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:
Whether the cost of an eligible capital property transferred to an individual on the dissolution of a partnership, all of the interests in which were held by that individual before the dissolution, can be increased pursuant to paragraph 98(5)(d).
Position:
No.
Reasons:
According to paragraph 98(5)(f), where a partnership ceases to exist and within 3 months after that time a taxpayer who was a member of the partnership continues to carry on alone the business that was the business of the partnership, the proceeds of disposition of property received by the proprietor is deemed to equal the "cost amount" to the partnership.
J. Gibbons
XXXXXXXXXX 5-962566
Attention: XXXXXXXXXX
April 17, 1998
Dear XXXXXXXXXX:
We are replying to your letter of July 25, 1996, requesting our comments on the interaction between subsections 14(3) and 98(5) of the Income Tax Act (the “Act”). More specifically, you inquire whether the cost of an eligible capital property transferred to an individual on the dissolution of a partnership, all the interests in which were held by that individual before the dissolution, can be increased pursuant to paragraph 98(5)(d) of the Act. We apologize for the delay in replying.
Written confirmation of the tax implications inherent in particular transactions are given by this Directorate only where the transactions are proposed and are the subject matter of an advance ruling request submitted in the manner set out in Information Circular 70-6R3. The following comments are, therefore, of a general nature only.
The facts of your hypothetical situation are as follows:
1. A husband and wife have carried on a broiler farm business in partnership since the early 70’s. The partnership owns all inventory, equipment, land, buildings and an eligible capital property.
2. In order to gradually phase in ownership, a 1/3 capital interest in the partnership was transferred to their son during the 1990’s for proceeds otherwise determined under subsection 73(4) of the Income Tax Act (the “Act”). This resulted in a capital gain against which both parents applied their enhanced capital gains exemption.
The parents wish to retire and transfer their remaining partnership interests in the manner described in point 2 above. (These transfers may result in a taxable capital gain not sheltered by the capital gains exemption.) After this transfer, the son will own all the interests in the partnership.
3. The son continues as a proprietor to operate the broiler business which was previously carried on by the partnership.
Where eligible capital property is acquired from a non-arm’s length person or partnership (the “transferor”), subsection 14(3) of the Act deems the purchaser’s “eligible capital expenditure” to be to 4/3 of the excess of the transferor’s “eligible capital amount” over certain related capital gains deductions. This latter amount is the total of all amounts that may reasonably be considered to have been claimed as a section 110.6 capital gains deduction by the transferor or any other person with whom the transferee was not dealing at arm's length in connection with the transferor's disposition of the property to the transferee or in connection with any previous disposition of the same property. The “eligible capital amount” is the amount determined for variable “E” in the definition of “cumulative eligible capital” in subsection 14(5) of the Act and is essentially 3/4 of the amount received by the transferor in respect of the disposition of the eligible capital property. These consequences are explained in paragraphs 23 and 24 of Interpretation Bulletin IT-123R6 (“Transactions involving Eligible Capital Property”).
In the case where a partnership ceases to exist and within 3 months after that time a taxpayer who was a member of the partnership continues to carry on alone the business that was the business of the partnership, paragraph 98(5)(f) of the Act deems the proceeds of disposition of any property received by the proprietor and that is used in carrying on the business that was the business of the partnership to be equal to the “cost amount” to the partnership. The term “cost amount” is defined in subsection 248(1) of the Act and in respect of eligible capital property equals 4/3 of the cumulative eligible capital. Accordingly, the son’s eligible capital expenditure in respect of the eligible capital property acquired from the partnership will equal 4/3 of the excess of the partnership’s cumulative eligible capital in respect of property over the related capital gains deductions, as described previously.
In your view, a more appropriate and logical result is obtained if one ignores the existence of the partnership and treats the parents as the indirect transferors of the eligible capital property.
In our view, the short answer to your proposition is that subsection 98(5) of the Act would be incomprehensible unless one recognizes the ownership of the property by the partnership. However, we have the following comments concerning your argument that two of this Directorate’s interpretations (one dated August 30, 1995, and the other dated December 27, 1990) support your view. According to you, the interpretation of August 30, 1995, indicates that, in the Directorate’s view, it is the partners who are the owners of the assets of the partnership, while the interpretation of December 27, 1990, takes the position that property received on dissolution of a partnership is not considered an acquisition of property.
Concerning the comments in the letter of August 30, 1995, they were made in the context of interpreting class 24 of Schedule II of the Income Tax Regulations. However, for certain tax purposes, including the winding-up of a partnership under subsection 98(5) of the Act, it is the Department’s view that a partnership and not its partners is the owner of property used in the partnership.
As regards the letter dated December 27, 1990, it clearly indicated that the position therein (that “no property becomes property of the partner when, upon dissolution of the partnership, he receives an undivided interest in each asset of the partnership in proportion to his partnership interest”) was to be taken only in the context of paragraph 55(3)(b) of the Act. In fact, in Income Technical News - Issue No. 3 dated January 30, 1995, it was stated that this position was adopted by the Department even though on a strict interpretation of the mid-amble of paragraph 55(3)(b), it could reasonably be concluded that property becomes property of a corporation in contemplation of a butterfly when it acquires a partnership interest as consideration for the transfer of property to the partnership and then butterflies the interest to its shareholders.
As regards your concern about double taxation, it appears that any double taxation arising out of this situation stems from the steps taken and not from inadequacies with the legislation. Generally, subsection 98(5) of the Act benefits taxpayers by allowing them to “roll-over” partnership property into a proprietorship. If the taxpayers wish to avoid subsection 98(5) of the Act, the transfer can be arranged so that the partnership sells the eligible capital property to the son separately before the partnership interests are sold to the son. In this case, subsection 98(2) of the Act will deem the proceeds of disposition of the eligible capital property to be equal to fair market value. Therefore, the partnership’s capital gain, if any, on this sale will flow through to the partners, who would be able to claim capital gains deductions accordingly. Thus, subsection 14(3) of the Act would not result in taxation of the same amount on a subsequent disposition of the eligible capital property by the son to a non-arm’s length buyer.
We trust that these comments will be of assistance.
Yours truly,
P. Spice
for Director
Business and Publications Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch
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