19 February 1996 External T.I. 9525185 - CG EXEMPTION - REMAINDER INTEREST

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.

Principal Issues:

Consequences to a taxpayer resulting from the transfer of a remainder interest in a qualified farm property to an unrelated party.

Position TAKEN:

There is an actual disposition of the remainder interest and a deemed disposition of the life estate resulting in a capital gain. Provided the real property is capital property and qualified farm property, any capital gains realized may be offset to the extent of the unused portion of the enhanced capital gain exemption.

Reasons FOR POSITION TAKEN:

Section 43.1 does not deem any disposition or proceeds in respect of the remainder interest, but deems only in respect of the life estate. It is deemed to have been disposed of and reacquired at its fair market value. The disposition of the residual interest is an actual disposition to which paragraph 69(1)(b) applies.

L. Barrows
XXXXXXXXXX 952518

February 19, 1996

Dear XXXXXXXXXX:

Re: Life Estate in Real Property

This is in reply to your letter of September 21, 1995, wherein you requested our comments on the interaction of sections 43.1 and 110.6 of the Income Tax Act (the "Act"). You also requested our comments on the meaning of "not dealing at arm's length" contained in paragraph 43.1(2)(b) thereof.

In the situation you describe, the taxpayer owns real property that meets the definition of "qualified farm property". The taxpayer proposes to gift a remainder interest in this property to an unrelated individual. This unrelated individual is not a child of the taxpayer and, accordingly, subsection 73(3) of the Act will not apply. The taxpayer, who has full access to the $500,000 capital gains exemption, will retain a life estate in the property.

The situation outlined in your letter would appear to relate to a specific, proposed transaction and confirmation of resulting tax consequences will only be provided in response to a request for an advance income tax ruling. The procedures for requesting an advance income tax ruling are outlined in Information Circular 70-6R2. We can, however, offer the following general comments.

Comments

Section 43.1 of the Act deals with the disposition of a remainder interest in real property by a taxpayer who retains the life estate or estate pur autre vie (lasting the lifetime of another person) in the property. Section 43.1 does not deem any disposition or proceeds in respect of the remainder interest to the unrelated individual, but rather deems only in respect of the life estate. Therefore, the transfer of the residual interest to the unrelated individual would be an actual disposition. Since a remainder interest in the real property is gifted to the unrelated individual, there are deemed proceeds of disposition equal to the fair market value of the property transferred pursuant to paragraph 69(1)(b) of the Act.

With respect to the life estate (which in fact was not disposed of), subsection 43.1(1) of the Act deems the taxpayer to have disposed of the life estate for proceeds of disposition equal to its fair market value at that time and to reacquire the life estate after that time at a cost equal to the same fair market value. As a result, when you consider the actual disposition of the remainder interest in conjunction with the deemed disposition of the life estate, a capital gain has resulted in the hands of the taxpayer equal to that which would have resulted had the property been disposed of in its entirety at fair market value. Therefore, provided the real property is capital property and "qualified farm property" of the taxpayer, any capital gains realized from these dispositions may be offset to the extent of the unused portion of the $500,000 capital gains exemption.

If the disposition of the remainder interest in the real property involves depreciable property, it follows that the actual or deemed proceeds of disposition for the purposes of paragraph 13(21)(d) and section 54 under the definition of proceeds of disposition would be credited to the appropriate capital cost allowance class up to the prorata portion of the capital cost of the depreciable asset which was partially disposed of. However, in respect of the life estate, it is our view that the deeming provisions (disposition and reacquisition) of subsection 43.1(1) of the Act do not extend beyond the purview of Subdivision C of the Act captioned, "Taxable Capital Gains and Allowable Losses".

IT-419R, a copy of which is enclosed, discusses the meaning of "arm's length". While the term "arm's length" is not defined in the Act, section 251 refers to two categories of persons: related persons and persons not related to each other ("unrelated persons"). Paragraph 251(1)(a) deems that related persons do not deal with each other at arm's length. This is the case regardless of how they actually conduct their mutual business transactions. This provision further states that individuals connected by blood relationship, marriage or adoption are related persons. Paragraphs 3 through 9 discuss these relationships in more detail.

With regard to unrelated persons, it is a question of fact, at a particular time, whether they are dealing with each other at arm's length. Since each transaction or series of transactions must be examined on its own merits, it is not possible to supply definitive guidelines to cover each situation. However, the following general criteria has been developed and used by the courts in determining if the transaction is arm's length:

- was there a common mind which directs the bargaining for both parties to a transaction;

- were the parties to a transaction acting in concert without separate interests; and

- was there "de facto" control.

Failure to carry out a transaction between unrelated parties at fair market value may be indicative of a non-arm's length transaction, but not conclusive. The key factor is whether there are separate economic interests which reflect ordinary commercial dealing between parties acting in their separate interests. Therefore, while we would agree that the fact the remainder interest was gifted to the unrelated person would warrant consideration in determining whether a non arm's length relationship existed, other factors relative to the circumstances of the particular transaction as discussed above would require equal consideration in making this determination.

We trust these comments will be of assistance to you.

Yours truly,

R. Albert
for Director
Business and General Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch

Enclosure