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Principal Issues: [TaxInterpretations translation] What is the amount to be included in the income of a corporation that disposes of eligible capital property to an arm's length corporation, where the eligible capital property was previously acquired from a corporation not dealing at arm's length with the transferor?
Position: According to the facts presented, $250,000
Reasons: As calculated in subsections 14(5), 14(3) and 14(1) of the Income Tax Act.
FEDERAL TAX ROUNDTABLE
APFF CONFERENCE 2005
Question 2
Disposition of eligible capital property between non-arm's length parties
Opco, a taxable Canadian corporation, carries on an active business in Canada. Opco owns capital property, depreciable property and goodwill. The fair market value of the goodwill is $1,000,000. Opco's cumulative eligible capital ("CEC") is nil, as it has never incurred an eligible capital expenditure (the goodwill was created by Opco). Opco's fiscal period end is December 31.
On December 30, 2003, Opco transferred all of its assets, including the goodwill, to a new taxable Canadian corporation ("Newco"). The proceeds of disposition of the goodwill were $1,000,000. At the time of the transfer, Opco owned 100% of the issued and outstanding shares of the capital stock of Newco.
As a result of the transfer, Opco included in its income for its 2003 taxation year an amount of $500,000 pursuant to paragraph 14(1)(b).
Under element A of the formula in the definition of CEC, as amended by the February 27, 2004 legislative proposals (the "Formula"), the balance in Newco's CEC account as at December 31, 2003 is $500,000. In effect, element A.1 of the Formula reduces Newco's 3/4 of eligible capital expenditures ($750,000) by one-half of the amount required to be included in Opco's income under paragraph 14(1)(b) (1/2 of $500,000).
FIRST QUESTION
On June 1, 2005, Newco disposes of its goodwill to Acquireco, a corporation dealing at arm's length with Opco and Newco, for proceeds of disposition of $1,500,000.
Considering that Newco did not acquire any other ECP during the 2004 and 2005 taxation years and has not amortized any goodwill since its acquisition, what amount does the CRA consider will be required to be included in Newco's income under paragraph 14(1)(b) for its taxation year ended December 31, 2005?
SECOND QUESTION
Assume that the transaction described in the first question did not occur. On June 1, 2005, Acquireco, a taxable Canadian corporation dealing at arm's length with Opco and Newco acquired all of the issued and outstanding shares of Newco held by Opco. As a result of the acquisition of control of Newco, the taxation year of Newco was deemed to end on May 31, 2005. Subsequently, Newco elected for December 31 to be its fiscal period end.
Based on Technical Interpretation 2003-0027245, dated December 16, 2003, the CRA is of the view that Newco should take into account A.1 when computing CEC as at December 31, 2005, notwithstanding the fact that Newco will no longer be dealing at arm's length with Opco at that time.
Considering that the CEC is calculated at a point in time (at the year-end date), does the Department of Finance agree with the CRA's position? If so, what is the underlying tax policy? Why would full depreciation not be allowed after the acquisition of control? Could the same reasoning be applied to paragraph 13(7)(e)?
CRA Response -- First question
Newco's income inclusion for the 2005 taxation year under subsection 14(1) is the sum of the amounts determined under paragraphs 14(1)(a) and 14(1)(b).
On the facts before us, the calculation in paragraph 14(1)(a) is nil since the F element of the definition of CEC is itself nil.
The calculation under paragraph 14(1)(b) is as follows:
2/3 x (A-B-C-D)
The value of item A in the above formula is equal to the excess of items E or F in the CEC definition over the total of the values of items A to D in that definition.
The value of item E in the definition of CEC is equal to 3/4 of the amount by which item (a) exceeds item (b) of item E. Thus, on the facts of this case, paragraph (a) is equal to $1,500,000 (being Newco's proceeds of disposition of the goodwill) while paragraph (b) is equal to 0. Element E is therefore equal to 3/4 of $1,500,000, or $1,125,000. On the facts of this case, Element F is nil.
Taking into account the changes to Element A under the February 27, 2004 legislative proposals (and reissued in July 2005), the value of Elements A to D of the definition of CEC is equal to $750,000 (for the purposes of the calculation, we assume that the total of Elements B to D is nil). There is no reduction under A.1 because Newco disposed of the goodwill acquired from Opco before the end of the year.
Thus, the excess of the total of values (E + F) over the total of values of items (A to D) in the definition of CEC is $375,000.
If we return to paragraph 14(1)(b), in order to determine the amount to be included in Newco's income, we must apply the following formula:
2/3 x (A-B-C-D)
In short, the result of the calculation under this formula is $250,000, which is the amount to be included in Newco's income for the 2005 taxation year.
François Bordeleau
952-1506
October 7, 2005
2005-014089
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