ARCHIVED - Transactions Involving Eligible Capital Property

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What the "Archived Content" notice means for interpretation bulletins

NO: IT-123R6

DATE: June 1, 1997

SUBJECT: INCOME TAX ACT
Transactions Involving Eligible Capital Property

REFERENCE: Section 14 (also sections 102 and 110.6; the definition of "eligible capital property" in section 54; subsections 20(4.2), 24(1), 39.1(5), 96(1), 104(21) and 104(21.2); the definition of "capital dividend account" in subsection 89(1), the definition of "exempt capital gains balance" in subsection 39.1(1) and the definitions of "Canadian partnership" and "individual" in subsection 248(1); paragraphs 20(1)(b), 20(1)(n) and 20(1)(p); and subparagraph 39(1)(b)(ii) of the Act; and section 21 of the Income Tax Application Rules, 1971 (ITAR))

Notice -- Bulletins do not have the force of law

Contents

• Application
• Summary
• Discussion and Interpretation
  • General (¶s 1-5)
  • The New System (¶s 6-12)
  • Taxpayers in the First Category (¶s 13-20)
  • Taxpayers in the Second Category (¶s 21-22)
  • Non-Arm's Length Transfers (¶s 23-24)
  • Replacement Properties (¶s 25-26)
  • Transitional Provisions (¶s 27-33)
  • Government Rights (¶ 34)
  • Capital Dividend Account (¶ 35)
  • Bad Debts From Sale of EC Property (¶ 36)
  • Amount Not Due Until Later Year (¶ 37)
  • Terminal Allowance (¶ 38)
  • Eligible Capital Property of a Deceased Taxpayer (¶ 39)
  • Related Bulletins
• Schedule A
• Schedule B
• Explanation of Changes

Application

This bulletin cancels and replaces Interpretation Bulletin IT-123R5, dated October 30, 1992. Generally, the rules dealt with in this bulletin (the new system) are applicable to corporations with taxation years commencing on or after July 1, 1988, and to other taxpayers with fiscal periods commencing on or after January 1, 1988. For a discussion of the relevant provisions for prior periods (the old system), see Interpretation Bulletin IT-123R4 dated May 30, 1985. Certain transitional provisions discussed in this bulletin affect the rules under both the new system and the old system.

Summary

This bulletin discusses transactions involving eligible capital property for a particular business of a taxpayer. Eligible capital property may be broadly described as intangible capital property, such as goodwill and other "nothings," the cost of which neither qualifies for capital cost allowance nor is deductible in the year of its acquisition as a current expense.

A portion of each expenditure to acquire eligible capital property is added into a pool, and a portion of the proceeds from each disposition of eligible capital property reduces the pool. A deduction may be claimed, in computing the taxpayer's income from the business for a particular year, of up to 7% of any positive balance in the pool at the end of that year. Generally, if the pool has a negative balance at the end of the year, an amount will be required to be included in computing the taxpayer's income. In certain circumstances, a portion of the negative balance is eligible for a capital gains deduction.

An election can be made to defer all or a portion of a negative balance in the pool resulting from a disposition of eligible capital property, if a replacement property is acquired in the immediately following year.

This bulletin also discusses other topics in connection with eligible capital property, including the transition from the old system to the new system.

Discussion and Interpretation

General

¶ 1. The cumulative eligible capital (cumulative EC) for a business is, in effect, an expenditure pool (the pool) relating to eligible capital property (EC property). EC property may be broadly described as intangible capital property, such as goodwill and other "nothings," the cost of which neither qualifies for capital cost allowance nor is deductible in the year of its acquisition as a current expense. As discussed more fully below, the pool is increased by a portion of each eligible capital expenditure (EC expenditure) made to acquire EC property and is decreased by each eligible capital amount (EC amount) resulting from a disposition of EC property. Generally, depending on whether the balance in the pool at the end of a particular taxation year is positive or negative, a deduction may be claimed or an amount must be included in income for the year.

¶ 2. The cumulative EC (i.e., the pool), as well as any EC expenditure or EC amount taken into account in calculating the balance of the pool, must be determined "in respect of a [particular] business." If a taxpayer has more than one business (see the current version of IT-206), these items must be determined separately for each business. For purposes of discussion in this bulletin, it is assumed that the taxpayer has only one business.

¶ 3. According to its definition in section 54, "EC property" is basically any property which, if disposed of by the taxpayer, would result in an EC amount. An "EC amount," which according to subsection 14(1) is an amount determined under variable E in the subsection 14(5) definition of "cumulative EC" (the method of calculation is discussed in ¶ 9 below), is essentially an amount resulting from a disposition of property where, if any payment had been made after 1971 by the taxpayer for that property, such payment would have qualified as an EC expenditure for the business. This test in variable E in the definition of "cumulative EC" is often referred to as the "mirror image test," which is discussed more fully in the current version of IT-386. The combined effect of the above-mentioned provisions is that an EC property is basically any property the cost of which would qualify as an EC expenditure of the taxpayer. For a discussion of what qualifies as an "EC expenditure," which is defined under subsection 14(5), see the current version of IT-143.

¶ 4. Unless specifically stated to the contrary, the reference in this bulletin to a "year" means a "taxation year" and, in the case of an individual, both "taxation year" and "year" mean the fiscal period of the business which ends in the taxation year.

¶ 5. The provisions regarding EC property as amended by S.C. 1988, c. 55 (formerly Bill C-139) or by subsequent amending statutes are referred to in this bulletin as the provisions under the "new system." The new system commenced at the taxpayer's "adjustment time," which is defined in subsection 14(5) as follows:

The system of provisions applying prior to the taxpayer's adjustment time is referred to in this bulletin as the "old system," which is dealt with (although not described as such) in IT-123R4. A comparison of the old and new systems is contained in Schedule A at the end of this bulletin.

