31 March 1993 Income Tax Severed Letter 3M05210-44 - APFF 1992: Question 44—Section 85 rollover

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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department. Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

                     TRANSLATION FROM FRENCH

ASSOCIATION DE PLANIFICATION FISCALE ET FINANCIFERE

                   REVENUE CANADA ROUND TABLE

1992 CONFERENCEASSOCIATION DE PLANIFICATION FISCALE ET FINANCIFERE
                   REVENUE CANADA ROUND TABLE
                          October 1992

Question 44

Section 85 rollover

Section 85 of the Act makes it possible to defer tax on income payable on the transfer of property.

ACo holds real property as capital property. This property has the following tax characteristics:

     -    adjusted cost basis:
               $200,000
     -    mortgage to pay:
               $700,000
     -    fair market value:
               $1,000,000

Mortgage interest is deductible for ACo under paragraph 20(1)(c) of the Act.

ACo wishes to sell the property to BCo which is controlled by the same shareholder as ACo. In order to avoid any tax impact, the parties wish to take advantage of section 85 of the Act. Thus, ACo sells the property to BCo at its fair market value of $1,000,000 and the consideration received is: a mortgage of $200,000 assumed, preferred shares $800,000, total: $1,000,000. In addition, on the sale, BCo agrees to assume a $500,000 mortgage in consideration for the issue of a demand note by ACo to BCo for $500,000.

Immediately after the sale, BCo buys back $500,000 of preferred shares by issuing a $500,000 note to ACo. Later, ACo and BCo respectively cancel the notes receivable held by each, in order to make compensation.

Is the Department of National Revenue of the view that paragraph 85(1)(b) of the Act applies to the situation referred to above? If not, is the Department of National Revenue of the view that this is an avoidance transaction within the meaning of subsection 245(2) of the Act? If yes, does the Department of National Revenue think that this series of transactions results directly or indirectly in an abuse in the application of the provisions of the Act, read as a whole, within the meaning of subsection 245(2) of the Act?

Can BCo continue to deduct interest on the portion of the $500,000 mortgage which corresponds to the debt assumed in consideration of the demand note by ACo to BCo?

Department of National Revenue response

The Department has already answered your first question in stating that paragraph 85(1)(b) of the Act did not apply when the portion of the mortgage in excess of the sum agreed upon was assumed by the purchaser in consideration for the issue by the vendor of a demand note for the amount of the said excess.

However, this administrative position is currently being questioned by the Department and is being analyzed more thoroughly.

Also, if the property is used by BCo to earn income, the Department considers that the mortgage is an amount paid to acquire a property in order to earn income and that the interest on this mortgage is deductible in calculating the income of BCo provided that the other conditions of paragraph 20(1)(c) of the Act are met.