2 June 1992 Income Tax Severed Letter 9212105 - Sale of Goodwill

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.

SUBJECT: SALE OF GOODWILL SECTION: 85(1), 14(1), 14(3)]

921210
M.P. Sarazin
(613) 957-2118

Attention: XXX

June 2, 1992

Dear Sirs:

Re: Sale of Goodwill on Incorporation of a Business

This is in reply to your letter dated April 13, 1992, wherein you requested a technical interpretation regarding the application of subsections 14(1), 14(3) and 85(1) of the Income Tax Act (Canada) (the "Act") in the following situation.

On the transfer of a business to a corporation wholly-owned by an individual, on a tax deferred basis pursuant to the provisions of subsection 85(1) of the Act, the individual will elect to transfer the goodwill associated with the business (the "eligible capital property") at its fair market value. As consideration, the individual will receive preferred shares of the corporation having a stated capital and aggregate redemption amount of $10 and the balance of the consideration will be in the form of a promissory note having a principal amount equal to the difference between the fair market value of the eligible capital property and the redemption amount of the preferred shares. A price adjustment clause included with the agreement will provide that, in the event that Revenue Canada determines that the fair market value of the eligible capital property transferred to the corporation is greater than the amount determined by the individual, the principal amount of the promissory note will be increased up to a maximum of $100,000 and the redemption amount of the preferred shares will be increased by the amount, if any, in excess of $100,000.

You have requested our opinion on the amount to be included in computing the individual's income pursuant to subparagraph 14(1)(a)(iv), the amount that will be deemed to be a taxable capital gain of the individual pursuant to subparagraph 14(1)(a)(v), and the amount that would be an eligible capital expenditure of the corporation under paragraph 14(5)(a).

Comments

It appears that the interpretation you seek relates to a proposed transaction to be undertaken by a specific taxpayer and, therefore, we bring to your attention Information Circular 70-6R2 dated September 28, 1990 issued by Revenue Canada, Taxation. Confirmation with respect to proposed transactions involving specific taxpayers will only be provided in response to a request for an advance income tax ruling. If you wish to obtain an advance income tax ruling for a particular taxpayer with respect to specific transactions which are contemplated, a written request for an advance income tax ruling can be submitted in accordance with the Information Circular. Nevertheless, we can offer the following general comments.

In general terms, subparagraph 14(1)(a)(iv) recaptures any deductions claimed by the individual under paragraph 20(1)(b) of the Act, while the amount by which the excess determined under subsection 14(1) exceeds the amount determined under subparagraph 14(1)(a)(v) is deemed to be a taxable capital gain of the individual from a disposition of capital property for the purposes of the capital gains deduction under section 110.6 of the Act.

On the assumption that the individual will be claiming the capital gain deduction in respect of the full amount determined under subparagraph 14(1)(a)(v), then subsection 14(3) of the Act operates to reduce the eligible capital expenditure incurred by the corporation by the amount so determined.

In a situation where a taxpayer elects to transfer an eligible capital property to a corporation at its fair market value pursuant to the provisions of subsection 85(1) of the Act in exchange for shares and debt consideration having a principal amount and a fair market value equal to the amount by which the cost of such property to the corporation (i.e. its fair market value) exceeds the paid-up capital of the shares of the corporation issued as a result of the transfer, we are of the view that the provisions of subsection 85(2.1) of the Act would not apply to reduce the paid-up capital of the shares.

Whether or not subsection 245(2) of the Act would apply to a series of transactions can only be determined subsequent to a review of all of the facts. However, in a situation where a taxpayer transfers his or her business to a corporation pursuant to subsection 85(1) of the Act and wishes to crystallize a capital gain which is eligible for the capital gains deduction, we would not consider this series of transactions, in and by themselves, to result in a misuse of a provision of the Act or an abuse having regard to the Act read as a whole.

The Department's general views with respect to price adjustment clauses in agreements is set out in Interpretation Bulletin IT-169 dated August 6, 1974.

The foregoing comments represent our general views with respect to the subject matter of your letter. The facts of a particular situation may lead to different conclusions. The foregoing opinions are not rulings and, in accordance with the guidelines set out in Information Circular 70-6R2 dated September 28, 1990, are not binding on the Department.

Yours truly,

for Director
Reorganizations and Foreign Division
Rulings Directorate
Legislative and Intergovernmental
Affairs Branch