Overview
This technical interpretation addresses whether a capital gains reserve under ITA 40(1)(a)(iii) is available when the proceeds from a share sale consist of shares or trust units issued at closing but held in escrow, with scheduled releases over time.
CRA clarifies that even though the escrow arrangement restricts the vendor’s ability to dispose of the units, this does not mean that the proceeds are payable in future years. As long as the units are issued at closing, the full proceeds are considered received, and no reserve is available.
1. The Transaction Structure
(Relevant: ITA 40(1)(a)(iii))
CRA considered a typical share-for-share (or share-for-units) exchange involving escrow:
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The vendor sells shares of a corporation for
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cash, plus
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units issued by a mutual fund trust.
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Approximately 80% of the units are held in escrow for up to five years.
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The escrow arrangement exists to secure:
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indemnity obligations,
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post-closing adjustments,
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vendor liabilities.
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The vendor is still the registered holder of all escrowed units and retains:
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the right to income distributions,
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the right to vote the units.
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Despite being restricted from dealing with the units, the vendor owns them.
2. When Are Proceeds “Payable”?
(Relevant: definition of “payable”; contract law principles)
For a capital gains reserve to apply under 40(1)(a)(iii):
A portion of the proceeds must be payable after the end of the year.
CRA emphasizes:
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“Payable” requires a genuine future obligation to pay.
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If the purchaser has already delivered the full consideration (cash + units), then:
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the purchaser has discharged their obligation,
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no portion remains “payable,”
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and no reserve can be claimed.
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For tax purposes:
Units issued to the vendor at closing count as received
—even if held in escrow, restricted, or subject to release schedules.
3. Escrow Restrictions Do Not Delay Payment
(Relevant: beneficial ownership principles)
CRA explains that escrow does not postpone receipt of proceeds because:
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The units belong to the vendor.
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Restrictions are imposed only to protect the purchaser’s indemnity rights.
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The vendor participates fully in income distributions.
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Voting rights remain with the vendor.
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The escrow agent’s limited ability to deal with the units does not change ownership.
Thus:
The escrowed units do not create a deferred payment arrangement.
4. Why a Reserve Cannot Be Claimed
(Relevant: 40(1)(a)(iii))
The reserve is only available when:
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amounts remain payable in future years, or
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a promissory note has been issued and not yet honoured (unless accepted as absolute payment).
CRA’s conclusion:
✘ No reserve
Because once the units are issued, there is no unpaid portion of the purchase price.
✔ Escrow ≠ unpaid proceeds
Escrow restrictions do not mean the vendor lacks beneficial ownership and do not convert proceeds into future payments.
Comparison to promissory notes
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A promissory note may or may not be considered “payment,” depending on whether it is conditional or absolute.
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Escrowed units are treated like absolute payment — the purchaser has fulfilled the entire purchase obligation.
5. Key CRA Interpretation Principles
- Legal relationships created by the parties’ contracts are respected unless they are a sham.
- Tax consequences follow the actual legal effect of the transaction.
- Once issued, units (or shares) constitute full satisfaction of the purchase price.
- Escrow arrangements used for indemnity security do not defer taxation.
Key Takeaways
- Issuing shares or trust units at closing counts as immediate payment, even if held in escrow.
- Escrow restrictions are not sufficient to create deferred proceeds.
- The vendor retains rights of ownership (income, voting), indicating the proceeds have been fully received.
- The sale is fully taxable in the year of closing.
Disclaimer
This summary is based on a redacted CRA technical interpretation. While believed to be accurate at the time of original publication, CRA positions may change and may not represent current administrative policy. This content is provided for general information only and should not be relied upon as tax, legal, or financial advice.
Redaction Notice
All names, phone numbers, office locations, signatures, and confidential identifiers from the original CRA documents have been removed to protect privacy and comply with publishing guidelines.
