16 July 1980 Income Tax Severed Letter

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.

XXXX

R.I. Gardham (613) 593-7295

July 16, 1980

Dear Sir:

This is in reply to your letter of March 4, 1980 in which you requested our opinion on several supplementary questions you have regarding our previous letter to you of May 29, 1980 concerning paragraph 5 of Interpretation Bulletin IT-403 .

In the example put forth in your letter, the owner of a particular parcel of real estate having a fair market value of $10,000 grants an option on that land for a period of five years to a party with whom he does not deal at arm's length. The grantor receives no consideration for granting the option. At the expiration of four years of the option period, when the property has a fair market value of $13,000, the option period is extended for another five years without any consideration being received by the grantor. As a result of this extension, the grantor is deemed to have disposed of the option for the difference between the option price ($10,000) and the fair market value of the option ($13,000) at the time it is extended. The land is finally acquired by the grantee when its fair market value is $18,000. You have asked for our counts on several questions you have dealing with two variations of the above example. We will answer your questions in the order they were presented.

In the first set of questions, you have asked as to assume that the grantee acquires the property for actual consideration equal to its fair market value of $18,000.

1. (a) You have asked for our views on how we would treat for tax purposes the acquisition of the property for actual consideration $18,000 when the option price was stated to be $10,000. In particular, you wish to know what effect our views will have on the amount which was previously included in the grantor's income under subsection 49(1) when the option was extended.

As we indicated in our previous letter, in a non-arm's length transaction where the fair market value of the land exceeds the stipulated option price, it is our view that paragraph 69(1) (b) will deem the proceeds if disposition to be the fair market value for the purposes of subsection 49(3). Based on this view, if the parties, as you have described, decide to overlook the stipulated option price and transfer the property for consideration equal to the fair market value, the Department will consider that the option has been exercised for the purposes of subsection 49(3) and (4). Consequently, the grantor may request the Department to re-open the previous years return to exclude from his income, the deemed amount included in his income under subsection 49(1).

1. (b) We do not necessarily hold this same view with respect to the grantor if the property is sold to a corporation controlled directly or indirectly by the grantee. If the grantee transfers his option to acquire the property to the corporation and the corporation then exercises the option, our previous views would generally have application to the grantor. However, if the option is not transferred and the grantor simply sells the land to the corporation, a technical argument exists to say that the option has not been exercised pursuant to subsection 49(3).

2. Agreed. Provided that the facts indicate that the proceeds of disposition are not due to him under the terms of the sale, until a subsequent year, a reserve may be available under paragraph 40(1) (a) (iii).

3. No, our answer would not change if the grantee subsequently transfers the land his corporation.

In the following set of questions, you have assumed that the grantee acquires the property for consideration equal to the stipulated option price of $10,000.

4. We agree. The amount to be added to the deemed proceeds of disposition of the grantor under subsection 49(3) is in respect of the consideration received by him for the option. Although the grantor was deemed to have previously disposed of the option under subsection 49(1) for deemed proceeds of $3,000, we do not view that amount as being consideration received by the grantor for the purposes of subsection 49(3).

5. The Department's practice of permitting an adjustment to the purchaser's cost of the property in a non-arm's length transaction is set out in paragraph 5 of Interpretation Bulletin IT-405 . Such an adjustment will only be allowed in situations where it can be shown that the transfer occurred at an amount other than fair market value by reason of an honest error and not by a deliberate attempt to evade or avoid taxes. We cannot confirm that this practice would be available in your example. A determination of this type can only be made once all of the relevant circumstances have been appraised and the Department is satisfied that an adjustment is warranted.

We trust the above information will be of assistance to you.

Yours truly,

J.F. VOGAN

for Director Non-Corporate Rulings Division