9 October 1986 Income Tax Severed Letter RCT 5-1595

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 May 14, 1986 wherein you inquire about the application of subsection 97(2) of the Income Tax Act (the "Act") to a transfer of goodwill in the following set of circumstances:

• 1. A parent corporation transferred all of the assets of a division of its business including the goodwill attached thereto to a wholly own subsidiary ("Subco").
• 2. The assets and goodwill of the division were transferred by the parent to Subco pursuant to an election under subsection 85(1) of the Act. The amount agreed upon for the goodwill was $1.00.
• 3. The goodwill has a fair market value of $100,000.00.
• 4. Subco is a partner in a partnership, the other partner being an arm's-length third party corporation. Subco is the majority partner of the partnership.
• 5. Subco will transfer the division assets into the partnership pursuant to an election under subsection 97(2) of the Act. In particular, the goodwill will be transferred at an elected value of $1.00.
• 6. For the purposes of the subsection 97(2) election, Subco and the partnership will specify a fair market value for the goodwill of $1.00.

In the above circumstances, you have asked us to confirm the following:

• a) that section 69 of the Act has no application to the transfer of the goodwill from Subco into the partnership because the opening words of subsection 97(2) of the Act expressly state: "Notwithstanding any other provision of this Act";
• b) that as long as Subco and the third party corporation are indeed at arm's length, it would not be reasonable to regard the amount by which the $100,000 fair market value of the goodwill exceeds the $1.00 agreed-upon amount for the goodwill as a gift pursuant to paragraph 85(1)(e.2) of the Act; and
• c) that as long as Subco and the third party corporation are in fact at arm's length, dealing with one another in the ordinary course of business, section 68 of the Act would not be applied to reallocate the purchase price.

In view of the fact that the rules in paragraphs 85(1)(a) to (f) of the Act are applicable, with changes to the various references in those paragraphs as indicated in subparagraphs 97(2)(a)(i) to (v), we confirm that sections 68 and 69 will not apply in the above circumstances.

The facts that you have submitted are insufficient for us to give a conclusive opinion as to whether or not paragraph 85(1)(e.2) of the Act would apply. However, we make the following comments with respect to this question:

• 1) With regard to the rollover from the parent corporation to Subco under subsection 85(1) of the Act, we assume that there was no non-share consideration received by the parent for the goodwill, (or at least that any such non-share consideration for the goodwill had a fair market value of no more than $1.00). Otherwise, notwithstanding that the parent and Subco had agreed upon an amount of $1.00 for the goodwill under paragraph 85(1)(a), such agreed upon amount would be deemed by paragraph 85(1)(b) to be an amount higher than $1.00.
• 2) For the same reason, with regard to the rollover from Subco to the partnership under subsection 97(2) of the Act, we assume that there was no consideration for the goodwill received by Subco which was "other than an interest in the partnership" (see paragraph 85(1)(b) as altered by subparagraph 97(2)(a)(ii)).
• 3) We are uncertain as to the meaning of fact 6 above, unless it is a repetition of fact 5. That is, while Subco and the other corporate partner of the partnership can agree under the election upon an amount with respect to the goodwill for purposes of determining the deemed proceeds therefor to Subco and deemed cost thereof to the partnership, the provisions of subsection 85(1) as altered by subsection 97(2) of the Act do not permit the parties to "agree" upon what the fair market value of the goodwill is.
• 4) As you point out, the $100,000 fair market value of the goodwill exceeds the $1.00 agreed upon amount for the goodwill (that is, the amount in subparagraph 85(1)(e.2)(ii)) by $100,000. However, paragraph 85(1)(e.2) will not apply if the $100,000 fair market value of the goodwill does not exceed the consideration received therefor (that is, the amount in subparagraph 85(1)(e.2)(i)). As indicated in our comment in 2) above, we assume that the only consideration received by Subco for the goodwill was in the form of an interest in the partnership. Therefore, if Subco received an interest in the partnership worth at least $100,000. paragraph 85(1)(e.2) could not apply. If such partnership interest received by Subco were worth less than $100,000, paragraph 85(1)(e.2) could apply. That is, if Subco and the other corporate partner in the partnership are in fact dealing at arm's length, it would in our opinion be reasonable to assume that in return for disposing of the $100,000 goodwill to the partnership, Subco should receive an interest in the partnership worth $100,000. If not, it would be reasonable to assume that the excess of the former over the latter was a gift (that is, that the parties were not really dealing at arm's length).

We trust that you will find the above comments helpful.