Translation disclaimer
This translation was prepared by Tax Interpretations Inc. The CRA did not issue this document in the language in which it now appears, and is not responsible for any errors in its translation that might impact a reader’s understanding of it or the position(s) taken therein. See also the general Disclaimer below.
Principal Issues: In a given fact situation, an individual made an election under subsection 110.6(19) in respect of his business carried on, on February 22, 1994, and, as a consequence of that election, has an "exempt gains balance" as defined under subsection 14(5). In 2005, the individual transfers his business to a wholly-owned corporation under section 85. Whether the individual could materialise his "exempt gains balance" by choosing an appropriate agreed amount.
Position: Yes. By choosing an appropriate agreed amount the individual could realize his "exempt gains balance" but it would trigger an inclusion in his income under paragraph 14(1)a) in the particular fact situation.
Reasons: The law.
2005-011698
XXXXXXXXXX Guy Goulet, CA, M.Fisc.
(613) 957-9768
May 6, 2005
Dear Sir,
Subject: Section 85 rollover of an eligible capital property
This is in response to your letter of February 17, 2005 requesting our comments on the interpretation of section 85 in the particular situation described below.
Unless otherwise indicated, all statutory references herein are to provisions of the Income Tax Act (the "Act").
Particular Situation:
The Particular Situation as you have presented it to us is as follows:
1. Mr. X runs a XXXXXXXXXX business as a sole trader. He carried on that business on February 22, 1994. On that date, he owned eligible capital property relating to that business representing goodwill ("Goodwill") with the following tax attributes:
Fair market value (FMV): $XXXXXXXXXX
Cumulative eligible capital amount (CEC) under subsection 14(5): $XXXXXXXXXX
Cost of Goodwill: $XXXXXXXXXX
At that time, Mr. X did not own any other eligible capital property. The Goodwill was acquired by Mr. X after the "adjustment time" as defined in subsection 14(5).
2. In his 1994 income tax return, Mr. X made an election under paragraph 110.6(19)(b) in respect of the Goodwill. The amount reported on the election form in respect of the business for the purposes of paragraph 110.6(19)(b) was $XXXXXXXXXX. The consequences of this election were as follows:
Taxable capital gain: $XXXXXXXXXX
Capital gains deduction: $XXXXXXXXXX
“Exempt gains balance” under 14(5): $XXXXXXXXXX
3. From 1994 to 2004, Mr. X continued to carry on his XXXXXXXXXX business as a sole proprietorship, did not acquire any other eligible capital property, and did not carry on any other businesses. His "exempt gains balance" under subsection 14(5) was still $XXXXXXXXXX.
4. In 2005, Mr. X proposed to transfer his business to a newly incorporated company (the “Corporation") of which he would be the sole shareholder by way of a tax rollover under subsection 85(1). On the date of the transfer, the tax characteristics of the Goodwill were as follows:
FMV: $XXXXXXXXXX
CEC: $XXXXXXXXXX
Cost of Goodwill: $XXXXXXXXXX
Your Questions
You would like us to answer the following questions:
1. Is it possible for Mr. X to apply the amount of his "exempt gains balance" of $XXXXXXXXXX by selecting an appropriate agreed amount under subsection 85(1)?
2. However, is it possible that the benefit of the paragraph 110.6(19)(b) election could be lost if the elected amount is set at 4/3 of the CEC?
3. What would be the impact on the Corporation of electing a higher or lower agreed amount further to Questions 1 and 2?
Our Comments
It appears to us that the situation described in your letter may be an actual situation involving taxpayers. The Canada Revenue Agency ("CRA") does not generally provide written opinions on proposed transactions otherwise than by way of advance ruling. Furthermore, it is the responsibility of the relevant Tax Services Office to determine whether completed transactions have received appropriate tax treatment. We can, however, offer the following general comments which may not be fully applicable in a particular situation.
In general, the "exempt gains balance" in respect of an individual's business generated on the filing of an election pursuant to paragraph 110.6(19)(b) does not affect the CEC, as that term is defined in subsection 14(5), in respect of that business. In addition, an individual must include in computing income for a taxation year in which the individual disposes of eligible capital property in respect of the individual's business the amounts determined under paragraphs 14(1)(a) and 14(1)(b). Generally, the amount to be included in paragraph 14(1)(a) relates to the "recapture" of the deduction claimed under paragraph 20(1)(b), while the amount to be included in paragraph 14(1)(b) relates to the excess of the proceeds of disposition over the cost of the eligible capital property. Where an amount is required to be included under paragraph 14(1)(b) in computing an individual's income, the individual may claim a reduction in the amount required to be included in income by an amount not exceeding the individual's "exempt gains balance”. However, the "exempt gains balance" is of no utility in calculating the amount to be included in income under paragraph 14(1)(a).
In the Particular Situation, it appears to us that it would be possible for Mr. X to realize the amount of his "exempt gains balance" of $XXXXXXXXX by electing a subsection 85(1) agreed amount of $XXXXXXXXX in respect of the Goodwill. However, an election of such an agreed amount would result in an amount being required to be included in Mr. X's income for 2005 under paragraph 14(1)(a) because Mr. X has already claimed deductions in respect of the Goodwill pursuant to paragraph 20(1)(b).
With respect to your second question, it appears to us that the benefit of the paragraph 110.6(19)(b) election in respect of goodwill, i.e. the "exempt gains balance", would be lost if the agreed amount elected in respect of goodwill was equal to 4/3 of the CEC balance in this case.
With respect to your last question, we are of the view that the choice of a higher or lower agreed-upon amount would have an impact on the determination of the Corporation's CEC and the amount, if any, to be included in the Corporation's income under paragraph 14(1)(b) in respect of the business. In this regard, the Corporation should consider, inter alia, paragraphs 85(1)(a) and 85(1)(d), proposed paragraphs 85(1)(d.1) and 85(1)(d.11), subsection 14(3), and proposed Element A of the definition of CEC in subsection 14(5).
Finally, please note that our comments do not constitute an advance income tax ruling and, as stated in paragraph 22 of Information Circular 70-6R5 dated May 17, 2002, are not binding on the CRA with respect to any particular situation.
We hope that our comments are of assistance.
Maurice Bisson, CGA
for the Director
Corporate Reorganizations and Resource Industries Division
Income Tax Rulings Directorate
Directorate General for Policy and Planning
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