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This translation was prepared by Tax Interpretations Inc. The CRA did not issue this document in the language in which it now appears, and is not responsible for any errors in its translation that might impact a reader’s understanding of it or the position(s) taken therein. See also the general Disclaimer below.
Principal Issue: [TaxInterpretations translation]
Where an election was made in 1994 pursuant to subsection 110.6(19) of the Act in respect of a depreciable property for a value in excess of 11/10 of its fair market value, could the reduction in the cost of that property pursuant to clause 110.6(19)(a)(ii)(C) result in recapture of depreciation to be included in the individual's income at the time of its disposition to a third party, rather than a larger capital gain?
Position:
Yes, in this case.
Reasons:
Paragraph 13(7)(e.1) of the Act applies where a taxpayer is deemed to have disposed of and reacquired depreciable property pursuant to subsection 110.6(19) and paragraph 13(7)(e) applies. In this case, the reduction in the cost of the property, calculated on the reacquisition, resulted in the transferor's cost of the property being higher before its disposition. Consequently, the reference to paragraph 13(7)(e.1) resulted in the application of subparagraph 13(7)(e)(iii) instead of subparagraph 13(7)(e)(i). The application of subparagraph 13(7)(e)(iii) resulted in a recapture on the eventual disposition of the property.
May 13, 2003
XXXXXXXXXX Tax Services Office Headquarters
Audit Division N. Deslandes, CGA
(613) 957-8961
Attention: XXXXXXXXXX
2003-000178
Request for technical interpretation: Effect of election under subsection 110.6(19) of the Income Tax Act.
This is in response to your fax of January 27, 2003, in which you requested our opinion on the above subject.
THE FACTS:
In 1990, Ms. X purchased a rental property from her father for $205,000. The value attributed to the land was $15,000 while the value attributed to the building was $190,000.
The capital cost allowance claimed for the years 1991 to 1993 was $20,369.
Ms. X made an election pursuant to subsection 110.6(19) of the Income Tax Act (the "Act") on February 22, 1994 for $210,000 regarding the building. Ms. X therefore declared a capital gain of $20,000 following that transaction.
Between 1994 and 1997, the capital cost allowance claimed was $14,949.
In 1998, Ms. X disposed of the property for $73,452, of which $15,000 was allocated to the land and $58,452 was allocated to the building.
During a subsequent audit, an appraisal of the property was made by the Quebec Tax Services Office establishing the fair market value of the building at $120,000 for the years 1990 and 1994.
Since Ms. X acquired the building from a person with whom she did not deal at arm's length, you are preparing to revise the acquisition cost of the building to $120,000 pursuant to paragraph 69(1)(a) and to make the necessary adjustments to the election made by Ms. X pursuant to subsection 110.6(19) in 1994 to take into account this new valuation.
You also indicated that the building is a non-qualifying real property. Consequently, the rules set out in subsection 110.6(21) are applicable.
The revision, affecting both the cost and the undepreciated capital cost (the "UCC") of the building, leads you to conclude that Ms. X must include an amount as recapture of depreciation in computing her income rather than a capital gain following her disposition of the building in 1998.
YOUR QUESTIONS:
You asked us whether we agree with your revision of the election made by Ms. X in 1994 pursuant to subsection 110.6(19) and the resulting tax consequences (recapture) of the disposition of the building in 1998. In addition, if we agree with your conclusions, you wish to know whether, in our opinion, the result obtained (recapture versus capital gain) is consistent with the legislature's intention.
In a telephone conversation (XXXXXXXXXX/Deslandes), we confirmed some of the calculations you made following the review of the election made by Mrs. X in 1994. In particular, following the application of clause 110.6(19)(a)(ii)(C), we agreed that the cost of the new acquisition of the building on which the election was made was $42,000. Since there is no ambiguity in this part, we will not repeat those calculations. However, this will be our starting point for applying subsection 110.6(21) since the building is a non-qualifying real property. Under the terms of that subsection, a portion of the non-qualifying capital gain is deferred until the property is actually disposed of. Paragraph (a) of that subsection computes the reduction in the gain as follows: the elector's capital gain ($90,000) minus the elector's eligible real property gain ($54,000) multiplied by 3/4. The result of this calculation is $27,000. You will note that for the purposes of the above formula, the wording of paragraph 110.6(21)(a) refers to the term "the elector’s capital gain". We are of the view that this expression does not refer to the capital gain declared by the elector but rather to the elector’s actual capital gain considering the adjustments you have made, i.e., the indicated amount of $210,000 less the cost of the property after taking into account the application of paragraph 69(1)(a), i.e., $120,000.
In addition, since this is a deferral, paragraph 110.6(21)(b) reduces the capital cost of the building by the amount calculated in paragraph (a), i.e., $27,000 multiplied by 4/3, or $36,000. As a result, the cost of the building, which was $42,000 as a result of the application of clause 110.6(19)(a)(ii)(C), is reduced to $6,000 as a result of the application of subsection 110.6(21).
