Can a cross-border earn-out create tax problems for the seller?

An earn-out pays part of the price later, depending on how the business performs. When the buyer, the seller or the business is in another country, one payment can reach two tax systems at different times. The clause itself is rarely the risk. The risk is the mismatch between when, and in what currency, each system counts the money. For the domestic rules, see how an earn-out is taxed.

When Canada counts the gain

For a Canadian-resident seller, the gain is worked out on the disposition. The Act allows a reasonable reserve only for proceeds payable after the end of the year, and the CRA describes a reserve in terms of proceeds not yet received. Whether a contingent amount qualifies is a point to settle with your accountant before filing, because a reserve, where available, can be claimed over only a limited number of years.

Currency and foreign tax

Foreign currency has to be converted. The CRA’s section 116 procedures show the approach in that setting: when a foreign currency is involved, the adjusted cost base is converted into Canadian dollars at its historical rate and the proceeds at the exchange rate in effect at the date of disposition. If another country taxes the payment, section 126 of the Act lets a Canadian resident deduct foreign non-business income tax from Canadian tax, but only up to a limit, so the year each country taxes the payment matters.

If the seller is not a resident of Canada

A non-resident who sells taxable Canadian property, which includes property used in a business carried on in Canada, must deal with section 116, except for excluded property as that section defines it. Unless the buyer made reasonable inquiry and had no reason to believe the seller was a non-resident, has the CRA’s section 116 certificate for the property (under subsection 116(4), or 116(5.2) for property such as depreciable property), or qualifies under the treaty-protected property rule, the buyer is liable to remit a percentage of the amount by which its cost exceeds the amount fixed by the certificate, if any, and may deduct that tax from what it pays the seller. A price that ends up higher through an earn-out raises that cost, so it needs planning. See buying from a non-resident seller.

Points to settle in the agreement

• How earn-out payments are described, and how that matches each party’s tax filings.
• The currency of payment and the exchange rate used.
• Who deals with the CRA if the total price changes after closing.