The New System

¶ 6. Although the definition of "cumulative EC" in subsection 14(5) provides for a determination of the balance in the pool of cumulative EC at any particular time, in actual practice taxpayers usually prepare a schedule of cumulative EC for each year, carrying forward the final balance in the pool at the end of one year as the opening balance for the next year. The balance in the pool at the beginning of the first year under the new system is simply 3/2 of (or 1½ times) the balance at the taxpayer's adjustment time, i.e., 3/2 of the balance (if any) at the end of the last year under the old system. The increases and decreases to the pool that occur under the new system are discussed in ¶s 7 to 26 below and are illustrated in Schedule B at the end of this bulletin.

¶ 7. The pool is increased in a particular year by 3/4 (the inclusion rate) of each EC expenditure made or incurred in the year. For a discussion of what qualifies as an EC expenditure, see the current version of IT-143.

¶ 8. The taxpayer may receive assistance from a government, municipality or other public authority in respect of, or for the acquisition of, EC property of a business. By virtue of subsection 14(10), the EC expenditure for the property is reduced by, or the pool is decreased by 3/4 of, the amount of such assistance that the taxpayer receives or is entitled to receive after February 21, 1994.

Example 1

The taxpayer acquires an EC property for $100,000 and receives government assistance of $50,000 towards the purchase of that property. The pool is increased by 3/4 of ($100,000 - $50,000) = $37,500.

Example 2

The taxpayer acquires an EC property for $100,000 in year 1. In year 2, the taxpayer becomes entitled to receive government assistance of $50,000 in respect of the property. In year 1, the pool is increased by 3/4 of $100,000 = $75,000. In year 2, the pool is decreased by 3/4 of $50,000 = $37,500. Therefore, as of year 2, the pool has been increased by a net amount of $75,000 - $37,500 = $37,500.

Subsection 14(10) can apply to assistance in the form of a grant, subsidy, forgivable loan, deduction from tax, investment allowance or any other form of assistance. The subsection does not apply, however, to assistance that the taxpayer receives or becomes entitled to receive after ceasing to carry on the business. If subsection 14(10) does apply and the taxpayer has reduced the EC pool by 3/4 of (or reduced the EC expenditure by) the amount of the assistance, the subsection allows the taxpayer to increase the pool by 3/4 of (or increase the EC expenditure by) any amount of the assistance that the taxpayer has repaid under a legal obligation to do so. This rule does not apply, however, if the taxpayer makes the repayment after ceasing to carry on the business (instead, the taxpayer claims a deduction under paragraph 20(1)(hh.1) as described in the current version of IT-313). By virtue of subsection 14(11), the above rules in subsection 14(10) can apply to the EC property (and thus to the EC pool) of a business carried on by a trust or partnership where a beneficiary of the trust or a member of the partnership, as the case may be, is the person that receives or becomes entitled to receive the assistance.

¶ 9. The pool is decreased in a particular year by each EC amount for the year. An EC amount results from a disposition of EC property. Examples of situations in which an EC amount can occur are given in the current version of IT-386. When an EC property has been disposed of, the resulting EC amount for the year of disposition is calculated by multiplying 3/4 (the inclusion rate) times what is referred to in this bulletin as the "base for the EC amount," which is simply the excess (if any) of

¶ 10. The pool is decreased by any amount by which it is required to be reduced by virtue of the operation of subsection 80(7). If an amount is forgiven on the settlement of a "commercial obligation" (as defined in subsection 80(1)) issued by the taxpayer, subsection 80(7) provides that 3/4 of the remaining unapplied portion of the forgiven amount (as determined under the rules in section 80) shall be applied (to the extent designated in prescribed form filed with the taxpayer's return for the taxation year in which the debt is settled) to reduce the taxpayer's EC pool.

¶ 11. If at the end of a taxation year there is a positive balance in the pool, paragraph 20(1)(b) provides for a deduction (the paragraph 20(1)(b) deduction), in computing the taxpayer's income from the business for that year, of up to 7% of such positive balance. The pool is then decreased by the amount so deducted.

¶ 12. If, on the other hand, there is a negative balance in the pool at the end of the year, subsection 14(1) usually requires that an amount be included in computing the taxpayer's income for the year. The rules for this income inclusion under subsection 14(1) vary for two different categories of taxpayers, as discussed below.

Taxpayers in the First Category

¶ 13. An individual resident in Canada throughout the taxation year (i.e., the year at the end of which the negative balance in the pool occurs) is included in the first category of taxpayers if the business for which the negative balance in the pool occurs is

For purposes of the above discussion, an "individual" as defined in subsection 248(1) includes a trust. A "Canadian partnership" is defined by section 102 as a partnership all of the members of which are resident in Canada at all relevant times (which, for purposes of subsection 14(1), would be throughout the partnership's entire taxation year for which the negative balance in the pool occurs). It should also be noted that an individual is not excluded from the first category of taxpayers if another member of any partnership mentioned in (b) above is a corporation, a corporate partnership or a tiered corporate partnership as described in ¶ 21(c) below.

By virtue of subsection 14(8), an individual that became or ceased to be resident in Canada during a particular taxation year is deemed to be resident in Canada throughout that year, for purposes of being included in the first category of taxpayers, as long as the individual was resident in Canada throughout the previous or the subsequent year.

¶ 14. If the taxpayer is in the first category, there is an income inclusion under subparagraph 14(1)(a)(iv) (the subparagraph 14(1)(a)(iv) recapture income inclusion), which is equal to the lesser of two amounts:

¶ 15. If the negative balance in the pool at the end of the year (i.e., the amount in ¶ 14(a) above) is greater than the total net recapturable amount (as determined by the formula described in ¶ 14(b) above),

• the total net recapturable amount (if any) is fully recaptured by means of the subparagraph 14(1)(a)(iv) recapture income inclusion for the year; and
• subparagraph 14(1)(a)(v) then applies.

The rules in subparagraph 14(1)(a)(v) differ for fiscal periods ending before February 23, 1994 (see ¶ 16 below) and fiscal periods ending after February 22, 1994 (see ¶ 17 below).

¶ 16. Generally, for each fiscal period ending before February 23, 1994, in addition to a subparagraph 14(1)(a)(iv) recapture income inclusion, there is a deemed taxable capital gain under subparagraph 14(1)(a)(v). A subparagraph 14(1)(a)(v) deemed taxable capital gain is calculated as the excess (if any) of

Note that the subparagraph 14(1)(a)(v) deemed taxable capital gain for the year should not be included in amount C in the formula in ¶ 14(b) above when determining the total net recapturable amount in a subsequent year.

