Principal Issues: In a given situation, whether (1) a partnership interest could be considered an eligible property under subsection 85(1.1)? and (2) pursuant to subsection 220(4.5), a former Canadian resident (emigrant) could continue postponing the payment of its departure tax related to the partnership interest if the emigrant transfers this interest to a taxable Canadian corporation pursuant to subsection 85(1)?
Position: (1) Yes (2) No.
Reasons: (1) Long standing position. (2) The law and practice.
XXXXXXXXXX 2006-021589 Marc LeBlond April 29, 2008
Dear Sir,
Subject: Subsections 85(1.1) and 220(4.5) of the Income Tax Act.
This is in response to your letter of October 30, 2006, in which you requested our comments on the above subject in relation to the particular situation described below. We apologize for the delay in responding to your request.
Unless otherwise indicated, all legislative references herein are to the provisions of the Income Tax Act (the "Act").
It appears to us that the situation described in your letter and summarized below could constitute an actual situation involving taxpayers. As explained in Information Circular 70-6R5, it is not the practice of this Directorate to provide comments on proposed transactions involving specific taxpayers otherwise than in the form of an advance income tax ruling. If your situation involved specific taxpayers and one or more completed transactions, you should submit all relevant facts and documents to the appropriate Tax Services Office for its opinion. However, we are able to offer the following general comments that may be of assistance to you. It should be noted that the application of one or more provisions of the Act generally requires the analysis of all the facts relating to a particular situation. Accordingly, and given that your letter only briefly describes a particular hypothetical situation, the comments we make below may not apply in full in a given particular situation.
The particular situation
- Mr. A, a resident of Canada, owned an interest in a partnership (the "Interest") whose principal assets were real property. Such real property did not constitute inventory to the partnership. To Mr. A, the Interest was "capital property" within the meaning of section 54.
- At a particular time in a particular taxation year (the "Emigration Year"), Mr. A ceased to be resident in Canada. By virtue of paragraph 128.1(4)(b), Mr. A was deemed to have disposed at the time (the "Time of Disposition") immediately before the time immediately before the particular time of his Interest for proceeds equal to its fair market value.
- Mr. A realized a taxable capital gain for his Emigration Year on the deemed disposition of his Interest and, pursuant to subsection 156.1(4), must pay a tax under Part I of the Act (the "Departure Tax") in respect thereof on or before the "balance due date", as defined in subsection 248(1), applicable to him for his Emigration Year.
- Instead of paying his Departure Tax, Mr. A made an election under subsection 220(4.5), in prescribed form and within the prescribed time, to defer payment of his Departure Tax by providing the Canada Revenue Agency (the "CRA") with sufficient security.
- A corporation ("Aco") was incorporated in Canada. Aco was a "taxable Canadian corporation", as defined in subsection 89(1).
- After ceasing to reside in Canada, Mr. A disposed of his Interest to Aco. In consideration, Aco issued to Mr. A shares of its capital stock with a FMV equal to the FMV of the Transferred Interest. Mr. A is the sole shareholder of Aco.
Your questions and analysis
First, you asked us to confirm that CRA's position remains that generally an interest in a partnership that is capital property could be considered an "eligible property", as defined in paragraph 85(1.1)(a). Furthermore, if applicable, you wish to know whether, in the situation you have submitted to us, Mr. A and Aco could make the election provided for in subsection 85(1) with respect to the transfer of the Interest by Mr. A to Aco.
Secondly, you asked us whether, in the situation you have submitted to us, Mr A would be obliged to pay his Departure Tax due to the transfer of his Interest to Aco. In addition, you wish to know whether our answer would be the same if Mr A received from Aco at the time of the transfer, as consideration for the transfer of his Interest, in addition to shares in the capital stock of Aco, a note the principal amount of which would be equal to the cost amount of the transferred Interest held by Mr A.
In your view, for the current purposes, the position set out by the CRA in its response to Question 50 of the 1986 Canadian Tax Foundation Conference Round Table (the "1986 Position") is applicable in the particular situation. Question 50, and the CRA's response to it, reads as follows:
Q. 50 Interests in Partnerships: Section 85
Do all interests in partnerships constitute capital property or an interest in the underlying assets? Will an interest in real property that is inventory be eligible for a subsection 85(1) transfer if the interest in the real property is held through a partnership?
