1993 Internal T.I. 9325277 F - Debtor's Gain

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.

December 6, 1993

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Debtor's Gain on Settlement of Debt & Subsequent Disposition of Assets

This is in response to your letter of September 2, 1993, concerning the application of section 80 of the Income Tax Act (the "Act") on the settlement of debt and the subsequent disposition of assets. The facts as we understand them are as follows:

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It is your opinion that the reduction to capital cost of depreciable assets as a result of the application of section 80 results in a reduction to the undepreciated capital cost of the assets as at that time but that this reduction does not reduce the capital cost of depreciable assets for recapture and capital gains purposes. As a result you are of the opinion that adjustments should be made to the relevant returns as follows:

(i)      recapture capital cost allowance claimed from the undepreciated capital cost to the original cost of the depreciable assets involved.

(ii)      reduce capital gains reported to the amount between proceeds and original cost of depreciable assets sold.

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You have asked us to review the information presented in your letter and to provide a response as soon as possible since you will be conducting an audit of the taxpayer in the middle of October.

Our Comments:

A taxpayer's gain from the disposition of any property is determined in accordance with the provisions of subsection 40(1) of the Act. The opening words of subsection 40(1) state "Except as otherwise expressly provided in this Part" and there are no other provisions that we are aware of that would apply to your situation. Subparagraph 40(1)(a)(i) provides, inter alia, that the gain is the amount by which the proceeds of disposition exceed the adjusted cost base of the property immediately before the disposition. It is the amount determined under subsection 40(1) of the Act that is then brought into subsection 39(1) of the Act to determine the taxpayers capital gain for the year. The term "adjusted cost base" of any property is defined in paragraph 54(a) of the Act. Subparagraph 54(a)(i) defines the adjusted cost base of depreciable property to mean its capital cost as of that time.

Paragraph 80(1)(b) provides, inter alia, that the amount of the excess, calculated in the preamble of subsection 80(1), to the extent that it has not been applied as provided in paragraph (a) shall be applied to reduce in prescribed manner the capital cost to the taxpayer of any depreciable property. Subsection 5400(1) of the Regulations provides that the reduction in paragraph 80(1)(b) of the Act be made to the maximum extent possible and the order in which to apply the reduction.

Firstly, to prescribed classes then to non-prescribed classes of depreciable property and then in the remaining order as specified.

The amount of a taxpayer's recaptured depreciation is determined in accordance with the provisions of subsection 13(1) of the Act.

Subsection 13(1) states "Where, at the end of a taxation year, the aggregate of all amounts determined under subparagraphs 21(f)(iii) to (viii) in respect of a taxpayer's depreciable property of a particular prescribed class exceeds the aggregate of all amounts determined under subparagraphs (21)(f)(i) to (ii.2) in respect thereof, the excess shall be included in computing the taxpayer's income for the year." The term "undepreciated capital cost" is defined in paragraph 13(21)(f) to mean the amount by which the aggregate of subparagraphs (i) to (ii.2) exceeds the aggregate of subparagraphs (iii) to (viii) thereof.

Generally the most common provisions of paragraph 13(21)(f) that apply are subparagraphs (i), (iii) and (iv). Subparagraph 13(21)(f)(i) is the capital cost to the taxpayer of each depreciable property of that class acquired before that time, subparagraph 13(21)(f)(iii) is the total depreciation allowed to the taxpayer for property of that class before that time, and subparagraph (iv) represents for each disposition before that time of the taxpayer of that class, the lesser of the proceeds of disposition of the property minus any outlays and expenses that were made or incurred by the taxpayer for the purpose of making the disposition, and the capital cost to the taxpayer of the property.

The term "total depreciation" has the meaning assigned by paragraph 13(21)(e) of the Act.

Although we agree with you that the term "capital cost" is not defined in the Act and as such we would generally use the original cost as the starting point in its determination which is consistent with our position as outlined in Interpretation Bulletin IT-174R, we cannot agree with your view that the reduction to capital cost under paragraph 80(1)(b) is only for the purposes of determining capital cost allowance and as such the original cost would be the capital cost of a depreciable property for such other purposes as determining recapture and capital gains. In our view in the situation described above, the capital cost of a particular depreciable property, as used in subparagraphs 13(21)(f)(i) and clause 13(21)(f)(iv)(B) and the adjusted cost base of that particular property as used in subparagraph 40(1)(a)(i), would be the reduced capital cost amount after applying the reduction under paragraph 80(1)(b) of the Act. Consequently, we cannot agree with your conclusions that it would be the original cost of that property.

