proceeds and paragraph 12(1)(g) of the Act does not apply to the future years' earn-out payments the proper treatment in our view would be as follows:
The vendor for purposes of subparagraph 40(a)(i) of the Act would in the year of disposition include in his proceeds of disposition the amount actually received or receivable plus the fair market value (the "FMV") of the earn-out rights at the date of disposition. The right to receive earn-out payments in future years would be considered consideration received on the disposition of the shares. A reserve would be allowed under subparagraph 40(a)(iii) for all amounts not due to him until after the end of the year. Each year's earn-out rights would be considered a separate capital property having an adjusted cost base ("ACB") equal to its FMV at the date of disposition of the shares. At the end of each year, that year's earn-out rights would be considered to have been disposed of for proceeds of disposition equal to the amount received or receivable for that year. A capital gain or loss (separate and distinct from the capital gain or loss on the prior disposition of the shares) would result in each year unless the proceeds for that year were equal to the ACB of that year's earn-out rights.
Where paragraph 12(1)(g) of the Act applies the earn-out payments would be included in income and capital gains treatment would not be available.
As stated in paragraph 1 of IT-426 the use of estimated proceeds and\or the application of paragraph 12(1)(g) of the Act may in some cases produce results that are unsatisfactory. Consequently, where the conditions described in paragraph 1 of IT-426 are met the Department will accept the use of the cost recovery method of reporting the gain or loss on the sale of shares under an earn-out agreement.
Although, the gains respecting the disposition of the shares may qualify for the capital gains deduction on qualified small business corporation shares the gains respecting the disposition of the earn-out rights would not qualify.
Unless as otherwise stated all references to statute are to the Income Tax Act S.C. 1970-71-72, c.63 as amended consolidated to June 10, 1993.
We trust our comments will be of assistance to you.
Yours truly,
R. Albert
for Director
Business and General Division
Rulings Directorate
Legislative and Intergovernmental
Affairs Branch
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