15 November 2012 External T.I. 2012-0462781E5 - Capital gain reserve

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 a taxpayer continue to claim the capital gain reserve if the purchaser resells the property and the new purchaser assumes the existing mortgage.
2. If the non-refundable down payment on a vehicle lease should be amortized over the terms of the lease or claimed as a current expense.

Position: 1. Depends on if the original POD due to the vendor from the original transaction remain payable or are considered paid.
2. If in nature of prepaid expense, it should be amortized

Reasons: Question of fact and law

XXXXXXXXXX
2012-046278
Lata Agarwal

November 15, 2012

Dear XXXXXXXXXX:

Re: Capital gain reserve and prepaid lease expense

This is in response to your correspondence dated September 20, 2012, wherein you requested our views on two hypothetical scenarios briefly described below.

Your first enquiry involves a situation where a corporate vendor ("Vendor"), on disposition of property to a purchaser, has been claiming a capital gain reserve ("reserve") pursuant to subparagraph 40(1)(a)(iii) of the Income Tax Act ("Act"), in regards to the part of its proceeds payable by the purchaser under a mortgage after the end of the year. You requested our views on whether the Vendor would still be entitled to claim the reserve if, subsequently, the purchaser resells the property to an unrelated third party and the Vendor agrees to "transfer" the existing mortgage to the new purchaser.

Your second enquiry involves a situation, where a corporation ("Lessee") makes a $10,000 non-refundable down payment on a 48-month lease for a vehicle in order to reduce the monthly lease payments. The Lessee has the option of returning the vehicle at the end of the lease without any penalty. You requested our views on whether the down payment is deductible as a current expense in the first year of the lease or should be amortized over the term of the lease.

Our Comments

Written confirmations of the tax implications inherent in particular transactions are provided by this Directorate where the transactions are proposed and are the subject matter of an advance income tax ruling submitted in the manner set out in Information Circular 70-6R5, Advance Income Tax Ruling, dated May 17, 2002. This Information Circular and other CRA publications can be accessed on the internet at http://www.cra-arc.gc.ca/formspubs/menu-e.html. Where a particular transaction has already been completed, a review of the relevant facts and circumstances surrounding the situation would be required. Such review would normally be conducted by the applicable Tax Services Office during the course of an income tax audit which, if undertaken, would be carried out after the particular taxpayer has prepared and filed its income tax return for the year. Notwithstanding the foregoing, we are prepared to provide the following comments that may be of assistance.

In response to question 41 at the 1993 Canadian Tax Foundation Roundtable, the CRA commented on a vendor's ability to claim a capital gains reserve where changes were made to the terms of the particular debt obligation subsequent to its issuance. In particular, we stated the following":Pursuant to subparagraph 40(1)(a)(iii), a taxpayer is entitled to a reserve related to proceeds of disposition that are not due until after the end of the taxation year.

If there is extinction of the debt in law, the vendor is considered to have accepted the new debt obligation as "absolute payment" of the old debt obligation and would thus be denied a reserve under subparagraph 40(1)(a)(iii) after that date because there is no longer anything due to the vendor from the purchaser in the original transaction.

On the other hand, if the note or mortgage is modified without being extinguished in law within the time limits set out in subparagraph 40(1)(a)(iii), a reserve will continue to be available to the vendor."

Therefore, in the situation you have described, whether a reserve under subparagraph 40(1)(a)(iii) of the Act would continue to be available to the Vendor could only be determined by undertaking a complete review of the legal and factual relationships that result from any agreements entered into between the parties. However, if the transactions have resulted in the extinguishment of the original debt obligation, no reserve would be available.

With regard to deductibility of leasing expenses, in general, the expenses should first meet the criteria set out in paragraphs 18(1)(a) and (h) of the Act, respectively (i.e., inter alia, the expense should be incurred for the purposes of earning income from business or property and should not be a personal or living expense of the taxpayer). Where a lump sum payment made at the beginning of a lease for a vehicle represents rent in respect of a period that is after the end of the year, subsection 18(9) of the Act would apply, which could have the effect of amortizing the lump sum payment over the period of the lease. Additionally, if the vehicle is a passenger vehicle, section 67.3 of the Act would then be applied to the amount otherwise deductible to compute the lease expense deductible, in each year. The portion of the actual lease charges paid or payable in a year in respect of a vehicle that cannot be deducted in the year pursuant to section 67.3 of the Act cannot be deducted in a subsequent year.

We trust that these comments will be of assistance.

Yours truly,

Michael Cooke
Manager
Business Income and Capital Transaction Section
Business and Employment Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch