5 March 1991 Ruling 901841 F - Reporting of Income from Non-incorporated Business After Dissolution

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.

Dear Sir:

We are writing in reply to your letter of July 19, 1990 addressed to the North York District Office, which was forwarded to our office on August 9 for reply, wherein you requested our comments regarding the reporting of income from a non-incorporated business after it has been dissolved.  We apologize for the delay in responding to your letter.

Your letter indicates that 24(1) Your questions are as follows:

1)     Is it acceptable to roll the assets of that business into a newly formed corporation on 24(1)

2)     Should the income from that business for its last fiscal period be reported in your 1990 personal income tax return which is required to be filed by April 30, 1991?

3)     Can capital cost allowance ("CCA") be claimed on a prorated basis for the last fiscal period of the business?

Our Comments

While we are unable to provide confirmation of the income tax effects of the particular situation described in your letter, we can offer the following general comments related to the reporting of income from a non-incorporated business in its final year of operation and transferring those business assets to a corporation. In addition, we have enclosed a copy of our Business and Professional Income Tax Guide which you may find useful in answering other questions relating to the reporting of business income.

24(1)

A proprietorship normally refers to an unincorporated business owned and controlled by one person.  A proprietor is the owner of a proprietorship and has the legal right or exclusive title to the business.  A business that is carried on in common with two or more persons with a view to earn a profit often constitutes a partnership.  A valid partnership may exist without a written partnership agreement.  The relevant partnership provincial law will generally determine whether an arrangement is a partnership.  As the determination of whether a partnership exists is a question of fact that can only be made when all the relevant facts of the situation are known, we are unable to provide confirmation as to whether a partnership existed in your situation.  You may wish to obtain legal or accounting advise on this matter. In view of the possibility that your business arrangement may have been a partnership, we have provided responses to your questions as they apply both to a sole proprietor and a partnership.

1)     In general, where a proprietorship, which used a property in that business, ceases but that property is retained and used by the proprietor for other purposes, the property will be deemed to have been disposed of by the business for proceeds of disposition equal to its fair market value.  Any resulting capital gain or loss will be reported by the business.  The property will then be deemed to be reacquired by the individual at a cost equal to its fair market value.  If a partnership ceases to exist, there are many rules dealing with the dissolution of the partnership, the transfer of partnership property to the partners and the disposition of a partnership interest.  As those rules are too numerous and complex to provide in this letter, you may wish to seek professional advise on this matter.

     Where a) a former sole proprietor, b) an individual who was formerly a member of a partnership which has since ceased to exist, or c) a partnership which has not ceased to exist transfers property to a corporation, the transfer would normally occur at an amount equal to the fair market value of the property transferred and the transferor would recognize any resulting capital gain or capital loss (with certain limitations) from the sale.  However, subsections 85(1) and 85(2) of the Income Tax Act (the "Act") provide rules for the transfer of certain property by an individual or a partnership, respectively, to a Canadian corporation for an "elected amount" which may be other than the fair market value of the property at the time of transfer, subject to certain limitations.  Depending on the elected amount chosen, it is possible for the transferor to transfer property into a corporation without immediate income tax consequences. Again, the details of the rules are too numerous and complex to include in this letter and you may wish to obtain legal or accounting advise on this matter.  However, in summary, provided the parties involved satisfy the conditions in subsection 85(1) or 85(2) of the Act, respectively, and properly elect in the prescribed form T2057 or T2058, respectively, the elected amount generally becomes the proceeds of disposition of the property to the transferor and the cost of the property to the corporation.  The appropriate election form must be filed with the income tax returns, for the year in which the transaction occurred, of the transferor and the corporation.  The consideration received by the transferor must include at least one share of the capital stock of the corporation.

