Principal Issues: [TaxInterpretations translation] You wish to know if subsection 70(5.1) applies to the situation in this case. You also wish to know what the tax consequences would be of a price adjustment at the end of year 5 where a taxable capital gains reserve was calculated under subparagraph 40(1)(a)(iii), taking into account that the years in question may be statute-barred.
Position: Subsection 70(5.1) is not the subject of an election; it applies automatically when all conditions of application are satisfied. Since the application and operation of the price adjustment clauses are not proposed transactions, we invite you to consult the TSO in your region who will be able to provide you with further information as to whether your clause can be accepted.
XXXXXXXXXX 2010-038470 Anne Dagenais, Advocate, M. Fisc. December 6, 2011
Dear Sir,
Subject: Death of a taxpayer - eligible capital property
This is in response to your October 26, 2010 e-mail requesting our opinion on the application of the Income Tax Act (the "Act") in the situation where a taxpayer dies and the estate sells goodwill to the children of the taxpayer.
Unless otherwise indicated, all statutory references herein are to the provisions of the Act.
Specifically, you described a situation where Mr. X carried on a business for which goodwill was generated over the years. Mr. X died and bequeathed all his property to his children. The estate did not carry on the business and sold the goodwill for $100,000 payable over 5 years at a rate of 20% per annum, subject to price adjustment. From year 1 to year 5, the estate claimed a reserve under subparagraph 40(1)(a)(iii) and reported an annual capital gain of $20,000. At the end of the fifth year, the price was adjusted to $95,000. The parties are not dealing at arm's length. You asked us to assume that paragraph 12(1)(g) does not apply and you added that the conditions required by Interpretation Bulletin IT-169, Price Adjustment Clauses, are satisfied.
You wish to know if subsection 70(5.1) applies to the situation in this case. You also wish to know what would be the tax consequences of the price adjustment at the end of year 5 where a taxable capital gains reserve was calculated in accordance with paragraph 40(1)(a)(iii ), taking into account that the years in question may be statute-barred. Finally, you wish to know if subsection 152(4.2) applies.
Our Comments
Subsection 70(5.1) provides for the tax-free transfer of an eligible capital property in the event of a person acquiring the property as a result of the death of a taxpayer. In particular, under paragraph 70(5.1)(a) the taxpayer is be deemed to have disposed of the property, immediately before the taxpayer's death, for proceeds equal to 4/3 of its cumulative eligible capital. By virtue of paragraph 70(5.1)(b), the person who acquires the property is deemed to have acquired a capital property at a cost equal to the deemed proceeds of disposition to the deceased taxpayer. Subsection 70(5.1) is not subject to the making of an election and applies automatically when all conditions for its application are satisfied.
The question of whether subsection 70(5.1) applies in the situation presented is a fact that can only be determined after an examination of all the facts and circumstances of the situation.
However, at first glance, since Mr. X died and the goodwill was bequeathed to his children, the provisions of subsection 70(5.1) seem to apply. Mr. X is deemed to have disposed of the goodwill for proceeds equal to 4/3 of its cumulative eligible capital, being a nil amount since Mr. X did not acquire the goodwill but, rather, generated it over the years. Thus, no amount would be included in Mr. X's income pursuant to subsection 14(1).
Furthermore, the estate of Mr. X is deemed, under paragraph 70(5.1)(b), to have acquired a capital property at a cost equal to the deemed proceeds of disposition to Mr. X, being a cost of nil. Thus, when the estate disposed of goodwill for proceeds of disposition of $100,000, it realized a capital gain of $100,000.
It is difficult for us to comment as requested on the situation that you have submitted to us since we do not have all the relevant facts. However, Interpretation Bulletin IT-169, Price Adjustment Clauses ("IT-169") addresses situations where the CRA determines that the FMV is higher or lower than the price otherwise determined by the parties to an agreement. Consequently, it is our opinion that this Bulletin does not apply in this situation.
The question of whether the CRA recognizes, as valid under its criteria, the clause that you labelled a "price adjustment" clause requires a full examination of all relevant facts. In that context, it is impossible for us to comment as to its retroactive effect to the day of the initial transaction, since we do not have all the particulars necessary to make that determination.
However, if it were appropriate to retroactively adjust the sale price, the CRA could apply subsection 152(4.2) in respect of taxation years already assessed in the ordinary manner described in Information Circular IC75-7R3, that is, any request for reassessment that will be made in respect of a statute-barred taxation year, subject to the other conditions set out in that Circular. As a result, a taxpayer must satisfy the five conditions for the CRA to agree to a reassessment giving rise to a refund.
To determine with certainty the tax treatment of the clause you have described to us, it would be necessary to proceed to a complete examination of the circumstances surrounding that clause. That review would normally be the responsibility of the Tax Services Office in your area as part of a tax audit following the filing of a tax return.
These comments do not constitute an advance income tax ruling and are not binding on the CRA with respect to a particular factual situation.
We hope that the above comments will be of assistance to you and answer your questions.
Best regards,
François Bordeleau, Advocate
Manager
Business and Trusts Section
Income Tax Rulings Directorate