Fiducie Claude Deragon – Tax Court of Canada finds that sales proceeds included contingent reverse earn-out amounts, but could be reduced by the operation a year later of a price adjustment clause

Vendors agreed to sell shares for a sale price of $16 million, of which $2 million was payable in subsequent years only if an EBITDA condition respecting the sold companies was satisfied. The sales agreements contained a simple price adjustment clause based on the final audited shareholders’ equity of the sold companies. When a substantial deficiency in shareholders’ equity subsequently emerged, a negotiated Settlement Agreement concluded more than a year after the sale reduced the gross sale price by $0.5 million (to $15.5 million), increased the portion of the sale price payable under the reverse earn-out to $3 million – and provided that the vendors would reimburse a further portion of the sale price out of amounts received by them under the earn-out.

Favreau J respected the retroactive downward adjustment, pursuant to the Settlement Agreement, of the proceeds of disposition by $0.5 million but, by the same token, considered that the reverse earnout amounts of $3 million could not be excluded from the proceeds of disposition notwithstanding their contingent nature. However, somewhat paradoxically, he did not permit a downward adjustment to the proceeds of disposition for the contingent obligation to refund the sale price to the purchasers.

He also noted that the taxpayer had relied on IT-462, para. 9 to avoid income treatment of the proceeds under s. 12(1)(g). Consistently with this reverse earnout policy, the vendors presumably could have recognized a capital loss in subsequent years when they refunded the sale price, although those years were not before him.

Neal Armstrong. Summary of Fiducie Claude Deragon v. The Queen, 2015 CCI 294, under s. 54 - "Proceeds of Disposition" - para. (a).