2003 Ruling 2003-0006993 - REPLACEMENT PROPERTY

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: Request for an advance income tax ruling where taxpayer replaces former property with a significantly larger replacement property that results in an expansion of the business.

Position: The fact that a property is purchased under a business expansion would not, in and by itself, mean that the property could not be considered a replacement property.

Reasons: As stated at the 2002 Canadian Tax Foundation Conference, the statement in paragraph 15 of IT-259R3, that the replacement property rules are not intended to encompass business expansions, was made in the situation where it could not be readily determined whether one particular property is actually being replaced by another. The comments were made in the context of a taxpayer who was in the process of expanding a retail operation by opening and closing a number of locations. The new properties acquired during this type of "business expansion" were not considered replacement properties because there was no correlation or causal relationship between their acquisition and the disposition of the existing properties. Further, IT-259R3 will be changed to clarify the comments on business expansion. In this situation, after considering all the facts, it can readily be determined that there is a correlation between the acquisition of the replacement property and the disposition of the former property.

XXXXXXXXXX 2003-000699

XXXXXXXXXX, 2003

Dear XXXXXXXXXX:

Re: Advance Income Tax Ruling Request - XXXXXXXXXX

This is in reply to your letter of XXXXXXXXXX, as amended through further written submissions (XXXXXXXXXX) and our recent telephone conversations (XXXXXXXXXX), in which you requested an advance income tax ruling on behalf of the above-noted company with respect to the application of the replacement property rules to the disposition of land.

We understand that, to the best of your knowledge and that of the taxpayers involved, none of the issues involved in the ruling request:

(i) is in an earlier return of a taxpayer or a related person,

(ii) is being considered by a tax services office or taxation center in connection with a previously filed tax return of a taxpayer or a related person,

(iii) is under objection by a taxpayer or a related person,

(iv) is before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has not expired, and

(v) is the subject of a ruling previously issued by the Directorate.

Unless otherwise stated, all references to a statute are to the Income Tax Act R.S.C. 1985 (5th Supp.), c.1, as amended, (the "Act") and all terms and conditions used herein that are defined in the Act have the meaning given in such definition unless otherwise indicated.

Definitions

1. "ACO" is XXXXXXXXXX.

2. "BCO" is XXXXXXXXXX.

3. "CCO" is XXXXXXXXXX.

4. "The Family Trust" is the XXXXXXXXXX.

5. "Mr. A" is XXXXXXXXXX.

6. "Mrs. A" is XXXXXXXXXX.

7. The terms "adjusted cost base", "capital property", and "proceeds of disposition" have the meaning assigned by section 54 of the Act.

8. The term "former property" has the meaning assigned by subsection 44(1) of the Act.

9. The term "replacement property" has the meaning assigned by subsection 44(5) of the Act.

10. The terms "disposition", "farming", and "former business property" have the meaning assigned by subsection 248(1) of the Act.

Our understanding of the facts, proposed transactions and the purpose of the proposed transactions is as follows:

Facts

11. ACO was incorporated in XXXXXXXXXX and has been actively involved in the business of farming in Canada since XXXXXXXXXX. ACO has an XXXXXXXXXX fiscal year-end.

12. ACO has the following share capital issued and outstanding:

(a) XXXXXXXXXX Class B voting common shares, XXXXXXXXXX of which are owned by Mrs. A and XXXXXXXXXX by Mr. A as trustee for the Family Trust;

(b) XXXXXXXXXX Class E non-voting, non-cumulative, retractable, redeemable preferred shares, owned by Mrs. A; and

(c) XXXXXXXXXX Class F non-voting, non-cumulative, retractable, redeemable preferred shares, owned by BCO.

13. Mrs. A controls ACO by virtue of her ownership of XXXXXXXXXX of its Class B common shares.

14. BCO is a wholly-owned subsidiary of CCO, a holding company incorporated solely for that purpose. BCO is in the business of XXXXXXXXXX. BCO has an XXXXXXXXXX fiscal year-end.