In order for the capital cost of depreciable property to be its original cost for recapture or capital gains purposes, ignoring the paragraph 80(1)(b) reductions as you have indicated, the Act would need a definition within subsection 13(21)(f) or section 54 of the Act, respectively containing opening words such as "Notwithstanding section 80". If the rules of section 80 were intended to have a restricted application as you have suggested, the opening words of section 80 would have suggested so. You would have expected to see such opening words as "for the purposes of..." and there are no such restrictions contained in the opening words. Alternatively, you would have expected the rules in section 80 not to have provided for a reduction to the capital cost but instead to have provided for a deemed paragraph 20(1)(a) amount such that the paragraph 13(21)(f)(iii) amount would have been increased which would be similar to the rules found under other provisions of the Act designed to ensure recapture on certain dispositions of depreciable property such as subsection 85(5) or paragraph 98(5)(e). This does not appear to be the intention of section 80 or of subsection 13(1) of the Act. In our view, subsection 13(1) does not require a taxpayer to include in income an amount that was never claimed as capital cost allowance.

In conclusion, for the purposes of calculating the capital gain section 54 would define the adjusted cost base to be the reduced capital cost amount after applying the reduction under paragraph 80(1)(b) of the Act and this same reduced capital cost should be used for purposes of subsection 13(1). Generally, where the proceeds of disposition of depreciable property of a particular class exceed both the undepreciated capital cost of the class and the reduced capital cost of the depreciable property, the application of subsection 13(1) would result in the recapture of all capital cost allowance claimed. This would occur in the simple scenario of one asset in the class as shown in the following example:

Example

Original Cost of Property $1,000,000 Capital Cost Allowance claimed 350,000 Undepreciated Capital Cost 650,000

The taxpayer has a debtor's gain of $200,000 that will result in a section 80 adjustment of $200,000. Regulation 5401(1) limits the reduction to the lesser of:

(a)      the amount by which

(i)      capital cost 1,000,000

exceeds

(ii)      capital cost allowance claimed 350,000

650,000

and

(b)      the amount by which

(i)      undepreciated capital cost 650,000

exceeds

(ii)      previous 5401(1) amounts 0 650,000

The reduction will be the entire $200,000, causing the capital cost to be reduced to $800,000. The taxpayer now sells the property for $1,500,000.

Recaptured Depreciation - subsection 13(1):

Where at the end of a taxation year, the aggregate of all amounts determined under subparagraphs 21(f)(iii) to (viii)...exceeds the aggregate of all amounts determined under subparagraph 21(f)(i) to (ii.2)...the excess shall be included in computing the taxpayers income for the year.

In our example the only applicable subparagraphs are 21(f)(i), (iii) and (iv).

21(f)(iii) total depreciation taken (13(21)(e)-CCA) 350,000 21(f)(iv) lesser of proceeds or capital cost 800,000 1,150,000 21(f)(i) capital cost 800,000

Recaptured Depreciation $ 350,000

Subsection 40(1) gain:

Proceeds of Disposition $1,500,000

Adjusted Cost Base (54(a)) 800,000 700,000

Subsection 39(1) - Capital Gain $ 700,000

Without section 80 application:

Recaptured Depreciation - Subsection 13(1)

21(f)(iii)  $ 350,000

21(f)(iv)  1,000,000 1,350,000

21(f)(i)  1,000,000

Recaptured Depreciation 350,000

Subsection 40(1) gain:

Proceeds of Disposition $1,500,000

Adjusted Cost Base 1,000,000 500,000

Subsection 39(1)  $ 500,000

So to conclude, recapture is as expected and the capital gain is increased by the amount of the subsection 80(1) adjustment. However, the application of subparagraph 13(21)(f)(iv) in the calculation of recapture under subsection 13(1) may effect this general result where the proceeds of disposition of property in the class which had been previously disposed of were less than their capital cost.

We would suggest that the calculation of recapture in your particular case be reviewed. We would appreciate being advised of the reviewed calculation and the reason for the recapture being less than expected.for DirectorBusiness and General DivisionRulings DirectorateLegislative and Intergovernmental Affairs Branch