13 January 1984 Income Tax Severed Letter 7-2848 - Deferral of tax on capital gains

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.

Dear XXX

This is in reply to your memorandum of September 21, 1983, concerning the deferral of tax on capital gains provided by section 44 of the Income Tax Act (the “Act”). This also confirms our telephone and written communications relating to this matter and in particular the clarification that you require only an opinion as to whether subsection 245(1) of the Act applies to the situation described below.

XXX

7. Where a taxpayer elects under subsection 44(1) of the Act, the gain from the disposition of the former property (assuming no reserve) is the lesser of two amounts, which are calculated under clause 44(1)(e)(i)(A) (proceeds less adjusted cost base) and clause 44(1)(e)(i)(B) (proceeds less cost of replacement property). You wish to apply subsection 245(1) of the Act to prevent the taxpayer from deducting the cost of the properties in 5 above in computing the amount under clause 44(1)(e)(i)(B) thereby compelling him to compute a bigger gain under clause 44(1)(E)(i)(A). In your view, the acquisition from the Company of the properties in issue was:
• (a) solely tax motivated (implying a lack of business purpose) directed at taking advantage of the elction under subsection 44(1) and/or
• (b) was an artificial transaction.

Our comments

In our view subsection 245(1) is not applicable in your case because it deals with a reduction of income rather than capital gains. The provision states that “in computing income ... no deduction may be made in respect of a disbursement or expense ... that ... would unduly or artificially reduce the income”. While a taxable capital gain is part of the income of a taxpayer by virtue of paragraph 3(b) of the Act, paragraph 44(1)(e) is concerned only with the computation of the gain (half of which is a taxable capital gain pursuant to section 38 of the Act). Where a transaction artificially or unduly reduces a capital gain, the reduction could be ignored by applying subsection 55(1), a provision relevant for purposes of subdivision C (capital gains) of the Act. However, in our opinion, subsection 55(1) of the Act should not be applied in the circumstances described because existing Jurisprudence indicates that the courts would not apply a tax avoidance provision to a transaction which was influenced and encouraged by a specific section of the Act provided it was correctly implemented in form. This is illustrated by the jurisprudence involving subsection 245(1) (there are no cases dealing with subsection 55(1)) in which the courts have distinguished the meaning of “unduly” and “artificially” from that of “fictitions” or “sham” and also considered the policy intention underlying the tax provisions allegedly being abused by taxpayers and under review by the courts.

In Shulman v. M.N.R. [[1961] C.T.C. 385] (61DTC 1213), the Courts interpreted “unduly” as relating to quantum and meaning “excessively” or “unreasonably”. The Court found that “artificially” means “unnatural” as opposed to “natural” or “not in accordance with normality”. In Seramco v. I.T.C. 1976 2 All E.R. 28 (PC), the english court held that “artificial” had a meaning different from “fictitious”, a fictitious transaction being one where those who are ostensibly parties to it never intend that the transaction should be carried out. The english court also stated that “artificial ... is ... a word of wider import”, however, “it is neither necessary nor wise for a court of construction to attempt to lay down in substitution for it, some parapharse which would be of general application to all cases ...”.

In addition to the meanings of the words “artificially” and “unduly”, the courts have also considered the government's policy intent underlying the tax provisions allegedly being abused. While the courts have struck down transactions purely tax motivated, in Produits LDG Products Inc. v. The Queen [[1976] C.T.C. 591] 76 DTC 634, the court commented:

• “There is nothing reprehensible in seeking to take advantage of a benefit allowed by the law. If a taxpayer has made an expenditure which, according to the Act, he may deduct when calculating his income, I do not see how the reason which prompted him to act can in itself make this expenditure non-deductible.” (pg. 6349)

In Alberta and Southern Gas [[1978] C.T.C. 780] (78 DTC 6566) the Supreme Court of Canada affirmed the decision of the Federal court - Appeal Division [[1977] C.T.C. 388] (77 DTC 5244) refusing to apply subsection 245(1) to a transaction, predominantly motivated by the saving of tax and involving the acquisition and, consequently, the deduction, pursuant to section 66, of the cost of an interest in a resource property. In this case, the Court reviewed the sections dealing with the cost of resource properties and the deduction allowed in section 66, and found that these provisions have the obvious purpose of encouraging the taxpayer to put money into resource properties. Given such incentive legislation, the Court concluded that a transaction that clearly falls within such object and spirit cannot be said to reduce income unduly or artificially merely because the taxpayer was influenced by tax considerations.

The conclusion which we draw from the above is that, since the cost of replacement property is made relevant in the computation of the gains of a former property by paragraph 44(1)(e) of the Act, it would be difficult to support the argument that such cost “unduly” or “artificially” reduces the gain (or income) pursuant to subsection 55(1) (or section 245(1)) of the Act.

While in our view, subsection 55(1) and 245(1) are not applicable in the situation at hand, you may wish to give consideration as too whether or not the properties acquired by the taxpayer meet the definition of replacement property in subsection 44(5) of the Act. While the intention (e.g. intended use vs. actual use) of the taxpayer is incorporated into this definition, said intention must be ascertained objectively and is usually explicated by the taxpayer's actions and not solely by his verbal explanations. In this respect the comments in paragraph 10 of Interpretation Bulletin IT-147R might be of assistance.