7 July 1999 External T.I. 9916185 - REPLACEMENT PROPERTY

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 replacement property rules allow a taxpayer to replace one building, which contained a kiln, a cafeteria, and a garage, destroyed by fire with three buildings housing each of the different functions separately.

Position: Possibly, but a question of fact in each situation.

Reasons: As indicated in paragraph 10, it is our position that in some situations it may be necessary to acquire more than one property to replace another. However, if, in particular circumstances, the purpose of such an arrangement is business expansion, then our position is that it would not be allowed.

XXXXXXXXXX 5-991618
J. Gibbons
Attention: XXXXXXXXXX

July 7, 1999

Dear XXXXXXXXXX:

This is further to your letter of December 7, 1999, in which you requested our views whether the replacement property rules in subsections 44(1) and 13(4) of the Income Tax Act would apply in a particular situation.

Written confirmation of the tax implications inherent in particular transactions is 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.

You asked us to assume the following:

1. The taxpayer is in the business of producing and supplying lumber.

2. On XXXXXXXXXX, a fire destroyed one of the taxpayer’s buildings, which housed a kiln (used to dry the wood), a garage (used to repair rolling stock) and a cafeteria (used by the taxpayer’s employees).

3. On XXXXXXXXXX, after the taxpayer’s XXXXXXXXXX year-end (in which the fire took place), the taxpayer reached an agreement with its insurance company.

4. The taxpayer will construct three separate buildings, each housing separately the kiln, the garage, and the cafeteria, to replace the one destroyed by fire.

5. The kiln and garage will be constructed on the same site. The cafeteria will be built closer to where the offices are situated.

On the basis of the above-stated facts, you request our views as to whether:

(1) the replacement property rules in subsections 44(1) and 13(4) will apply to allow the taxpayer to defer recognition of capital gains and recapture of capital cost allowance on the disposition of the building destroyed by fire,

(2) the three new buildings will qualify as replacement property for one building, and

(3) subsection 44(2) will apply to determine the timing of the disposition and the receipt of the proceeds?

Will the replacement property rules in subsections 44(1) and 13(4) apply to allow the taxpayer to defer recognition of capital gains and recapture of capital cost allowance on the disposition of the building destroyed by fire?

For purposes of this first question, you made the following statements:

1. The new kiln, garage and cafeteria will be built within the prescribed time limits.

2. The new kiln, garage and cafeteria will qualify as replacement properties.

3. The taxpayer will not dispose of the new properties prior to the disposition of the original property, as determined by subsection 44(2).

4. The appropriate elections under subsections 44(1) and 13(4) will be made.

Based on the above statements of facts, it is likely that the replacement property rules in subsections 44(1) and 13(4) will apply to the proceeds of disposition received as a result of the destruction of the building described above. However, while most of your statements can be easily verified in a particular situation, the question of whether a property qualifies as a replacement property requires a more in-depth review.

Will the three new buildings qualify as replacement property for one building?

As you are aware, paragraph 10 of Interpretation Bulletin IT-259R3 states that, in some situations, it may be necessary to purchase more than one property to replace another. While this is the case, in some circumstances like this, we might conclude that the replacement property rules are being used to expand a taxpayer’s business. It is our position, as stated in paragraph 15 of IT-259R3, that the replacement property rules are not intended to encompass business expansions. While we respect your view that it is not the taxpayer’s intention to construct separate buildings for business expansion purposes, we cannot provide assurance as to how we would view this situation in an actual review.

Will the provisions of subsection 44(2) of the Act apply to determine the timing of the disposition of the property (for purposes of determining the capital gain and/or recapture of capital cost allowance, if any, on the disposition of the taxpayer’s property) and accordingly, the timing of the elections under subsections 44(1) and 13(4) of the Act?

With respect to this question, we refer you to paragraph 2(b) of IT-259R3. This paragraph states that, for involuntary dispositions of former property (depreciable property of a prescribed class or any other capital property but excluding eligible capital property), the replacement property must be acquired before the end of the second taxation year following the year in which subsection 44(2) deems the disposition of the former property to occur and the proceeds of that disposition to be receivable. The subsection deems the disposition to occur and the proceeds to be receivable in the year in which the earliest of the following events occurs:

a) the taxpayer agrees on the full amount of compensation for the property;

b) the tribunals or courts make the final determination of compensation for the property;

c) two years elapse after the loss, destruction or taking of the property if no proceeding before a tribunal or court has been taken before that time;

d) the taxpayer dies or ceases to be a resident in Canada which results in the deemed disposition of the property; and

e) a corporate taxpayer that is not a subsidiary corporation, referred to in subsection 88(1), is wound up.

In your letter, you assert that paragraphs (b), (d), and (e) do not apply. You also state that the final agreement was reached with the insurance company on XXXXXXXXXX. Given these facts, and the fact that the former property was destroyed on XXXXXXXXXX, it would seem that the disposition would be deemed to occur and the proceeds would be deemed to be receivable on XXXXXXXXXX.

Application of subsection 44(4)

In answer to this last issue, we refer you to paragraph 7 of IT-259R3. This paragraph states that, if a former property is depreciable property, subsection 44(4) provides that if a taxpayer elects on that property under subsection 44(1), the taxpayer is deemed to have elected also under subsection 13(4), and if the taxpayer elects under subsection 13(4), the taxpayer is deemed to have elected under subsection 44(1) as well.

We trust that these comments will be of assistance.

Yours truly,

John Oulton, CA
for Director
Business and Publications Division
Income Tax Rulings and
Interpretations Directorate

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