¶ 17. Generally, for each fiscal period ending after February 22, 1994, in addition to a subparagraph 14(1)(a)(iv) recapture income inclusion, there is an income inclusion under subparagraph 14(1)(a)(v). A subparagraph 14(1)(a)(v) income inclusion is determined by the following formula:
A - B - C - D

A subparagraph 14(1)(a)(v) income inclusion calculated under the above formula cannot be less than zero. The variables in the formula are as follows:

A		is the negative balance in the pool at the end of the year (i.e., the amount in ¶ 14(a) above).
B		is the total net recapturable amount as of the end of the year as determined in ¶ 14(b) above.
C		is 1/2 of variable B in the formula in ¶ 14(b) above.
D		is the amount that the taxpayer claims out of the taxpayer's "exempt gains balance" (as defined in subsection 14(5)) in respect of the business for the year.

With regard to variable D above, the taxpayer will have created an exempt gains balance if the taxpayer was an individual (other than a trust) or a personal trust and the taxpayer made an election to have paragraph 110.6(19)(b) apply in respect of a business carried on by the taxpayer on February 22, 1994 (otherwise than as a member of a partnership). Subsection 110.6(19) was added to the Act to allow taxpayers to recognize capital gains accrued to February 22, 1994, because of the elimination of the $100,000 capital gains exemption for dispositions of property after that date. Paragraph 110.6(19)(b) provides for the creation of a deemed taxable capital gain equal to the amount of the subparagraph 14(1)(a)(v) deemed taxable capital gain (if any) that would have resulted under the rules for fiscal periods ending before February 23, 1994 (as discussed in ¶ 16 above) if

• the taxpayer's taxation year had ended on February 22, 1994, and
• the taxpayer had disposed of all the EC property of the business for an amount of proceeds designated by the taxpayer.

The taxpayer will then have included the paragraph 110.6(19)(b) deemed taxable capital gain in income for the taxation year that included February 22, 1994 and it will have qualified for a capital gains deduction (subject to the limitations in section 110.6 in force as of February 22, 1994). Note that this is so regardless of whether or not the taxpayer's paragraph 110.6(19)(b) designated proceeds were equal to the fair market value of all the taxpayer's EC property for the business as of February 22, 1994 (for the sake of brevity, the latter amount is hereafter referred to simply as the "fair market value"). Note also that since the deemed taxable capital gain will have occurred under paragraph 110.6(19)(b) rather than under subparagraph 14(1)(a)(v), the taxpayer's paragraph 110.6(19)(b) designated proceeds will not have resulted in an EC amount that reduced the EC pool at that time. If the taxpayer's paragraph 110.6(19)(b) designated proceeds were equal to or less than the fair market value, the taxpayer's exempt gains balance will have started out at an amount equal to the taxpayer's deemed taxable capital gain. (If the taxpayer's paragraph 110.6(19)(b) designated proceeds were more than the fair market value, less favourable results will have occurred. For further particulars, see paragraph 110.6(19)(b) and also subsection 14(9).)

The taxpayer may claim all or a portion of the exempt gains balance as variable D in the above formula in order to reduce a subparagraph 14(1)(a)(v) income inclusion resulting, for example, from an EC amount pertaining to an actual disposition of an EC property for which a paragraph 110.6(19)(b) election had previously been made.

The taxpayer's exempt gains balance for a particular taxation year is reduced by any amount claimed as variable D above for a previous year.

When a subparagraph 14(1)(a)(v) income inclusion occurs, the following rules apply:

• The subparagraph 14(1)(a)(v) income inclusion for the year is included in the taxpayer's income from the business for the year. However, if some or all of the subparagraph 14(1)(a)(v) income inclusion can reasonably be attributed to a disposition of "qualified farm property" as defined in subsection 110.6(1), some or all of that income inclusion may qualify for a capital gains deduction by the taxpayer. (Although, as mentioned earlier, the $100,000 capital gains exemption was eliminated for dispositions of property occurring after February 22, 1994, there was no such elimination of the $500,000 capital gains exemption for dispositions of qualified farm property.) The rules in section 14 should be consulted in conjunction with those in section 110.6 to determine the amount of capital gains deduction that may be claimed for the subparagraph 14(1)(a)(v) income inclusion.
  
• In addition to the amount of the subparagraph 14(1)(a)(iv) recapture income inclusion for the year being added back to the pool (see ¶ 14(c) above), also added back to the pool are
  
  • the amount of the subparagraph 14(1)(a)(v) income inclusion for the year,
    
  • the amount of variable D for the year in the above formula, and
    
  • 1/2 of variable B in the formula in ¶ 14(b) above.

Note that the subparagraph 14(1)(a)(v) income inclusion for the year should not be included in amount C in the formula in ¶ 14(b) above when determining the total net recapturable amount in a subsequent year.

¶ 18. Although subparagraph 14(1)(a)(v) can apply in the manner described in ¶s 15 to 17 above to a trust resident in Canada throughout the year (i.e., because such a trust can be included in the first category of taxpayers -- see ¶ 13 above), a capital gains deduction is generally not available to a trust under section 110.6. However, it may be possible in some cases for a beneficiary (of the trust) who is an individual resident in Canada throughout the year (see ¶ 13 above) to claim a capital gains deduction in respect of the trust's subparagraph 14(1)(a)(v) amount by means of the flow-through provisions in subsections 104(21) and (21.2) in conjunction with section 110.6, subject to the requirements contained in all of these provisions. Subsections 104(21) and (21.2) are discussed in the current version of IT-381.

