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 CCRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.
Principal Issues:
1) Does subsection 1102(14) of the Regulations apply in this situation?
Position: YES
SECTIONS: ITA Subsection 13(21), Regulation 1102(14), Part XI and Schedules II and VI of the Regulations
Reasons:
1) An interest in land was acquired by the taxpayer from a person with whom the taxpayer was not dealing at arm's length and the property was property of a separate prescribed class of the person.
April 25, 2003
Technical Applications and Valuations Division Income Tax Rulings Directorate
Christine Savage Luisa A. Majerus
Co-ordinator, Resources Industry (613) 946-3558
Attention: Denis McClure, Forestry Specialist
2002-015326
XXXXXXXXXX
XXXXXXXXXX
Timber Property Acquired by Non-Arm's Length Person
We are writing in response to your memorandum of July 12, 2002, wherein you requested our views on subsection 1102(14) of the Income Tax Regulations (the "Regulations") and the definition of "timber resource property" in subsection 13(21) of the Income Tax Act (the "Act") with respect to certain non-arm's length transfers of timber property.
Facts
1. XXXXXXXXXX was incorporated on XXXXXXXXXX and purchased the assets of XXXXXXXXXX from a third party.
2. The freehold land included in the purchase comprised some XXXXXXXXXX acres, a portion of which included standing timber. The purchase also included grazing permits on a further XXXXXXXXXX acres of Crown land such that the actual size of XXXXXXXXXX was in excess of XXXXXXXXXX acres. The portion of the purchase price allocated to the acquisition of the XXXXXXXXXX lands and timber was $XXXXXXXXXX. The portion of the purchase price allocated to the acquisition of grazing leases was $XXXXXXXXXX.
3. XXXXXXXXXX, through XXXXXXXXXX, acquired the XXXXXXXXXX and the taxpayer's representative indicated that there was no intention of harvesting, on a commercial basis, any of the standing timber on XXXXXXXXXX's freehold land of XXXXXXXXXX acres. As such, at the time of the original acquisition in XXXXXXXXXX made no attempt to allocate the $XXXXXXXXXX purchase price for the land and timber between the land and the standing timber.
4. From the XXXXXXXXXX carried out selective logging on some of its freehold land in order to clear land XXXXXXXXXX. For the fiscal year ended XXXXXXXXXX, XXXXXXXXXX's gross revenue from timber sales was $XXXXXXXXXX and the related net income was $XXXXXXXXXX.
5. At the end of the XXXXXXXXXX fiscal year, a timber cruise was commissioned. Qualified professionals carried out the timber cruise during the XXXXXXXXXX. The results of the cruise are summarized as follows:
XXXXXXXXXX XXXXXXXXXX
Quantity of harvestable timber (cunits) XXXXXXXXXX XXXXXXXXXX
Value of harvestable timber $1XXXXXXXXXX $XXXXXXXXXX
6. The quantity of merchantable timber on hand was sufficient to justify a continual harvest on a perpetual yield basis. On XXXXXXXXXX, the Board of Directors of XXXXXXXXXX decided to enter into the logging business on a commercial basis as the annual cut was expected to be in the range of XXXXXXXXXX cunits per year.
7. The logging operation was carried out through XXXXXXXXXX's wholly owned subsidiary, XXXXXXXXXX.
8. XXXXXXXXXX sold to XXXXXXXXXX the right to cut and remove an amount of timber for a period of approximately XXXXXXXXXX equal to the harvestable volume of timber on the XXXXXXXXXX deeded lands at XXXXXXXXXX as per the XXXXXXXXXX cruise.
9. The consideration received by XXXXXXXXXX for the XXXXXXXXXX right was a non-interest bearing demand note in the amount of $XXXXXXXXXX representing the fair market value determined by the timber cruise and one common share of XXXXXXXXXX.
? An election was filed pursuant to subsection 85(1) of the Act. The elected transfer price was $XXXXXXXXXX.
? The XXXXXXXXXX agreement was dated XXXXXXXXXX. The proceeds of disposition of $XXXXXXXXXX were reported by XXXXXXXXXX as a disposition of capital property on its tax return for the year ended XXXXXXXXXX. The property disposed of was described as the sale of "timber cutting rights".