15. CCO has XXXXXXXXXX Class A voting common shares issued and outstanding, XXXXXXXXXX of which are owned by Mr. A and XXXXXXXXXX is owned by Mrs. A.

16. Mr. A controls BCO by virtue of his ownership of XXXXXXXXXX of CCO's Class A common shares.

17. Mr. A and Mrs. A are married and therefore, are related by virtue of paragraph 251(2)(a) of the Act.

18. Since ACO is controlled by Mrs. A and BCO by Mr. A, and Mrs. A and Mr. A are related, ACO and BCO are related by virtue of subparagraph 251(2)(c)(ii) of the Act.

19. ACO owns approximately XXXXXXXXXX acres of land that it uses in the farming business (the "Farmland").

20. ACO's income is derived mainly from the sale of XXXXXXXXXX. ACO also earns other income as follows:

(a) Rental income from BCO for a portion of the Farmland that has an area of approximately XXXXXXXXXX acres, which BCO uses for the storage of equipment and materials used in its XXXXXXXXXX business; and

(b) The sale of XXXXXXXXXX to BCO, which BCO extracts from the Farmland and uses in its XXXXXXXXXX business.

21. ACO has received an offer from an arm's length third party (the "Purchaser") to purchase two parcels of the Farmland that are located in the City of XXXXXXXXXX. The two parcels of Farmland are adjacent but separate properties, described as Lot 1 and Lot 2 of XXXXXXXXXX (hereafter, "Lot 1" and "Lot 2").

22. Lot 1 and Lot 2 were purchased in XXXXXXXXXX and each have an approximate area of XXXXXXXXXX acres. Lot 1 and Lot 2 are very valuable compared to farmland in rural areas because of their location within the boundaries of the City of XXXXXXXXXX. Lot 1 and Lot 2 have a current market rate of approximately $XXXXXXXXXX per acre.

23. Lot 1 includes the portion of the Farmland that is rented to BCO. Lot 2 and the remaining portion of Lot 1 are used by ACO for the purpose of farming, specifically for the XXXXXXXXXX.

24. The offer to purchase Lot 1 and Lot 2 is conditional upon the Purchaser receiving permission from the City of XXXXXXXXXX to further subdivide Lot 1 and Lot 2 into smaller residential or commercial lots.

25. ACO has accepted the offer to purchase Lot 1 for a purchase price of $XXXXXXXXXX. ACO has received a $XXXXXXXXXX deposit that the Purchaser will forfeit if the sale does not proceed.

26. ACO has accepted the offer to purchase Lot 2 for a purchase price of $XXXXXXXXXX. ACO has received a $XXXXXXXXXX deposit that will be returned to the Purchaser if the sale does not proceed.

27. The closing date for the sale of Lot 1 will be no later than XXXXXXXXXX, and for Lot 2 the closing date will be no later than XXXXXXXXXX.

28. Lot 1 and Lot 2 are capital property of ACO and have a nominal adjusted cost base.

Proposed Transactions

It is proposed that:

29. On or before XXXXXXXXXX, ACO will sell Lot 1 to the Purchaser, and on or before XXXXXXXXXX, ACO will sell Lot 2 to the Purchaser.

30. Before the end of the first taxation year following the taxation year during which Lot 1 is disposed of, ACO will purchase two parcels of land, described as Lot 5 and Lot 6 of XXXXXXXXXX, Block 1, in the City of XXXXXXXXXX (hereafter, "Lot 5" and "Lot 6"). Lot 5 and Lot 6 are adjacent but separate properties. Lot 5 has an area of XXXXXXXXXX acres and a purchase price of $XXXXXXXXXX. Lot 6 has an area of XXXXXXXXXX acres and a purchase price of $XXXXXXXXXX. Lot 5 and Lot 6 will both be rented to BCO for the storage of equipment and materials used in its XXXXXXXXXX business.