¶ 19. Subparagraph 14(1)(a)(v) can apply in the manner described in ¶s 15 to 17 above where the business is carried on by a Canadian partnership (i.e., if the first category of taxpayers applies -- see ¶ 13(b) above). By virtue of subsection 96(1), the subparagraph 14(1)(a)(v) amount is calculated at the partnership level but flows through to the partnership's members (see the current version of IT-138). It may be possible in some cases for a member of the Canadian partnership who is an individual resident in Canada throughout the year (see ¶ 13 above) to claim a section 110.6 capital gains deduction with respect to his or her share of the subparagraph 14(1)(a)(v) amount, subject to the requirements contained in all of the above-mentioned provisions. In the case of a member of the Canadian partnership which is a corporation, its share of the subparagraph 14(1)(a)(v) amount will not qualify for a capital gains deduction. In the case of a member of the Canadian partnership which is a trust, see ¶ 18 above.

¶ 20. If

• an individual is a member of a partnership,
• a subsection 110.6(19) election has been made in respect of the individual's interest in the partnership, and
• the partnership has a subparagraph 14(1)(a)(v) amount, a share of which flows through the partnership to the individual (see ¶ 19 above),

the individual's share of the subparagraph 14(1)(a)(v) amount may be able to be reduced by means of subsection 39.1(5). For further particulars, see subsection 39.1(5) and the calculation of an individual's "exempt capital gains balance" as determined under subsection 39.1(1).

Taxpayers in the Second Category

¶ 21. The second category of taxpayers includes the following:

¶ 22. If the taxpayer is in the second category and there is a negative balance in the pool at the end of the year, there may be an income inclusion (i.e., in the income from the taxpayer's business) under paragraph 14(1)(b). The income inclusion is calculated as the excess (if any) of

The amount of the paragraph 14(1)(b) income inclusion for the year is then added back to the pool. Also added back to the pool is amount (b) above (i.e., 1/2 of the net amount of all paragraph 20(1)(b) deductions under the old system less income inclusions under the old system). These two add-backs to the pool bring the pool balance back to nil. In other words, these add-backs ensure that no portion of the negative balance at the end of the year can be subject to taxation in a subsequent year.

Non-Arm's Length Transfers

¶ 23. Where a person (e.g., a corporation or an individual, including a trust) or a partnership (either of which is hereafter referred to as the "transferee") acquires, directly or indirectly, in any manner whatever, an EC property from a non-arm's length person or partnership (either of which is hereafter referred to as the "transferor"), subsection 14(3) can sometimes reduce the transferee's EC expenditure. In addition to the requirement that the transferor and transferee must not be dealing at arm's length, subsection 14(3) can apply only if the property was first an EC property for the transferor's business and is then acquired as an EC property for the transferee's business. The subsection does not apply, however, to property acquired by the transferee as a consequence of the death of the transferor. Where subsection 14(3) applies, the transferee's EC expenditure is "deemed" (determined) to be 4/3 of

Example

Mr. A acquires an EC property for his business. The purchase price for the property is $100 and thus he adds $75 to the EC property pool for the business. The balance in the pool at the end of the year is $75 and Mr. A claims a paragraph 20(1)(b) deduction of $5, reducing the pool balance to $70. In the following year, Mr. A sells the EC property to A Jr., his son, for $200 (the fair market value at that time). Mr. A's EC amount from the disposition is $150 (assume that there are no costs for the disposition), which causes a negative balance of $80 in his EC pool at the end of that year. Under subparagraph 14(1)(a)(iv), $5 of that negative balance is included in Mr. A's income as a recapture of the prior year's paragraph 20(1)(b) deduction (see the rules discussed in ¶ 14 above). The remaining $75 is included in Mr. A's income under subsection 14(1)(a)(v) and he claims a corresponding capital gains deduction of $75 in respect of the disposition of the property (see the rules discussed in ¶s 16 and 17 above). Under subsection 14(3), A Jr.'s EC expenditure for the EC property acquired for his business is determined to be 4/3 of his father's $150 EC amount minus 4/3 of his father's $75 capital gains deduction. A Jr.'s EC expenditure is therefore $100 instead of the $200 he actually paid, and $75 rather than $150 is added to the pool for his business.

Finally, it should be noted that the above reduction to the transferee's EC expenditure can be reversed to the extent that the transferee receives proceeds, in a subsequent disposition of the property, in excess of the transferee's EC expenditure (as initially determined under the subsection 14(3) formula given above). However, if the subsequent disposition is to a person or partnership (the subsequent transferee) that does not deal at arm's length with a person who has claimed a section 110.6 capital gains deduction in connection with the property, the subsequent transferee's EC expenditure could be reduced by virtue of subsection 14(3) -- see (b) in the subsection 14(3) formula above.

¶ 24. Subparagraph 110.6(19)(b)(ii) contains a rule that pertains to the reduction, under subsection 14(3) as described in ¶ 23(b) above, to a non-arm's length transferee's EC expenditure for EC property. Under the rule in subparagraph 110.6(19)(b)(ii), if the non-arm's length transferor made an election for the EC property under paragraph 110.6(19)(b) (see ¶ 17 above) before it was acquired by the transferee, the transferor's paragraph 110.6(19)(b) deemed taxable capital gain is deemed to have been claimed as a section 110.6 capital gains deduction by the transferor or by any other person with whom the transferee was not dealing at arm's length in connection with a disposition of the EC property on February 22, 1994. In other words, the transferee's EC expenditure for the EC property would be reduced by 4/3 of the transferor's paragraph 110.6(19)(b) deemed taxable capital gain in respect of the property.

Replacement Properties

¶ 25. Where a taxpayer disposes of an EC property (the former property) in a particular taxation year (the first year) and in the immediately following year (the second year) acquires another EC property to replace the former property, subsection 14(6) can be used to prevent the reduction of a positive balance (or the creation of a negative balance) in the pool at the end of the first year which might otherwise result from the disposition. In such a situation, the taxpayer can elect under subsection 14(6) to exclude from the calculation of the base for the EC amount that would otherwise occur for the first year, such part (not exceeding the total) of that base as is used by the taxpayer in the second year to acquire the replacement property. Thus, where all of the base for the EC amount is so used, the disposition of the former property cannot result in any EC amount in the first year or cause a negative balance in the pool at the end of the first year. The amount excluded in this manner from the calculation of the base for the EC amount that would otherwise occur for the first year then becomes the base for an EC amount for the second year. The resulting deferred EC amount, which is calculated by multiplying that base by the inclusion rate of 3/4, decreases the pool in the second year but is offset by the increase to the pool in the same year of 3/4 of the EC expenditure for the replacement property.

