21 May 2014 External T.I. 2014-0528021E5 - Classification of Timber Limits

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: What is the income tax treatment of proceeds of disposition of land with standing timber where the timber is harvested and the land is subsequently disposed of?

Position: The disposition of the timber limit may result in a recapture or capital gain.

Reasons: Application of the law.

XXXXXXXXXX
2014-052802
Boriana Christov
May 21, 2014 (613) 946-5350

Dear XXXXXXXXXX,

Re: Tax Treatment of Disposition of Land Included in Class 15

This is in response to your email of April 15, 2014 concerning the tax treatment of the gain realized on the disposition of land for the purposes of the capital cost allowance (the "CCA") classification under Schedule II of the Income Tax Regulations (the "Regulations").

Written confirmation of the income tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling request as described in Information Circular 70-6R5 dated May 17, 2002 issued by the Canada Revenue Agency. A fee is charged for this service. Although, we are unable to provide any comments with respect to your particular fact situation otherwise than in the form of an advance income tax ruling, the following general comments may be of assistance.

Unless otherwise indicated, all references herein are to the Income Tax Act (footnote 1) (the "Act").

I. YOUR QUESTION

You would like to know the tax treatment of the gain realized on the disposition of land with standing timber where the timber is harvested and the land is subsequently disposed of. In particular, your question concerns the following:

(i) what is the appropriate CCA class for timber limits; and
(ii) how to treat the gain on the disposition of the land, namely whether the gain will result in a recapture or a capital gain.

II OUR COMMENTS

For the purposes of the present inquiry, it is our understanding that the property in question is categorized as a "timber limit" and not as a "timber resource property" as per the definition in subsection 13(21) of the Act. If this is not the case, our answer to your question will differ.

The term "timber limit" is not defined in the Act. Generally a right not categorized as a "timber resource property" will be a timber limit. As well, timber limits are created where the right to cut timber cannot reasonably be regarded as being a right that is renewable or replaceable. Timber limits usually include, among others, the right to cut which arises from the ownership of private land with timber.

A. General Discussion

Generally, a deduction in respect of the capital cost of a timber limit or a right to cut timber from a limit other than a timber resource property is calculated in accordance with Schedule VI of the Regulations and the disposition of such property may result in a capital gain.

A taxpayer may deduct an amount of CCA for timber limits and cutting rights in accordance with paragraph 20(1)(a) and paragraph 1100(1)(e) of the Regulations. The amount that may be claimed is calculated in accordance with Schedule VI of the Regulations. Each timber limit is prescribed to be a separate class by virtue of subsection 1101(3) of the Regulations. The value of land acquired as part of a timber limit is included in the capital cost. Moreover, the land is not considered to be a separate property.

As indicated in paragraph 5 of Interpretation Bulletin IT-481 (Consolidated) (Archived), the sale of a timber limit or cutting right, unlike the sale of a timber resource property, may, depending on all of the facts, result in a capital gain where the proceeds of disposition exceed the capital cost of the property. Paragraph 39(1)(a) does not exclude timber limits from capital gains treatment as it does timber resource properties. A capital gain will not result if the facts indicate that the sale transaction is on income account.

Accordingly, the proceeds received from the disposition of such land (up to the capital cost of the whole property) must be credited to the class and will result in a recapture of CCA if the credit results in a negative balance of the undepreciated capital cost ("UCC") of the timber limit. Any excess over the capital cost of the property will be reported as a capital gain under subsection 39(1) of the Act.

The calculation for CCA is an aggregate of 1/10 of certain amounts expended plus a pro-rated amount based on the volume of wood cut in a year divided by the total volume available multiplied by the capital cost of the timber.

For this calculation, the residual value of the land is deducted from the total cost of the timber limit. The residual value means the estimated value of the property if the merchantable timber were removed. The amount of the allowance is limited by the available UCC. A formulaic description would be:

Rate = (capital cost of timber limit - residual value of land)/
Total volume available to cut

1. The volume cut in a year would be multiplied by the above rate and 1/10 of the cost of surveying, cruises, etc. could be taken in addition; or
2. Rather than deduct an amount based on the calculation, a taxpayer can choose to deduct the lesser of $100 and the amount of his or her timber sales in a year.

In comparison, Class 15 is generally used for "immovable wood assets." (footnote 2) These are assets acquired for the purpose of cutting and removing merchantable timber from a timber limit in a situation where the property will be of no further use to the taxpayer after all merchantable timber has been removed from the limit. Common examples of such assets include: camp and depot buildings (including water, sewer and electrical systems), roads, bridges, canals, culverts, railway track and grading, dams, telephone lines, fire protection towers, docks and wharves for loading logs and for loading or unloading supplies, and flumes and chutes. Vessels located in land-locked waters, in circumstances where they cannot be removed or sold, are also considered to be assets of this kind.

By virtue of paragraph 1100(1)(f) of the Regulations and Schedule IV to the Regulations, a taxpayer with property in class 15 is entitled to claim CCA based on a rate per cord or board foot of production in the year. If all the property in class 15 was used for the one limit or section thereof, the rate per cord or board foot is determined by dividing the UCC of the property by the number of cords or board feet of timber in the limit or section thereof as at the commencement of the taxation year. Where different parts of the class were used in connection with different timber limits or sections thereof, separate rates are computed for each part of the class as though each part of the class were the taxpayer's only property of that class.

B. Conclusion

Based on the foregoing, the cost of land with standing timber characterized as a timber limit would be more appropriately included in Schedule VI rather than under Class 15 of Schedule IV of the Regulations.

The application of the above rules to your particular inquiry may result in recapture or capital gain at the time of the sale of the timber limit. More precisely, and in accordance with the definition of UCC in subsection 13(21) of the Act, an amount equal to the lesser of the proceeds of disposition and the capital cost of the property will reduce the UCC of the property prior to the disposition and will result in a recapture of CCA where the reduction results in a negative amount of UCC. The recapture has to be fully included in income as per subsection 13(1) of the Act. On the other hand, any excess of the proceeds of disposition of the land over the capital cost of the property will be treated as a capital gain pursuant to subsection 39(1) of the Act.

We trust that these comments will be of assistance.

Yours truly,

Fiona Harrison, CPA, CA
Manager
Resources Section
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs

FOOTNOTES

Note to reader: Because of our system requirements, the footnotes contained in the original document are shown below instead:

1 R.S.C. 1985, c. 1 (5th suppl.) as amended.
2 See Interpretation Bulletin IT-501 – Capital Cost Allowance – Logging Assets (Archived), dated September 4, 1984.