Principal Issues: [TaxInterpretations translation] (1) Does the capital gain on the disposition of farmland qualify for the exemption under section 110.6 of the Income Tax Act for qualified farm property?
(2) If the farmland is held personally by the taxpayer and his or her spouse for a period of at least 24 months after the dissolution of the partnership that previously owned the land and the land is leased to an arm's length producer, will the capital gain on the disposition of the land qualify for the capital gains exemption?
Position: (1) Yes.
(2) Yes.
Reasons: The Income Tax Act.
XXXXXXXXXX 2005-016188
June 7, 2006
Dear Sir,
Subject: Request for Technical Interpretation – Qualified Farm Property
This is further to your letter dated November 28, 2005, in which you requested a technical interpretation of the application of section 110.6 of the Income Tax Act (the "Act") to a capital gain arising on the disposition of farmland. We apologize for the delay in responding to your question.
RELEVANT FACTS
Your request for a technical interpretation states the following facts:
- The taxpayer has farmed for more than 10 years;
- During this period, the taxpayer's only income was from farming;
- The farmland was transferred to a partnership of which the taxpayer and his spouse were partners;
- For a period of 5 years, the interests held by the taxpayer and his spouse qualified as "interests in a family farm partnership";
- Following health problems of the taxpayer, the farmland was leased to a farmer who dealt at arm’s length with both the taxpayer and his spouse;
- The partnership was wound up pursuant to subsection 98(3) and the farmland continues to be leased to a farmer who deals at arm’s length with the taxpayer and his spouse.
QUESTION
Your request for a technical interpretation raises the following two questions:
(1) If the farmland is sold by the partnership immediately prior to the winding up of the partnership, will the capital gain on the disposition qualify for the exemption under section 110.6 for qualified farm property?
(2) If the farmland is held personally by the taxpayer and his spouse for a period of at least 24 months after the winding up of the partnership and is leased to an arm's length farmer, will the capital gain from the disposition of the land qualify for the capital gains exemption?
ANALYSIS
(1) If the farmland is sold by the partnership immediately prior to the winding up of the partnership, will the capital gain on the disposition qualify for the exemption under section 110.6 for qualified farm property?
For your first question, we have assumed that the partnership disposed of the farmland prior to its winding up pursuant to subsection 98(3). We must therefore determine whether the sale of the farmland by the partnership qualifies for the capital gains exemption for qualified farm property.
Upon the disposition of a qualified farm property1 , an individual may benefit from a capital gains exemption, provided for in section 110.6, up to a maximum amount of $500,000.
In the context of the sale of the farmland by the partnership, it is necessary to determine whether the taxpayer's and his spouse's interests in the partnership each constitute an "interest in a family farm partnership" as that term is defined in subsection 110.6(1). You will appreciate that this is a factual determination that requires a thorough examination of the use of the partnership property both for a 24-month period prior to the sale of the farmland and at the time of disposition of that capital property.
Since the facts in this case are insufficient to allow us to undertake that analysis, you asked us to presume that the interests of the taxpayer and his spouse constitute such holdings. We are prepared to proceed on the basis of such a presumption provided that this is not seen as an endorsement of your conclusion.
Assuming, therefore, that the taxpayer's and his spouse's interests constitute interests in a family farm partnership at the time of the sale of the farmland by the partnership, our analysis must focus on whether the farmland constitutes "qualified farm property" to the taxpayer and his spouse. The definition of "qualified farm property" is found in subsection 110.6(1).
The passages of that definition that are relevant in the light of the facts of this case are reproduced below:
Qualified farm property, of an individual (other than a trust that is not a personal trust) at any particular time means a property owned at that time by the individual, the spouse or common-law partner of the individual or a partnership, an interest in which is an interest in a family farm partnership of the individual or the individual’s spouse or common-law partner that is
(a) real property that was used by
(i) the individual,
[…]
(iii) a spouse, common-law partner, child or parent of a person referred to in subparagraph (i) or (ii),
[…]
(v) a partnership, an interest in which is an interest in a family farm partnership of an individual referred to in any of subparagraphs (i) to (iii),
in the course of carrying on the business of farming in Canada …
In this case, the partnership disposed of farmland while it was leased to a third party dealing at arm's length. According to the above passages of the definition of "qualified farm property", the farmland must therefore have been owned at that time - that is, at the time immediately preceding its sale - by the partnership in which the taxpayer and his spouse hold an interest as a family farm partnership. In addition, the farmland must have been used in the course of carrying on a farming business in Canada, either by the partnership or by a person who held an interest in the family farm partnership, including the taxpayer or the taxpayer's spouse.2
Paragraph (vi)3 of the definition of "qualified farm property" contains the requirements that must be satisfied in order for that property to be considered to be used in the course of carrying on a farming business in Canada:
(vi) the property or property for which the property was substituted (in this subparagraph referred to as “the property”) was owned by a person who was the individual, a beneficiary referred to in subparagraph (ii) or a spouse, common-law partner, child or parent of the individual or of such a beneficiary, by a personal trust from which the individual acquired the property or by a partnership referred to in subparagraph (v) throughout the period of at least 24 months immediately preceding that time and […]
(B)4 the property was used by a corporation referred to in subparagraph (iv) or a partnership referred to in subparagraph (v) principally in the course of carrying on the business of farming in Canada throughout a period of at least 24 months during which time the individual, a beneficiary referred to in subparagraph (ii) or a spouse, common-law partner, child or parent of the individual or of such a beneficiary was actively engaged on a regular and continuous basis in the farming business in which the property was used, […]
Thus, farmland is considered to be used in the course of carrying on a farming business in Canada if the requirements of paragraph (vi) or paragraph (vii) of the definition of "qualified farm property" are satisfied.
