12 September 1990 Ministerial Correspondence 901144 F - Transfer of Depreciable Property into and Out of a Partnership

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.

September 12, 1990

Dear Sirs:

Re:  Section 20 of the Income Tax Application Rules, 1971 (the "ITAR")

We are writing in reply to your letter of June 12, 1990, wherein you requested our opinion as to whether subsections 20(1) and 20(1.2) of the ITAR will be applicable to depreciable property transferred to and from a partnership under subsections 97(2) and 98(3), respectively, of the Income Tax Act (the "Act").

Facts

Our understanding of the facts of a situation given to illustrate the issues is as follows:

1.     Corporation A owns land in the province of Quebec which it leases to Corporation B pursuant to an emphyteutic lease entered into prior to December 31, 1971 ("VDay").

2.     As required under the emphyteutic lease, Corporation B constructed a building on the leased land.

3.     The VDay value of the building is considerably in excess of its capital cost and undepreciated capital cost ("U.C.C.").

4.     Corporation A and Corporation B are not related and deal at arm's length.

5.     Corporation A and Corporation B decide to form a partnership to hold the property and earn rental income therefrom. Accordingly, Corporation A transfers the land to the partnership pursuant to subsection 97(2) of the Act, electing the cost amount of the land as the proceeds of disposition. Corporation B then transfers the building together with the rights as lessee under the emphyteutic lease to the partnership pursuant to subsection 97(2) of the Act, electing the U.C.C. of the building as proceeds of disposition.

6.     The number of units issued by the partnership to the parties on the rollover transactions is based on their relative interests, as negotiated between the parties.  Corporation A  will receive a 40% interest in the partnership and Corporation B will receive a 60% interest in the partnership. The adjusted cost base of the respective partnership interests is equal to the respective amounts elected pursuant to subsection 97(2) of the Act.

7.     The emphyteutic lease will be extinguished upon the merger of the rights of the lessor and the lessee within the same entity, i.e. the partnership.

8.     If the partnership is dissolved prior to a sale of the property, an undivided interest in the partnership's property will be transferred to each of the partners pursuant to subsection 98(3) of the Act.

Your Questions

1.     Will the partnership be entitled to use paragraph 20(1)(a) of the ITAR, pursuant to either subsection 20(1.2) or  paragraph 20(1)(b) of the ITAR, when it disposes of the building?

2.     If the partnership is dissolved using subsection 98(3) of the Act, will paragraph 20(1)(a) of the ITAR be applicable to Corporation B when it disposes of its undivided interest in the building received from the partnership?

3.     Will an allocation to Corporation B of 100% of the tax-free zone related to the building on the dissolution of the partnership, as provided for in the partnership agreement, be acceptable for the purposes of subsection 103(1) of the Act?

Our Comments

While we are unable to provide confirmation of the income tax effects of the particular situation outlined in your letter, we can offer the following general comments related to the application of subsections 20(1) and 20(1.2) of the ITAR and subsection 103(1) of the Act to the transfer of depreciable property into and out of a partnership.

1.     Application of subsection 20(1.2) of the ITAR 

     It is our opinion that subsection 20(1.2) of the ITAR provides that where a taxpayer owned a depreciable property prior to 1972 and transfers it to a partnership under subsection 97(2) of the Act after 1971, for the purposes of subsection 20(1) of the ITAR, the partnership will be deemed to have acquired it before 1972 and owned it continuously since December 31, 1971 until it is disposed of. Therefore, even though paragraph 20(1)(a) of the ITAR will not apply to determine the contributing partner's deemed proceeds of  disposition, since his proceeds of disposition otherwise determined will be less than his capital cost, the rules in paragraph 20(1)(a) of the ITAR (by virtue of subsection 20(1.2) of the ITAR) may apply when the partnership disposes of such property (as discussed in 2 below).  Where the agreed amount for depreciable property transferred under subsection 97(2) of the Act is the U.C.C. of the property to the transferor immediately before the disposition, subsection 97(4) of the Act will deem the partnership to have acquired that property at a capital cost equal to the capital cost of the transferring partner.