Subsection 14(7) contains requirements that must be satisfied in order for a property to qualify as a replacement property for a former property. See also the current version of IT-259.

¶ 26. An election under subsection 14(6) is to be filed with the taxpayer's return for the year in which the replacement property is acquired. In the situation described in ¶ 25 above, i.e., where the former property is disposed of in the first year and the replacement property is not acquired until the second year, the taxpayer should initially file the return for the first year without the benefit of the subsection 14(6) election. Then, when the election is filed with the return for the second year, the taxpayer may request a reassessment of the tax for the first year. Further particulars may be found in the current version of IT-259.

Transitional Provisions

¶ 27. As indicated in Schedule A, the inclusion rate under the new system is 3/4, whereas it was 1/2 under the old system. Also, the taxpayer's total proceeds from the disposition of EC property are used in the base for the EC amount for the year of disposition under the new system, whereas only the portion of the total proceeds becoming payable to the taxpayer in any particular year was used in the base for the EC amount for that particular year under the old system. The coming-into-force rules for the new system, as described below, permit the transition from the old system to the new system while taking into account these differences.

¶ 28. Where a disposition of an EC property occurred in a year that was under the old system (i.e., before the taxpayer's adjustment time) either

an EC amount from the disposition can still occur in a later year under the new system (i.e., after the taxpayer's adjustment time) where a portion of the proceeds from the disposition does not become payable until that later year. In calculating the EC amount for that later year under the new system, only the portion of the total proceeds from the disposition that becomes payable to the taxpayer in that year will be used in the base for the EC amount. The inclusion rate is 3/4. Note that, in most cases, the disposition has resulted in an EC amount for an earlier year under the old system (because a portion of the proceeds became payable to the taxpayer in that earlier year) and thus the outlays and expenses made or incurred in connection with the disposition have already been taken into account in the base for the EC amount for that earlier year.

¶ 29. Where a disposition of an EC property occurred under the old system (i.e., before the taxpayer's adjustment time) but after June 17, 1987, otherwise than pursuant to the terms of an obligation entered into in writing before June 18, 1987, in calculating the EC amount for the year of disposition under the old system the taxpayer's total proceeds from the disposition must be used in the base for the EC amount (thus, there cannot be any further EC amount from the disposition in a later year under the new system). The inclusion rate is 1/2.

¶ 30. Where a disposition of an EC property occurs in a year under the new system (i.e., after the taxpayer's adjustment time) but pursuant to the terms of an obligation entered into in writing on or before June 17, 1987, an EC amount occurs under the new system for each year in which any portion of the proceeds from the disposition becomes payable to the taxpayer. In calculating the EC amount for each of these years, the inclusion rate is 3/4 and the portion of the proceeds from the disposition that becomes payable to the taxpayer in that year is taken into account in the base for the EC amount. In the first of these years (which may or may not be the year of the disposition), outlays and expenses made or incurred by the taxpayer in connection with the disposition are also taken into account in the base for the EC amount, to the extent that such outlays and expenses were not otherwise deductible in computing the taxpayer's income.

¶ 31. Subsection 14(3), as described in ¶ 23 above, applies to acquisitions of EC property by a transferee from a non-arm's length transferor that occur after 1987. However, if such an acquisition occurred after 1987 but before the transferee's adjustment time, i.e., while the old system was still in effect for the transferee, a factor of 2 rather than 4/3 is used in the formula in ¶ 23 above when determining the transferee's EC expenditure for the property. 1/2, rather than 3/4, of that EC expenditure is then added to the transferee's pool under the old system.

¶ 32. Where the taxpayer has disposed of a former property in the last year under the old system and acquired a replacement property in the first year under the new system, a subsection 14(6) election can be made in essentially the same manner as described in ¶s 25 and 26 above. It should be noted, however, that whether the taxpayer should use

for purposes of determining the base for the EC amount that would otherwise occur in the year of the disposition (which is under the old system) depends on the date of the disposition (or the date of any written obligation entered into for the disposition). In this connection, see the transitional rules described in ¶s 28 and 29 above. For purposes of calculating, in the year of the acquisition of the replacement property (which is under the new system), both the deferred EC amount to be deducted from the pool for the former property and the amount to be added to the pool in connection with the EC expenditure for the replacement property, an inclusion rate of 3/4 is used.

¶ 33. In determining what portion of the total proceeds from a disposition becomes payable to a taxpayer in any particular year for purposes of applying the transitional provisions described above, the comments in IT-123R4 should be considered, including those regarding section 21 of the Income Tax Application Rules, 1971 (ITAR). As indicated in those comments, subsection 21(1) of the ITAR (as it read for years under the old system) reduced the amount payable to the taxpayer for any particular year to a percentage that was less than 100% of that amount payable only if the disposition occurred before the 1984 calendar year. However, the terms of a disposition before 1984 may have called for periodic payments one or more of which would become payable, as it turns out, some time after the taxpayer's adjustment time, i.e., in a year or years under the new system. In such a case, the transitional provision described in ¶ 28 above applies, but is modified by subsection 21(1) of the ITAR as it read in the year of the disposition. That is, an amount payable in a year under the new system is reduced to the percentage of that amount payable as determined in the year of the disposition which occurred before 1984.

Government Rights

¶ 34. In addition to the percentage limitation rule described in ¶ 33 above (which applies to amounts payable from all dispositions of EC property occurring before 1984), subsection 21(1) of the ITAR contains further limitations on the calculation of an EC amount resulting from the disposition of, or allowing the expiration of, a government right. If the disposition or expiration of the government right occurred before June 18, 1987 (or pursuant to the terms of an obligation entered into in writing before June 18, 1987), see the limitation rules discussed in ¶ 13 of IT-123R4. It should be noted that, even though the disposition or expiration occurred in a year that was under the old system, these rules in ¶ 13 of IT-123R4 can still apply for the purpose of determining an amount that becomes payable in a year that is under the new system, i.e., for the purpose of applying the transitional provision described in ¶ 28 above. If the disposition or expiration of the government right has occurred after June 17, 1987 (otherwise than pursuant to the terms of an obligation entered into in writing before June 18, 1987), subsection 21(1) of the ITAR applies, in the year of such disposition or expiration, with respect to the taxpayer's total proceeds rather than with respect to the portion of such proceeds payable to the taxpayer. The total proceeds from the disposition or expiration of the government right are calculated as the actual total proceeds minus the greater of two amounts:

Capital Dividend Account

¶ 35. An amount relating to a corporation's gain on the disposition of an EC property is included in its "capital dividend account" by virtue of its definition in subsection 89(1). For further particulars on this topic, see the current version of IT-66.