Department's Position
This question was answered at the 1984 tax conference. An interest in a partnership is not considered to be an interest in its underlying assets for purposes of section 85. An interest in a partnership could be held by its owner as capital property or inventory, depending on the circumstances. An interest in a partnership with assets that include an inventory of real property would be eligible for a subsection 85(1) transfer. A determination of whether a partnership exists has to be made on the basis of the facts of each case.
[emphasis added]
You are also of the view that, in the particular situation, Mr. A would no longer be able to take advantage of the relief provided by subsection 220(4.5). In support, you stated that "there are no provisions similar to section 128.3 to allow a transfer of a partnership interest pursuant to subsection 85(1) to result in the shares received as consideration being a continuation of the former property."
Our Comments
Response to your first question
We confirm that the CRA's 1986 position is still valid. Consequently, we are of the view that in the situation you have presented to us, depending on the circumstances, the Interest could be considered an "eligible property" as defined in paragraph 85(1.1)(a) and therefore, provided the other conditions of subsection 85(1) were satisfied, Mr. A and Aco could make the subsection 85(1) election in respect of Mr. A's transfer of the Interest to Aco.
In that regard, we refer you to the case of William H. Loyens v. Her Majesty the Queen, 2003 TCC 214 (2003 DTC 355), in which the Tax Court of Canada determined that the tax-free transfer of the Varna partnership interest to Lobro Stables Corporation was valid pursuant to subsections 85(1) and 85(1.1).
Answer to your second question
We agree with you that, in the particular situation, Mr. A would be obliged to pay his Departure Tax as a result of the transfer of his Interest to Aco, regardless of whether he receives from Aco, as consideration for the Interest transferred, shares in the capital stock of Aco or both shares in its capital stock and a note payable on demand by it. Our conclusions are based on the following observations.
The CRA states in the Guide "Emigrants and Income Tax - 2007" (T4056(E) Rev. 07) (the "Guide") that the Departure Tax must be paid when the non-resident person of Canada sells or otherwise disposes of property owned by the person at the time the person ceased to be a resident of Canada, as follows:
Can you elect to defer the payment of tax on income relating to the deemed disposition of property?
You can elect to defer the payment of tax on income relating to the deemed disposition of property, regardless of the amount. You would then pay the tax later, without interest, when you sell (or otherwise dispose of) the property. This election does not apply to the deemed disposition of an employee benefit plan.
[emphasis added]
In the particular situation, Mr. A having disposed of his Interest to Aco, we are of the view that Mr. A would be obliged to pay his Departure Tax.
The relevant parts of section 220(4.5) for the purposes hereof are as follows:
If an individual who is deemed by subsection 128.1(4) to have disposed of a property (other than a right to a benefit under, or an interest in a trust governed by, an employee benefit plan) at any particular time in a taxation year (in this section referred to as the individual’s “emigration year”) elects, in prescribed manner on or before the individual’s balance-due day for the emigration year, that this subsection and subsections (4.51) to (4.54) apply in respect of the emigration year,
(a) the Minister shall, until the individual’s balance-due day for a particular taxation year that begins after the particular time, accept adequate security furnished by or on behalf of the individual on or before the individual’s balance-due day for the emigration year for the lesser of
(i) the amount determined by the formula
A - B - [((A - B)/A) × C]
where
A
A is the total amount of taxes under Parts I and I.1 that would be payable by the individual for the emigration year if the exclusion or deduction of each amount referred to in paragraph 161(7)(a) were not taken into account,
B is the total amount of taxes under those Parts that would have been so payable if each property (other than a right to a benefit under, or an interest in a trust governed by, an employee benefit plan) deemed by subsection 128.1(4) to have been disposed of at the particular time, and that has not been subsequently disposed of before the beginning of the particular year, were not deemed by subsection 128.1(4) to have been disposed of by the individual at the particular time
[...]
[emphasis added]
From the above passages in subsection 220(4.5), it is clear that, in general, where the CRA accepts security for Departure Tax in respect of a property and the individual subsequently disposes of that property, the CRA as a technical matter can no longer allow the individual to defer payment of the Departure Tax.
We hope that our comments are of assistance.
Best regards,
Maurice Bisson, CGA
Manager
Corporate Reorganizations and Resource Industries Section
Corporjate Reorganizations and Resource Industries Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch.