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.
Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CCRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.
Principal Issues: Whether disposition of water rights, originally capitalized to the cost of the associated farmland, would be considered a disposition of land or eligible capital property; If it is ECP, could any of the original cost be reallocated to the CEC pool; Could a 14(1.01) election me made with respect to the disposition?
Position: Given the change in Albert legislation, proceeds would probably result in an eligible capital amount; Prior to change in law, costs were correctly capitalized to the land, and there is no provision in the Act allowing these costs to be reallocated to CEC; Question of fact whether 14(1.01) election could be made.
Reasons: Meets the mirror image test in subsection 14(5) in that, now that these 14(1) rights can be sold separately from the land, the purchaser could make a reasonable argument that they are eligible capital property; Since these rights were correctly considered to be part of the land, there is no mechanism to transfer the costs to the CEC pool because of a change in the provincial legislation; All of the facts of a particular situation must be considered before any definitive comments can be made on subsection 14(1.01).14(5)
XXXXXXXXXX Wayne Antle, CGA
2002-017830
May 7, 2003
Dear XXXXXXXXXX:
Re: Technical Interpretation Request: Disposition of Water Rights
This is further to your letter of November 15, 2002, concerning the tax treatment of proceeds received on the disposition of water rights. We also acknowledge the additional information submitted on March 20, 2003.
Our understanding of the facts is as follows:
The Government of Alberta has recently changed the legislation governing water rights associated with farmland, whereby these rights can now be sold separately from the associated land, if certain conditions are met. Essentially, water rights constitute the right to irrigate an identified parcel of land in perpetuity. Before the legislation was amended, the water rights were permanently linked to the farmland, and could not be sold separately. The water rights were originally purchased from a public authority, the Irrigation District, and became permanently linked to the particular parcel of land at that time. If the land were subsequently sold, the corresponding water rights would have also passed to the new owner. Whether the water rights were acquired directly from the Irrigation District, or as part of land that was purchased, the cost of these rights was always considered to be part of the cost of the associated land for tax purposes.
Given the recent change in Alberta legislation, you have asked for our comments on the tax treatment of proceeds received on the sale of water rights, where the underlying land has not been sold. In particular you have asked:
1. Is the sale of water rights a disposition of farmland or eligible capital property?
2. If it is farmland, would the proceeds be a grind to the cost of the farmland, or would it trigger a capital gain or loss?
3. If it is a disposition of eligible capital property:
a. Should a reasonable portion of the original acquisition costs be reallocated from the land to the eligible capital property?
b. Can an election under subsection 14(1.01) be made?
Written confirmation of the tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and are the subject matter of an Advance Income Tax Ruling request. Where the particular transactions are completed, the inquiry should be addressed to the relevant Tax Services Office. However, we are prepared to provide the following comments.
Farmland or Eligible Capital Amount
Element E of the definition of "cumulative eligible capital" in subsection 14(5) of the Income Tax Act (the "Act") defines an eligible capital amount as 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 eligible capital expenditure for the business (the "mirror image test"). Therefore, the proceeds received from the sale of water rights would be eligible capital property if, had the vendor made a payment to acquire the water rights, such payment would have been an eligible capital expenditure to the individual.
An eligible capital expenditure ("ECE"), within the meaning of subsection 14(5) of the Act, may be broadly defined as an expenditure made after 1971, which is on capital account and made for the purpose of gaining or producing income from a business. Many expenditures, however, can meet these broad requirements but still fall within one of the specific exclusions contained in the definition. The definition excludes, among other things, outlays or expenditures that are otherwise deductible, form part of the cost of tangible capital property, or form part of the cost of intangible capital property that is included in a prescribed capital cost allowance class.
In our view, a reasonable argument can be made that the proceeds from the disposition of water rights (which can now be sold separately from the land) would be considered an eligible capital amount. Using the mirror-image test, if the taxpayer had purchased the water rights, it is likely that these rights would be considered an eligible capital expenditure, similar to other government rights. However, we cannot provide more definitive comments without reviewing all of the facts and documentation of a particular transaction. This would normally only be done in the context of an advance income tax ruling request.
Original Cost of Water Rights
It is our view that the cost of the water rights was correctly included in the cost of the associated land, where the land was acquired prior to the change in the Alberta legislation. There is no provision in the Act to permit the re-classification of the cost from the land to the cumulative eligible capital ("CEC") account. We feel that the costs were not misclassified originally, and the change in the provincial legislation governing water rights does not result in a deemed change in use, or deemed disposition. Therefore, in computing the amount to be included in income under subsection 14(1) of the Act, and the CEC, it is our view that the eligible capital expenditure in respect of the water rights would be nil if these rights were last acquired prior to the Alberta legislation being amended.
Deemed Capital Gain
Subsection 14(1.01) of the Act allows a taxpayer to elect to remove a portion of the proceeds of disposition of an eligible capital property from the CEC account and recognize a capital gain on the portion of the proceeds in excess of the ECE in respect of the property. The ECE is deemed to be the proceeds of disposition for the purposes of subsection 14(5) of the Act and is accordingly deducted from the CEC. The election does not apply to goodwill, or to any eligible capital property where the ECE cannot be determined. Furthermore, the election cannot be made if the taxpayer has an exempt gains balance. We are unable to provide definitive comments on the application of subsection 14(1.01) of the Act without reviewing all of the facts and documentation in an actual situation. We will consider a request for an advance income tax ruling on a proposed transaction, if all the necessary information is provided.
Where the disposition of the water rights results in an income inclusion under subsection 14(1) of the Act, subsection 14(1.1) of the Act may apply to deem part of this amount to be a capital gain. If the eligible capital property is "qualified farm property" as defined in subsection 110.6(1) of the Act, the taxpayer may be able to claim a capital gains deduction with respect to the disposition. Please refer to the 2002 Farming Income Guide for more information in this regard.
We trust that our comments will be of assistance.
Yours truly
John Oulton, CA
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
Policy and Legislation Branch
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