10 June 1986 Income Tax Severed Letter RCT 5-1774

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.

Dear Sirs:

This is in reply to your letter of June 10, 1986.

You give the following set of facts:

• 1) Pursuant to subsection 85(2) of the Income Tax Act (the "Act") a partnership transfers its business assets and undertakings to a newly incorporated company which is owned 50% by each of the two partners. After the transfer the partnership ceases carrying on a business.
• 2) Assets transferred include accounts receivable, inventory and furniture and equipment.
• 3) Liabilities assumed include trade payables and customer deposits for goods to be delivered at a later date.

You ask whether the partners will each be able to claim, in calculating their respective incomes from the partnership for its final year, a reserve under paragraph 20(1)(m) of the Act in connection with the customer deposits that have been included in their respective incomes under paragraph 12(1)(a) of the Act. You ask secondly whether the new corporation or the partners will be required by paragraph 12(1)(e) of the Act to include in income in the subsequent year the customer deposits which were transferred from the partnership to the corporation.

In our opinion, the answer to your first question is that the partners cannot claim a paragraph 20(1)(m) reserve because, as you indicate, after the subsection 85(2) rollover occurs, the partnership ceases to carry on the business in question and ceases to be legally obligated to deliver the goods in question.

The new corporation will also not be entitled to claim a deduction under paragraph 20(1)(m) of the Act because although it carries on the business in question and is legally obligated to deliver the goods in question, it is not the taxpayer which initially brought the deposits received into income under paragraph 12(1)(a).

With regard to your second question, since neither the partners nor the new corporation may claim a deduction under paragraph 20(1)(m) of the Act as of the end of the year in which the subsection 85(2) rollover occurs, therefore neither the partners nor the new corporation will be required to include an amount with respect thereto in income for the following year under paragraph 12(1)(e) of the Act.

Notwithstanding the above, if the requirements of paragraph 20(24) of the Act have been met, a joint election under that paragraph could be filed by the partners and the new corporation which would permit the partners to deduct a reasonable amount paid by them to the new corporation as consideration for the corporation's undertaking to provide the goods in question, and under which the amount so received by the new corporation would be brought into its income as a deemed paragraph 12(1)(a) amount received for goods not delivered before the end of the year. The new corporation could then claim a paragraph 20(1)(m) reserve with respect thereto which would of course be included in its income in the following year under paragraph 12(1)(e) of the Act.

We trust that the above clarifies this matter for you.