2021-0920561E5 Cost Recovery Method in IT-426R

Principal Issues: Whether the cost recovery method of reporting a capital gain on the sale of shares subject to an earnout agreement could be used where the proceeds of disposition are paid by the buyer to the seller by way of the issuance of publicly traded shares or shares of a private corporation.

Position: Whether the conditions set out in paragraph 2 of archived IT-426R are met in a particular situation is a question of fact that requires an analysis of all relevant facts in a particular situation. The mere fact that a portion of the POD is made in the form of the issuance of shares of a particular corporation to the vendor will not preclude the application of the cost recovery method of reporting a capital gain on the sale of shares.

Reasons: See below.

Author: Neave, Troy
Section: 12(1)(g), 39(1)

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                                                                                                               Troy Neave

April 11, 2023

Dear XXXXXXXXXX:

Re: Cost Recovery Method in Interpretation Bulletin IT-426R

We are writing in response to your e-mail dated November 24, 2021 in which you requested our comments concerning the application of the cost recovery method as it is described in Interpretation Bulletin IT-426R (Archived) - Shares Sold Subject to an Earnout Agreement (“IT-426R”). We apologize for the delay in responding to your request.

You have asked us if the cost recovery method of reporting a capital gain on the sale of shares subject to an earnout agreement could be used where the proceeds of disposition are paid by the buyer to the seller by way of the issuance of publicly traded shares or shares of a private corporation.

Our Comments

This technical interpretation provides general comments about the provisions of the Income Tax Act (“the Act”). It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination. The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R12, Advance Income Tax Rulings and Technical Interpretations.

The Canada Revenue Agency has established an administrative policy that allows a taxpayer to use the cost recovery method to report a capital gain or capital loss on the sale of shares subject to an earnout agreement if all the conditions described in paragraph 2 of IT-426R are satisfied. This method effectively defers recognition of all or a portion of the capital gain or capital loss on the disposition of the shares until the point in time when the amounts that are in respect of the proceeds of disposition become determinable. The question of whether these conditions are met in a particular situation is a question of fact that requires an analysis of all relevant facts in a particular situation.

“Proceeds of disposition” (“POD”) is defined in section 54 of the Act for capital gains purposes and includes, among other things, “the sale price of property that has been sold”. The expression “sale price” is not defined in the Act but is generally accepted to mean the actual value of all consideration received by a seller from a buyer, including any combination of cash, property, and assumption of liabilities. The POD in any particular transaction must therefore be determined based on an examination of all the facts and circumstances of the case. The mere fact that a portion of the POD is received in the form of the issuance of shares of a particular corporation to the vendor will not preclude the application of the cost recovery method of reporting a capital gain on the sale of shares.

We trust our comments will be of assistance.

Yours truly,

Amanda Couvrette, CPA, CA

Manager

Business Income and Capital Transactions

Legislative Policy and Regulatory Affairs Branch

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