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: Whether the taxpayer could elect under the replacement property rules on a voluntary disposition.
Position: In this situation, no.
Reasons: For voluntary dispositions, a replacement property must be acquired before the end of the first taxation year following the year of disposition of the former property.
April 28, 2004
XXXXXXXXXX HEADQUARTERS
XXXXXXXXXX Tax Services Office Randy Hewlett, B.Comm.
613-957-8973
2004-006966
Replacement Property Rules
We are writing in response to your request for our opinion on the application of the replacement property rules in the situation described below.
Facts
Our understanding of the relevant facts is as follows:
? The Taxpayer is a corporation that has a XXXXXXXXXX fiscal year-end.
? On XXXXXXXXXX, the Taxpayer sold land and an office building, which was rented since XXXXXXXXXX to XXXXXXXXXX related corporations and other unrelated parties. The XXXXXXXXXX related corporations used the office building to earn income "other than rent".
? For the fiscal year-end XXXXXXXXXX, the Taxpayer derived XXXXXXXXXX% of its total rental revenue from the portion of the office building that was rented to the XXXXXXXXXX related corporations.
? The Taxpayer reported a capital gain and recapture resulting from the disposition in its XXXXXXXXXX corporate tax return. The Taxpayer included a letter with its XXXXXXXXXX return stating that it intended to elect under the replacement property rules to defer the capital gain and recapture. The letter indicated that a replacement property had not yet been acquired but the Taxpayer intended to do so within the time period required under the replacement property rules.
? In XXXXXXXXXX, the Taxpayer entered into negotiations to purchase a new office building and land to replace the old office building and land that was disposed of. The acquisition was not finalized until XXXXXXXXXX.
? The Taxpayer included a letter with its XXXXXXXXXX corporate tax return, requesting that an adjustment be made to its XXXXXXXXXX return to defer the capital gain and recapture included in income as a result of the disposition of the old office building and land.
? The Taxpayer rents the new office building to the XXXXXXXXXX related corporations and other unrelated parties. The Taxpayer's rental revenue derived from the portion of the new office building rented to the XXXXXXXXXX related corporations is XXXXXXXXXX% of its total rental revenue. The new office building is XXXXXXXXXX square feet, of which XXXXXXXXXX square feet is rented to the two related corporations.
? The Taxpayer is of the view that the replacement property rules should apply to defer the capital gain and recapture resulting from the disposition of the old office building and land. In its view, there were special circumstances that prevented it from acquiring the new office building prior to the time period required under the replacement property rules, as follows:
o The nature of the business of the XXXXXXXXXX related corporations required that a new office building be located in a certain area. There was a short supply of quality commercial real estate in the area in which the Taxpayer wanted the new office building to be located; and
o The Taxpayer entered into negotiations to acquire the new office building in XXXXXXXXXX, anticipating a closing date in XXXXXXXXXX. However, the son of the owner also wanted to acquire the property. The son of the owner obtained an agreement from his father that allowed him until XXXXXXXXXX, to attempt to secure financing to purchase the property. The son could not arrange the financing and the Taxpayer resumed negotiations. The Taxpayer was unable to close the deal prior to the end of its XXXXXXXXXX taxation year.
? In its representations, the Taxpayer refers to paragraph 9 of IT-259R4, Exchange of Property, wherein it is stated: "A taxpayer is considered to have acquired replacement property at the time the acquisition would ordinarily be considered to have been made under the provisions of the Act and the general principles of law." In the Taxpayer's view, this "terminology means there are also some unordinary or exceptional situations that the Minister can permit". The Taxpayer contends that it was always its intention to conclude the transaction before XXXXXXXXXX.
You inquired whether the replacement property rules apply in the situation described above. You also inquired if subsection 220(3.2) of the Act applied to allow the Taxpayer to late file the election under subsections 13(4) and 44(1) of the Act, even though the new office building and land were not acquired within 12 months of the end of the taxation year in which the old office building and land were disposed of.
