26 July 2010 Internal T.I. 2010-0370781I7 - POD - Purchase Price Adj for Debt

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.

Principal Issues: Whether a debt adjustment should be permitted as a reduction to POD in respect of a share sale.

Position: In this case, yes.

Reasons: The debt is corporate debt for which an undertaking had been provided to retire corporate debt within the purchase agreement. No benefit accrues to the shareholder vendors. Consistent with case law.

							July 26, 2010

	Kitchener/Waterloo TSO			HEADQUARTERS
	Estates and Trust Division		Income Tax Rulings
  							James Atkinson CGA
	Attention : Angela Olmstead		(519) 457-4832

  							2010-037078

Proceeds of Disposition - Purchase Price Adjustment

This is in response to your undated memorandum received June 8, 2010 concerning the meaning of "proceeds of disposition", as that term is defined in section 54 of the Income Tax Act (the "Act"). Your question arises in the context of a review of a capital gain reported by XXXXXXXXXX in its XXXXXXXXXX return, resulting from the disposition of its shareholdings in XXXXXXXXXX .

The Share Purchase Agreement ("SPA") governing the transaction provided for a negative adjustment (the "Debt Adjustment") in respect of corporate debt obligations reflected on XXXXXXXXXX 's balance sheet as at the closing date. The issue is whether the Debt Adjustment should be deducted in computing the POD of the shares, thereby reducing the capital gain realized by XXXXXXXXXX .

Included in your submission was a copy of the SPA dated XXXXXXXXXX , a copy of your proposal letter dated December 18, 2009, and, a copy of a letter from XXXXXXXXXX (the "Rep") in response to your proposal, dated XXXXXXXXXX . Based upon a review of your memorandum and the documents submitted, our understanding of the facts is as follows:

1. XXXXXXXXXX is an inter-vivos personal trust established by a Deed of Settlement dated XXXXXXXXXX .

2. The SPA, dated XXXXXXXXXX , was entered into by XXXXXXXXXX ("XXXXXXXXXX") as the purchaser and the XXXXXXXXXX shareholders as vendors. XXXXXXXXXX , who held XXXXXXXXXX Class C common shares of XXXXXXXXXX , was party to that agreement.

3. The purchase price for the XXXXXXXXXX shares was described in Section XXXXXXXXXX of the SPA as follows:

The aggregate purchase price for the Company Shares shall be XXXXXXXXXX less an amount equal to the Debt as reflected on the Estimated Closing Balance Sheet, as such amount may be adjusted pursuant to Section XXXXXXXXXX (the "Purchase Price").

[Emphasis added.]

4. According to a reconciliation attached to the Rep's letter, the aggregate purchase price ($XXXXXXXXXX) was reduced by $XXXXXXXXXX , reflecting the Debt Adjustment, in computing the POD attributable to the XXXXXXXXXX shares disposed of by the vendor shareholders.

You are not certain whether or not the reduction of POD in respect of the Debt Adjustment is correct. You observe, by way of example, that if an individual disposed of a residential property and received as consideration an amount to retire the underlying debt (i.e., directly or indirectly as a consequence of the purchasors' assumption of the mortgage), such an amount would be included in POD. Accordingly, in your view, it is not clear why the Debt Adjustment should be allowed as a reduction to the POD of the XXXXXXXXXX shares disposed of by the XXXXXXXXXX shareholders.

The Rep takes the position that the purchase price for the XXXXXXXXXX shares was based upon the corporate enterprise value (i.e., the value of the enterprise that does not have any debt) of XXXXXXXXXX , and, notes that it is customary in transactions comprising a business acquisition that the financing of the target corporation is replaced with internal financing from the purchaser or from other sources.

The Rep states that XXXXXXXXXX did not want to assume the existing debts of XXXXXXXXXX and therefore lent $XXXXXXXXXX (i.e., the Debt Adjustment) to XXXXXXXXXX to allow XXXXXXXXXX to pay its creditors. The Rep states that the amount did not result in the receipt of additional funds by the XXXXXXXXXX shareholders; the XXXXXXXXXX shareholders received only the net purchase price (i.e., the purchase price less the Debt Adjustment). Accordingly, the Debt Adjustment should be allowed as a deduction from the aggregate purchase price stated in Section XXXXXXXXXX of the SPA in arriving at the POD attributable to the XXXXXXXXXX shareholders.

Our comments

In our view, the Debt Adjustment should be permitted as a deduction in computing POD.

The expression "proceeds of disposition" is defined in section 54 of the Act. The "sale price" of property that has been sold is expressly stated in paragraph (a) of that definition.
The expression "sale price" is not defined in the Act. However, the term is defined in The Dictionary of Canadian Law, 3rd Edition, as follows:

Sale Price. 1. Actual value of thing exchanged. 2. Amount paid for a thing purchased. 3. The phrase "sale price" is not apt to describe an offered price. In this context, sale price means a price agreed upon between the seller and a buyer who was obtained with the assistance of the co-operating agent.

POD are normally determined with reference to the sale price reflected in the contract governing the sale. In most purchase and sale transactions, the consideration exchanged accurately reflects the sale price. However, where the consideration received upon the disposition of a property is inconsistent with the stated sale price, the POD must be determined based on an examination of all the facts and circumstances of the case.

Canadian courts have, on several occasions, considered the determination of POD where differences existed between the reported sales price and the value of consideration exchanged. In Belle-Isle v. MNR, [63 DTC 347] (TAB), aff'd. [66 DTC 5100] (SCC), the appellant sold a hotel to a corporation for consideration consisting of shares and a mortgage. The Minister reassessed the appellant on the basis that the actual value of the shares was substantially in excess of the value attributed to them when acquired as part of the consideration for the sale of the hotel. Dumoulin J. found that the POD of the hotel had to be increased to reflect the real value of the consideration received, as the reported selling price of the shares did not represent their market value.

In Fradet v. The Queen, [83 DTC 5445] (FCTD), aff'd. [86 DTC 6411] (FCA), the issue concerned whether or not an amount paid to retire certain debts of a corporation, whose shares were being sold, was deductible in computing POD of the shares to the vendor shareholders. The facts of the case are not dissimilar to the situation described in your memorandum. The parties had agreed that part of the selling price received from the buyer would be used by the vendors to retire the debt obligations. Walsh, J. took a "realistic" approach and agreed with the adjustment to the "sales price", thereby allowing the taxpayers' appeal.

In the example you cite, involving an individual disposing of a residential property and receiving as consideration an amount to retire the underlying debt (i.e., the outstanding mortgage), we agree that such an amount would be considered part of the POD attributable to the sale of the property. Compensation received directly or indirectly (i.e., constructively) under such circumstances accrues to the benefit of the vendor as the debt retired is a personal obligation of the vendor. The situation described in your memorandum is distinguishable as the debt in question is an obligation of the corporate entity XXXXXXXXXX , not the individual shareholders. Consequently, and in contrast to your example, there is no benefit accruing to the vendor shareholders as a result of the retirement of the corporate debt obligations.

We trust these comments are of assistance.

S. Parnanzone
Manager
For Director
Business and Partnerships Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch