In a business acquisition transaction, it is not uncommon to find an assumption by the purchaser of the obligations of the vendor to deliver goods or perform services in the future for which the vendor has already received payment. In such a scenario, there are two possible outcomes from a tax perspective, as set out below:
No election made under subsection 20(24) of the Income Tax Act
Typically the purchaser would treat the assumed obligation as part of the consideration for the purchase of the business. Where no election is made, the purchaser would not be able to deduct expenses required to fulfill the obligations since the expenses would relate to the acquisition of a capital asset. The vendor would include in its income the payment it receives from its customers but no deduction would be allowed to the vendor since no expenses would have been incurred to fulfill the obligations.
Election made under subsection 20(24) of the Income Tax Act
In contrast, if consideration has been received by the purchaser for the assumption of obligations, an election under subsection 20(24) may be available. The tax burden associated with prepaid income amounts then shifts from the vendor to the purchaser.
In effect, the election allows the vendor to deduct the amount of consideration in respect of the assumed obligations from its income. Meanwhile, the purchaser must recognize that amount in its income but is allowed to deduct any expenses related to the performance of the vendor’s obligations.
When should the election be made?
The execution of an election pursuant to subsection 20(24) is often in the interests of the vendor. Whether making the election is in the purchaser’s interest is dependent upon the amount of the income inclusion, the period over which the deductions may be made and the amounts of those deductions.
Since the election can only be made if both parties agree, it is imperative that both sides determine whether the election is right for them and be prepared to negotiate should the other side disagree.
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