24 May 2001 Internal T.I. 2001-0081607 - PROPERTY TAX ; INTEREST

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 18(2)(e) or (f) apply if 18(2)(d) applies

Position: no

Reasons: wording of Act

		May 24, 2001

	Saskatoon TSO	HEADQUARTERS
	Audit Division	Partnerships Section
		Denise Dalphy, LL.B.
	Attention: Sandra MacNevin
		2001-008160

Subsection 18(2) of the Income Tax Act (the "Act")

This is in reply to your memorandum of March 23, 2001 where you enquire about the application of the above-referenced subsection of the Act. In particular, you have asked whether the limitations in paragraph 18(2)(e) or (f) apply to limit the deductibility of interest and property taxes in a situation where the taxpayer holds the land primarily for the purpose of earning rental income where the taxpayer earns rental income. We also provide comments on a similar question that was presented to us in an e-mail transmission originating with Brenda Vidal.

Your Analysis

"As we interpret 18(2), there are three segments. The preamble together with paragraphs (a) and (b) (the first segment) denies a deduction for property taxes or interest on loans used to acquire land for all land acquisitions. The second segment, [beginning with "unless" and running to the end of paragraph (d)] contains an exception from the restriction described in the preamble under certain circumstances. In the third segment (beginning with "except") there is a partial exception from the restriction in the preamble for those who do not meet the exceptions in (c) and (d)."

"Arguably, the partial exception allowed in the third segment of the subsection provides for a relaxing of restrictions otherwise imposed by the first segment, and the partial exception is not applicable at all to the second segment of the provision. The result is that those who meet the conditions in the second segment of 18(2) are entirely exempt from any limitation imposed by 18(2). Those who do not meet the conditions in that segment [land developers, businesses holding land for expansion, etc.] are limited to the amounts described in (e) and (f). In fact, any interpretation that would have the partial exception in (e) and (f) apply to taxpayers in (c) or (d) would result in only those taxpayers being able to deduct any interest on land and property taxes, and then only to the extent allowed by (e) and (f). All other taxpayers would get no deduction for the expenses described in (a) and (b). Therefore, our interpretation is that where a taxpayer meets the conditions of paragraphs (c) or (d), he does not need to concern himself with the allowances of (e) or (f)."

"Given the analysis above, it is difficult to understand why rent would not satisfy the requirements of 18(2)(d) and why a taxpayer who holds land primarily to earn rent and who has a reasonable expectation of profit would be barred from deducting property taxes and interest in excess of income from that land for a particular year, as Technical Interpretation 9606735 seems to say."

[Emphasis added]

Our Comments

We share your opinion on the proper interpretation of subsection 18(2). It is also consistent with comments in IT-153R3 (in particular, the last paragraph in paragraph 1 therein) and tax policy. We shall place a correction note in our database with respect to interpretation E9606735. We hope this opinion will be of assistance.

Hypothetical Scenario

Ms. Vidal has presented the following situation for our comments:

"I own farmland that I inherited from my parents. I'm a non-resident, so I won't be farming the land (not in the business). I will earn rental income (either cash rent or crop share rent) from the land, and that's the reason that I'm holding the land. I may not be holding it for speculation purposes (or I may be holding it primarily for the purpose of resale or development). I may just want to keep it for other reasons. But in the meantime, I'm going to earn income from the property in the form of rent."

Our Comments

In order to not be subject to the deduction limits in paragraphs 18(2)(e) and (f), a taxpayer must qualify under paragraph 18(2)(c) or (d). If the land is not used in the type of business described in paragraph (c), we must look to (d) to determine whether the taxpayer can qualify on the basis that "the land can reasonably be considered to have been, in the year," "held primarily for the purpose of gaining or producing income of the taxpayer from the land for the particular year."

We agree that the word "income" in paragraph (d) would include rental income. However, the fact that a taxpayer generates rental income will not, in and of itself, satisfy the purpose test. The main question that must be addressed is "what is the taxpayer's main reason for holding the land?" In Heinze (85 DTC 51) the Tax Court of Canada addressed this issue. The Court stated:

"Concerning provision 18(2)(e), having regard to the cost of the land, ($130,000) and the gross rent income ($3,000), it cannot be reasonably said that the land was "held primarily for the purpose of gaining or producing income of the taxpayer of the land" for those years. It seems to me that it is not only a question of intention but that the criteria must be objective as suggested by the wording of the provision."

Mr. Heinze appealed this decision to the Federal Court - Trial Division (97 DTC 5219). The Court analyzed the exempting sections in subsection 18(2) and concluded that neither one applied to the taxpayer. The Court further concluded that since rental income was received merely to reduce losses, and not for the purpose of gaining or producing (net) income, no amount of the taxpayer's interest and property expenses were deductible.

Accordingly, with reference to the above hypothetical scenario, it is essential to know why you are holding the land. If the primary purpose for holding the land is to earn rental income (either cash rent or crop share rent), then you would not be subject to the loss restriction rules in (e) or (f). In Heinze (97 DTC 5219), the Federal Court - Trial Division asked itself this question and concluded that the purpose test was not satisfied:

"Was the land held primarily for the purpose of gaining or producing income during the relevant years? The plaintiffs admitted that the sole purpose for holding the land was to use it for a farming operation when the mortgage was paid off and farm machinery could be acquired. It is obvious from the minimal gross revenue the plaintiffs obtained in the relevant years that it was not being held in those years for the purpose of gaining or producing income. Accordingly, it cannot be said that the interest and property tax expenses were being incurred for the purpose of gaining or producing income in those years" (see for example Deputy Minister of Revenue of Québec v. Lipson, [1979] C.T.C. 250 (S.C.R.).)

However, if, in the above scenario, you are holding the land primarily for speculation purposes, or you are holding it primarily for the purpose of resale or development, or for any other reasons not within the ambit of the purpose test, your interest and property tax deductions will be limited to the income generated from the land.

Finally, subsection 18(2) is a limitation section, not a permissive section. As such, even if subsection 18(2) does not apply to a taxpayer, it is possible that another provision in the Act may nonetheless preclude a taxpayer from deducting his expenses (for example, if the taxpayer does not have a reasonable expectation of profit, no deductions will be permitted).

For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Legislation Access Database (LAD) on the Canada Customs and Revenue Agency's mainframe computer. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, they can be provided with the LAD version, or they may request a copy severed using the Privacy Act criteria, which does not remove client identity. Requests for this latter version should be made by you to Mrs. Jackie Page at (819) 994-2898. A copy will be sent to you for delivery to the client.

Steve Tevlin
for Director
Business and Partnerships Division
Income Tax Rulings Directorate

c.c.: Brenda Vidal
International Tax
Saskatoon TSO 23

Joanne Sluzar
Senior International Tax Officer
Compliance Programs Branch

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