Bad Debts From Sale of EC Property

¶ 36. Subsection 20(4.2) provides for a deduction for a bad debt arising on a disposition of EC property occurring after June 17, 1987 (other than on a disposition pursuant to the terms of an obligation entered into in writing before June 18, 1987). Further particulars regarding subsection 20(4.2) are contained in the current version of IT-442. For a bad debt arising on a disposition of EC property occurring before June 18, 1987 (or on a disposition pursuant to the terms of an obligation entered into in writing before June 18, 1987), paragraph 20(1)(p) may still apply -- see paragraph ¶ 19 of IT-123R4.

Amount Not Due Until Later Year

¶ 37. Where a sale of an EC property results in an income inclusion in the year of disposition under subsection 14(1) as described above, but some part of the sale price is not due until a later year, a reserve under paragraph 20(1)(n) is not permitted. This is because the sale of an EC property is not considered to be a sale of property "in the course of the business" as required by paragraph 20(1)(n).

Terminal Allowance

¶ 38. Section 24 contains a rule allowing, under certain conditions, a taxpayer who has ceased to carry on a business to deduct the full amount of any positive balance in the cumulative EC pool for the business. An exception to this rule occurs where there is a "rollover" of the taxpayer's positive balance in the pool to the taxpayer's spouse or corporation. For further discussion of this topic, see the current version of IT-313. It should also be noted that subparagraph 39(1)(b)(ii) precludes claims for capital losses on the disposition of EC property whether or not the business to which it relates has ceased.

Eligible Capital Property of a Deceased Taxpayer

¶ 39. The rules regarding EC property that apply as a result of the death of a taxpayer, including those pertaining to the acquisition of EC property of a deceased taxpayer by another person, are discussed in the current version of IT-313.

Related Bulletins

The titles of the interpretation bulletins referred to above are as follows:

IT-66		Capital Dividends
IT-138		Computation and Flow-Through of Partnership Income
IT-143		Meaning of Eligible Capital Expenditure
IT-206		Separate Businesses
IT-259		Exchanges of Property
IT-313		Eligible Capital Property -- Rules Where a Taxpayer Has Ceased Carrying on a Business or Has Died
IT-381		Trusts -- Capital Gains and Losses and the Flow-Through of Taxable Capital Gains to Beneficiaries
IT-386		Eligible Capital Amounts
IT-442		Bad Debts and Reserves for Doubtful Debts

Schedule A

Comparison of Old and New Systems

		- - - - - - - - - - - - - Treatment under - - - - - - - - - - - - -
Transaction or Item		Old System		- - - - - - - - - New System - - - - - - - - -
		All Taxpayers		First Category1		Second Category2
Balance in pool at end of immediately preceding year under the old system		Becomes opening balance in pool in current year		3/2 of balance becomes opening balance in pool in current year (first year under new system). See ¶ 6 of this bulletin.		3/2 of balance becomes opening balance in pool in current year (first year under new system). See ¶ 6 of this bulletin.
Balance in pool at end of immediately preceding year under the new system		N/A		Becomes opening balance in pool in current year. See ¶ 6 of this bulletin.		Becomes opening balance in pool in current year. See ¶ 6 of this bulletin.
EC expenditure		Increase pool by 1/2 of EC expenditure.		Increase pool by 3/4 of EC expenditure. See ¶ 7 of this bulletin.		Increase pool by 3/4 of EC expenditure. See ¶ 7 of this bulletin.
Disposition of EC property		Decrease pool by EC amount = 1/2 × (proceeds payable to the taxpayer less outlays and expenses).		Decrease pool by EC amount = 3/4 × (taxpayer's total proceeds less outlays and expenses). See ¶ 9 of this bulletin.		Decrease pool by EC amount = 3/4 × (taxpayer's total proceeds less outlays and expenses). See ¶ 9 of this bulletin.
Positive balance in pool at end of the year		May deduct up to 10% of positive balance for purposes of computing income for year. Decrease pool by amount deducted.		May deduct up to 7% of positive balance for purposes of computing income for year. Decrease pool by amount deducted. See ¶ 11 of this bulletin.		May deduct up to 7% of positive balance for purposes of computing income for year. Decrease pool by amount deducted. See ¶ 11 of this bulletin.
Negative balance in pool at end of the year		Income inclusion occurs equal to full amount of negative balance. Increase pool by the income inclusion to bring balance back to nil.		A subparagraph 14(1)(a)(iv) recapture income inclusion occurs if deductions previously claimed. There may also be a subparagraph 14(1)(a )(v) deemed taxable capital gain (which may qualify for a capital gains deduction) if the fiscal period ends before February 23, 19943, or a subparagraph 14(1)(a)(v) income inclusion (which may qualify for a capital gains deduction for qualified farm property) if the fiscal period ends after February 22, 19943, either of which is reduced by an adjustment (if there were old system deductions). A sub-paragraph 14(1)(a)(v) income inclusion may also be reduced by means of the "exempt gains balance." Increase pool by all these amounts (i.e., the subparagraph 14(1)(a)(iv) recapture income inclusion, the subparagraph 14(1)(a)(v) deemed taxable capital gain or subparagraph 14(1)(a)(v) income inclusion, the adjustment, and the amount of exempt gains balance used) to bring pool balance back to nil. See ¶s14 to 17 of this bulletin.		Income inclusion is equal to the negative balance less an adjustment (which occurs if there were old system deductions). Increase pool by both amounts (i.e., the income inclusion and the adjustment) to bring balance back to nil. See ¶ 22 of this bulletin.

