CRA accepts capital gains and then capital loss treatment of an asset sale made on a reverse earnout basis, where the targets were not achieved

On the closing date for the sale by Opco of the assets, being capital property with an ACB of $150,000, of one of its two businesses to an arm's length purchaser, it was agreed that the purchaser: would pay $3,500,000 on the closing date, plus an adjustment a few months later (based on the finalized financial statements), which turned out to be $150,000; and would pay two further deferred amounts 12 and 18 months after the closing date of $300,000 and $200,000 if, in each case, the purchased business achieved targeted customer retention rates.

The two deferred payments were not made on the agreed dates because of disagreements about the method for their computation. 21 months after the closing date, the parties agreed that a deferred payment of $50,000, rather than $200,000 + $300,000, would be paid.

CRA indicated that, based on IT-462, para. 9, s. 12(1)(g) would not apply to the maximum amount provided for in the contract (here, of $4,150,000), provided that it was equal to the FMV of the sold business’s assets on the closing date.

Accordingly, Opco realized a capital gain of $4,000,000 in its taxation year of the closing and therefore had appropriately paid a capital dividend of $2,000,000 shortly after the date of the payment of the $150,000 adjustment. Furthermore, when it was agreed that the deferred payments would be reduced to $50,000, at that point, Opco incurred a capital loss of $450,000. This reduced Opco's CDA by $225,000 at that time, but did not affect the validity of the $2,000,000 capital dividend previously paid (even if that capital loss was carried back).

No capital gains reserve could be claimed in the taxation year of the closing since the $4,150,000 sales proceeds were not “determinable” (i.e., were subject to a contingent reduction).

Neal Armstrong. Summaries of 2 April 2025 External T.I. 2019-0818321E5 F under s. 12(1)(g) and s. 40(1)(a)(iii).