7 August 2008 External T.I. 2008-0280971E5 - Limit on interest and property tax - Vacant Land

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: May an individual taxpayer that is subject to subsection 18(2) of the Act, by virtue of subsection 18(3), deduct interest: 1. to the extent that the assisted-entity earns gross revenue from the land in excess of its other expenses; or 2. to the extent of the base level deduction of the assisted-entity, where the assisted-entity is a corporation whose principal business is the development for sale of real property and has a base level deduction available to it?

Position: 1. No 2. No

Reasons: Pursuant to paragraphs 18(2)(e) and (f) of the Act, a taxpayer that is subject to subsection 18(2) of the Act, by virtue of subsection 18(3), may only deduct interest to the extent of the total of that taxpayer's (i.e., not the assisted-entity's) gross revenue from the land in excess of its other expenses, and in the case of a corporate taxpayer whose principal business, inter alia, is the development for sale of real property, that corporation's (i.e., not the assisted-entity's) base level deduction.

XXXXXXXXXX 								2008-028097
L. Carruthers, CA
August 7, 2008

Dear XXXXXXXXXX :

Re: Subsections 18(2) and 18(3)
Interest on vacant land

This is in reply to your letter of May 28, 2008, in which you requested our technical interpretation of subsections 18(2) and 18(3) of the Income Tax Act (the "Act"). Specifically, you ask whether an individual taxpayer that is subject to subsection 18(2) of the Act, by virtue of subsection 18(3) which generally includes a taxpayer who assists certain other entities (each an "assisted-entity") to acquire land, may deduct interest:

• to the extent that the assisted-entity earns gross revenue from the land in excess of its other expenses; and
• to the extent of the base level deduction of the assisted-entity, where the assisted-entity is a corporation whose principal business is the development for sale of real property and has a base level deduction available to it.

Our Comments

Written confirmation of the tax implications inherent in particular transactions are given by this Directorate only where the transactions are proposed and are the subject of an advance income tax ruling request submitted in a manner set out in Information Circular 70-6R5. We are, however, prepared to provide the following comments which are of a general nature only. All Canada Revenue Agency publications referred to herein may be accessed on the Internet at http://www.cra-arc.gc.ca/formspubs/menu-e.html.

Interpretation Bulletin IT-153R3, Land developers - Subdivision and development costs and carrying charges on land, deals with the special treatment accorded to interest and property taxes on vacant land held as inventory. Generally, a taxpayer's deduction for such carrying charges incurred in a taxation year is limited to the extent of the taxpayer's net income from the land for the year (being the gross income from the land for the year less other deductions exclusive of the carrying charges). However, for a corporation whose principal business is the leasing, rental or sale or the development for lease, rental or sale (or any combination thereof), of real property owned by it, to or for a person with whom the corporation is dealing at arm's length, the deduction for such carrying charges incurred in a taxation year is limited to the extent of the corporation's aggregate of the net income from the land for the year and the corporation's base level deduction for the year.

The above noted limitations are pursuant to paragraphs 18(2)(e) and (f) of the Act, which are reproduced below:

"Notwithstanding paragraph 20(1)(c), in computing the taxpayer's income for a particular taxation year from a business or property, no amount shall be deductible in respect of any expense incurred by the taxpayer in the year as, on account or in lieu of payment of, or in satisfaction of,

(a) interest on debt relating to the acquisition of land, or
(b) property taxes (not including income or profits taxes or taxes computed by reference to the transfer of property) paid or payable by the taxpayer in respect of land to a province or to a Canadian municipality,
unless, having regard to all the circumstances (including the cost to the taxpayer of the land in relation to the taxpayer's gross revenue, if any, from the land for the particular year or any preceding taxation year), the land can reasonably be considered to have been, in the year,
(c) used in the course of a business carried on in the particular year by the taxpayer, other than a business in the ordinary course of which land is held primarily for the purpose of resale or development, or
(d) held primarily for the purpose of gaining or producing income of the taxpayer from the land for the particular year,
except to the extent of the total of
(e) the amount, if any, by which the taxpayer's gross revenue, if any, from the land for the particular year exceeds the total of all amounts deducted in computing the taxpayer's income from the land for the year, and
(f) in the case of a corporation whose principal business is the leasing, rental or sale, or the development for lease, rental or sale, or any combination thereof, of real property owned by it, to or for a person with whom the corporation is dealing at arm's length, the corporation's base level deduction for the particular year."