1	For a determination of which taxpayers are included in the first category, see ¶ 13 of this bulletin.
2	For a determination of which taxpayers are included in the second category, see ¶ 21 of this bulletin.
3	An individual partner's share of a partnership's subparagraph 14(1)(a)(v) amount may also be able to be reduced by means of the partner's "exempt capital gain balance" -- see ¶ 20 of this bulletin.

Schedule B

The Cumulative Eligible Capital Pool

Example of Calculation under the New System

Assumptions:

1)		The taxpayer is an individual whose business has a fiscal year end of December 31.
2)		The balance in the pool at the end of the 1987 taxation year under the old system was $100,000.
3)		The total net amount of paragraph 20(1)(b) deductions less subsection 14(1) income inclusions under the old system was $15,000.
4)		The acquisitions and dispositions of EC property, resulting in EC expenditures and EC amounts, respectively, are as indicated below under the transactions for each year.
5)		The EC property which is purchased in 1993 replaces the EC property sold in 1992. The taxpayer therefore makes a subsection 14(6) election when filing the 1993 return and requests that the EC amount for the 1992 sale be adjusted in accordance with that election.
6)		The EC property which the taxpayer purchases in 1994 for $100,000 is from a non-arm's length vendor who incurs no selling expenses. The transaction results in a subparagraph 14(1)(a)(v) income inclusion of $60,000 for the vendor. However, the EC property is a qualified farm property and all of the $60,000 is sheltered from taxation in the vendor's hands by means of a section 110.6 capital gains deduction.

Transaction or Item						Variable in 14(5) definition of "cumulative EC"		Increase			Decrease			Balance
1988 Taxation Year
Opening balance: 3/2 × $100,000 (see assumption 2)						C								$	150,000
EC expenditure for $50,000:
Add to pool 3/4 of EC expenditure						A		$	37,500						187,500
Deduct from pool paragraph 20(1)(b) deduction @ 7%						P					$	13,125			174,375
1989 Taxation Year
Deduct from pool paragraph 20(1)(b) deduction @ 7%						P						12,206			162,169
1990 Taxation Year
Sale of EC property:
Sale proceeds			$	410,000
Less selling expenses				10,000
				----------
Base for the EC amount			$	400,000
				======
Deduct from pool EC amount = 3/4 of base						E						300,000			(137,831)1
Subparagraph 14(1)(a)(iv) recapture income inclusion, which is limited to total net recapturable amount:
Old system (see assumption 3)			$	15,000
New system:
Previous paragraph 20(1)(b) deductions:
1988	$	13,125
1989		12,206
		----------
		25,331
Less previous income inclusions		N/A		25,331
		----------		----------
Subparagraph 14(1)(a)(iv) recapture income inclusion -- add this amount back to the pool			$	40,331		R			40,331	2
				======
Subparagraph 14(1)(a)(v) deemed taxable capital gain:
Negative balance in the pool at the end of the year (see above)			$	137,831
Less the sum of
Subparagraph 14(1)(a)(iv) recapture income inclusion for the year (see above)	$	40,331
1/2 of the $15,000 portion of the net recapturable amount that originates from the old system (see assumption 3)		7,500		47,831
		----------		----------
Subparagraph 14(1)(a)(v) deemed taxable capital gain -- add this amount back to the pool			$	90,000		B			90,000	2
				======
Add back to pool 1/2 of the $15,000 portion of the net recapturable amount that originates from the old system (see calculation of deemed taxable capital gain immediately above)						D.1			7,500	2					NIL 2
1991 Taxation Year
EC expenditure for $100,000:
Add to pool 3/4 of EC expenditure						A			75,000						75,000
Deduct from pool paragraph 20(1)(b) deduction @ 7%						P						5,250			69,750
1992 Taxation Year
Sale of EC property:
Sale proceeds			$	210,000
Less selling expenses				10,000
				----------
Base for EC amount as otherwise determined				200,000
Less amount excluded under subsection 14(6) election filed with the 1993 return (see assumption 5)				200,000
				----------
Revised base for EC amount			$	NIL
				======
Deduct from pool EC amount = 3/4 of revised base						E						NIL			69,750
Deduct from pool paragraph 20(1)(b) deduction @ 7%						P						4,883			64,867
1993 Taxation Year
Base for the EC amount = the $200,000 excluded from base for EC amount for 1992 under subsection 14(6) election filed with this year's return (see assumption 5):
Deduct from pool EC amount = 3/4 of that base						E						150,000			( 85,133)
EC expenditure for $240,000 to replace EC property sold in 1992 (see assumption 5):
Add to pool 3/4 of EC expenditure						A			180,000						94,867
Deduct from pool paragraph 20(1)(b) deduction @ 7%						P						6,641			88,226
1994 Taxation Year
Purchase of EC property for $100,000 -- subsection 14(3) calculation of EC expenditure (see assumption 6):
Vendor's EC amount			$	75,000
Less vendor's capital gains deduction				60,000
				----------
Difference			$	15,000
				======
Purchaser's EC expenditure = 4/3 of difference			$	20,000
				======
Add to pool 3/4 of purchaser's EC expenditure						A			15,000						103,226
Deduct from pool paragraph 20(1)(b) deduction @ 7%						P						7,226			96,000
1995 Taxation Year
Deduct from pool paragraph 20(1)(b) deduction @ 7%						P						6,720			89,280
1996 Taxation Year
Deduct from pool paragraph 20(1)(b) deduction @ 7%						P						6,250			83,030

1	This is the negative balance of the end of the 1990 taxation year.
2	The three "add backs" bring the pool balance from $(137,831) back to nil.

Explanation of Changes

Introduction

The purpose of the Explanation of Changes is to give the reasons for the revisions to an interpretation bulletin. It outlines revisions that we have made as a result of changes to the law, as well as changes reflecting new or revised departmental interpretations.

Reasons for the Revision

This bulletin has been revised to reflect amendments to the Income Tax Act enacted under the 5th Supplement to the Revised Statutes of Canada, 1985; S.C. 1994, c. 21 (formerly Bill C-27); S.C. 1995, c. 3 (formerly Bill C-59); and S.C. 1995, c. 21 (formerly Bill C-70). The bulletin is not affected by any proposed legislation released as of May 30, 1997.