31. Before the end of the first taxation year following the earlier of the taxation years during which Lot 1 or Lot 2 is disposed of, ACO will purchase XXXXXXXXXX quarter sections of land (hereafter, collectively referred to as the "Quarter Sections"). The Quarter Sections are adjacent but separate properties, and the vendor will not sell them individually. XXXXXXXXXX Each of the Quarter Sections is XXXXXXXXXX acres and has a purchase price of $XXXXXXXXXX. The total acreage of the Quarter Sections is XXXXXXXXXX and the total purchase price is $XXXXXXXXXX. ACO will use the total acreage of the Quarter Sections for farming, specifically for the XXXXXXXXXX.

32. In its return of income for the taxation year during which Lot 1 and Lot 2 is disposed of, ACO will elect under subsection 44(1) of the Act that:

(a) Lot 5 and Lot 6 will each be a replacement property for the XXXXXXXXXX acres of Lot 1 rented to BCO, and of the total proceeds of disposition of $XXXXXXXXXX from the sale of Lot 1, $XXXXXXXXXX will be used to acquire Lot 5 and Lot 6. This amount is based on the proportionate acreage of Lot 1 rented to BCO, calculated as XXXXXXXXXX. Of this amount:

(i) $XXXXXXXXXX will be used to acquire Lot 5. This amount is based on the proportionate acquisition cost that Lot 5 is of the total acquisition cost of Lot 5 and Lot 6, calculated as $XXXXXXXXXX ; and

(ii) $XXXXXXXXXX will be used to acquire Lot 6. This amount is based on the proportionate acquisition cost that Lot 6 is of the total acquisition cost of Lot 5 and Lot 6, calculated as $XXXXXXXXXX.

(b) Each of the Quarter Sections will be a replacement property for Lot 2 and the XXXXXXXXXX acres of Lot 1 used in farming, and:

(i) Of the total proceeds of disposition of $XXXXXXXXXX from the sale of Lot 1, $XXXXXXXXXX will be used to acquire the Quarter Sections. This amount is based on the proportionate acreage of Lot 1 used in farming, calculated as XXXXXXXXXX; and

(ii) Of the total proceeds of disposition of $XXXXXXXXXX from the sale of Lot 2, $XXXXXXXXXX will be used to acquire the Quarter Sections. This amount will be determined by subtracting from the $XXXXXXXXXX total acquisition cost of the Quarter Sections, the $XXXXXXXXXX amount determined under paragraph 32(b)(i) above.

(c) The gain from the disposition of Lot 1 and Lot 2 will be calculated in accordance with paragraph 44(1)(e) of the Act, and:

(i) For the purpose of calculating the gain from the disposition of Lot 1, the capital cost of its replacement property, determined without reference to paragraph 44(1)(f) of the Act, will be $XXXXXXXXXX. This amount is the total of the amounts determined under paragraphs 32(a)(i), (ii), and (b)(i) above. As a result, there will not be a capital gain on the disposition of Lot 1, since this amount is equal to the actual proceeds of disposition of $XXXXXXXXXX; and
(ii) For the purpose of calculating the gain from the disposition of Lot 2, the capital cost of its replacement property, determined without reference to paragraph 44(1)(f) of the Act, will be $XXXXXXXXXX. This is the amount determined under paragraph 32(b)(ii) above. As a result, there will be a capital gain on the disposition of Lot 2 of $XXXXXXXXXX, since this amount is less than the actual proceeds of disposition of $XXXXXXXXXX.