     Application of paragraph 20(1)(b) of the ITAR

     In order for paragraph 20(1)(b) of the ITAR to apply, a partner transferring depreciable property into a partnership must not be dealing at arm's length with the partnership.  It is a question of fact whether a partner deals at arm's length with a partnership of which he is a member and paragraphs 11, l2 and 15 of Interpretation Bulletin IT-419 provide comments on this matter.  Where a partner, that is not dealing at arm's length with a partnership, transfers after 1971 a depreciable property owned by him prior to 1972 into the partnership pursuant to subsection 97(2) of the Act at an agreed amount equal to the U.C.C. of the property, the partner's proceeds of disposition will not exceed his capital cost.  It is our opinion that before paragraph 20(1)(b) of the ITAR could apply to such property acquired by the partnership, the condition in the preamble to subsection 20(1) of the ITAR requiring the proceeds of disposition received by the partner to be greater than the capital cost of the property must be met.  As this condition will not be met under the contemplated rollover of property under subsection 97(2) of the Act, paragraph 20(1)(b) of the ITAR is not applicable to the partnership on the acquisition of the property nor is paragraph 20(1)(a) of the ITAR available to the partnership on the subsequent disposition of the property.  This result is described in paragraph 12 of Interpretation Bulletin IT-217 which states that: "Except where subsection 20(1.1) or (1.2) of the ITAR applies, paragraph 20(1)(a) of the ITAR will never apply to a subsequent owner if a previous owner of the depreciable property could not use paragraph 20(1)(a) of the ITAR to determine his 'deemed proceeds'".

2.     Where subsection 20(1.2) of the STAR applies to depreciable property acquired by a partnership, the rules in paragraph 20(1)(a) of the ITAR will apply to the subsequent disposition of that property by the partnership, only if the  capital cost of such property to the partnership is less than the proceeds of disposition otherwise determined and the property's fair market value on VDay. 

     Where a partnership disposes of property, to which subsection 20(1.2) of the ITAR applies, in accordance with subsection 98(3) of the Act, paragraph (f) thereof deems the partnership to have disposed of the property for proceeds of disposition equal to the cost amount (i.e. the U.C.C.) of such property immediately before its distribution.  Consequently, paragraph 20(1)(a) of the ITAR will not apply to calculate the deemed proceeds of disposition of the property disposed of, since the proceeds of disposition of the property can not exceed its capital cost.  This result is to be expected since the partnership will not have a capital gain resulting from the disposition of that property.

     The provisions of paragraph 20(1)(a) of the STAR will not apply, by virtue of subsection 20(1.2) of the STAR, to a former partner of the partnership receiving the property described in the preceding paragraph, as it is our opinion that subsection 20(1.2) of the ITAR applies only once and only in the situation where the initial transferor actually acquired the property before 1972.  It is only for the purposes of subsection 20(1) of the ITAR that subsection 20(1.2) of the ITAR deems the transferee to have acquired the property before 1972.  For all other provisions of the Act, including consideration of the application of subsection 20(1.2) of the ITAR, the actual date of acquisition is applicable.

3.     The determination as to whether subsection 103(1) of the Act applies to an allocation of income to the partners of a partnership which are dealing at arm's length with each other  is a question of fact which can only be made after all of the  facts of the situation are known.  It is our opinion that  subsection 103(1) of the Act will not generally apply where the allocation is consistent with a predetermined method  provided for in the partnership agreement, is not a  spontaneous or optional arrangement decided after or upon the termination of any given year or event, and the principal reason for the arrangement is not reasonably considered to result in the reduction or postponement of the tax that might otherwise have become payable under the Act.  As indicated in #2 above, there will be no tax-free zone available to any partner upon the distribution of property to them from the partnership.  Consequently, we have not commented on the application of subsection 103(1) of the Act to that situation and we trust that this brief outline of the Department's general views on the application of subsection 103(1) of the Act will be satisfactory.

These comments represent our opinion of the law as it applies generally.  As indicated in paragraph 24 of Information Circular 70-6R dated December 18, 1978, 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