Principal Issues: A management corporation leases a building during two years to its associated corporation and then to third parties before to sell it. Whether recapture CCA could be treated in part as active business income and in part as investment income?
Position:
Yes.
Reasons:
This position is in accordance with the tax policy underlying subsection 129(6) and subsection 129(1).
December 15, 2011
Eastern Quebec Tax Services Office Income Tax Rulings Directorate Business and Trusts Division Attention: Annie Morin Danielle Bouffard
2011-041389
Recapture of depreciation - income from an active business and income from a specified investment business
This is a follow-up to your email that we received on July 13, 2011, as well as our telephone conversation (Bouffard/Morin) regarding the above subject.
Unless otherwise indicated, all statutory references herein are to the provisions of the Income Tax Act (the “Act")
You described a situation where a holding corporation has, in the course of its specified investment business within the meaning of subsection 125(7), leased a property for two years to an associated corporation that used it in the course of actively carrying out its business. The holding corporation treated the rents as active business income under subsection 129(6). During the next two years, the holding corporation leased the property to a non-associated corporation. The holding corporation has claimed capital cost allowance ("CCA") on this property in computing its income for the years it was used to earn income from property or from an active business. The holding corporation has sold the property and must include an amount in its income as recapture of depreciation.
You wish to know if it is possible to split the recapture of depreciation made by the holding corporation from the sale of the building based, first, on the number of years the property generated income from an active business under subsection 129(6) and, secondly, the number of years in which it generated property income.
Our Comments
Under the definition of "income" in subsection 129(4), which definition applies for the purposes of section 129, the income of a corporation for a taxation year from a source that is a property:
(a) includes the income or loss from a specified investment business carried on by it in Canada other than income or loss from a source outside Canada, but
(b) does not include the income or loss from any property
(i) that is incident to or pertains to an active business carried on by it, or
(ii) that is used or held principally for the purpose of gaining or producing income from an active business carried on by it.
To the extent that an amount paid or payable to a corporation (for example, to the holding corporation) by an associated corporation is deductible in computing its income from a business that it is actively carried on in Canada, subsection 129(6) provides that for the purpose of determining income from a source in Canada that is property, the amount paid or payable shall be deemed to be income of the holding corporation from a business that it actively carries on in Canada, and not income from a source in Canada that is a property.
In addition, for the purposes of subsection 129(6) and section 125, an outlay or expense expenditure made or incurred by the holding corporation, to the extent that the outlay or expense is made or incurred to earn income from the property, is deemed by subparagraph 129(6)(b)(ii) to have been made or incurred to gain or produce income from an active business carried on in Canada. As stated in the 1972 Budget Speech, the purpose of introducing that measure was to prevent corporate income from being converted into investment income within a corporate group in order to benefit from a dividend refund.
Furthermore, as stated in paragraph 7 of Interpretation Bulletin IT-73R6, if subsection 129(6) deems rental income to be active business income and capital cost allowance on the rented building was deducted in computing active business income, the CRA's position is that any recapture of capital cost allowance on the disposition of the building would also be considered to be active business income.
That position is based in part on the response to question 1.24 as part of the APFF's 1989 Roundtable discussion where the Minister stated [TaxInterpretations translation]: "Where such depreciation is recaptured under subsection 13(1), the Minister considers it to be income derived from an active business in Canada for the purposes of sections 125 and 129 of the Act."
In the context of the situation under review, the position you propose, which is to treat a portion of the recaptured depreciation as income from an active business and another portion as property income, appears reasonable to us although there is no provision in the Act expressly supporting this conclusion.
We hope that these comments are of assistance.
François Bordeleau, Advocate
Manager
Business and Trusts Section
Income Tax Rulings Directorate