10 March 2004 External T.I. 2003-0047905 - Debt Assumption by Partnership

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.

Principal Issues: Whether the assumption of the excess mortgages by a general partnership represents consideration for the properties transferred under an election pursuant to subsection 97(2).

Position: Yes.

Reasons: Consistent with court decisions and with paragraph 17 of Interpretation Bulletin IT-291R3, it is our view that the assumption by the Partnership of the excess mortgages represents consideration for the purposes of paragraph 85(1)(b) and subsection 97(2).

XXXXXXXXXX 2003-004790
Fiona Harrison
March 10, 2004

Dear XXXXXXXXXX:

This is in reply to your letter of November 5, 2003, wherein you requested our comments with respect to the applicability of paragraph 85(1)(b) of the Income Tax Act (the "Act"). In particular you enquire as to whether the change in our position concerning paragraph 85(1)(b) which is contained in paragraph 17 of Interpretation Bulletin IT-291R3 is applicable to a situation where the transferee is a general partnership.

You present the following hypothetical situation:

1. Mr. A, Mr. B and Mr. C ("Co-owners") are residents of Canada who own undivided interests in several commercial rental properties (the "Properties").

2. The percentage ownership by the Co-owners in the various Properties varies.

3. All of the Co-owners are actively involved in the management and administration of the business (the "Real Estate Business"). It is assumed that the Co-owners are not currently carrying on the Real Estate Business in partnership.

4. As a result of prior commercial activities of the Real Estate Business, the mortgages outstanding on certain Properties exceed the combination of the historical cost of the land and the undepreciated capital cost of the buildings ("tax basis"). In the aggregate, the amounts of the mortgages exceed the tax basis of the Properties. However, the proceeds received by the Co-owners from all of the mortgages, including any refinancing were reinvested in the Real Estate Business.

5. The Co-owners would like to create a general partnership (the "Partnership") with respect to the Real Estate Business. Each Co-owner will transfer his interest in the Properties to the Partnership pursuant to subsection 97(2) of the Act. As consideration therefor, the Partnership will assume an amount of the mortgages which is equal to an amount not in excess of the tax basis of the Properties and will issue a general partnership interest for the difference between the FMV of the Properties and the assumed mortgages. The elected amount pursuant to subsection 97(2) will be the tax basis of the Properties.

6. Shortly thereafter, the Partnership will assume the remaining mortgages (the "Excess Mortgages") which will reduce both the FMV and the adjusted cost base of the Co-owners' partnership interests. The assumption of the Excess Mortgages by the Partnership will result in each Co-owner having a negative adjusted cost basis in his interest in the Partnership.

7. At all times, the Co-owners will not be limited partners as defined under subsection 40(3.14) of the Act and will not be specified members as defined under subsection 248(1) of the Act.

As noted in paragraph 17 of Interpretation Bulletin IT-291R3, the Agency has reconsidered its position on the applicability of paragraph 85(1)(b) in situations involving a transfer of property having liabilities in excess of its cost amount where the excess liabilities are allocated to other property transferred or are assumed by the transferee in consideration for the delivery of a promissory note in the amount of the excess.

You request our view as to whether this change in position will affect the elected amount of the Properties for the purpose of the election under subsection 97(2) 1 in the above-described situation.

In our view, the assumption by the Partnership of the Excess Mortgages represents consideration for the Properties for the purposes of paragraph 85(1)(b) and subsection 97(2). Accordingly, the Co-owners will realize a gain on the transfer. In this regard we cite the 1996 Federal Court of Appeal decision in MDS Health Group Ltd., 97 DTC 5009, and the 1990 Federal Court-Trial Division decision in Haro Pacific Enterprises Limited, 90 DTC 6583. In these cases, the court held that the consideration received by the partner, on a transfer of property to a partnership that was subject to an election under subsection 97(2), included a cash payment received by the partner from the partnership a few days after the transfer.

The above comments are an expression of opinion only and as noted in Information Circular 70-6R5 are not binding on the Canada Revenue Agency.

Yours truly,

Mark Symes
Manager
Corporate Reorganizations Section 1
Reorganizations and Resources Division
Income Tax Rulings Directorate

ENDNOTES

1 Paragraph 97(2)(a) provides that the provisions of paragraphs 85(1)(a) to (f) apply, with certain modifications, to dispositions of certain property to a Canadian partnership.