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Sale of insurance brokerage client list – Tax consequences

Have you or your clients ever sold an intangible property like a client list?  A recent Tax Court of Canada case, George Smith v. Her Majesty the Queen, highlights the tax implications that can arise on the sale of such a property.

In this case, the property was an insurance brokerage client list. Overly simplified, the facts were as follows:

1. Mr. Smith practiced as a licensed insurance broker in Quebec for a number of years.

2. Mr. Smith and another insurance brokerage company (“BFL”) entered into an agreement of referral in November, 1995 whereby BFL provided Mr. Smith with the use of BFL’s office facilities and services in consideration of splitting the commission/fee income earned and paid on any premiums paid the insurer’s policyholder during the term of the agreement.

3. The agreement of referral also provided BFL with the option to purchase Mr. Smith’s client list.

4. Mr. Smith and BFL entered into a sale agreement effective January 1, 2002 whereby Mr. Smith agreed to sell his client list to BFL.

5. On January 1, 2002 Mr. Smith’s client list generated annual base commission revenue of $156,000. Accordingly, BFL and Mr. Smith agreed on a purchase price of 2.25 times the annual commissions which equated to a purchase price of $351,000.

6. Subject to certain adjustments, the purchase price was payable as follows:

a. January 1, 2002 – $142,000 (40.7%)
b. January 1, 2003 – $69,500 (19.77%)
c. January 1, 2004 – $69,500 (19.77%)
d. January 1, 2005 – $69,500 (19.76%)

7. It was understood that the purchase price was based on represented annual revenue of $156,000 and that the subsequent payments in 2003, 2004 and 2005 would be calculated by applying the percentage of the scheduled payments (as referred to above), to the actual year’s revenue from the appellant’s clientele received in the subject year multiplied by the acquisition factor of 2.25.

8. The balance of payment due to be paid was also subject to an agreed to interest rate payment.

9. Given the above, the actual payments received were as follows:


Actual Year’s Revenue

2.25 Factor




April 18, 2002






Previous Year’s Revenue

2.25 Factor


Subsequent Down Payment

Interest Income

January 15, 2003






February 26, 2004






January 10, 2005







10. Mr. Smith appears to have included the received amounts in his income yearly pursuant to subsection 14(1) of the Income Tax Act (the “Act”), including the interest amounts received as will be further explained below.

Dispositions of property are usually subject to the “capital gains” rules under subdivision (c) of Part I of Division B of the Act. The result of applying the capital gains rules is that any profit from the disposition of a property is treated as a capital gain with only 50% of such amount being included in taxable income. A further advantage to the capital gains rules is that if all of the proceeds have not yet been received in the year of disposition, then deferral opportunities may exist to tax a portion of the resulting capital gains at the earlier of when the proceeds are received or over a five year period from the disposition date.

However, the capital gains rules do not apply to certain types of property. One of these exceptions is for “eligible capital property”. Eligible capital property receipts, which will generally include client list disposition receipts, are taxed under subsection 14(1) of the Act which falls in subdivision (b) of Part I of Division B of the Act. The good news about being taxed under subsection 14(1) is that any net receipts are also subject to a taxable inclusion rate of 50% (like capital gains). However, a negative aspect of being taxed under this provision is that no tax deferral opportunities are possible (unlike those that might exist for capital gains as described above) for proceeds that are not yet due.

Accordingly, given the 50% taxable treatment laid out in subsection 14(1), Mr. Smith took the position that the subsequent payments he received in 2003 – 2005 were taxed pursuant to such beneficial treatment.

The Canada Revenue Agency (“CRA”) disputed Mr. Smith’s treatment of the received amounts subsequent to the date of disposition of his client list as being subject to subsection 14(1) of the Act. Instead, the CRA reassessed Mr. Smith to include the received amounts (exclusive of the interest payments) in 2003, 2004 and 2005 to be captured under paragraph 12(1)(g) of the Act which includes the following amounts in a taxpayer’s income:

12(1)(g) payments based on production or use — any amount received by the taxpayer in the year that was dependent on the use of or production from property whether or not that amount was an instalment of the sale price of the property, except that an instalment of the sale price of agricultural land is not included by virtue of this paragraph;

As you can see, paragraph 12(1)(g) is a very broad provision. The downside to being taxed under paragraph 12(1)(g) is that such amounts are fully taxable as opposed to being only 50% taxable to the extent that such amounts were caught under subsection 14(1).

In addition, the interest amounts received by Mr. Smith were reassessed by the CRA to be fully taxed under paragraph 12(1)(c) of the Act as interest income as opposed to being only 50% taxed under subsection 14(1).

Ultimately, the Tax Court of Canada found in favour of the CRA whereby such amounts received by Mr. Smith in 2003, 2004 and 2005 were taxed either as interest income (as appropriate) and amounts taxable under paragraph 12(1)(g) since the “Purchase Price” and the adjustments to the Purchase Price were all computed and determined by the annual commissions received from the appellant’s client list and nothing else. Accordingly, Mr. Smith had an additional 50% income inclusion that he appears to not otherwise have included in his income for his 2003 – 2005 taxation years.

This case is an important lesson for taxpayers to ensure that dispositions of property and the resulting tax consequences are carefully thought through. Given the broad language of paragraph 12(1)(g), taxpayers and their advisors need to be careful of this trap.