21 December 1993 Income Tax Severed Letter 9319777 - Deemed Acquisition of Previously Unrecognized Goodwill

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.

                                         December 21, 1993

  Toronto District Office                Head Office
  Business Enquiries                     Rulings Directorate
                                         (613) 957-8953
  Attention: Philip Keirstead
                                         931977

Relationship between Subsection 149(10) and Paragraph 14(5)(b)

We are writing in response to your letter of July 14, 1993, wherein you requested our opinion as to the appropriateness of a taxpayer claiming to have made or incurred an outlay or expense in respect of an eligible capital expenditure within the meaning of paragraph 14(5)(b) of the Act as a result of the application of the deeming provision of subsection 149(10) of the Act which applied to a corporation upon losing its exempt status. You question whether the taxpayer should be able to consider goodwill not previously recognized in the corporation's financial statements as property owned by it immediately prior to its loss of exempt status which subsection 149(10) would deem it to have disposed of and immediately reacquired.

Facts

XXXXXXXXXX

Our opinion

In order for XXXXXXXXXX to succeed, it must first establish that the unrecorded goodwill was property owned by it prior to the change in status which subsection 149(10) deemed it to have disposed of and reacquired at fair market value.

The following definitions are relevant to the issue:

"Property" is defined in subsection 248(1) to mean "property of any kind whatever whether real or personal or corporeal or incorporeal...".

"Eligible capital property" ("ecp") is defined in subsection 54(d) to mean "any property, a part of the consideration for the disposition of which would, if he disposed of the property, be an eligible capital amount in respect of a business".

"Eligible capital amount" ("eca") is defined in subsection 14(1) of the Act to mean "an amount determined in respect of a business of a taxpayer under subparagraph (5)(a)(iv)". Subparagraph 14(5)(a)(iv) reads "the aggregate of all amounts each of which is 3/4 of the amount, if any, by which (A) an amount which, as a result of a disposition occurring after the taxpayer's adjustment time and before that time, he has or may become entitled to receive, in respect of the business carried on by or formerly carried on by him where the consideration given by him therefor was such that, if any payment had been made by him after 1971 for that consideration, the payment would have been an eligible capital expenditure of the taxpayer in respect of the business exceeds (B) all outlays and expenses to the extent that they were not otherwise deductible in computing the taxpayer's income and were made or incurred by him for the purpose of giving that consideration".

This definition of eca provides that a disposition by XXXXXXXXXX of its unrecorded goodwill, while not something which it had acquired by way of purchase or acquisition, nevertheless results in the receipt of an amount which must be included in the calculation required by subsection 14(1) of the Act.

Once determined that the unrecorded goodwill, if disposed of by XXXXXXXXXX would result in the receipt of an eca, such unrecorded goodwill then falls within the definition of ecp.

Since the definition of ecp assumes as a starting point that all items which fall within it are "any property", then the result is that the unrecorded goodwill is property within the definition in subsection 248(1) of the Act, which definition is applicable to subsection 149(10) of the Act.

XXXXXXXXXX was therefore deemed by subsection 149(10) to have disposed of and immediately reacquired its goodwill at a cost equal to the fair market value.

While a determination that the amount in dispute was property owned by XXXXXXXXXX at the time of losing its status may resolve the issue in respect of the cost at which the 'for-profit' XXXXXXXXXX will have acquired the goodwill, no part of the amount, being capital in nature, will be deductible under the Act unless it falls within the definition of "eligible capital expenditure" ("ece") found in paragraph 14(5)(b) of the Act.

That definition requires, amongst other things, that the amount be (1) an outlay or expense made or incurred by the taxpayer, (2) as a result of a transaction, and (3) for the purpose of gaining or producing income from the business.

With respect to the first condition, while it is arguable that a deemed reacquisition does not fall within the definition of an outlay or expense because no actual transaction takes place, we believe the stronger view to be that such a deeming provision, by definition, does not require an actual transaction but instead dictates that one treat an event, for the purposes of the Income Tax Act, as though it had occurred notwithstanding the absence of an actual outlay or expense.

The issue of what constitutes a transaction has been considered on several occasions by the courts, but never, it seems, in the context of a deeming provision. In M.N.R. v. Granite Bay Timber Co. Ltd., 58 DTC 1066 (Ex.Ct.), affd. without written reasons in 59 DTC 1262 (S.C.C.), Mr. Justice Thurlow had occasion to consider the term transaction and concluded that the word was "wide enough to embrace all types of voluntary processes or acts by which property of one person may become vested in another without regard for the reason for such processes or acts and regardless also of whether the process is undertaken or the act is done for consideration in whole or in part or for no consideration at all. It may not be wide enough to embrace a transmission or devolution upon death...".

In Boardman et al. v. The Queen, 85 DTC 5628 (F.C.T.D.), Mr. Justice Strayer was faced with whether certain events constituted transactions within the meaning of subsection 245(2) of the Act. The plaintiff, Mr. Boardman, was a shareholder of a corporation which owned two houses. As part of the divorce proceedings between Mr. Boardman and his spouse, the Court ordered the Registrar of Land Titles to convey to the spouse the two houses owned by the corporation. Mr. Justice Strayer held that on the facts there was a transfer, but stated his conclusion was due to the very broad wording used in the section. He wrote:

"The test in this subsection is cast very broadly to cover any 'sales, exchanges, declarations of trust, or other transactions of any kind whatever...' which confer a benefit on a taxpayer. It was said by Jackett P. in M.N.R. v. Dufresne,(1967), 67 DTC 5105 at 5110 (Ex. Ct.) that the word 'transaction ... is used in the widest possible sense as meaning any act having operative effect in relation to a business or property...'. While the vesting by court order of a company's property in the hands of the former wife would not, perhaps, in the narrow sense of the term, be considered a 'transaction' I am satisfied that the term as used in subsection 245(2) is broad enough to cover this situation."

While these cases could be used to argue that the mere application of subsection 149(10) of the Act does not constitute a transaction in the narrow sense, the better view, much as stated above, is that one must treat such deemed transactions as actual transactions. The argument that Parliament, had it wished to treat deemed reacquisitions as transactions, could have used the broader language "transactions of any kind whatever" sidesteps what it is that a deeming provision does, which is to fictionalize for the purposes of the Act that something has happened which we know in fact has not.

Once one uses as a starting point that a deemed reacquisition constitutes an actual purchase of goodwill, then the third test is easily met since the Department is not suggesting that the goodwill, had it been acquired in the normal manner, is not related to XXXXXXXXXX business and the earning of income.

Though the effect of the deeming provision is that a taxpayer is entitled to deductions in respect of goodwill in circumstances in which no funds were actually disbursed, we should point out that the application of subsection 149(10) in the opposite situation (that is to say when a for-profit corporation becomes a non-profit corporation) could result in the taxability of eligible capital amounts upon a deemed disposition of goodwill, notwithstanding that no amount of cash is actually received by the corporation upon the change of status.

Finally, we have considered your argument that Parliament could not have contemplated that a taxpayer be entitled to a deduction in respect of previously unrecognized and unpurchased goodwill since, in enacting paragraph 149(10)(c) of the Act, it articulated the policy that the cost base of depreciable property be limited to the actual cost notwithstanding an increase in fair market value. While the argument has merit, we believe the better view is that the absence of a subsection specifically prohibiting the deduction in situations such as the one under review suggests an intention to have the general rules apply which, in the context of eligible capital expenditures, result only in a limited deduction.

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