29 March 1996 External T.I. 9600785 - FORFEITED DEPOSIT

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.

L. Barrows
XXXXXXXXXX							960078

Attention: XXXXXXXXXX

March 29, 1996

Dear XXXXXXXXXX:

Re: Forfeited Deposit

This is in reply to your letter of December 27, 1995 in which you requested our views on the tax treatment of a forfeited deposit. We apologize for the delay in our response.

You described a situation in which taxpayers who have owned a parcel of land for over 40 years made application, in 1989, for a plan of subdivision. Previously, the land was farmed. In 1995, the owners received an Offer to Purchase on the land and a non-refundable deposit of $200,000. This deposit was forfeited when the prospective purchaser was unable to complete the transaction on the closing date.

We should advise that written confirmation of the tax implications inherent in a particular fact situation is only given by this Directorate when there is a proposed transaction which is the subject matter of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R2. In addition, where the particular transactions are completed, the enquiry should be addressed to the relevant Tax Services Office. However, in response to your request, we can provide the following general comments which are not binding on the Department.

Our Comments

You make reference to paragraph 3 of IT-461 which discusses the tax treatment of a forfeited deposit from a purchaser's prospective. Paragraph 8 of IT-334R2 (copy enclosed) discusses the tax treatment of a forfeited deposit by a vendor. It states that "a taxpayer entitled to retain a deposit upon the cancellation of a contract may realize a capital gain on the forfeiture where the taxpayer's rights under the contract are capital in nature. However, if the rights disposed of under the contract are of an income nature, the amount forfeited will be ordinary income to the taxpayer".

IT-218R (copy enclosed) discusses profit, capital gains and losses from the sale of real estate, including farmland and inherited land and the conversion of real estate from capital property to inventory and vice versa. Paragraph 12 of this bulletin states that "vacant land that is a capital property used to produce income will be considered to have been converted to inventory at the earlier of

(a) the time when the owner commences or causes the commencement of improvements thereto with a view to selling it, and

(b) the time of making application to the relevant authority for approval of a plan to subdivide the land into lots for sale, provided that the taxpayer proceeds with the development of the subdivision".

In addition, paragraph 24 states that "it is the Department's view that the filing of a subdivision plan and selling lots thereunder does not in itself affect the status of the gain notwithstanding the subdivision may enhance the value of such land. However, where the taxpayer goes beyond the mere subdivision of the land into lots and installs improvements such as watermains, sewers or roads, or carries on an extensive advertising campaign to sell the lots, the taxpayer will be considered to have converted the land from capital property into a trading property."

It would seem that making application to the relevant authority for approval of a plan to subdivide land into lots is only the first of many events in the development of a subdivision. In our view, the mere subdividing of land, in absence of some of the improvements mentioned in paragraph 24 of IT-218R, does not result in the development of a subdivision as required in paragraph 12 of IT-218R.

Whether a property is a capital property at a particular time is a determination of fact to be made based on all of the circumstances at that time. In our view, where a property is a capital property, in the absence of plans to proceed with the development of a subdivision, making application to the relevant authority for approval of a plan to subdivide would not, in and by itself, cause the property to be considered as being converted to inventory. Where this is the case, the entire amount of a forfeited deposit would be considered capital in nature and a capital gain on the forfeiture would be realized in the year received.

On the other hand, if the facts are such that a conversion of the land from a capital property to a trading property has taken place, paragraph 15 of IT-218R would have application. The date of conversion is the relevant date. The taxpayer would have a notional capital gain on the date of conversion which would not be considered to give rise to taxable capital gains until the year in which the lots were actually sold. In addition, an inventory gain on the increase in value of the property between the date of conversion and the date of sale would also be realized at the time of sale. In a situation where the sale transaction is never completed, in our view, a reasonable allocation of the amount forfeited should be made to capital and to income and reported in the year received. This could be accomplished by apportioning the forfeited amount on a prorata basis using fair market value estimates for the land which are applicable at the date of conversion and at the proposed closing date pursuant to the purchase and sale agreement.

We trust these comments will be of assistance.

Yours truly,

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

Enclosures