7 July 1991 Income Tax Severed Letter - Replacement property rules

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.

Subject: XXX Replacement Properties Section 44 of the Income Tax Act (the "Act")

This is in reply to your memorandum of June 10, 1991, requesting our opinion on the issues raised by both the Mississauga District Office and the taxpayer's representatives concerning whether the Company named above is eligible for the capital gain deferral.

Our Understanding of the facts is as follows:

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Taxpayer's Position

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District Office Position

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Our Comments

As indicated in paragraph 14 of Interpretation Bulletin IT-259R2 Exchange of Property, subsections 13(4.1), 14(7) and 44(5) of the Act provide that a particular property is replacement property, if it is acquired for the same or similar use as the use to which the taxpayer put the former property. Generally, the Department has adopted a fairly broad interpretation of these terms. On the assumption that:

• (a) the property was, in fact, acquired as a replacement property for the former business property;
• (b) the taxpayer has made the election required by section 44 in his return of income for the year in which he acquired the replacement property; and
• (c) the replacement property had not been disposed of by the taxpayer prior to the time he had disposed of the former property, the provisions of section 44 would operate to defer the capital gain on the disposition of the former property.

The question, however, of whether the acquisition of a particular capital property by a taxpayer qualifies as a replacement property depends on the facts in each case. Under the requirements of Section 44 of the Act the replacement property for the former property must be acquired within the time limit permitted by that section and the taxpayer must make an election with his return of income for the taxation year in which he acquires the replacement property. Because of these requirements it is our view that it must be apparent from the facts of the particular case that the taxpayer had acquired such property as a replacement property for the former property and that it is so used within a reasonable period of time.

Subsection 44(1) of the Act was enacted to permit a business to relocate without adverse income tax consequences. This provision was not intended to encompass business expansions, consolidations, or speculative undertakings which appear to be the nature of these transactions as there does not seem to be any correlation between the disposition of a "former business property" and the acquisition of a "replacement property". In our view, replacement as used in the phrase "as a replacement for his former property" contemplates a direct substitution, i.e. there should be a causal relationship between the disposition of one property (or properties) and the acquisition of the replacement property(ies). Of course the ultimate determination of whether the acquisition of a particular property qualifies as a replacement property depends on the particular facts in each case and a complete review of all relevant documents. In interpreting this subsection in this manner we are placing some emphasis on the dictionary meaning of the word "replacement" as discussed by Audit in the phrase "as a replacement for his former property." From our review of the submissions, specific replacements were not acquired for specific disposals. If, however, a store is closed in a location in Canada and a new store is opened in a new location anywhere in Canada and a causal relationship can be established, it is our view that the provisions of subsection 44(1) can be utilized. Thus, we cannot agree with the District Office analysis concerning geographic location (the "market") and it may be that certain locations would qualify for the capital gain deferral.

The Department has taken the position that, for practical purposes, it may be impossible for a business wishing to relocate to dispose of its former business property prior to the acquisition of its replacement. The wording in subsection 44(1) was thus amended to permit a taxpayer to acquire a replacement property prior to the disposition of the former business property. It is our view that the determination as to whether a property is a "replacement property" for the purposes of subsection 44(5) of the Act involves a finding of fact in a particular case. There are no specific timing guidelines that can be used in this respect. As noted above, it is our view that geographical location would not necessarily be a critical factor in establishing the use of an asset which otherwise qualifies as a replacement property. (Bill C-18 amends paragraph 44(5)(c) of the Act to provide that, effective April 2, 1990, taxable Canadian property can only be replaced by taxable Canadian property. Formerly, Canadian residents could replace Canadian property with foreign property.)

Although, we agree that the phrase "... acquired a capital property (in this section referred to as his "replacement property") as a replacement for his former property ..." contained in the wording between paragraphs 44(1)(d) and 44(1)(e) of the Act has meaning, we will address your other concerns because it seems likely to us that a causal relationship could be established between some or all of the replacement properties and some or all of the former business properties. It is not clear from the submissions, but if business operations in locations A and B are being carried on simultaneously (other than for a more or less brief transitional period, for example while stock at the former location is liquidated), it is our view that the stores acquired or built in location A are not replacements for any of the stores in location B by virtue of their simultaneous operation and thus would not qualify as replacement properties pursuant to subsection 44(5) of the Act.

It is not possible to give a general interpretation stating what is a reasonable length of delay in using a capital property in a taxpayer's business and still having it qualify as a replacement property. Generally, vacant land held for future store development would be excluded from the definition of replacement property and not qualify for the deferral as non-use does not constitute use. Should a qualifying building on land owned by the taxpayer be under construction at the expiration of the time period, costs incurred up to that date will be available to defer the gain on the former property. This of course will depend on the facts of each particular situation and on general business practices.

One of the requirements of subsection 44(1) of the Act is that the relevant election be filed in his return of income for the year. As stated in paragraph 7(c) of IT-259R2, the election should take the form of a letter attached to a return of income for the year in which the replacement property is acquired and the letter should include descriptions of the property that is to be replaced. Provided it is evident the new property is in fact replacement property such an election will be accepted. Although the company records its election on the last page of each year's claim. "THE TAXPAYER ELECTS UNDER SECTION 44(1) TO HAVE THE LISTED PROPERTIES DESIGNATED AS "REPLACEMENT PROPERTIES" " and, in Audit's, XXX in our view, not all of the conditions stated in paragraph 7 of IT-259R2 have been met. However, draft subsection 220(3.2) of the Act and draft section 600 of the Regulations (released May 24, 1991) may extend the time for making or amending a section 44 election in respect of 1985 and subsequent taxation years where the taxpayer can demonstrate that the failure to elect on time was inadvertent or that the election would have been made on time had the taxpayer been aware of the election. Permission may also be granted to make an election where it can be demonstrated that the election was not filed on time because of circumstances beyond the control of the taxpayer. Still, the taxpayer would have to show a causal relationship between the disposal of "former business properties" and the acquisition of "replacement properties" in order to utilize the particular sections of the Act.

The "Pooling Method" as described in the submission does not in our view comply with the requirements of subsection 44(1) of the Act. Paragraph 10 of IT-259R2 states that there must be some correlation or direct substitution between the disposition of a "former business property" and the acquisition of a "replacement property". It is thus our position that only capital gains resulting from specific acquisitions matched with specific dispositions can be deferred.

We trust our comments will be of assistance to you.