(d) The capital cost for Lot 5, Lot 6 and each of the Quarter Sections will be calculated in accordance with paragraph 44(1)(f) of the Act, and for that purpose:

(i) The capital cost of Lot 5 will be reduced by the amount of $XXXXXXXXXX, pursuant to subparagraph 44(1)(f)(ii) of the Act. This is the amount determined under paragraph 32(a)(i) above;

(ii) The capital cost of Lot 6 will be reduced by the amount of $XXXXXXXXXX, pursuant to subparagraph 44(1)(f)(ii) of the Act. This is the amount determined under paragraph 32(a)(ii) above; and

(iii) The capital cost of each of the Quarter Sections will be reduced by $XXXXXXXXXX, pursuant to subparagraph 44(1)(f)(ii) of the Act. This amount is based on a proportionate share of the total of the amounts determined under paragraphs 32(b)(i) and (ii) above for each of the Quarter Sections, calculated as XXXXXXXXXX.

33. The calculations in paragraph 32 are based on the premise that Lot 1 and Lot 2 have an adjusted cost base of nil, as noted in paragraph 28 above, and will only change as a result of outlays and expenses associated with the disposition of Lot 1 and Lot 2, and the acquisition of Lot 5, Lot 6, and the Quarter Sections.

Purpose of the Proposed Transactions

34. ACO will purchase Lot 5 and Lot 6 to replace the XXXXXXXXXX acres of Lot 1 currently rented to BCO. ACO wants to ensure that it has a sufficient area of land within the urban boundaries of the City of XXXXXXXXXX that can be rented to BCO for the storage of equipment and materials used in its XXXXXXXXXX business that was displaced by the sale of Lot 1.

35. ACO is purchasing the Quarter Sections to replace Lot 2 and the XXXXXXXXXX acres of Lot 1 used in farming to:

(a) Ensure that it has a sufficient area of land to continue the existing farming operations;

(b) Expand its farming business; and

(c) Utilize the proceeds of disposition from the sale of Lot 1 and Lot 2 to the greatest extent possible in deferring the gain from the dispositions.

Rulings Given

Provided that:

(a) The preceding statements constitute a complete and accurate disclosure of all of the relevant facts, proposed transactions and the purpose of the proposed transactions;

(b) The proposed transactions are completed in the manner described above; and

(c) There are no other transactions, which may be relevant to the ruling requested,

Our rulings are as follows:

A. Lot 1 and Lot 2 will each be considered a former business property of ACO, pursuant to the definition thereof in subsection 248(1) of the Act.

B. Lot 1 and Lot 2 will each be considered a former property of ACO, for purposes of subsection 44(1) of the Act.

C. Pursuant to subsection 44(5) of the Act, we confirm that:

a. Lot 5 and Lot 6 will each be considered a replacement property for the XXXXXXXXXX acres of Lot 1 rented to BCO, as set out in paragraph 32(a) above; and

b. Each of the Quarter Sections will be considered a replacement property for Lot 2 and the XXXXXXXXXX acres of Lot 1 that is used in farming, as set out in paragraph 32(b) above.

D. ACO's gain from the dispositions of Lot 1 and Lot 2 will be calculated in accordance with paragraph 44(1)(e) of the Act, as set out in paragraph 32(c) above.

E. ACO's capital cost for the acquisitions of Lot 5, Lot 6 and each of the Quarter Sections will be calculated in accordance with paragraph 44(1)(f) of the Act, as set out in paragraph 32(d) above.

These rulings are given subject to the limitations and qualifications set out in Information Circular 70-6R5 issued by the CCRA on May 17, 2002, and are binding on the CCRA provided that the proposed transactions are carried out on or before XXXXXXXXXX.

These rulings are based on the Act in its present form and do not take into account any proposed amendments to the Act which, if enacted, could have an effect on the rulings provided herein.

Except as expressly stated, these rulings do not imply acceptance, approval or confirmation of any income tax implications of the facts or proposed transactions.

Nothing in these rulings should be construed as implying that the CCRA has agreed to or reviewed the determination of the capital cost, adjusted cost base, or fair market value of any particular property referred to herein.

Yours truly,

XXXXXXXXXX
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
Policy and Legislation Branch

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