25 August 2009 Internal T.I. 2009-0310861I7 - 149(1)(l)--Distribution to Members on Winding-Up

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: How are amounts distributed to members of a 149(1)(l) entity upon the winding-up of the entity treated for income tax purposes?

Position: The receipt of funds will be in exchange for the cancellation of the membership and will result in a disposition to the taxpayer. The amount received from the 149(1)(l) entity will be proceeds of disposition. The member will incur either a capital gain or capital loss depending on the adjusted cost base.

Reasons: The definition of "disposition" and "property" in subsection 248(1) of the Act. The definition of "proceeds of disposition" and "adjusted cost base" in section 54 of the Act.

									August 25, 2009

	Edmonton Tax Services Office				HEADQUARTERS	
                                                      Income Tax Rulings Directorate
	Attention:  Richard Kuna				L. Zannese
                                                      (613) 957-2747

									2009-031086

149(1)(l) Entity-Taxation of Amounts Distributed to Members on Winding-Up

This is in response to your email of February 16, 2009, requesting our views on the tax treatment of amounts received by members of a 149(1)(l) entity upon the winding-up of the entity. You advised that you are satisfied that the "XXXXXXXXXX " (the "Association") qualifies as an entity described in paragraph 149(1)(l) of the Income Tax Act (the "Act"). However, based on our review of the information you provided to us on June 29, 2009, it appears that the Association may be a cooperative corporation as that term is defined in subsection 136(2) of the Act. If upon reviewing the facts you determine that this is the case, the comments below would not apply, and you should write to the Charitable and Financial Institutions Section of our Directorate in order to obtain comments specific to this type of entity.

FACTS

An Association was created to XXXXXXXXXX . The members of the Association were the owners of land to which the XXXXXXXXXX was provided. The members signed a contract with the Association and paid a fee to the Association of approximately $XXXXXXXXXX per year.

The Association is in the process of selling its assets (principally XXXXXXXXXX ) to another company. The Association will be distributing the proceeds from the sale of the assets to its members as the Association is winding-up its operations. In addition, the Association has surplus funds that it claims have resulted from annual membership payments that were not needed to maintain the assets. These funds will be returned to the members.

ISSUES

(i) How is the distribution of amounts arising from the sale of the assets of the Association treated for tax purposes in the hands of the members?

(ii) How is the distribution of surplus funds taxed in the hands of the members?

(iii) Is the Association required to issue any information slips to the members?

ANALYSIS

Paragraph 149(1)(l) of the Act exempts from tax a "club, society, or association" if the club, society or association is not a charity, and is organized and operated exclusively for social welfare, civic improvement, pleasure or recreation or for any other purpose except profit. In addition, no part of the income of the club, society or association can be payable or be available to any of its members. For the purposes of determining the amount of income payable or made available to members, income is defined in subsection 149(2) of the Act to not include any capital gains realized by the club, society or association.

It is not clear how the Association is structured. It may be a corporation with or without share capital, or it may be an unincorporated entity. The tax consequences of receiving funds from the Association upon its wind-up will be discussed under each of these methods of organization.

In our view, the Association is transferring assets (i.e., the cash from the sale of its assets), in exchange for cancelling the member's interest in the Association. This transaction appears to meet the definition of "disposition" contained in subsection 248(1) of the Act which includes:

"(a) any transaction or event entitling a taxpayer to proceeds of disposition of the property;

(b) any transaction or event by which,

(i) where the property is a share, bond, debenture, note, certificate, mortgage, hypothecary claim, agreement of sale or similar property, or an interest, or for civil law a right, in it, the property is in whole or in part redeemed or cancelled...."

If the Association is a corporation with share capital, then subsection 84(2) of the Act would apply to this distribution. Subsection 84(2) provides that upon the disposition of a share by a shareholder of a corporation, the amount received up to the amount of the paid up capital of the share is received tax-free; any amount received in excess is a dividend to the shareholder.

The amount of surplus funds that are returned to the members will be included in the member's proceeds of disposition. The fact that some of the proceeds of disposition may be from monthly fees paid by the members that were not used to maintain the Association's property does not matter. All amounts received by a member on account of the member's interest in the Association are proceeds of disposition, unless a provision of the Act deems the amount to be something else (for example, subsection 84(2) can deem part of this amount to be a dividend). Absent a provision of the Act, all amounts received will be proceeds of disposition.