For the purpose of subsection 18(2) of the Act, subparagraph 18(3)(b) (reproduced below) expands the meaning of "interest on debt relating to the acquisition of land" such that it:

"includes interest paid or payable in the year by a taxpayer on borrowed money that may reasonably be considered (having regard to all the circumstances) to have been used to assist, directly or indirectly,

(i) another person with whom the taxpayer does not deal at arm's length,

(ii) a corporation of which the taxpayer is a "specified shareholder", or

(iii) a partnership of which the taxpayer's share of any income or loss is 10 percent or more,

to acquire land to be used or held by that person, corporation or partnership [i.e. the assisted-entity] otherwise than as described in paragraph (2)(c) or (d), except where the assistance is in the form of a loan to that person, corporation or partnership and a reasonable rate of interest on the loan is charged by the taxpayer;"

In our view, an individual taxpayer that is subject to subsection 18(2) of the Act, by virtue of the above definition in subsection 18(3), may not deduct interest:

• to the extent that the assisted-entity earns gross revenue from the land in excess of its other expenses; or
• to the extent of the base level deduction of the assisted-entity, where the assisted-entity is a corporation whose principal business is the development for sale of real property and has a base level deduction available to it.

Moreover, pursuant to paragraphs 18(2)(e) and (f) of the Act, in our view, a taxpayer that is subject to subsection 18(2) of the Act, by virtue of the above definition in subsection 18(3), may only deduct interest to the extent of the total of that taxpayer's (i.e., not the assisted-entity's) gross revenue from the land in excess of its other expenses, and in the case of a corporate taxpayer whose principal business, inter alia, is the development for sale of real property, that corporation's (i.e., not the assisted-entity's) base level deduction. Further, as the assisted-entity owns the land, such a taxpayer would generally not have any gross revenue from the land nor, if it were a corporate taxpayer, would it satisfy the principal business test.

This position is consistent with the following comments found in paragraphs 10 and 11 of IT-153R3 as well as those of the Tax Court in Anstel Holdings Ltd v MNR [91 DTC 1050]:

IT-153R3:

"10. ...Where it may reasonably be considered (having regard to all the circumstances) that the corporation or partnership [i.e., the assisted-entity] used the money received from the issuance of the shares, the contribution of capital or the interest-free loan to acquire land to be used or held primarily for the purpose of resale or development, the taxpayer who subscribes for shares, contributes capital or makes the interest-free loan will be subject to subsection 18(2) and accordingly, will be denied any deduction for the interest paid or payable on the borrowed money. Furthermore, the interest expense so denied is not added to the taxpayer's inventory cost of land because it is in respect of land that the taxpayer does not own.

11. For 1988 and subsequent taxation years, where a taxpayer holds on capital account shares of a corporation or an interest in a partnership as a result of a transaction described in 10 above, paragraph 53(1)(d.3) and subparagraph 53(1)(e)(xi) respectively provide for an addition to the adjusted cost base of such properties equal to the amount of the interest expense denied to the taxpayer under subsection 18(2) by reason of subparagraph 18(3)(b)(ii)."

Anstel Holdings:

"I stop at this point to say that since Chatelaine [the assisted-entity] "used and held" the Point Robert lots, and not Anstel, then obviously Anstel cannot avail itself of the exculpatory effects of subparagraphs (c) and (e) above.

Therefore, to give effect to subsection 18(2), since Anstel's gross revenue from the "land" in 1980 and 1981 was nil, no deduction for the interest on the borrowed money may be had by Anstel."

We trust that our comments will be of assistance.

Yours truly,

R.A. Albert, CA
For Director
Financial Sector and Exempt Entities Division
Income Tax Rulings Directorate