8 October 1992 Income Tax Severed Letter 920970A - Fresh Start Rule

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.

920970
24(1) T.B. Kuss
(613) 957-2117

Attention: 19(1)

October 8, 1992

Dear Sirs:

Re: Canada - U.S. Income Tax Convention
Article XIII, Paragraph 9

This is in reply to your letter dated March 27, 1992 requesting a technical interpretation regarding the application of Article XIII, paragraph 9 of the Canada - U.S. Income Tax Convention (the "U.S. Convention") to the following hypothetical situation.

• 1. In 1974 Mr. A, a U.S. citizen and resident, acquired a Canadian rental property for $150,000. Of that amount, $50,000 was for the land and $100,000 was for the building. Mr. A held the property and continued to be a U.S. resident until his death in 1990.

Document Disclosed Pursuant to The Access To Information Act Document Divulgué en vertu de la loi sur l'accès à l'information

• 2. On January 1, 1985 the property was appraised at $300,000. Of that amount, $100,000 was for the land and $200,000 was for the building.
• 3. At the time Mr. A died, the land and building each had a fair market value equal to its January 1, 1985 fair market value. The undepreciated capital cost of the building at the time of death was $60,000. The rental property was bequeathed to Mrs. A who is Mr. A's wife. Mrs. A is a U.S. citizen and resident.
• 4. Mrs. A then sells the rental property for fair market value consideration of $100,000 for the land and $200,000 for the building.

Analysis and Discussion

On Mr. A's death, paragraphs 70(5)(a) and (b) operate to deem Mr. A to have received proceeds of disposition of $100,000 for the land and $130,000 for the building, respectively. Absent any treaty relief Mr. A would have a capital gain on the land of $50,000, recapture on the building of $40,000 and a capital gain on the building of $30,000. If we assume that Mr. A had previously filed a return under section 216 and claimed an amount under paragraph 20(1)(a), the recapture portion of the gain would be included in Mr. A's income pursuant to subsection 216(5), while the taxable capital gain would be included pursuant to subparagraph 115(1)(b)(i). Treaty relief is not available in respect of the recapture. Paragraph 9 of Article XIII of the U.S. Convention (the "Paragraph") should provide relief in respect of the capital gains, however the extent of that relief is unclear. Paraphrasing the midamble of the Paragraph, the amount of the gain which is liable for tax in Canada in accordance with Article XIII shall be reduced by the proportion of the gain attributable on a monthly basis to the period ending on December 31 of the year in which the U.S. Convention enters into force, or such greater portion of the gain as is shown to the satisfaction of the competent authority of Canada to be reasonably attributable to that period.

It is arguable that because the December 31, 1984 value for the property was the same as the value at the date of death it is reasonable to say that the entire gain was attributable to the period ending December 31, 1984 and should therefore be completely exempt. However it is conceivable that the value of the property may have dropped subsequent to December 31, 1984 and then recovered prior to

Document Disclosed Pursuant to The Access To Information Act Document Divulgué en vertu de la loi sur l'accès à l'information

the date of death. If this was the case, we suggest you take this up with the competent authority. Information Circular 71-17R3 provides procedures to be followed when requesting competent authority consideration.

Mrs. A will be deemed to have acquired the land at a cost of $100,000 and the building at a cost of $130,000 pursuant to paragraphs 70(5)(c) and (d) respectively (assuming the building was either in a separate class or was the only asset in the class). Paragraph 70(5)(e) would not have application as the capital cost of the building to Mr. A does not exceed the amount determined under paragraph 70(5)(d).

When Mrs. A sells the land and building she will realize a capital gain on the building of $70,000. In our view, provided the Canadian competent authority was satisfied that the entire gain on the building arose before January 1, 1985, the Paragraph will exempt this gain as we would consider that the building had been acquired by Mrs. A in an alienation of property which qualified as a non-recognition transaction in Canada. Although on Mr. A's death a portion of the gain on the building was exempt from tax in Canada by virtue of the Paragraph, a portion of the "gain" was clearly only deferred through the operation of paragraphs 70(5)(a) and (b) and would therefore be considered a non-recognition transaction.

We hope our comments are of assistance.

Yours truly,

for Director
Reorganizations and Foreign Division
Rulings Directorate
Legislative and Intergovernmental
Affairs Branch

Document Disclosed Pursuant to The Access To Information Act Document Divulgué en vertu de la loi sur l'accès à l'information