Principal Issues: Whether the acquisition of farm quota under the particular fact situation qualifies as a deductible business expense pursuant to paragraph 18(1)(a) of the Act.
Position: No.
Reasons: In the fact situation provided, the acquisition of the farm quota with an unlimited life is an eligible capital expenditure and is not deductible in the current period pursuant to paragraph 18(1)(b) of the Act. Instead, 75% of the expenditure is added to the cumulative eligible capital account and the taxpayer may claim, on a declining-balance basis, up to 7% of the balance of the account at the end of its taxation year as a deduction under paragraph 20(1)(b) of the Act.
XXXXXXXXXX 2010-036980 T. Posadovsky, CMA November 25, 2010
Dear XXXXXXXXXX :
Re: Acquisition of Farm Quota
We are writing in reply to your correspondence dated May 21, 2010, wherein you requested an advance income tax ruling on behalf of the Class B shareholders of the XXXXXXXXXX , incorporated as XXXXXXXXXX (the "Investment Fund").
In your letter, you outlined a number of proposed transactions contemplated by the XXXXXXXXXX . The XXXXXXXXXX is the provincial marketing board responsible for, among other things, managing XXXXXXXXXX supply and marketing on behalf of XXXXXXXXXX producers (the "Producers"). The proposed transactions involve the winding up of a trust and two funds administered by the XXXXXXXXXX . You explained that the current structure will be replaced with a general purpose fund (the "New Fund") that will be more efficient and result in increased benefits to the industry.
You explained that the XXXXXXXXXX intends to redeem the Investment Fund's Class B preferred shares currently held by Producers. In an effort to preserve capital, the XXXXXXXXXX will ask Producers to contribute the proceeds from the Class B share redemption to the New Fund. Producers will receive one unit of "A" production quota ("A quota") in exchange for one unit of "B" production quota ("B quota") and redemption proceeds attributed to one Class B share (likely $XXXXXXXXXX par value). The XXXXXXXXXX feels that this exchange will result in positive income benefits to the Producers as those who do not agree to the offer will continue to hold B quota which is subordinate to A quota in production allocation decisions.
You wish to know whether amounts given to the XXXXXXXXXX , all of which will be contributed to the New Fund, will qualify as a deductible business expense to the producers pursuant to paragraph 18(1)(a) of the Income Tax Act (the "Act").
As discussed in our telephone conversation of November 10, 2010, we are unable to provide a formal ruling on this matter since, as explained in paragraph 15 of Information Circular IC-70-6R5, the circumstances are such that all the pertinent facts cannot be fully established at the time of the request for the ruling. Your deposit will be returned to you under separate cover. We will, however, provide the following general comments which may be of assistance.
Our Comments
Based on your submission, it is not clear how XXXXXXXXXX will redeem the Class B shares. Where shares are redeemed by a corporation resident in Canada, the redemption may result in a deemed dividend under subsection 84(3) of the Act, or subsection 84(2) of the Act in the case of a winding-up, discontinuance or reorganization of its business. Under such circumstances, the corporation is deemed to have paid and the shareholder is deemed to have received a dividend equal to the amount by which the amount paid, or the funds distributed, as the case may be, exceed the paid-up capital in respect of the particular shares. Whether or not one of these subsections will apply to a given situation is a question of fact.
As you indicated in your letter, the XXXXXXXXXX proposes to exchange one A quota for a Producer's B quota and $XXXXXXXXXX in redemption proceeds (the par value of one B share). In our view, this constitutes a sale and purchase transaction where one unit of A quota will be acquired from the XXXXXXXXXX for consideration or cost equal to $XXXXXXXXXX plus one B quota paid by the Producer.
The acquisition of a farm quota with an unlimited life is considered to be an eligible capital expenditure ("ECE") as defined in subsection 14(5) of the Act. An ECE in respect of a business is a capital outlay (i.e., an expenditure that results in an enduring benefit), the cost of which is not deductible pursuant to paragraph 18(1)(b) of the Act. However, 75% of the expenditure is added to the taxpayer's cumulative eligible capital ("CEC") account and the taxpayer may claim, on a declining-balance basis, up to 7% of the balance of the account at the end of the taxation year as a deduction under paragraph 20(1)(b) of the Act. The deduction claimed reduces the balance in the CEC account, which is carried forward to the subsequent year.
As a result of this transaction, each Producer will have a disposition of B quota, the proceeds of which will be deducted from their CEC account. Note that a disposition of one or more eligible capital properties during a taxation year may result in an income inclusion for tax purposes under section 14 of the Act for that year. However, such income inclusions generally arise only where, at the end of the year, the CEC balance in respect of the taxpayer's business is a negative amount.
For further information on this subject, please refer to IT-143R3, Meaning of Eligible Capital Expenditure, IT-123R6, Transactions Involving Eligible Capital Property, and IT-386R, Eligible Capital Amounts, all of which are available on our website at www.cra-arc.gc.ca.
We trust our comments will be of assistance to you.
Yours truly,
Guy Goulet CA, M.Fisc.
for Director
Ontario Corporate Tax Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch