22 July 2008 External T.I. 2008-0277681E5 - Terminal Loss - Cessation of Business

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: Is a terminal loss available in respect of depreciable property upon the cessation of a business?

Position: No. No terminal loss may be claimed until the property is disposed of.

Reasons: The law. Consistent with pp.8 of IT-478R2, pp.6 of IT-172R, and previous positions.

XXXXXXXXXX 							2008-027768
								James Atkinson CGA
(519) 457-4832
July 22, 2008

Dear XXXXXXXXXX :

Re: Terminal Loss - Franchise Agreement - Cessation of Business

This is in response to your fax received May 5, 2008, and our subsequent telephone conversation (Atkinson/XXXXXXXXXX ) on May 27, 2008, concerning the tax treatment of remaining undepreciated capital cost of a franchise upon the cessation of a business.

Our understanding of the facts is as follows:

1. An individual (taxpayer) entered into a franchise agreement in XXXXXXXXXX to operate a business in the food service industry as a sole proprietorship.

2. The franchise agreement (the "Agreement") was for a term of XXXXXXXXXX years, beginning in XXXXXXXXXX and ending in XXXXXXXXXX .

3. The cost incurred in respect of the acquisition of the franchise (i.e., the franchise fee) was capitalized for tax purposes and added to Class 14 for capital cost allowance (CCA) purposes, depreciable over XXXXXXXXXX years, utilizing a straight-line basis. CCA has been claimed in respect of the Class 14 property during the years the business operated.

4. In XXXXXXXXXX business operations were ceased and a buyer for the franchise could not be found.

During our telephone conversation, you expressed uncertainty whether the Agreement was terminated when the business ceased or whether the taxpayer continues to retain the rights pursuant to the Agreement. You requested our opinion on whether a terminal loss may be claimed in respect of the balance of undepreciated capital cost (UCC) of the franchise (i.e., the Class 14 balance) in the year the business ceased.

Our Comments:

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. Although we cannot comment on your specific situation, we are prepared to provide the following general comments, which may be of assistance.

A taxpayer disposing of the remaining property of a class after ceasing a business, in which the property was used, may qualify for a "terminal loss" even though income is no longer earned from the business at the time of the disposition. A terminal loss generally represents the total by which the costs exceed the total of all decreases (usually reflecting the sales proceeds of any property disposed and the total of any CCA claims made) of depreciable property of a prescribed class and is calculated when all the assets in the class are disposed of. Subsection 20(16) of the Income Tax Act (the "Act") provides the authority to claim a "terminal loss" in respect of a taxpayer's depreciable property.

However, if a business is discontinued, the taxpayer is not entitled to claim a terminal loss for the UCC of a particular class of depreciable property that was used in the business unless and until all the assets in the class are disposed of, as explained in paragraph 8 of Interpretation Bulletin 478R2 - Capital Cost Allowance - Recapture and Terminal Loss. This condition is imposed by paragraph 20(16)(b) of the Act, which states that a terminal loss may only be claimed in a particular taxation year where "the taxpayer no longer owns any property in that class", at the end of the particular taxation year.

Furthermore, the taxpayer is not entitled to claim CCA on the property in any subsequent year unless it is used in that year to earn income from a business or property as required for purposes of a deduction under paragraph 20(1)(a) of the Act and subsection 1100(1) of the Income Tax Regulations.

Therefore, a terminal loss may not be claimed merely by the fact that a business has ceased operations. The determination whether or not a terminal loss may be claimed, in the circumstances described, substantially rests upon the determination whether or not the franchise has been disposed of. In the case of the Agreement, formal termination of it by means of cancellation would be considered a disposition. But, where the contract rights under the Agreement remain in effect, even though they may not be currently exercised, it remains that the franchise property has not been disposed of. Based on the facts presented to us, we are unable to determine if there has been a disposition of the franchise property in the situation described. Whether the property has otherwise been disposed of (i.e., the agreement has been cancelled or subsequently transferred to a new franchisee/purchasor) involves a question of fact that must be addressed before a conclusive answer can be given. We do not have sufficient information to comment further at this time.

In accordance with paragraph 22 of Information Circular 70-6R5, the above comments are only an expression of an opinion, and as such should not be construed as an advance income tax ruling, nor are they binding on the CRA.

We trust that these comments will be of assistance.

Yours truly,

S. Parnanzone
For Director
Business and Partnerships Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch