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:
The effect a section 85 rollover of eligible capital property will have if the property was previously the subject of a CGD election under subsection 110.6(19).
Position:
The benefits of the CGD election will be lost in many situations where the property is rolled over to a corporation.
Reasons:
To avoid subsection 14(1) income, the elected amount must be at the secondary lower limit which likely will be less than the amount elected upon under the CGD election. The elected amount for section 85 (ie. the lower amount) thus becomes the corporations cost.
March 17, 1997
Halifax Tax Services Office Income Tax Rulings
Kevin McGuigan and Interpretations
Technical Advisor Directorate
Jim Wilson
(613) 957-2123
963100
Subsections 85(1) & 110.6(19) of the Income Tax Act ("Act")
This is in reply to your memorandum dated September 12, 1996 in which you asked for our comments concerning the interaction of subsections 85(1) and 110.6(19) of the Act. More specifically, you have described a situation in which a taxpayer has made an election under subsection 110.6(19) of the Act with respect to either a depreciable property or an eligible capital property, as the case may be, and then has subsequently transferred that particular property to his corporation in accordance with subsection 85(1) of the Act. You are concerned that since the undepreciated capital cost ("UCC") or cumulative eligible capital ("CEC"), as the case may be, will not be bumped to reflect the capital gain arising from the capital gains deduction election ("CGD election"), the taxpayer will not be able to take back non-share consideration upon his section 85 rollover equal to the CGD election amounts without triggering tax implications. Your reasoning, in brief, is that since the secondary lower limit in the subsection 85(1) election, that is, the least of the amounts determined under paragraph 85(1)(d) or (e), as the case may be, will equal the UCC or 4/3 of the CEC, as the case may be, then non-share consideration in excess of those amounts, as a consequence of the interaction of paragraphs 85(1)(a) and (b) of the Act, will result in tax consequences.
We agree with your conclusion that non-share consideration in excess of the secondary lower limit, which will, as a consequence of paragraph 85(1)(b) of the Act, increase the minimum amount that could be elected upon under subsection 85(1) of the Act, will result in immediate tax implications to the taxpayer where the taxpayer has previously claimed a deduction under paragraph 20(1)(a) or (b) of the Act with respect to that particular class or with respect to the CEC, as the case may be (hereinafter referred to as "CCA" or "CEC deduction"). In our view this result is consistent with tax policy since the transferor has not been taxed with respect to amounts previously claimed under paragraphs 20(1)(a) or (b), as the case may be, of the Act. However, as you will note from the examples provided below, certain anomalies result from subsequent rollovers of such property.
In the event no CCA or CEC deduction has been claimed, a taxpayer would normally elect at an amount in excess of the UCC or 4/3 the CEC (ie. an amount equal to the designated amount under 110.6(19) of the Act), as the case may be, and would take back non-share consideration equal to that elected amount. No immediate tax implications would arise in such cases. However, this situation would likely be uncommon.
Note: We have provided an example with respect to eligible capital property, however, the same problems arise with depreciable property.
Eligible Capital Property
Unlike a CGD election made on a property described in paragraph 110.6(19)(a) of the Act, a CGD election on property described in paragraph 110.6(19)(b) of the Act (i.e. eligible capital property) does not result in a deemed disposition and reacquisition of that particular property for purposes of the whole Act. The eligible capital property shall be deemed to be disposed of by the taxpayer at the time of the CGD election strictly for purposes of section 110.6 of the Act. The CEC of the taxpayer will not be affected by the CGD election. Subsection 14(3) of the Act does not apply at this particular time.1
Where an election is filed in respect of all eligible capital property in respect of a business of an individual, the taxable capital gain realized on the election is added to a special account called the "exempt gains balance". Any gain2 subsequently realized on a disposition of eligible capital property (eg. a disposition where a subsection 85(1) election has been made), which would otherwise have been required to be included in income pursuant to subsection 14(1) of the Act, may be reduced by the balance of the amount in the "exempt gains balance" account.
Example 1:
Assume the taxpayer acquired a fishing license in 1993 at a capital cost of $20,000 and claimed $1,000 under paragraph 20(1)(b) in his 1993 taxation year. The taxpayer only has the one eligible capital property. The taxpayer subsequently makes an election under paragraph 110.6(19)(b) of the Act with respect to that asset at a time when it has a fair market value of $30,000 (ie. he crystallizes the entire $10,000 gain). Shortly after the CGD election, the taxpayer transfers the asset to his corporation, elects under subsection 85(1) at $30,000, and takes back 1 share with nominal value and non-share consideration equal to $30,000. For purposes of Example 1 and 2, "election" means the CGD election, "rollover" means the subsection 85(1) rollover and "sale" means the subsequent asset sale by the corporation to a third party.
Taxpayer's CEC Prior to After After
Election Election Rollover
14(5)(A) $15,000 $15,000 $15,000
less:
14(5)(E) $ N/A $ N/A $22,500
14(5)(F) 1,000 1,000 1,000
CEC Balance $14,000 $14,000 $(8,500)
*(no change) (see below)
* However, the taxable capital gain realized on the CGD election ($7500) is added to a special account called the "exempt gains balance" (see Variable D below in 14(1)(a)(v) computation).