10. In its taxation year ended XXXXXXXXXX cut XXXXXXXXXX cunits of timber. Accordingly, it claimed CCA on the portion of the acquisition cost equal to the ratio of the cunits cut during the year over the total cunits available.
11. The annual CCA amount was computed in accordance with Schedule VI of the Regulations with the computation being attached to XXXXXXXXXX T2S (8) "Summary of Capital Cost Allowance" each taxation year. The XXXXXXXXXX right was never characterized as a Class 33 asset or as a timber resource property by XXXXXXXXXX. All of the tax returns for the XXXXXXXXXX taxation years were assessed as filed.
12. During the XXXXXXXXXX was the subject of an audit by CCRA. The auditor became aware of the disposition of the XXXXXXXXXX right by XXXXXXXXXX and reviewed the sale agreements and relevant tax returns. On XXXXXXXXXX, the taxpayer's representative received a letter requesting detailed information on the XXXXXXXXXX transaction whereby the XXXXXXXXXX right was transferred from XXXXXXXXXX. CCRA did not propose any audit adjustments.
13. In XXXXXXXXXX, a plan of reorganization was implemented to qualify the shares of XXXXXXXXXX as shares of the capital stock of a family farm corporation such that the shares could be bequeathed to XXXXXXXXXX adult children on a tax-free rollover basis pursuant to subsection 70(9.2) of the Act.
14. In XXXXXXXXXX, it was noted that the XXXXXXXXXX Agreement whereby the XXXXXXXXXX right was transferred to XXXXXXXXXX needed to be addressed. Two issues were dealt with:
i. XXXXXXXXXX.
ii. XXXXXXXXXX.
15. The XXXXXXXXXX right sold by XXXXXXXXXX and acquired by XXXXXXXXXX under the XXXXXXXXXX Agreement was described as the disposition of "timber cutting rights" on the Section 85 election form filed with respect to the XXXXXXXXXX Agreement.
16. XXXXXXXXXX.
17. XXXXXXXXXX carried on active logging operations from the date of the XXXXXXXXXX Agreement until it was wound-up into XXXXXXXXXX Since XXXXXXXXXX also carried on all of the "non-farming activities" of XXXXXXXXXX in order to preserve the family farm corporation status of the XXXXXXXXXX shares in accordance with the objectives of XXXXXXXXXX estate plan.
18. In XXXXXXXXXX siblings, XXXXXXXXXX decided to list XXXXXXXXXX for sale. The assets listed for sale were those owned by XXXXXXXXXX
19. In XXXXXXXXXX, an agreement was reached with a third party, whereby the third party purchased all of the issued shares of XXXXXXXXXX and all of the assets of XXXXXXXXXX. The third party purchaser commissioned an independent timber cruise to determine the quantity of merchantable timber on the freehold lands owned by XXXXXXXXXX. The final sale agreement allocated $XXXXXXXXXX of the sale proceeds to the timber cutting rights owned by XXXXXXXXXX.
20. XXXXXXXXXX had significant net capital losses from the disposition of marketable securities in XXXXXXXXXX was wound-up into XXXXXXXXXX net capital losses offset a portion of the taxable capital gain reported by XXXXXXXXXX on the disposition of a timber limit.
21. On its tax return for the taxation year ended XXXXXXXXXX reported the following amounts with respect to the disposition of the timber cutting rights:
Recaptured CCA - Timber Limit $ XXXXXXXXXX
Capital gain - Disposition of Timber Limit $ XXXXXXXXXX
Legislation
Part XI of the Regulations includes the rules applicable for capital cost allowance ("CCA"). A deduction for CCA is allowed for timber limits and cutting rights by virtue of paragraph 1100(1)(e) of the Regulations:
For the purposes of paragraphs...20(1)(a) of the Act, the following deductions are allowed in computing a taxpayer's income for each taxation year:
(e) such amount as he may claim not exceeding the amount calculated in accordance with Schedule VI in respect of the capital cost to him of a property, other than a timber resource property, that is a timber limit or a right to cut timber from a limit;
Paragraph 1102(14)(d) of the Regulations describes the rule applicable for non-arm's length transfers of property:
For the purposes of this Part [Part XI]...where a property is acquired by a taxpayer
(d) from a person with whom the taxpayer was not dealing at arm's length (otherwise than by virtue of a right referred to in paragraph 251(4)(b) of the Act) at the time the property was acquired, and the property, immediately before it was so acquired by the taxpayer, was property of a prescribed class or a separate prescribed class of the person from whom it was so acquired, the property shall be deemed to be property of that same prescribed class or separate prescribed class, as the case may be, of the taxpayer.
