27 September 2000 External T.I. 2000-0039335 - Change in CCRA's position re 85(1)(b)

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: Application of 85(1)(b) where debt in excess of cost amount of transferred asset assumed on the insuance of a note

Position: Paragraph 85(1)(b) applies

Reasons: Assumed debt is considered to be consideration given for the transferred asset

Case Update
Canadian Tax Foundation Conference
September 2000

Change in the CCRA's Position Regarding Paragraph 85(1)(b)

Revenue Canada stated in its answer to question 47 at the Revenue Canada Round Table at the 1984 annual conference of the Canadian Tax Foundation that paragraph 85(1)(b) does not apply to a transfer of a property with liabilities in excess of cost amount where the excess is allocated to another property or is assumed by the purchaser in consideration for the delivery by the vendor of a promissory note in the amount of the excess. At the Revenue Canada Forum at the Foundation's 1996 Corporate Management Tax Conference Revenue Canada, indicated that this position was under review.

The review has now been completed. Where, after 2000, a property (the "First Property") is transferred pursuant to the provisions of section 85, and:

(a) the purchaser assumes an obligation of the vendor as consideration for the acquisition from the vendor of a second property (for example, a note of the vendor) and the purchaser subsequently disposes of that property to the vendor;

(b) the purchaser assumes an obligation of the vendor as consideration for the redemption or acquisition by the purchaser of its shares held by the vendor; or

(c) the purchaser subscribes for shares of the vendor,

the obligation so assumed or the property so contributed will be regarded as consideration for the First Property. Thus, if the total non-share consideration so considered to have been given by the purchaser for the First Property exceeds the amount agreed upon by the vendor and purchaser in their election under subsection 85(1), paragraph 85(1)(b) will apply to increase the amount agreed upon.

Consider the situation, for example, where the purchaser assumes an obligation of the vendor as consideration for a note of the vendor. Assume Sellco has a capital property with a cost amount of $200 and a fair market value of $1000 and a mortgage on the property of $700. Sellco transfers the $1000 property to Buyco pursuant to section 85 and issues Buyco a promissory note for $500. The agreement between Sellco and Buyco provides that, as consideration for the capital property, Buyco will assume $200 of the mortgage liability and will issue to Sellco $500 worth of redeemable preference shares and $300 worth of common shares and that, as consideration for the promissory note issued by Sellco, Buyco will assume $500 of the mortgage liability of Sellco. At some time after the transfer, Buyco redeems the preference shares by surrendering the promissory note to Sellco. In the CCRA's view, the entire amount of the mortgage assumed is assumed as consideration for the transferred property. Sellco has received non-share consideration on the transfer of $700 and this is the lowest amount which could be elected in respect of the transfer under section 85.

Consider also the following alternative situation using the same initial facts as those of the above example, but involving the redemption of the shares of the purchaser held by the vendor. On the initial transfer of the subject capital property, Buyco issues Class A preferred shares which are redeemable for $300 and Class B preferred shares redeemable for $700. Following the transfer, Buyco redeems the Class B shares. The consideration given upon the redemption is the assumption of the $700 mortgage. In the CCRA's view, the entire amount of the mortgage assumed is assumed as consideration for the transferred property. Sellco has received non-share consideration on the transfer of $700 and this is the lowest amount which could be elected in respect of the transfer under section 85.

As a final example, consider again the same initial facts as those of the first example, but where Buyco borrows $700 which it uses to subscribe for shares of Sellco. Sellco uses the $700 to repay its mortgage liability. Sellco then transfers the $1000 property to Buyco for shares of Buyco and elects at $200 under section 85. Buyco repurchases $700 of its shares held by Sellco and Sellco pays $700 to Buyco as a return of capital. The $700 capital contribution to Sellco by Buyco will be regarded as consideration for the transferred property such that paragraph 85(1)(b) will apply to deem the elected amount to be $700.

The CCRA confirms its view that paragraph 85(1)(b) does not apply to increase proceeds if the fair market value of the non-share consideration given (including the assumption of debt by the purchaser) is allocated among several properties transferred to and retained by the purchaser and the amount allocated to each asset is not greater than the amount elected in respect of each asset.

File: 2000-003933
Date: September 2000

??