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 proposed transactions will 1) trigger a capital gain in respect of the farm property, 2) allow the taxpayer to claim a capital gain deduction for qualified farm property, and 3) allow the taxpayer to claim a capital gains exemption for a principal residence.
Position: 1) Yes. 2) Maybe. 3) Yes.
Reasons: 1) Rules of 85(1). 2) The property would be qualified farm property based on the rules for periods prior to May 1,2006, however, after that date there are proposed change to the definition of qualified farm property. 3) The farm house can qualify as a principal residence, however, it can not be legally severed from the farm property so there can be only one agreed amount on a 85(1) which would have to be allocated on a reasonable basis between the farm land and the principal residence.
Charles Rafuse
XXXXXXXXXX 613-957-8967
2005-013239
October 23, 2006
Dear XXXXXXXXXX:
Re: Transfer of family farm property to a corporation
This is in reply to your letters of May 16, and September 23, 2005, your fax of January 30, 2006 and our telephone conversations (Rafuse/XXXXXXXXXX), concerning the application of the Income Tax Act (the "Act") in a proposed scenario.
You have indicated that your client, Mr. X, owns farm property consisting of a farmhouse and 176 acres of farmland plus outbuildings that he inherited in 1976 from his father. He has resided in the farmhouse since 1976 and his father continuously and actively farmed the farmland for more than 5 years prior to his death in 1976. Due to municipal bylaws it is not possible to legally sever the farmhouse from the farmland. Your client wishes to crystallize his capital gain and put in place an estate freeze in favour of his four adult children by transferring the farm property to a taxable Canadian corporation, Newco.
Newco will be incorporated with authorized share capital consisting of four separate classes of voting, fully participating, common shares, and one class of non-voting, non-participating preference shares. Each of Mr. X's four adult children will subscribe for a separate class of Newco's common shares. Mr. X and Newco will jointly elect to have the rules in subsection 85(1) of the Act apply to the transfer of the farm property to Newco for which Mr. X will receive consideration including preference shares as well as cash.
Your question is whether Mr. X is able to claim a capital gains deduction for qualified farm property ("QFP"), pursuant to subsection 110.6(2) of the Act and a capital gains exemption for a principal residence, pursuant to paragraph 40(2)(b) of the Act. In addition, you would like to know if Mr. X is able to transfer, under the rules of subsection 85(1) of the Act, the farmhouse as a separate property to Newco.
Written confirmation of the tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R5, Advance Income Tax Rulings, dated May 17, 2002. If your enquiry concerns completed transactions, the enquiry should be directed to the local tax services office. However, we are prepared to offer the following general comments.
The rules in subsection 85(1) of the Act enable a taxpayer to dispose of "eligible property" (defined in subsection 85(1.1) to a taxable Canadian corporation. The transferor is permitted to dispose of the property to the transferee for an "agreed amount" which must be within certain limits. This agreed amount generally becomes the proceeds of disposition of the property to the transferor and the cost to the transferee. Where the agreed amount exceeds the adjusted cost base of the transferor a capital gain will generally result. Accordingly, it is our opinion that Mr. X can trigger a capital gain by using subsection 85(1) to transfer his farm property to Newco. We would refer you to IT-291R3 - Transfer of Property to a Corporation under r Subsection 85(1) for a discussion of the rules related to this type of rollover.
As the principal residence portion, in Mr. X's case, cannot be severed from the rest of the property, the principal residence portion is not a separate property for the purpose of subsection 85(1). Therefore, Mr. X is not permitted to elect two agreed amounts in respect of the principal residence portion and the non-principal residence portion under subsection 85(1). Under subsection 85(1), Mr. X can only elect one agreed amount for the entire property. However, for the purpose of computing the principal residence exemption under paragraph 40(2)(b) of the Act, a portion of the agreed amount under subsection 85(1) is to be allocated to the part of the entire property that qualifies as a principal residence, as this expression is defined in subsection 54 of the Act. The allocation of the agreed amount between the principal residence portion and the non-principal residence portion has to be realistic and reasonable.
Generally speaking, subsection 110.6(2) of the Act permits a capital gains deduction of up to $500,000 for an individual who is resident in Canada throughout the year and disposed of QFP in the year. Real property will meet the definition of QFP in subsection 110.6(1) if certain conditions are satisfied. Under subparagraph (a)(vii) of the definition of QFP in subsection 110.6(1), where a property was last acquired by an individual before June 18, 1987, the property is QFP if it was used by certain persons that include the individual, or a parent of the individual principally in the course of carrying on the business of farming in Canada in at least 5 years during which the property was owned by the individual, or a parent of the individual. Based on the information you provided, it would appear that Mr. X's farmland qualifies as QFP because of the farming use by Mr. X's father.
In conclusion, if Mr. X realizes a capital gain on the transfer of the farm property to Newco and if the farm property otherwise qualifies as QFP, Mr. X may be entitled to a capital gains deduction under subsection 110.6(2). In addition, Mr. X may be entitled to a principal residence exemption under 40(2)(b) in respect of the portion of the farm property that qualifies as principal residence under the definition in subsection 54 of the Act.
While the above comments are based on the existing legislation, we would mention that the Minister of Finance released draft legislation ("Draft Legislation") on August 31, 2006, in a document titled "Legislative Proposals and Explanatory Notes to Implement Remaining Budget 2006 Income Tax Measures." The Draft Legislation contains provisions, with application to dispositions of property that occur after May 1, 2006, dealing with the conditions that are to be met in order for real property to qualify as QFP. The conditions in the Draft Legislation in their present form do not seem to affect the comments made above as they pertain to the scenario you described.
We trust this information is helpful.
Yours truly,
S. Parnanzone
For Director
Business Incentives and Capital Transactions Section
Business and Partnerships Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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