Subsection 13(21) of the Act defines a timber resource property to mean:
(a) a right or licence to cut or remove timber from a limit or area in Canada (in this definition referred to as an "original right") if
(i) that original right was acquired by the taxpayer (other than in the manner referred to in paragraph (b)) after May 6, 1974, and
(ii) at the time of the acquisition of the original right
(A) the taxpayer may reasonably be regarded as having acquired, directly or indirectly, the right to extend or renew that original right or to acquire another such right or licence in substitution therefor, or
(B) in the ordinary course of events, the taxpayer may reasonably expect to be able to extend or renew that original right or to acquire another such right or licence in substitution therefor, or
(a) any right or licence owned by the taxpayer to cut or remove timber from a limit or area in Canada if that right or licence may reasonably be regarded
(i) as an extension or renewal of or as one of a series of extensions or renewals of an original right of the taxpayer, or
(ii) as having been acquired in substitution for or as one of a series of substitutions for an original right of the taxpayer or any renewal or extension thereof;
Subsection 1101(3) of the Regulations provides that for the purposes of Part XI and Schedule... VI of the Regulations,
Each property of a taxpayer that is
(a) a timber limit other than a timber resource property, or
(b) a right to cut timber from a limit other than a right that is a timber resource property,
is hereby prescribed to be a separate class of property.
The XXXXXXXXXX right essentially extended and replaced the XXXXXXXXXX right. It is arguable that the XXXXXXXXXX right would be considered an "original right" by virtue of paragraph (a) of the definition of timber resource property in subsection 13(21) of the Act. It is also arguable that the XXXXXXXXXX right would be considered a timber resource property by virtue of paragraph (b) of such definition.
In the case of Avril Holdings Ltd., 69 DTC 5263 (Ex. Ct.), affirmed 70 DTC 6366 (SCC), the Court concluded that where the proceeds of sale of an interest in and to all sand and gravel contained in gravel pit lands depreciable as industrial mineral mines, proceeds from the sale of a right of way over such lands, and proceeds from the sale of the fee simple interest in such lands, were all considered proceeds of disposition of the depreciable property.
As commented by the Court in the case of Highway Sawmills Limited, 66 DTC 5116 (SCC), the phrase "timber limits" describes "a parcel of land with merchantable timber standing upon it". Furthermore, the Court commented, "under the scheme of the relevant sections of the Act and Regulations, a timber limit is treated as a class of depreciable property." The Court concluded that disposition of the piece of land in this case after all the merchantable timber standing on it had been removed, would be considered disposition of a timber limit, a depreciable property. (See also the case of Larsen, 99 DTC 5757 (FCA), where the grant of a right to remove timber from agricultural land was found to be a disposition of "qualified farm property".)
XXXXXXXXXX were not dealing at arm's length and the ranch land and standing timber originally acquired by XXXXXXXXXX was considered a timber limit and was included in Schedule VI of the Regulations by both the auditor and the taxpayer. The XXXXXXXXXX right was a right to cut all merchantable timber standing on such land in perpetuity.
Based upon the above-noted facts and jurisprudence, it is our view that the grant of the XXXXXXXXXX right represented a part disposition of XXXXXXXXXX interest in land. Therefore, the XXXXXXXXXX right would be deemed a property of XXXXXXXXXX included in Schedule VI of the Regulations pursuant to paragraph 1102(14)(d) of the Regulations. This is the case even though the XXXXXXXXXX right would otherwise be considered a timber resource property.
We trust these comments will be of assistance.
for Director
Reorganizations and Resources Division
Income Tax Rulings Directorate
Policy and Legislation Branch
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