28 February 1991 Ministerial Correspondence 910144 F - Reserves - Assumption of a Mortgage

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 Sirs:

Re:  Application of Subparagraph 40(1)(a)(iii) of the Income Tax Act (the "Act")

This is in reply to your letter of December 21, 1990, whereby you request our opinion in respect of the application of subparagraph 40(1)(a)(iii) of the Act and to paragraph 6 of Interpretation Bulletin IT-236R2 specifically as those provisions would apply to a reserve where there is an assumption of a mortgage by the purchase.

The hypothetical facts given are as follows:

1.     Vendor sells a property for proceeds of $6.5 million.  The adjusted cost base is $2.5 million.

2.     The payment on closing is $1.9 million.

3.     The purchaser will assume a mortgage of $2.4 million.

4.     The balance of the proceeds is due in 1994.

There were two mortgages originally given on the property by the Vendor and these mortgages have been consolidated by the Vendor into one mortgage to acquire a better rate of interest.  The amount of the original two mortgages and the amount of the new mortgage may be slightly different because of a penalty charged to cancel the original mortgage.

You request our opinion as to whether or not, in the above circumstances, the special calculation as shown in paragraph 6 of It-236R2 would be available.  As stated in that paragraph, where the reserve for proceeds is not due, the assumption of the mortgage will be deducted from the proceeds in the denominator of the formula.

Please note that the Department does not provide opinions pertaining to a proposed transaction otherwise than by way of an advance income tax ruling.  However, we cam provide you with the following general comments.

Our Comments

Generally, the reasonableness of a reserve will be acceptable if in the calculation of the reserve, consideration is given to any mortgages assumed by a buyer in situations where the vendor has previously given a mortgage to a third party either at the time of acquisition of the land or to finance the cost of improvements to the land including construction of a building on the land.  In our view, these mortgages do not constitute a net right of the seller in the property, thus it is generally acceptable to calculate the reserve in accordance to the net right only.  In the situation at hand, we are of the view that the vendor can calculate his reserve according to the special calculation set out in IT-236R2  as long as the deduction does not exceed the lesser of the limits mentioned in subparagraphs 40(1)(a)(iii)(C) and (D) of the Act.  In our view, the word "assumed" in paragraph 6 of IT-236R2 may be interpreted to allow two assumable mortgages which would otherwise qualify for the special calculation, to be consolidated into one mortgage, thus conforming to the intention expressed in IT-236R2.

The above comments are only expressions of opinion on the application of the Income Tax Act to the hypothetical example given and as such should not be construed as advance income tax rulings, nor are they binding on the Department.

We trust our comments will be of assistance.

Yours truly,

for DirectorBusiness and General DivisionRulings DirectorateLegislative and Intergovernmental Affairs Branch