Legislative and Other Changes

Effective for taxation years ending after November 1991, the following structural amendments to the Act were made:

• The definitions of "cumulative eligible capital" (cumulative EC), "eligible capital expenditure" (EC expenditure) and "adjustment time" were removed from paragraphs 14(5)(a), (b) and (c) of the Act, respectively, and instead placed in alphabetical order in subsection 14(5).
• The definition of "eligible capital property" (EC property) was removed from paragraph 54(d) of the Act and instead placed in alphabetical order (with other definitions) in section 54.
• The definition of "capital dividend account" was removed from paragraph 89(1)(b) of the Act and instead placed in alphabetical order (with other definitions) in subsection 89(1).
• The definitions of "government right," "original right" and "specified right" were removed from paragraphs 21(3)(a), (b) and (c) of the Income Tax Application Rules, 1971 (ITAR) and instead placed in alphabetical order in subsection 21(3) of the ITAR.
• The above-mentioned definition for "cumulative eligible capital" was changed in form to a mathematical formula.

These structural amendments to the Act are reflected in ¶s 3, 5, 6, 34 (formerly ¶ 29) and 35 (formerly ¶ 30) and Schedule B of the bulletin.

¶ 8 is new. It has been added to the bulletin in order to discuss the effect of the rules in subsections 14(10) and (11). These subsections apply to assistance from a government, municipality or other public authority that a taxpayer receives or becomes entitled to receive after February 21, 1994, and to repayments of such assistance.

¶ 10 is new. It has been added to the bulletin in order to discuss the effect of an amendment to section 14 that applies to taxation years ending after February 21, 1994. The amendment relates to subsection 80(7) and the forgiveness of debt.

A new part has been added at the end of ¶ 13 (formerly ¶ 11) in order to discuss the deemed residence rule in subsection 14(8). Although subsection 14(8) was added to the Act since this bulletin was last issued, it applies for the 1988 and subsequent taxation years.

¶ 14 (formerly ¶ 12) has been revised in order to reflect an amendment to section 14 that applies to taxation years ending after February 21, 1994. This amendment is shown in ¶ 14 as variable B.1 and it is related to the amendment covered in new ¶ 10 with respect to subsection 80(7) and the forgiveness of debt (see explanation above). Also in ¶ 14, we now use the term "subparagraph 14(1)(a)(iv) recapture income inclusion" rather than "income inclusion under subsection 14(1)" in order to distinguish this income inclusion from the "subparagraph 14(1)(a)(v) income inclusion" described in ¶ 17.

¶s 15 to 17 replace former ¶ 13. ¶ 17 reflects amendments to section 14 that generally apply to fiscal periods ending after February 22, 1994. These amendments to section 14 relate to the elimination of the $100,000 capital gains exemption in section 110.6, which applies for dispositions of property after February 22, 1994, as well as related amendments to section 110.6 permitting the recognition of capital gains accrued to February 22, 1994. The amendments to section 14 include what we refer to in the bulletin as the "subparagraph 14(1)(a)(v) income inclusion," the "exempt gains balance" and related amendments.

¶ 18 (formerly ¶ 14), which refers to a beneficiary of a trust in connection with the application of subparagraph 14(1)(a)(v) to the trust, is revised as a consequence of the revisions to the rules described in ¶s 15 to 17 (formerly ¶ 13).

¶ 19 (formerly ¶ 15), which refers to a member of a Canadian partnership in connection with the application of subparagraph 14(1)(a)(v) to the partnership's business, is revised as a consequence of the revisions to the rules described in ¶s 15 to 17 (formerly ¶ 13).

¶ 20 is new. It has been added to the bulletin to make a reference to subsection 39.1(5) and the definition of "exempt capital gains balance" in subsection 39.1(1), both of which were added to the Act for the 1994 and subsequent taxation years.

The last part of ¶ 23 (formerly ¶ 18) has been revised in order to clarify that the subsequent disposition of the property need not be at arm's length in order for the reversal of the subsection 14(3) reduction to the transferee's EC expenditure to occur, but that the subsequent transferee could then be subject to the subsection 14(3) reduction.

¶ 24 is new. It has been added to the bulletin in order to discuss the rule in subparagraph 110.6(19)(b)(ii), which applies to EC property acquired by a non-arm's length transferee after February 22, 1994.

In Schedule A of the bulletin, the last item under the heading "First Category" has been revised because of the amendments to the law that are reflected in ¶s 15 to 17 (formerly ¶ 13).

Assumption 6 of Schedule B has been revised. This revision refers to a subparagraph 14(1)(a)(v) income inclusion (which is discussed in ¶ 17 under the rules for fiscal periods ending after February 22, 1994).

Other changes to the bulletin include

• clarification changes; and
• the removal of the detailed discussion of topics considered outside the scope of the new bulletin.

Notice -- Bulletins do not have the force of law

Interpretation bulletins (ITs) provide Revenue Canada's technical interpretations of income tax law. Due to their technical nature, ITs are used primarily by departmental staff, tax specialists, and other individuals who have an interest in tax matters. For those readers who prefer a less technical explanation of the law, the Department offers other publications, such as tax guides and pamphlets.

While the ITs do not have the force of law, they can generally be relied upon as reflecting the Department's interpretation of the law to be applied on a consistent basis by departmental staff. In cases where an IT has not yet been revised to reflect legislative changes, readers should refer to the amended legislation and its effective date. Similarly, court decisions subsequent to the date of the IT should be considered when determining the relevancy of the comments in the IT.

An interpretation described in an IT applies as of the date the IT is published, unless otherwise specified. When there is a change in a previous interpretation and the change is beneficial to taxpayers, it is usually effective for all future assessments and reassessments. If the change is not favourable to taxpayers, it will normally be effective for the current and subsequent taxation years or for transactions entered into after the date of the IT.

A change in a departmental interpretation may also be announced in the Income Tax Technical News.

If you have any comments regarding matters discussed in this IT, please send them to:

Date modified:

2002-09-04