6 October 2000 Internal T.I. 2000-0035277 - DISPOSITION OF SHARES IN CO-OP

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: Whether redemption of shares in co-operative corporation which holds a grazing lease can be considered the disposition of eligible capital property and qualify for the capital gains deduction.

Position: No

Reasons: Shares are excluded from definition of eligible capital expenditure. Share redemption results in deemed dividend per 84(3).

		October 6, 2000

	Calgary Tax Services Office	HEADQUARTERS
	Business Audit Section	Wayne Antle
(613) 957-2102
	Attention: Kenneth E. Friesen
		2000-003527

Disposition of Shares in XXXXXXXXXX (the "Co-op")

This is in response to your letter dated June 27, 2000 concerning whether a farmer who disposed of his interest in the Co-op can report the disposition as a capital gain and claim the capital gains deduction. Our understanding of the facts is as follows:

The Alberta government leases large tracts of its land to groups of farmers who use the land to graze their cattle. They usually form an association to hold the lease on their behalf and charge the members a nominal membership fee and grazing fee to cover the maintenance costs on the land. In some cases, the farmers form a cooperative corporation to hold the grazing leases. Many of these associations or corporations accumulate significant sums of cash because they are allowed to keep revenues paid by oil and gas companies for access to the leased land in order to explore for, and exploit, oil and gas reserves.

The Co-op is a corporation formed to provide land to its farmers/shareholders for grazing their cattle. It holds XXXXXXXXXX acres of deeded land, and leases XXXXXXXXXX acres of crown land from the Alberta Government. Each share entitles the farmer to graze one head of cattle on the land managed by the Co-op, and only shareholders are permitted to graze cattle on this land. According to the bylaws of the Co-op, shareholders may dispose of their shares by selling them back to the Co-op, transferring them to family members, or transferring them to the purchasers of their farm property, if they sell their farms in their entirety.

XXXXXXXXXX operated a family farm near the land managed by the Co-op. Throughout the period from XXXXXXXXXX acquired XXXXXXXXXX shares in the Co-op. During XXXXXXXXXX, the Co-op bought back his shares for proceeds in excess of the shares' paid-up capital ("PUC"). You issued a letter to him proposing to include a deemed dividend in his XXXXXXXXXX income pursuant to subsection 84(3) of the Income Tax Act (the "Act"). The representative for XXXXXXXXXX has responded to the letter, arguing that the shares in the Co-op were, in reality, rights to graze cattle. As such, they constitute eligible capital property, and meet the definition of qualified farm property in subsection 110.6(1) of the Act. Each shareholder would, therefore, report the gain on the disposal of the shares as a capital gain, and be entitled to claim the corresponding capital gains deduction.

Our Comments

We agree with your proposal letter to XXXXXXXXXX. Where a corporation resident in Canada purchases, redeems or cancels shares of its capital stock for an amount greater than the shares' paid-up-capital, subsection 84(3) of the Act, basically, provides that the corporation is deemed to have paid, and the shareholders are deemed to have received, dividends on the shares purchased, cancelled or redeemed equal to the amount by which the proceeds exceed the PUC of the shares. Since XXXXXXXXXX sold his shares back to the Co-op, and received proceeds greater than the shares' PUC, in our view, he would be deemed to have received a dividend on his shares. In computing his capital gain or loss on the disposition of his shares, the amount of the deemed dividend would be excluded from the calculation of his proceeds pursuant to paragraph (j) of the definition of proceeds of disposition in section 54 of the Act. Therefore, based on the facts provided, XXXXXXXXXX would have a capital loss on the disposal of his shares. We have not considered whether the shares in the Co-op meet the definition of qualified farm property since XXXXXXXXXX does not have a capital gain on the sale of his shares, and this determination is, therefore, not relevant in his case.

We have considered the arguments raised by XXXXXXXXXX representative that the shares should be considered to be eligible capital property. An eligible capital expenditure, within the meaning of subsection 14(5) of the Act, may be broadly defined as an expenditure made after 1971 which is on capital account and is made for the purpose of gaining or producing income from a business. Many expenditures, however, can meet these broad requirements but still fall within one of the specific exclusions in the definition. In particular, paragraph (f) of the definition provides that the cost of a share, partnership interest, or an interest in a trust, etc, cannot be considered to be an eligible capital expenditure. Accordingly, XXXXXXXXXX shares in the Co-op would be specifically excluded from the definition of eligible capital expenditure in subsection 14(5) of the Act.

Other Questions

In your letter, you have also raised a couple of general questions concerning grazing leases. You ask whether a membership in a grazing association that is not a corporation can be considered qualified farm property. This can only be determined after reviewing all of the facts, including the nature of the association and the terms and conditions of the lease. In our view, a grazing lease can represent a leasehold interest for the purposes of Class 13 of Schedule II of the Income Tax Regulations. If the lease gives the right to exclusive possession of the land, it could be considered real property for the purposes of the definition of qualified farm property in subsection 110.6(1) of the Act. However, a permit which gives the farmer a right to use the land, with no interest in the land, would not be considered to be real property.

You also ask whether an association holding a leasehold interest in land can qualify for the capital gains deduction upon disposition of its interest. Subsection 110.6(2) of the Act provides that this deduction may only be claimed by an individual other than a trust. If the leasehold interest in the land meets the definition of qualified farm property, and it is held by a family farm partnership or personal trust, then it may be possible to allocate any net taxable capital gain to the partners or beneficiaries, as the case may be, for the purposes of computing the partners' or beneficiaries' capital gains deduction. The facts of each case must be reviewed in order to determine the particular tax consequences.

We trust that our comments will be of assistance.

John Oulton
Manager
Business, Property, and Employment Income Section III
Business and Publications Division
Income Tax Rulings Directorate
Policy and Legislation Branch

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