Principal Issues: Where a partnership disposes of all its milk quotas in the same day, some of them being eligible for the capital gains exemption and some not, whether the partnership may, in a first transaction, dispose for fair market value proceeds of all its "eligible" quotas using the election under subsection 14(1.01) and, in a second transaction, dispose of its "ineligible" quotas on a rollover basis under subsection 85(2)?
Position: Yes.
Reasons: Wording of the Act and previous positions.
XXXXXXXXXX 2011-039423 U. Chalupa 613-957-2124 May 11, 2011
Dear Madam,
Subject: Request for Technical Interpretation - Subsections 14(1.01) and 85(2) of the Income Tax Act
This is in response to your letter of January 28, 2011, in which you requested a technical interpretation regarding the interaction between the application of subsection 14(1.01) of the Income Tax Act (the "Act") and subsection 85(2) with respect to a particular situation.
Unless otherwise indicated, any reference in this letter to a statutory provision is a reference to a provision of the Act.
Particular Situation:
The facts of the particular situation, as described in your letter, can be summarized as follows:
Farm A S.E.N.C. is a partnership that has been carrying on a dairy farming business for a number of years. It owns eligible capital property represented by XXXXXXXXXX kilograms of milk with a market value of $XXXXXXXXXX.
The cost incurred to acquire all of those milk quotas was $XXXXXXXXXX. Quotas are acquired per kilogram of butterfat per day (kg of BF per day). These kilograms of milk are identical in terms of the rights conferred on the holder. Nevertheless, each offer or tender for the acquisition of additional kilograms, at a particular date, includes a number ("Offer Number") (e.g. 572NOV10) awarded by the Quebec Federation of Dairy Producers (the "Federation").) Each dairy farmer has a producer number and has a complete record of the kg of BF/day acquired over the years, with the relevant dates of acquisition.
As part of the incorporation of the farm business, Farm A S.E.N.C. transferred all of its business assets, including the milk quotas it owned, to a newly incorporated corporation.
However, of the XXXXXXXXXX kilos of milk, only XXXXXXXXXX would be qualified farm property ("QFP") for the purposes of section 110.6. As for the XXXXXXXXXX kilos of milk remaining, they would be ineligible for the sole reason that they were acquired less than two years previously by Farm A S.E.N.C.
According to the Federation's statement, the total cost incurred for the purchase of XXXXXXXXXX kilos of milk constituting QFP would be $XXXXXXXXXX, while the cost incurred to purchase the remaining XXXXXXXXXX kilos would be $XXXXXXXXXX.
Farm A S.E.N.C. would like to dispose of the assets in two stages: the first transfer would involve XXXXXXXXXX kilos of milk and would be covered by the election under subsection 14(1.01) and the second transfer would involve all other business assets, including the XXXXXXXXXX kilograms of milk not yet transferred. This second transfer would occur free of tax by virtue of subsection 85(2).
Finally, you emphasize that all the quotas held by Farm A S.E.N.C. would be eligible for the election under subsection 14(1.01). Thus, this election would not be, for example, restricted by virtue of subsection 14(1.03).
Questions:
1. You asked us if it is possible, in the context described above, to structure the proposed dispositions of milk quotas so that, firstly, the election under subsection 14(1.01) is used for the quotas eligible for the capital gains deduction and, secondly, the tax rollover under subsection 85(2) is used for the quotas that are not eligible for that deduction.
2. You also asked us to confirm that for the purposes described in paragraph 14(1.01)(a), the deemed proceeds of XXXXXXXXXX kilos of quotas disposed of in the first transfer in connection with the election under subsection 14(1.01), would be equal to the eligible capital expenditure incurred to acquire such eligible capital property, namely $XXXXXXXXXX.
Our Comments:
As stated in paragraph 22 of Information Circular 70-6R5 dated May 17, 2002, it is the practice of the Canada Revenue Agency (the "CRA") not to issue a written opinion regarding projected transactions otherwise than by advance rulings. Furthermore, when it comes to determining whether a completed transaction has received the appropriate tax treatment, the decision comes first to our tax services offices as a result of the review of all facts and documents. which is usually done as part of an audit engagement. However, we can offer the following general comments, which we hope will be helpful. These comments may, however, under certain circumstances, not apply to a particular situation.
We are of the view that even though quotas are generally considered fungible assets that are difficult to identify in a partial sale, it is clear from the CRA's technical interpretations in the past that within this set of fungible goods, it is possible to have separate groups with their own tax characteristics.
For example, in Technical Interpretation 2006-0197401E5, a taxpayer's cumulative eligible capital expenditure account included qualified quotas and unqualified quotas for purposes of the election under subsection 14(1.01). It was then necessary to determine how subsection 14(1.01) should apply in such a situation where there is a partial disposition of those quotas. It was suggested that, in the case of a partial disposition of quotas consisting of quotas that were qualified and unqualified for the purposes of the election under subsection 14(1.01), a proportional calculation should be made of the number of quotas sold in each class. However, the CRA clarified that in the circumstances of that case, the taxpayer's expense for qualified quotas for the purposes of subsection 14(1.01) should be calculated on a separate basis, according to the number of quotas sold from that class.
Furthermore, in Technical Interpretation 2000-0028665, the CRA clarified, in the context of a disposition of the totality of a taxpayer's quotas, that it was possible in those circumstances to structure the disposition transactions under subsection 85(1) so as to first dispose of the unqualified quota portion and then the qualified quota portion by determining different agreed amounts based on the tax characteristics of each part of the quotas sold.
In the circumstances of this case, it appears to us that it is possible to structure the transaction so that, in the first place, the quotas eligible for the capital gains deduction can be identified and transferred with a utilization of the election under subsection 14(1.01) and, second, all non-qualified quotas are transferred free of tax under subsection 85(2). Indeed, according to the facts described in your request, the partnership would dispose of all of its quotas under the terms of the transactions. In addition, the tax characteristics attached to each group of quotas would be easily identifiable. Thus, to the extent that all the other conditions set out in the Act are satisfied, it would be reasonable to allow for the structuring of the quota dispositions as proposed in your letter.
With respect to your second question, paragraph 14(1.01)(a) provides that for the purpose of subsection (5) other than the description of A in the definition “cumulative eligible capital”, the proceeds of disposition of the particular property are deemed to be equal to the amount of that eligible capital expenditure that the taxpayer incurred to acquire the capital property. According to the facts submitted in your request, it appears that the capital expenditure incurred by the taxpayer to acquire the XXXXXXXXXX kilos of qualified quotas was $XXXXXXXXXX. Thus, it is that amount of $XXXXXXXXXX that is the deemed proceeds of disposition referred to in paragraph 14(1.01)(a).
We hope that these comments are of assistance.
Best regards,
Stéphane Prud'Homme, Notary, M. Fisc.
Manager
Mergers and Acquisitions Section
Corporate Reorganisations and Resource Industry Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch