CRA implicitly finds that the extinguishing of property in a non-arm's length transaction does not result in deemed fair market value proceeds

CRA has found that where a partnership which was wound-up under s. 98(5) was leasing property from the the partner which received the partnership business, s. 98(5) rollover treatment will not apply to the leasehold interest of the partnership, assuming that the leasehold interest was extinguished by merger into the freehold interest of the lessor partner on the winding-up rather than being received by that partner.  Instead, the partnership would be able to claim a terminal loss with respect to the leasehold interest, on the basis that it was disposed of for nil proceeds of disposition.

Since s. 98(5) windings-up generally occur as non-arm's length transactions, this interpretation appears to implicitly accept that s. 69(1)(b) , which deems the receipt of fair market value proceeds on the disposition of "anything to a person with whom the taxpayer is not dealing at arm's length," does not apply to an extinguishing of a property by operation of law.

Neal Armstrong.  Summary of 31 May 2012 T.I. 2011-0426091E5 under s. 98(5).