It is important to note that the term "shareholder" is defined in subsection 248(1) of the Act to include "members and any other person entitled to receive a dividend." It is always a question of fact whether a member meets the definition of shareholder. If the Association is a corporation without share capital (discussed below), it is still possible that the members meet the definition of shareholder, as they may have rights and obligations similar to a shareholder and may be entitled to dividends. If this is the case, then subsection 84(2) of the Act could apply to the amount the members receive upon the winding-up of the Association, even if the Association has no share capital.

If the Association is a corporation without share capital, and its members are not shareholders, or if the Association is an unincorporated entity, it is likely that the memberships are capital property to the members. Thus, the disposition of the membership interest would result in either a capital gain or a capital loss depending on the proceeds of disposition and the member's adjusted cost base. The proceeds of disposition would be the total of all amounts paid to the member on account of the cancellation of the membership. The adjusted cost base of a membership would be the original cost paid by the member plus any additions or subtractions to that amount made in accordance with subsection 53(1) and 53(2) of the Act. If the membership was held as personal use property, no capital loss can be recognized on its disposition.

Archived Interpretation Bulletin IT-409, "Winding-Up of a Non Profit Organization" ("IT-409") states that amounts received by members of a corporation without share capital upon the winding-up of the corporation are proceeds of disposition from the disposition of the member's interest. When determining the amount of the adjusted cost base of a membership, only the initial funds paid for the membership are included. If a member pays monthly or yearly dues, these are generally considered to be for "services" the member received and are not added to the adjusted cost base of the membership. It may be that the memberships in the present case had no initiation fee and therefore have an adjusted cost base of nil.

In our view, the winding-up of an unincorporated entity is very similar to the winding-up of a corporation without share capital. A membership in an unincorporated entity meets the definition of property contained in subsection 248(1) of the Act. A transaction in which a payment is made from an unincorporated entity to its member, for the purposes of cancelling the membership, likely qualifies as a disposition for purposes of the Act. The funds received from the unincorporated entity are the members' proceeds of disposition (including any surplus from annual membership payments). The adjusted cost base of the membership is calculated by taking the initial cost of the membership and adding or subtracting amounts in accordance with subsection 53(1) and 53(2) of the Act.

CONCLUSION

In our view, the payment of an amount by the Association to its member upon its winding-up results in the disposition of that member's interest. The amount received by the member is the member's proceeds of disposition. If the Association is a corporation with share capital then subsection 84(2) of the Act may apply. The result would be that the amount received by the member in excess of paid-up capital would be deemed to be a dividend. The Association may elect to have part of this dividend be a capital dividend and exempt from tax (subject to the rules for capital dividend accounts, which may raise timing issues). Any amount remaining would be a taxable dividend to the member.

If the Association is a corporation without share capital whose members are not shareholders, or if it is an unincorporated entity, it appears that the membership interest would be a capital property to the member. The disposition of this capital property would result in either a capital gain or loss depending on the adjusted cost base of the interest. The proceeds of disposition would be equal to the amount paid by the Association as a result of the cancellation of the membership, and would include amounts relating to the sale of the Association's assets and any surplus funds held by the Association. The member's adjusted cost base would be determined in accordance with sections 53 and 54 of the Act. When determining a member's adjusted cost base, only the amount initially paid by a member would be included. Any yearly fees paid by the members would be viewed as fees for services.

With respect to required forms, if the Association is deemed to have paid a dividend, the Association may be required to issue a T5, "Statement of Investment Income" form to its members. We are not aware of any other forms that must be issued by the Association in this situation.

We trust that these comments will be of assistance.

For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency's electronic library. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, they can be provided with the electronic library version, or they may request a severed copy using the Privacy Act criteria, which does not remove client identity. You should make requests for this latter version to Mrs. Jackie Page at (819) 994-2898. A copy will be sent to you for delivery to the client.

Eliza Erskine
A/Manager
Non-Profit Organizations and
Aboriginal Issues
Financial Sector and Exempt Entities Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch