28 July 1993 External T.I. 9300315 F - Mandatory Inventory Adjustment

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.

XXXXXXXXXX

Attention:  XXXXXXXXXX

Dear Sirs:

RE:  Subsections 85(1)(c.2) and 28(1)(c) of the Income Tax Act (the "Act")

Your letter of December 10, 1992 which was addressed to the Calgary District Taxation Office has been forwarded to us for reply. In that letter you requested the Department's view on your interpretation of subsection 85(1)(c.2) of the Act with respect to a situation involving the sale of certain eligible capital property ("quota") and livestock inventory ("cattle") by a taxpayer to a corporation pursuant to subsection 85(1) of the Act. We apologize for the delay in responding.

The situation outlined in your letter assumes the following:

(d)     the taxpayer carries on a farming business immediately before the transfer of the quota and cattle to the corporation;

(e)     the taxpayer uses the cash method of reporting income and has included, under subsection 28(1)(c) of the Act, an amount of $100,000 in computing his farming income for the last fiscal year ended before the transfer;

(f)     the transfer is made one day after the end of that fiscal year;

(g)     the fair market value of the cattle exceeds $100,000 on the date of the transfer; and

(h)     the agreed amount in respect of the transferred quota in the subsection 85(1) election is such that the transfer of such quota would result in an amount of $100,000 to be included in computing the taxpayer's income under subparagraph 14(1)(a)(iv) of the Act.

Your interpretation of subsection 85(1)(c.2) of the Act leads to different tax consequences depending on whether the sale of the quota and cattle takes place at the same time or whether the sale of the quota occurs before the sale of the cattle. It is your opinion that if the transfer of the quota and cattle occurs at the same time, the taxpayer would have to include $100,000 in his income in the taxation year in which the sale takes place, as follows:

Income from the sale of the quota pursuant to subparagraph 14(1)(a)(iv) of the Act $100,000 Proceeds of disposition of the cattle pursuant to paragraph 85(1)(c.2) of the Act 100,000 Deduction under paragraph 28(1)(f) of the Act (100,000)

Amount to be included in income $100,000

If the sale of the quota occurs before the sale of the cattle, it is your view that the taxpayer would not be required to include any amount in his income for the year of sale because the agreed amount in respect of the cattle in the subsection 85(1) election could be the cost amount of the cattle which is nil. This is because A in the formula set out in subparagraph 85(1)(c.2)(i) is defined as "the amount that would be included by reason of paragraph 28(1)(c) in computing the taxpayer's income for the taxpayer's last taxation year commencing before the particular time if that year had ended immediately before the particular time". Since the sale of the quota would occur before the transfer of the cattle, it is your view that the paragraph 28(1)(f) deduction of $100,000 would be totally offset by the income of $100,000 from the sale of the quota and, consequently, no loss would be incurred for the purposes of paragraph 28(1)(c) of the Act. Therefore, the amount to be included in A of the formula in subparagraph 85(1)(c.2)(i) would be nil, unless the taxpayer and the corporation chose to designate some amount in respect thereof.

Provided that the facts of a given situation establish that the transfer of the quota occurs separate from and before the transfer of the cattle, we would agree with your analysis as described above. As stated in Clause 15 of the Explanatory Notes to Legislation relating to Income Tax, dated June 29, 1988, the mandatory inventory adjustment under paragraph 28(1)(c) of the Act will apply only in a loss year. Because of the income generated from the sale of the quota, the taxpayer would not incur any loss in the year which is deemed, for the purpose of determining the elected amount, to end immediately before the transfer of the cattle. Consequently, the provisions of paragraph 28(1)(c) of the Act would not apply. The purpose of subparagraph 85(1)(c.2)(i) of the Act, as stated in Clause 64 of the Explanatory Notes to Legislation relating to Income Tax, dated May 28, 1991, is, in part, to prevent the transfer of purchased inventory by a taxpayer to a corporation at nil cost in order to avoid the application of the mandatory inventory adjustment under paragraph 28(1)(c) of the Act. Since no loss will be realized for the taxation year in which the transfer is to be made, the transfer of the cattle under subsection 85(1) of the Act could not be said to be made to avoid the mandatory inventory adjustment under paragraph 28(1)(c) of the Act.

As to the question of whether two T2057 election forms should be filed, Form T2057 requires that the date of the transfer be noted on the form and indicates that if properties were transferred on different dates, separate election forms should be filed. Therefore, there is no requirement to file separate election forms if the transfers are made on the same date. However, in order to avoid unnecessary misunderstanding as to the timing of the transfers, it may be advisable to use a separate T2057 election form for each transfer and indicate the time of the transfer on each form.

The above comments represent our general view with respect to the subject matter of your letter. These comments do not constitute an advance income tax ruling and therefore, as described in paragraph 21 of Information Circular 70-6R2, are not binding on the Department.

Yours truly,

for DirectorReorganizations and Foreign DivisionRulings DirectorateLegislative and Intergovernmental Affairs Branch