Subsection 14(1) Computations
14(1)(a)(iv) Amount = $1,000 (to be included in income)
(eg. lesser of: excess ($8,500) & Variable F ($1,000))
14(1)(a)(v) Amount = $0 (to be included in income)
(eg. A-B-C-D (8,500 - 1,000 - N/A - 7,500 = $0))
To carry the example through to its conclusion, if the corporation subsequently sells the asset at its present fair market value of $30,000 (assuming that value did not change since the dates of the CGD election and the section 85 rollover), the following tax implications would arise:
Corporation's CEC After After
Rollover Sale
14(5)(A) *$15,000 **$22,500
less:
14(5)(E) $ N/A $22,500
14(5)(F) N/A N/A
CEC Balance $15,000 ($0)
(no 14(1) implications)
* From the interaction of subsection 14(3) and subparagraph 110.6(19)(b)(ii), the corporation's eligible capital expenditure with respect to the acquisition of the licence is deemed to equal $20,000 (4/3 x ($22,500 less $7500) = $20,000)
** Immediately after the disposition of the asset to a third party, paragraphs 14(3)(c) and (d) would operate to adjust the original eligible capital expenditure of the corporation to the amount that should have been recorded if not for the prior subsection 14(3) adjustment described above.
Example 2:
Lets now use the same facts as example 1, however, the taxpayer elects under subsection 85(1) at 4/3 of his CEC balance to avoid any immediate subsection 14(1) implications, and takes back non-share consideration of $18,666.66.
Taxpayer's CEC Prior to After After
Election Election Rollover
14(5)(A) $15,000 $15,000 $15,000
less:
14(5)(E) $ N/A $ N/A $14,000
14(5)(F) 1,000 1,000 1,000
CEC Balance $14,000 $14,000 $0
*(no change) (no 14(1) implications)
* However, the taxable capital gain realized on the CGD election ($7500) is added to a special account called the "exempt gains balance" (see Variable D below in 14(1)(a)(v) computation).
To carry the example through to its conclusion, if the corporation subsequently sells the asset at its present fair market value of $30,000 (assuming that value did not change since the dates of the CGD election and the section 85 rollover), the following tax implications would arise:
Corporation's CEC After After
Rollover Sale
14(5)(A) *$11,166 **$14,000
less:
14(5)(E) $ N/A $22,500
14(5)(F) N/A N/A
CEC Balance $11,166 ($8,500)
(see below)
* From the interaction of subsection 14(3) and subparagraph 110.6(19)(b)(ii), the corporation's eligible capital expenditure with respect to the acquisition of the licence is deemed to equal $14,888.88 (4/3 x ($18,666.66 less $7500) = $14,888.88)
** Immediately after the disposition of the asset to a third party, paragraphs 14(3)(c) and (d) would operate to adjust the original eligible capital expenditure of the corporation to the amount that should have been recorded if not for the prior subsection 14(3) adjustment described above.
Subsection 14(1) Computations
14(1)(a)(iv) Amount = $0
(eg. lesser of: excess ($8,500) & Variable F ($0))
14(1)(a)(v) Amount = $8,500 (to be included in income)
(eg. A-B-C-D (8,500 - N/A - N/A - N/A = $8,500))
Summary
As you will note, the benefits from making a CGD election will effectively be lost where the taxpayer does not choose an agreed amount in his subsection 85(1) rollover that is equal to the amount designated in the CGD election. The problem is that the corporation does not have an "exempt gains balance" for purposes of variable D in subparagraph 14(1)(a)(v). The "exempt gains balance" created on the CGD election is that of the taxpayer. In addition, to make things worse, because subsection 14(3) of the Act applies regardless of the fact that the property was rolled over to the corporation at less than its FMV, the corporation's CEC is temporarily (ie. until the asset is disposed) reduced because of the taxpayer's section 110.6 deduction. This is not the case with paragraph 13(7)(e) of the Act3 with resect to depreciable property.
In the event the taxpayer makes a CGD election in respect of depreciable property that has potential recapture, it would also not be advisable to consider a subsequent subsection 85(1) rollover on that particular property. Unless the taxpayer can elect under subsection 85(1) at his ACB, which would likely only be considered where there is no recapture or the recapture is nominal, subsection 85(1) should not be considered for the same reasons as explained above (ie. the benefits of the CGD election will effectively be lost where the taxpayer does not choose an agreed amount in his subsection 85(1) rollover that is equal to the amount designated in the CGD election). If you require an example with respect to depreciable property, please call the writer.
for Director
Reorganizations and International Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch
ENDNOTES
1 This explains why there is not an equivalent provision to paragraph 13(7)(e.1) for purposes of subsection 14(3) of the Act. However, subsection 14(3) will apply to reduce the corporation's eligible capital expenditure upon the section 85 rollover.
2 That is, the amount that would be required to be included in income under subsection 14(1) of the Act pursuant to subparagraph 14(1)(a)(v) thereof. In this regard, as a brief comparative to the depreciable property rules, subparagraph 14(1)(a)(v) brings into income the taxable capital gain element of the property while 14(1)(a)(iv) brings into income the subsection 13(1)/recapture element.
3 Subparagraph 13(7)(e)(i) of the Act only applies where the purchaser's capital cost is otherwise greater than the capital cost of the vendor.
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