24 June 2010 External T.I. 2010-0369551E5 - Capital Gains Reserve - Disp to Closely Held Corp

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.

Principal Issues: Can a capital gains reserve be claimed by a taxpayer in respect of the disposition of farmland to a closely held corporation.

Position: Unable to opine. Depends upon whether or not the corporation is controlled by the taxpayer, and, whether or not proceeds of disposition are payable to the taxpayer after the end of the year.

Reasons: The determination rests upon the resolution of matters which are a question of fact. The law.

XXXXXXXXXX
					2010-036955
					James Atkinson CGA
					(519) 457-4832
June 24, 2010

Dear XXXXXXXXXX :

Re: Capital Gains Reserve / Disposition to Family Owned Corporation

This is in response to your letter dated June 2, 2010, concerning the capital gains reserve under subparagraph 40(1)(a)(iii) of the Income Tax Act ("Act").

In your correspondence, you describe a hypothetical situation as follows:

1. Mr. A and Mrs. A are a married couple who are shareholders of a closely held corporation ("Farmco") which carries on a farming business. Their shareholdings consist of all the issued and outstanding preferred shares of Farmco, being two classes of preferred shares, one class which has no voting rights (the "Freeze Shares") and the other which provide 50% of the voting rights. Mr. A and Mrs. A's adult child owns all the issued and outstanding common shares of Farmco, which provide the other 50% of the voting rights.

2. Current shareholdings result from a share freeze transaction under taken in the past.

3. Mr. A and Mrs. A personally own a parcel of farm land which they wish to sell to Farmco at fair market value for a promissory note to be issued by Farmco.

4. Mr. A and Mrs. A would each like to claim a capital gains reserve under subparagraph 40(1)(a)(iii) in respect of the capital gain from the sale of the farm land to Farmco.

You note that subparagraph 40(2)(a)(ii) of the Act places a limitation upon the claiming of a reserve under subparagraph 40(1)(a)(iii) where the purchaser of the property is a corporation that, immediately after the sale, was "controlled, directly or indirectly, in any manner whatever," by the taxpayer.

You have considered the meaning of the phrase "controlled, directly or indirectly, in any manner whatever," as defined in subsection 256(5.1) of the Act, and have concluded that, since Mr. A and Mrs. A own 50% of the votes of Farmco, neither has de jure control. As a consequence, you conclude that Mr. A and Mrs. A are not precluded from claiming a reserve under subparagraph 40(1)(a)(iii) in respect of a capital gain arising upon the disposition of farm land.

You have asked for confirmation whether your conclusion above is correct.

Our Comments:

The situation outlined in your letter appears to relate to a factual one, involving a specific taxpayer. It is not this Directorate's practice to comment on proposed transactions involving specific taxpayers other than in the form of an advanced income tax ruling. For more information about how to obtain a ruling, please refer to Information Circular 70-6R5, Advanced Income Tax Rulings, dated May 17, 2002. This Information Circular and other CRA publications can be accessed on the internet at http://www.cra-arc.gc.ca. Should your situation involve a specific taxpayer and a completed transaction, you should submit all relevant facts and documentation to the appropriate Tax Services Office ("TSO") for their views. A list of TSOs is available on the "Contact Us" page of the CRA website. Although we cannot comment on your specific situation, we are prepared to provide the following general comments, which may be of assistance.

Where a taxpayer disposes of capital property in a taxation year, the capital gain otherwise determined may be reduced under subparagraph 40(1)(a)(iii) of the Act by a reasonable reserve in respect of proceeds of disposition that are payable to the taxpayer after the end of the year.

Without knowing the terms of the promissory note, we are unable to conclude whether or not proceeds of disposition are payable after the end of the year. Where the terms of a promissory note indicate that it is payable on demand or the promissory note is accepted as absolute payment, it would be our view that there are no proceeds of disposition payable after the end of the year in respect of which a reserve may be claimed.

Subparagraph 40(2)(a)(ii) precludes a taxpayer from claiming a reserve under subparagraph (1)(a)(iii) if the purchaser of the property is a corporation that, immediately after the sale was, inter alia, "controlled, directly or indirectly, in any manner whatever," by the taxpayer. The expression "controlled, directly or indirectly, in any manner whatever," encompasses de facto control (i.e., control in fact) in addition to de jure control, pursuant to subsection 256(5.1) of the Act

De facto control goes beyond de jure control and includes the ability to control "in fact" by any direct or indirect influence and may exist even without the ownership of any shares. De facto control can take many forms, e.g., the ability of a person to change the board of directors or reverse its decisions, to make alternative decisions concerning the actions of the corporation in the short, medium or long term, to directly or indirectly terminate the corporation or its business, or to appropriate its profits and property. The existence of any such influence, even if it is not actually exercised, would be sufficient to result in de facto control.

Whether or not de facto control exists in a particular case is a question of fact that can only be resolved by reviewing the documents and surrounding circumstances of the case. Such a determination, as it may relate to any specific case, is generally made by the local TSO. Based upon the limited facts provided, we are unable to conclude that Farmco is not controlled, directly or indirectly, in any manner whatever, by Mr. or Mrs. A and accordingly we are unable to confirm whether a reserve under subparagraph 40(1)(a)(iii) may be claimed.

We trust that these comments will be of assistance.

Yours truly,

S. Parnanzone
For Director
Business and Partnerships Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch