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: (1) Can leasehold improvements acquired to replace a former business property: namely a building, be considered replacement property? (2) If so, if a leasehold improvement is still under construction at the end of the first taxation year following the initial year can it be considered replacement property? (3) Where corporations are running the business through a joint venture, that is not a partnership at law, which taxation year is relevant in applying the replacement property rules?
Position: (1) Yes. (2) Only that portion of it that is being used for the same or similar use as the former business property. (3) Each corporation's taxation year is relevant for their portion of the replacement property.
Reasons: (1) Leasehold improvements are considered to be depreciable property pursuant to subsection 1100(1)(b) of the Regulations. (2) Subsections 13(4), 13(4.1), 44(1) and 44(5) require, among other things, that the capital property was acquired and used in the business before the end of the first taxation year following the initial year to qualify as replacement property. (3) The replacement property rules apply to the taxpayer and the joint venture is not a taxpayer.
XXXXXXXXXX 2005-015617
S. Lewis
July 31, 2006
Dear XXXXXXXXXX:
This is in reply to your letter dated October 25, 2005, and emails dated February 14, 2006, and February 15, 2006, wherein you requested a technical interpretation as to whether leasehold improvements made by a joint venture to space leased in a complex can qualify as replacement property pursuant to subsection 13(4.1) of the Income Tax Act, R.S.C. 1985 (5th Supp.), c.1, as amended (the "Act"). You have also inquired whether the deadline for the acquisition of a replacement property would be determined with reference to a joint venture's fiscal year-end or each venturer's taxation year-end.
We have the following understanding of the hypothetical facts:
1. A number of corporations formed a joint venture for the purpose of carrying on the business of a pub on premises, comprising land and building, ("Old Premises") owned by them.
2. The corporations each have a fiscal year-end of January 31 while the joint venture has a fiscal year year-end of June 30.
3. A developer purchased the land and building that housed the pub before January 31, 2006.
4. The joint venture has obtained from the developer a long-term lease in a new complex in order to run a pub.
5. Under the lease the joint venture will be responsible for the leasehold improvements.
6. This new complex may not be completed by January 31, 2007 and, if it is completed by that date, the leasehold improvements might not be completed before January 31, 2007.
You have identified the following issues:
1. Do the leasehold improvements constitute replacement property for the building part of the Old Premises?
2. Is it the fiscal year of the joint venture or of each member corporation that is relevant in determining the deadline by which the replacement property must be acquired?
3. If the leasehold improvements have not been completed by the deadline for the acquisition of a replacement property for the Old Premises on the assumption that the leasehold interest costs otherwise qualified as such property, will the construction costs incurred before the cut off date qualify as replacement property even though the business of the new pub has not commenced by that date?
Hereinafter all references to the "Regulations" are references the Income Tax Regulations.
The situation outlined in your letter appears to relate to a factual one, involving a specific taxpayer. It is not this Directorate's practice to comment on proposed transactions involving specific taxpayers other than in the form of an advanced income tax ruling. For more information about how to obtain a ruling, please refer to Information Circular 70-6R5, "Advanced Income Tax Rulings, dated May 17, 2002. This Information Circular and other CRA publications can be accessed on the internet at http://www.cra-arc.gc.ca. Should your situation involve a specific taxpayer and a completed transaction, you should submit all relevant facts and documentation to the appropriate Tax Services Office ("TSO") for their views. A list of TSOs is available on the "Contact Us" page of the CRA website. Although we cannot comment on your specific situation, we are prepared to provide the following general comments, which may be of assistance, regarding the issues you have raised.
Replacement Property
Subsections 13(4), 13(4.1), 44(1) and 44(5) in the Act contain the replacement property rules that are relevant to the aforementioned facts.
Subsection 44(1) provides for a deferral of all or part of a capital gain on the disposition of a property that was immediately before the disposition a former business property when a replacement property is acquired. Similarly, where the former business property is a depreciable property of a prescribed class and is disposed of, subsection 13(4) provides for the deferral of all or part of the recapture of capital cost allowance ("CCA") where a replacement property is acquired. The deadline for the acquisition of a property as a replacement property for a former business property is the end of the year following the year of disposition of the former property.