2)     Where during a fiscal period, the business of a proprietor is terminated, the fiscal period of that business will end at that time.  The question of whether a partnership has ceased to exist at a point in time is generally determined under the partnership law of the province in which the partnership is formed and in accordance with the terms of the partnership agreement between the partners.  When a partnership ceases to exist at any time during its usual fiscal period, the fiscal period shall be deemed to have ended immediately before that time even if the distribution of the partnership assets is incomplete.  If the affairs of a partnership are wound up at any time during its usual fiscal period and all the partnership property is distributed prior to, or concurrently with, the winding-up of the partnership, that winding-up will normally bring the fiscal period to an end.

     If the fiscal period of a proprietorship or a partnership is other than the calendar year, a shortened fiscal period may result in two periods of operation being required to be reported in the same income tax return of an individual.  To avoid this situation, the proprietor or the individual who is a member of a partnership may wish to make an election under subsection 25(1) or 99(2) of the Act, respectively.  These elections serve to shift the taxation year of the income, for what would be the second fiscal period ending in the same taxation year, to the next taxation year of the individual.  The result of these elections is that the fiscal period of thebusiness will be deemed to have ended at the time it normally would have ended or in the case of a partnership, immediately before that time, rather than at the date the proprietorship terminated or the partnership ceased to exist.  For example: if a proprietorship with a fiscal period of March 1 to February 28 ceases operations on September 30, 1989, the individual would normally have to report the income or loss for two taxation years - one ended February 28, 1989 and the other ended September 30, 1989 in the proprietor's 1989 personal income tax return.  However, by making an election under subsection 25(1) of the Act, that individual can report the income or loss for the short fiscal period March 1 to September 30, 1989 in the 1990 income tax return since the fiscal period will be deemed to be from March 1, 1989 to February 28, 1990.

     There is no prescribed form for making the election under subsection 25(1) or 99(2) of the Act.  Our Department considers that an individual has made an election if the income tax return which includes the elected fiscal period is filed with the appropriate supporting information.  A note to the effect that the election is being made should be included with that return.  A valid election may be made by an individual partner regardless of whether the other members of the partnership make the same election.  It should be noted that an otherwise valid election loses its validity if the individual is not a resident of Canada at the time the elected fiscal period would have ended.

     Inventory sold after ceasing to carry on a business is deemed to have been sold in the course of carrying on a business.  All the consideration received or receivable for the inventory is included in income in the year the inventory is sold and the cost of inventory is deducted in the same way as if it had been sold in the ordinary course of carrying on a business to arrive at a profit therefrom.  However, where an election has been filed by an individual under subsection 25(1) or 99(2) of the Act, this income will be included in the deemed fiscal period.

     However, where a proprietor has a fiscal year other than a calendar year, taxable capital gains and allowable capital losses resulting after the business ceased from the disposition of capital property previously used in the business must be reported in the calendar year of that individual in which the disposition occurs, regardless of whether an election has been made to extend the last fiscal period of the business under subsection 25(1) of the Act.  Any capital gain or capital loss which occurs as a result of a partnership disposing of its business property after it ceases to exist and before the end of the deemed fiscal period will be reported in the deemed fiscal period.

3)     Where a proprietorship or a partnership disposes of its depreciable property after it ceases to exist, CCA in respect of the property not disposed of at the time the business ceases will be permitted on a prorated basis for the duration of the short fiscal period.  While no CCA can be claimed on property disposed of on the day the business ceases, a terminal loss may be available.  Where an election is made under subsection 25(1) or 99(2) of the Act, it will not affect the availability or the amount of the CCA claim.  However, any recapture of CCA or terminal loss on the disposition of depreciable property after the taxpayer ceases to carry on a business and before the end of the extended fiscal period will be included in the computation of income for the elected period.  As a result any CCA claimed for the short taxation year will increase the recapture or reduce the terminal loss arising from the disposition of the depreciable property at any time between the cessation of the business and the deemed year end.

These comments represent our opinion of the law as it applies generally.  As indicated in paragraph 21 of Information Circular 70-6R2 dated September 28 1990, this opinion is not a ruling and accordingly, it is not binding on Revenue Canada Taxation.

We trust these comments will be of assistance.

Yours truly,

for DirectorBusiness and General DivisionRulings DirectorateLegislative and Intergovernmental Affairs Branch