In this case, the farmland appears to satisfy the requirements of the preamble to subparagraph (vi) of the definition of "qualified farm property", since the partnership owned the land throughout the 24-month period preceding the time of the sale. We refer you to Technical Interpretation 2005-0121232E5 which states the following: [TaxInterpretations translation]
In our view, the use of the phrase "throughout the period [...] immediately preceding that time" suggests that the property must be owned by one of the persons referred to in subparagraphs (i) to (iii) above throughout a combined and uninterrupted period of at least 24 months immediately preceding the disposition of the property.
Clause (B) requires that the farmland be used by the partnership principally in the course of carrying on the business of farming in Canada throughout a period of at least 24 months during which time the taxpayer or the taxpayer's spouse was actively engaged on a regular and continuous basis in the farming business in which the property was used. As such, it is not necessary that the property be used principally in the farming business at the time of its disposition, but rather that it be used principally in such a business for any 24-month period during which the taxpayer or the taxpayer's spouse was actively engaged on a regular and continuous basis in the farming business in which the property was used.
Whether real property is used principally in the business of farming in Canada is a question of fact. In determining whether an asset is used principally in the business of farming, the CRA is of the view that this requirement is satisfied where more than 50% of the use of the property is in the business of farming. We refer you to Technical Interpretation 2004-0063481E5 which supports our position. In this case, this requirement appears to be satisfied because of the 5-year period during which the partnership of the taxpayer and his spouse carried on a farming business.
In this case, and based on the facts you have provided, we are of the view that the capital gain arising from the disposition of the farmland by the partnership would qualify for the capital gains exemption on qualified farm property.
(2) If the farmland is held personally for a period of at least 24 months after the winding up of the partnership and is leased to an arm's length producer, will the capital gain on the disposition of the land qualify for the capital gains exemption?
In order to answer this question, we wish to clarify the effect of a partnership winding up pursuant to subsection 98(3).
Where a partnership has ceased to exist and a rollover is effected under subsection 98(3), all of the partnership property is distributed to the persons who were members of the partnership before its winding up. Thus, each partner becomes the owner of an undivided interest in each of the partnership properties. In this case, following the winding up of the partnership and the subsection 98(3) rollover, the taxpayer and his spouse each own an undivided interest in the farmland.
Your question requires us to revisit the definition of "qualified farm property". As a preliminary matter, we accept that the requirements noted in the preamble to the definition and in subparagraphs (i) to (v) are satisfied since, at the time of the sale of the farmland, the taxpayer and his spouse each owned an undivided interest in it. In addition, at different times, the farmland was used either by the taxpayer and his spouse in the course of carrying on a farming business in Canada or by the partnership whose interests were interests in a family farm partnership.
Our analysis must therefore focus on the application of subparagraph (vi) of the definition of "qualified farm property". As discussed above, and on the facts of this case, the requirements of the preamble to that subparagraph are satisfied since the farmland was owned by the taxpayer and his spouse for the entire 24-month period preceding the time of the sale of the land.
Either clause (A) or clause (B) of subparagraph (vi) must then be applied. Since clause (A) cannot be applied - the facts in this case being insufficient – resort must be made to clause (B). This requires that the property - the farmland - be used by a partnership principally in the course of carrying on a farming business in Canada throughout a 24-month period during which the taxpayer or his or her spouse was actively engaged on a regular and continuous basis in the farming business in which the property was used.
As noted earlier, any 24-month period preceding the particular time - the time of the sale - may be used to determine whether the requirements of clause (B) are satisfied. Thus, we are of the view that the 5-year period during which the partnership - in which the taxpayer and his spouse held interests in a family farm partnership - used the farmland principally in the course of carrying on a farming business in Canada can be used to satisfy the requirements of clause (B). Indeed, during this period, you indicated that the taxpayer and his spouse were actively engaged on a regular and continuous basis in the farming business as carried on by the partnership.
Consequently, our answer to your second question is yes.
François D. Bordeleau, LL.B.
Individuals, Business and Partnerships Section
Income Tax Rulings Directorate
ENDNOTES
1 See the definition of that term in subsection 110.6(1) of the Act.
2 Of course, real property may have been used in the course of carrying on a farming business by other persons or entities. Here, we have referred only to those persons relevant to the facts.
3 Subparagraph (vii) contains other requirements which - if satisfied - result in a particular property being considered to be used in the course of carrying on a farming business in Canada. We do not believe that this subparagraph is relevant in this case since it applies only to property acquired before June 18, 1987.
4 Subparagraph (vi) requires that either the requirements of clause (A) or the requirements of clause (B) be satisfied. In this case, we are unable to conclude that clause (A) applies because of the facts you have provided.