11 February 2000 External T.I. 1999-0004935 - ACB OF PROMISSORY NOTE REC'D FROM SPOUSE

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues: If the taxpayer receives a demand non-interest bearing promissory note as consideration for property transferred to a spousal trust, will the adjusted cost base of the promissory note be equal to the stated value of the note (which should also be equal to its fair market value)?

Position: Question of fact.

Reasons: The ACB of capital property is equal to the cost to the taxpayer plus or minus the adjustments described in subsections 53(1) and (2). Since "cost" is not a defined term in the Act, reference must be made to its ordinary meaning and related jurisprudence. On this basis, we accept that cost means the sum or equivalent expended, paid or charged for something. However, in some cases, property is considered to have been acquired at an amount other than cost by virtue of specific provisions in the Act. For example, in a situation where property is acquired from a non-arm's length person at an amount in excess of the fair market value thereof, paragraph 69(1)(a) provides that the taxpayer is deemed to have acquired the property at the fair market value of that property rather at the amount paid for it. Finally, where a sales agreement does not clearly support the contention that a promissory note has been accepted as absolute payment, it is arguable that the note may not be regarded as capital property that has been acquired.

XXXXXXXXXX 1999-000493
J. Gibbons
Attention: XXXXXXXXXX

February 11, 2000

Dear XXXXXXXXXX:

We are replying to your letter of August 31, 1999, in which you requested clarification of the rules in subsection 73(1) of the Income Tax Act when property is transferred to a spousal trust and a promissory note is received in return. In particular, you wish to know the income tax consequences, if any, of receiving the promissory note and the adjusted cost base of the promissory note.

As requested, we have considered your questions and have provided some comments below. However, we cannot confirm the tax implications of particular transactions unless the transactions are proposed and are the subject matter of an advance ruling request submitted in the manner set out in Information Circular 70-6R3. Thus, our comments are of a general nature only.

You describe the following hypothetical facts:

• The taxpayer and the taxpayer's spouse are resident in Canada.
• A Canadian resident "spousal trust" (the "Trust") was created by the taxpayer.
• The Trust deed states that the taxpayer's spouse is entitled to receive all of the income of the Trust that arises before his or her death and no person except that spouse beneficiary may, before his or her death, receive or otherwise obtain the use of any of the income or capital of the Trust.
• The taxpayer transfers capital property to the Trust. The fair market value of the property is $1,000 and its adjusted cost base is $100.
• The taxpayer does not elect to have the provisions of subsection 73(1) of the Act not apply.

Question 1.

Assuming that the taxpayer receives a demand non-interest bearing promissory note equal in value to the transferred property (i.e., a promissory note for $1,000) as consideration for the property, will subsection 73(1) still apply to deem the transfer to take place at the adjusted cost base of the transferred property?

Question 2.

Assuming that the taxpayer receives a demand non-interest bearing promissory note with a fair market value less than the fair market value of the transferred property (but greater than the adjusted cost base (ACB) thereof) as consideration for the property, will subsection 73(1) still apply to deem the transfer to take place at the adjusted cost base of the transferred property?

Your view - Questions 1 and 2

You are of the view that subsection 73(1) will continue to apply since subsection 73(1) does not preclude a taxpayer from receiving a note or similar debt instrument as consideration for the transferred property.

Our view - Questions 1 and 2

Subsection 73(1) sets out the rules for determining a taxpayer's proceeds of disposition and the purchaser's acquisition price when capital property is transferred from the taxpayer to a spouse, a spousal trust, or a former spouse in settlement of rights arising out of their marriage. In our view, this provision applies whether or not the taxpayer receives a promissory note or other consideration for the property transferred. Thus, assuming that the requirements of subsection 73(1) are otherwise met, and that an election not to have subsection 73(1) apply is not made, the proceeds of disposition of the transferred property would be deemed to be equal to the adjusted cost base of the capital property to the taxpayer immediately before the transfer. Further, the Trust would be deemed to have acquired the shares at that time for an amount equal to such proceeds of disposition.

Question 3

Assuming that the taxpayer receives a demand non-interest bearing promissory note as consideration for the transferred property, will the adjusted cost base of the promissory note be equal to the stated value of the note (which should also be equal to its fair market value)?

Your view

It is your view that, based on the definition of ACB in section 54 of the Act, the ACB of the promissory note would equal its cost to the taxpayer, adjusted by the provisions in subsections 53(1) and (2). Since cost is not a defined term in the Act, you refer to its ordinary meaning in Black's Law Dictionary. This dictionary defines cost to mean "the sum or equivalent expended, paid or charged for something." As the taxpayer has a legally enforceable right to the stated value ($1,000 in situation #1 above), it is your view that he or she should be considered to have charged the equivalent of the fair market value (FMV) and stated value of the promissory note to acquire the note. Thus, assuming subsection 53(2) does not apply to reduce the ACB of the promissory note, the ACB of the promissory note should equal its fair market value.

Our view

The ACB of capital property is equal to the cost to the taxpayer plus or minus the adjustments described in subsections 53(1) and (2). Since "cost" is not a defined term in the Act, reference must be made to its ordinary meaning and related jurisprudence. On this basis, we accept that cost means the sum or equivalent expended, paid or charged for something. However, in some cases, property is considered to have been acquired at an amount other than cost by virtue of specific provisions in the Act. For example, in a situation where property is acquired from a non-arm's length person at an amount in excess of the fair market value thereof, paragraph 69(1)(a) provides that the taxpayer is deemed to have acquired the property at the fair market value of that property rather than at the amount paid for it.

In addition to the deeming provisions in the Act which establish certain values for tax purposes, other provisions in the Act may affect the amount of a capital gain or loss that is to be reported. For example, paragraph 40(2)(g) of the Act deems certain capital losses to be nil. Given these various income tax provisions relating to the determination of tax values and capital gains and losses, we are unable to confirm whether the approach proposed in your letter for determining the cost of the property received by a spouse from a spousal trust is appropriate. In order to do so, we would have to review the complete details surrounding both the acquisition and the disposition of the particular property. Further, in a situation such as the one described in your letter, i.e., where a promissory note is received by a spouse as consideration for capital property transferred to a spousal trust, we would have to examine the relevant agreements to determine if the promissory note is, in fact, capital property "acquired" by the spouse. For example, where a sales agreement does not clearly support the contention that a promissory note has been accepted as absolute payment, it is arguable that the note may not be regarded as capital property that has been acquired.

We trust that these comments will be of assistance.

Yours truly,

John Oulton
for Director
Business and Publications Division
Income Tax Rulings Directorate

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