19 February 1992 Income Tax Severed Letter 9200735 - Capital Gains Reserves

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.

Subject: CAPITAL GAINS RESERVES Section(s): 40(1)(a)(iii), 40(1)(a)(ii)]

920073
C. Tremblay
(613)952-1361

XXX

February 19, 1992

Dear Sirs:

Re: Capital Gains Reserve

This is in reply to your letter of January 6, 1992, requesting a technical interpretation of subparagraph 40(1)(a)(iii) of the Income Tax Act (the "Act"). You wish us to confirm that a taxpayer who sells land to another taxpayer can continue to claim a capital gain reserve in respect of a debt arising from the sale which is due in the taxation year, where by virtue of an amendment to the terms of the debt in that year, the maturity date is extended to a subsequent taxation year. You also request that we confirm that if the security for the debt is replaced by security of the same type that the vendor can continue to claim a capital gain reserve.

You gave hypothetical situations involving the extension of the maturity date of a mortgage, the replacement of the mortgage security, and the amendment of the repayment schedule.

The situations that are described appear to involve a series of actual proposed transactions. It is not the Department's practice to give written opinions concerning proposed transactions, as indicated in Information Circular 70-6R.

Should you wish to request an advance ruling on these or other transactions which may be proposed, please refer to Information Circular 70-6R for the procedure to be followed. Although we are unable to provide any opinion in respect of the specific transactions described in your letter, we have set out some general comments which may be of some assistance.

Our Comments

The Department's position with respect to reserves arising from the disposition of capital property is contained in Interpretation Bulletin IT-236R3. Comments in this regard are also contained in IT-436R Reserves-Where Promissory Notes are Included in Disposal Proceeds. This bulletin may also apply where a mortgage is accepted by the vendor as part of the sales proceeds. Former IT-436 contains comments in paragraphs 9 & 10 which, although not included in IT-436R due to the introduction of new 5 year time limit restrictions, are still considered relevant in some situations. In essence the former bulletin states that there are situations where a vendor who has taken back a promissory note (mortgage) may, in conjunction with the person who acquired the property, agree to extend the original due date of the note (mortgage). The extension may occur before the original due date or even after the original due date but before the end of the vendor's taxation year for which the reserve is being considered. In these and similar situations the Department's practise is to permit a vendor to continue claiming a reserve if the debt instrument, originally taken back on a disposition is extended within the time limits indicated and the renewed instrument (as conditional payment) is accepted as a continuing evidence of the original debt.

Providing that the other requirements of paragraph 40(1)(a) of the Act are met the taxpayer would be able to claim a reserve in the year for the portion of proceeds that are not due.

Whether the re-negotiated note would be considered to be accepted as "conditional payment" rather than as "absolute payment" is a question of fact. Generally a change from an interest-bearing to interest-free note would precipitate a disposition (see paragraph 7, Interpretation Bulletin IT-448). However, where a promissory note comes due or is considered disposed of during the year and then is re-negotiated before the end of that year, even with changes to the original terms of that note, we are of the view that the renegotiated note may be accepted only as conditional payment of the unpaid balance of the original note such that the holder of the note retains his legal recourse with respect to the original note and the original proceeds of disposition. This position is set out in paragraphs 9, 10 and 11 of former IT-436.

The Department's position with respect to the acceptance of promissory notes and reserves under subparagraph 40(1)(a)(iii) is contained in IT-436R. Paragraph 3 of the Bulletin states, with regard to "conditional payment", that "Normally the Department will assume that the promissory note is received as conditional payment unless the sales agreement clearly indicates that the note has been accepted as absolute payment". Thus, it would appear, unless there is evidence to the contrary, that a re-negotiated note may be considered to be accepted as conditional payment and not as absolute payment.

Where a purchaser and a vendor have agreed to substitute security for the loan which would not change the loan payable or the terms of the repayment we are of the opinion that the taxpayer would continue to be entitled to a reserve under paragraph 40(1)(a)(iii) since the mere substitution of security does not constitute payment of the debt with the result that the amount is still due. However, as stated in paragraph 4 of IT-436, where a promissory note has been accepted as absolute payment, no amount is due in respect of the disposition since the debt is considered to have been paid or satisfied by the receipt of the promissory note, and therefore no reserve is available.

We trust our comments will prove helpful, however, please note that the above comments are an only an expression of our opinion based on the limited information provided. As such they are not an advance income tax ruling and our reply could very well change based on an actual review of all the facts of a particular case.

Yours truly,

for Director
Business and General Division
Rulings Directorate
Legislative and Intergovernmental
Affairs Branch