A "former business property" is defined in subsection 248(1) of the Act to mean a capital property that is real property or an interest in real property (excluding a rental property) that was used by the taxpayer, or a related person, primarily for the purpose of gaining income from a business. The Old Premises where the pub business is carried on would qualify as a former business property
The deferral of CCA recapture in respect of a former property that is depreciable property, such as a building, is available under subsection 13(4) if, among other conditions, it is replaced by property that is also depreciable property. Subsection 13(21) of the Act defines "depreciable property" generally, as a property that was acquired by the taxpayer and in respect of which the taxpayer has been allowed (or would have been allowed if the taxpayer owned the property at the end of the year and the available-for-use rules in subsection 13(26) were not applicable) to a deduction under paragraph 20(1)(a) of the Act. A leasehold interest in respect of a property, to the extent that a capital cost has been incurred in respect of that property, is a depreciable property because CCA is allowed in respect of the capital cost of a leasehold interest pursuant to subsection 1100(1) of the Regulations. In particular, a leasehold interest and its related costs may fall into Class 13 or another Class of Schedule II pursuant to subsection 1102(5) of the Regulations.
A leasehold interest in real property (other than an interest as security for a debt such as a mortgage) is considered an interest in real property, pursuant to subsection 248(4) of the Act. Accordingly, in our view, the capital cost of a leasehold interest in respect of a building may qualify as a replacement property for a building that is a former business property if the definition of replacement property in subsections 13(4.1) and 44(5) is otherwise met. Generally, pursuant to subsections 13(4.1) and 44(5) of the Act, leasehold interest costs (improvements) can be considered replacement property if they are used for the purpose of gaining or producing income, if they are acquired by the taxpayer to replace the former property, and if they are used by that taxpayer (or a related person) in the same or similar business for the same or similar use.
Although leasehold interest costs may qualify as replacement property of a former business property, they must be incurred by the replacement deadline, being the end of the year following the year of disposition of the former property. With reference to the situation you described, the leasehold interest costs that may qualify as replacement property, for the building portion of the Old Premises, would be only those costs that have been incurred by the replacement deadline. In our view, the eligible costs of the improvements or alterations made to the leased space would generally consist of the construction costs incurred (excluding holdbacks) or progress billings received (excluding holdbacks) by the taxpayer by the replacement deadline.
It should also be noted, however, that for the purposes of determining whether a particular property is a replacement property of a former business property, subsections 13(4.1) and 44(5) effectively require that the particular property actually be used by the replacement deadline for the same or similar use as the use to which the former property was put. Thus in the hypothetical fact situation, only the portion, if any, of the leasehold costs that are actually used in the new pub's business before the end of the first taxation year following the year of disposition of the Old Premises can qualify as replacement property. This means that the new pub's business must be carried on by the replacement deadline.
Joint Venture
Subsections 44(1) and 13(4) apply to a taxpayer who disposes of a former business property in a particular taxation year (the "Reference Year") and acquires a replacement property by the end of the first year following the particular taxation year of disposition. In the case of a joint venture, the Reference Year to be used in determining the deadline for the acquisition of the replacement property depends on whether or not the joint venture is a partnership at law. Whether or not a joint venture is a partnership is a question of fact. The meaning of partnership is discussed in Interpretation Bulletin IT-90, What is a Partnership? If the joint venture is not a partnership at law, the Reference Year that is relevant, in determining the period within which the replacement property must be acquired, is each joint venturer's taxation year.
If the joint venture is a partnership, the Reference Year is the partnership's fiscal period. For further details, see paragraph 23 of Interpretation Bulletin IT-259R4, Exchanges of Property.
We trust that the foregoing comments are of assistance
Yours truly,
S. Parnanzone
For Director
Business and Partnerships Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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