The replacement property rules in sections 13 and 44 of the Income Tax Act (the "Act") permit a taxpayer to elect to defer the recognition of income or capital gains where a "former property" is involuntarily disposed of, or a former property that is a "former business property" is voluntarily disposed of, and a "replacement property" is acquired. To be considered a replacement property, the particular property must meet all the requirements outlined in subsection 13(4.1) or 44(5) of the Act. The definition of replacement property and the application of the replacement property rules are discussed in detail in IT-259R4. The definition of former business property is in subsection 248(1) of the Act, and further explained in detail in IT-491, Former Business Property.
In our view, you do not need to address the issues of whether the old office building and land meet the definition of former business property or whether the new office building and land meet the definition of replacement property, because the Taxpayer does not meet the basic requirement in subsection 13(4) or 44(1) of the Act relating to the time period in which a replacement property must be acquired. For voluntary dispositions, a replacement property must be acquired before the end of the first taxation year following the year of disposition of the former property, pursuant to paragraph 13(4)(c) or 44(1)(d) of the Act [For dispositions that occur in taxation years that end on or after the day that is 12 months before December 20, 2002, proposed amendments to paragraphs 13(4)(c) and 44(1)(d) of the Act require that the replacement property be acquired within 12 months following the first taxation year of disposition of the former property. Since the Taxpayer disposed of the old office building and land on XXXXXXXXXX, the proposed amendments to paragraphs 13(4)(c) and 44(1)(d) of the Act are not applicable].
In the situation described above, the Taxpayer reported the voluntary disposition of the old office building and land in its XXXXXXXXXX taxation year. In order for the new office building and land to qualify under the replacement property rules, it would have to have been acquired before the end of the first taxation year following the year of disposition of the old office building and land. In other words, it would have to have been acquired by the end of the Taxpayer's XXXXXXXXXX taxation year. Given the fact that the Taxpayer did not obtain legal title to the property until
XXXXXXXXXX, we are of the view that the requirements of paragraph 13(4)(c) or 44(1)(d) of the Act are not met. As a result, the Taxpayer cannot elect under the replacement property rules to defer the recapture and capital gain resulting from the disposition of the old office building and land that was included in its income in XXXXXXXXXX.
In terms of your inquiry on whether subsection 220(3.2) of the Act would permit the Taxpayer to use the replacement property rules, we note that this provision does permit a taxpayer to late file an election under subsection 13(4) or 44(1) of the Act [Subsections 13(4) and 44(1) of the Act are prescribed provisions enumerated in section 600 of the Income Tax Regulations]. In our view, while a taxpayer may late file an election under subsection 13(4) or 44(1) of the Act, all other requirements of the provisions must still be met. As a result, we are of the view that the application of subsection 220(3.2) of the Act would not benefit the Taxpayer because it did not acquire the new office building and land before the end of the first taxation year following the year of disposition of the old office building and land [i.e., before its XXXXXXXXXX taxation year].
With respect to the Taxpayer's representations described above, we would like to note that paragraph 9 of IT-259R4 also refers to IT-285R2, Capital Cost Allowance-General Comments. IT-285R2 discusses when a taxpayer will be considered to have "acquired" a depreciable property under the Act. A taxpayer will generally be considered to have acquired a depreciable property at the earlier of: (a) the date on which title to it is obtained, and (b) the date on which the taxpayer has all the incidents of ownership such as possession, use, and risk. In our view, the Taxpayer did not acquire the new office building and land by XXXXXXXXXX, because there is no indication that it had all the incidents of ownership by that time and actually obtained legal title to it on XXXXXXXXXX. In our view, there are no "unordinary or exceptional situations", legislative or otherwise, that would allow a taxpayer to obtain the beneficial income tax treatment on a voluntary disposition if the replacement property is not acquired within the required time frame.
We trust our comments are of assistance. For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the CRA's electronic library. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, they can be provided with the electronic library version, or they may request a severed copy using the Privacy Act criteria, which does not remove client identity. Requests for this latter version should be made by you to Mrs. Jackie Page at (819) 994-2898. A copy will be sent to you for delivery to the client.
Randy Hewlett, B. Comm.
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
Policy and Planning Branch
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