The election under subsection 110.6(19) in respect of a depreciable property also affects its UCC in the following ways. First, the deemed disposition in paragraph 110.6(19)(a) results in the UCC being reduced by $120,000, which is the lesser of the capital cost and the proceeds of disposition. In addition, where an election is made pursuant to subsection 110.6(19) in respect of a depreciable property, paragraph 13(7)(e.1) indicates that the elector is deemed not to be dealing at arm's length with himself or herself, thereby triggering the application of paragraph 13(7)(e) of the Act. Since the cost of the property to the individual as a result of this election ($6,000) is less than the capital cost of the property ($120,000) to the individual immediately before the individual disposed of the property, subparagraph 13(7)(e)(iii) applies and deems the capital cost of the property to be the capital cost of the property to the transferor immediately before the transferor disposed of the property, and the excess ($120,000 - $6,000) is deemed to have been allowed as a deduction in respect of the property. In this case, the subsection 110.6(19) election results in the UCC being reduced to nil.
The 1994 election therefore had an impact on the cost of the property ($6,000) and on the UCC ($0), with the result that the disposition of the building in 1998 for $58,452 generated recapture of $58,452 and a gain of $52,452 to Mx. X. However, we agree with your comments that, in computing the capital gain, the application of the parenthesis in paragraph 39(1)(a) results in the gain being reduced by the amount otherwise included in income. Since the entire gain is included in income on a recapture basis, this results in a capital gain of $0. Consequently, Ms. X will only have recapture of $58,452 to include in her income.
According to the Explanatory Notes, the purpose of the cost reduction pursuant to clause 110.6(19)(a)(ii)(C) was to discourage electors from designating amounts in excess of fair market value and thereby triggering larger capital gains in 1994, at the risk of having a large capital gain included in income on the actual disposition of the property.
In the situation presented, the impact of the reduction in the cost of the property provided for in clause 110.6(19)(a)(ii)(C) on the application of paragraph 13(7)(e.1) is not only a negative factor in that a significant gain resulted from the disposition of the property, but even more so because the gain resulting from the disposition of the building was reflected in recapture of depreciation.
We therefore contacted the Department of Finance ("Finance") to determine whether the result obtained was consistent with the deterrent intent of the cost reduction under clause 110.6(19)(a)(ii)(C). They indicated to us that the purpose of paragraph 13(7)(e.1) was to ensure that subparagraph 13(7)(e)(i) applies for the purpose of determining the capital cost to the taxpayer of the property that the taxpayer is reacquiring as a result of the election made pursuant to subsection 110.6(19). Where the property is depreciable property of a prescribed class, whether separate or not, before the deemed disposition, it is depreciable property of the same class of the taxpayer on its deemed reacquisition.
Consequently, an election made pursuant to subsection 110.6(19) in respect of depreciable property was not intended to result in recapture of depreciation. Note that the amount added to the description of F in the definition of UCC in subsection 13(21) as a result of the deemed disposition of the property is identical to the amount added to the description of A in that formula as a result of the deemed reacquisition of the property.
In essence, although paragraph 13(7)(e.1) is broadly worded, it was intended for elections pursuant to subsection 110.6(19) in respect of depreciable property to engage subparagraph 13(7)(e)(i). In no way was this paragraph intended to engage subparagraph 13(7)(e)(iii) so as to cause recapture of depreciation to be triggered on the subsequent disposition of the property having regard to an election that had been made pursuant to subsection 110.6(19).
Notwithstanding Finance's explanations, the following comments on Antosko in P. W. Hogg and J. E. Magee, Principles of Canadian Income Tax Law (1995), at section 22.3(c) "Strict and purposive interpretation", at pp. 453-454, summarize an interpretive rule that may be useful in a case such as this:
It would introduce intolerable uncertainty into the Income Tax Act if clear language in a detailed provision of the Act were to be qualified by unexpressed exceptions derived from a court"s view of the object and purpose of the provision ... [The Antosko case] is simply a recognition that "object and purpose" can play only a limited role in the interpretation of a statute that is as precise and detailed as the Income Tax Act. When a provision is couched in specific language that admits of no doubt or ambiguity in its application to the facts, then the provision must be applied regardless of its object and purpose. Only when the statutory language admits of some doubt or ambiguity in its application to the facts is it useful to resort to the object and purpose of the provision.
In our view, the wording of subsection 110.6(19) and paragraph 13(7)(e.1) is not ambiguous in its application to the situation you have presented to us. Furthermore, even relying on the ordinary meaning of the words and taking into account the overall context of the legislative provisions, particularly with respect to the deterrent aspect of the reduction in cost when the elector indicates an amount greater than the fair market value, our conclusion is that the recapture of $58,452 to be included in Ms. X's income is a tax result that is supported in law, even though a judge could be lenient towards a taxpayer in a case such as the one presented.
For your information, unless exempted, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Customs and Revenue Agency's library. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, the CRA library version can be provided. Alternatively, the client may request a severed copy using the Privacy Act criteria, which does not remove client identity. Requests for this latter version should be made by you to Ms. Jackie Page at (819) 994-2898. A copy that has been severed in accordance with the Privacy Act will be sent to you for delivery to the client.
We hope you find these comments helpful. Should you require any additional information regarding this matter, please do not hesitate to contact us.
Best regards,
Ghislaine Landry, CGA
Manager
Individuals, Corporate and Partnership Section
Business and Partnership Division
Income Tax Rulings Directorate
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