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 the recapture of CCA on the disposition of rental property may be considered "income of the corporation for the year from an active business" within the meaning of the definition of this expression in subsection 125(7) of the ITA. The income from the rental property was not considered income from a specified investment business in prior years since the corporation employed more than 5 full-time employees. After the disposition, the corporation no longer employed more than 5-full time employees.
Position: No.
Reasons: The recapture of CCA will be considered income from a specified investment business since the corporation did not employ more than 5 full-time employees throughout the year.
XXXXXXXXXX J. Gibbons, CGA
2000-004910
March 6, 2001
Dear XXXXXXXXXX:
We are replying to your letter dated September 15, 2000, concerning the income tax characterization of the recapture of capital cost allowance (CCA) in the particular situation described below. You wish to know whether the recapture of CCA may be considered "income of the corporation for the year from an active business" within the meaning of the definition of this expression in subsection 125(7) of the Income Tax Act (the "Act").
As requested, we have considered the situation outlined in your letter 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 70-6R4. Thus, our comments are of a general nature only.
Facts
1. The principal purpose of the business of Realco is to derive rental income from several residential apartment blocks.
2. In prior years, Realco employed throughout the year more than 5 full-time employees in the business. Therefore, the rental income earned by Realco was income from an active business carried on by the corporation, rather than income from a "specified investment business" as defined in subsection 125(7) of the Act. Realco thus claimed the small business deduction on its rental income in its prior years.
3. During the year, two of Realco's rental properties were surrendered at the same time due to foreclosure, resulting in deemed proceeds of disposition pursuant to subsection 79(3) of the Act. The dispositions resulted in the recapture of CCA on each of the two foreclosed properties.
4. Throughout the period before the foreclosures, Realco employed more than 5 full-time employees in the business.
5. Immediately following the foreclosures, Realco reduced the number of full-time employees so that there were no longer more than 5 full-time employees employed in the business throughout the year. However, Realco continues to operate its business.
6. No services are provided to Realco by an associated corporation.
Based on the foregoing, you ask:
i) Whether the recapture of CCA will be deemed to be income from an active business carried on by Realco or income from a specified investment business. In this regard, you referred to paragraph 9 of IT-73R5, "The Small Business Deduction", which states than on cessation of a business, recapture of CCA will generally be considered to be income from the same category of business as that to which the source originally related. You also referred to the income tax case, The Queen v. Richard D. Arnos (82 DTC 6165) wherein the Federal Court of Appeal opined that "recaptures of capital cost allowance are of the same nature as the revenue from the property in respect of which the capital cost allowance has been deducted". Since Realco was deemed to be earning active business income from the properties immediately before the foreclosures, you ask whether the recapture of CCA from the foreclosures will also be considered income from an active business.
ii) Assuming that each of the remaining rental properties was originally purchased while Realco was deemed to be earning active business income, whether the recapture of CCA will be considered income from an active business or a specified investment business, on a subsequent disposition of these properties, while Realco does not employ more than 5 full-time employees. In this regard, you again referred to paragraph 9 of IT-73R5 and the Richard D. Arnos case.
According to the definition of "active business carried on by a corporation" in subsection 125(7) of the Act, this expression does not include a "specified investment business" (also defined in subsection 125(7)), which, subject to certain exceptions, is a business the principal purpose of which is to derive income from property. One of the exceptions provided in the definition of this term is where the corporation employs in the business throughout the year more than 5 full-time employees. As a result, a business, the principal purpose of which is to derive income from property, will generally be a specified investment business for the entire year even if it employs more than 5 full-time employees for part of the year. Accordingly, whether a corporation's rental business constitutes an active business or a specified investment business is an annual determination. In the situation you described, it is therefore our view that the recapture of CCA on the disposition of property that is used in the business will be income from a specified investment business.
The position in paragraph 9 of IT-73R5, which you referred to in your letter, applies to a recapture of CCA after the cessation of a business. In such a case, it is necessary to look to the nature of the former business to determine the character of the recapture of CCA since the business no longer exists.
Finally, as regards the Arnos case, we do not feel that it is particularly relevant to the situation you described. In its decision in Arnos, as indicated above, the Federal Court of Appeal indicated that "recaptures of capital cost allowance are of the same nature as the revenue from the property in respect of which the capital cost allowance has been deducted ...". Applied to Realco, in our view, this simply means that the recapture of CCA should be treated as rental income. It thus remains to be determined whether this rental income is income from an active business or a specified investment business, which, in Realco's case, turns on whether Realco employed throughout the year more than 5 full-time employees.
The role of the Customs Canada and Revenue Agency is to administer and enforce the Act as passed by Parliament. Should you have any tax policy concerns, they may be addressed to the Department of Finance, Tax Policy Branch, L'Esplanade Laurier, 140 O'Connor Street, Ottawa, Ontario, K1A 0G5.
We trust that these comments will be of assistance.
Yours truly,
Milled Azzi, CA
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
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