The vendor of a minority (capital property) shareholding (under 5%) of a U.S. company (TargetCo) is a limited partnership (“Partnership”) with its central management and control in Canada (so that it is a “Canadian resident partnership” as defined in s. 248(1)) with both resident and non-resident partners sells such shares to an arm’s-length purchaser (BuyerCo) for proceeds received on closing exceeding the shares’ adjusted cost base – and, in addition, may receive additional payments in future years pursuant to an earnout (which is not a reverse earnout).
Having regard to whether the cost recovery method described in IT-426R, para. 2 is available:
1. Does a “Canadian resident partnership” satisfy subpara. 2(f)?
2. Does the passive involvement of Partnership in the negotiation of the sale satisfy the subpara. 2(c) condition that the vendor and the purchaser cannot agree on the value of the underlying goodwill?
3. Does the T5013 information return prepared by Partnership meet the subpara. 2(e) condition?
4. If Partnership instead is ineligible under para. 2, can the eligible partners access that rule?
The conditions for the application of the cost recovery method described in paragraph 2 of Interpretation Bulletin IT-426R (Archived) were not designed to apply to limited partnerships in situations such as described above.
CRA indicated:
The definition of “Canadian resident partnership” … is not relevant for the application of [subpara. 2(f)] … . Moreover, a limited partnership is not a person resident in Canada for the purposes of the Act (although it is deemed to be a separate person resident in Canada for limited purposes in subsection 96(1)).
The CRA will in general consider that [subpara. 2(c)] … is satisfied even if a particular vendor is not directly involved in the negotiations for the sale of shares, when [the other conditions are satisfied]. …
… T5013 forms … do … not constitute a return of income for the purpose of [subpara. 2(e)] … .
[T]he conditions for the application of the cost recovery method described in paragraph 2 … were not designed to apply to limited partnerships. Therefore, neither a partnership nor the partners of a partnership in situations such as described above may use the cost recovery method … .