Principal Issues: [TaxInterpretations translation] (1) Where an election is made pursuant to subsection 110.6(19) of the Income Tax Act - for example, where the amount specified is greater than 11/10 of the fair value of a non-qualifying real property - is it possible for the reduction in the capital cost of the property to result in a recapture to be included in the taxpayer's income at the time of its disposition to a third party rather than in a larger capital gain?
(2) Does the Federal Court of Appeal's decision in Holder v. The Queen alter the findings set out in Technical Interpretation 2003-000178?
Position: (1) Yes.
(2) No.
Reasons: The Income Tax Act.
July 7, 2006
XXXXXXXXXX Headquarters Audit Division François Bordeleau XXXXXXXXXX Tax Services Office 2006-018596
Request for Technical Interpretation - Impact on UCC of an election made under 110.6(19) of the Income Tax Act (the "Act")
This is further to your email dated May 9, 2006, in which you asked us to confirm the validity of Technical Interpretation 2003-000178 that we issued on May 13, 2003, with respect to the impact of an election made under subsection 110.6(19) on the undepreciated capital cost ("UCC") of the property subject to the election.
You also asked us to consider whether the recent judgment of the Federal Court of Appeal in Holder1 affects the conclusion set out in the above technical interpretation.
FACTS
We refer you to Technical Interpretation 2003-00178 which contains a detailed description of the relevant facts on which this document is based.
QUESTIONS
Your email contained the following two questions:
(1) Where an election is made under subsection 110.6(19) - in particular, where the amount shown is greater than 11/10 of the fair market value of the property - is it possible that the reduction in the cost of the property will result in recapture to be included in the individual's income upon its disposition to a third party rather than a larger capital gain?
(2) Does the Holder decision of the Federal Court of Appeal alter the conclusions set out in Interpretation 2003-000178?
ANALYSIS
(1) Recapture of depreciation
Under subsection 110.6(19), a taxpayer could elect to crystallize any accrued capital gain in order to use the $100,000 capital gains exemption2 that applied only to dispositions up to February 22, 1994. The mechanism in subsection 110.6(19) provided for the deemed disposition of the capital property as well as its acquisition by the taxpayer.
According to the factual circumstances underlying Interpretation 2003-000178, the taxpayer made an election under subsection 110.6(19). The deemed disposition of the capital property was for $120,000 and the reacquisition was for $42,000. However, since the property was non-qualifying real property, subsection 110.6(21) provides for a reduction in the capital cost of the property. That cost, which was $6,000, was relevant for the purpose of calculating any capital gain or loss arising on a subsequent disposition of the property by the taxpayer. We refer you to Technical Interpretation 2003-000178 which clearly indicates how to calculate those values.
Where a taxpayer makes the election under subsection 110.6(19), the re-acquisition of the property under that provision triggers the application of subparagraph 13(7)(e)(iii) for depreciation purposes. Paragraph 13(7)(e.1) provides that a taxpayer who makes the election under subsection 110.6(19) is deemed to have acquired the property from a person with whom the taxpayer does not deal at arm's length (in this case, the taxpayer).
In this case, the property is reacquired at a capital cost ($6,000) that is less than the previously determined capital cost ($120,000). Under subparagraph 13(7)(e)(iii) of the ITA, the capital cost to the acquiror of the property is deemed to be $120,000 and the difference between the two amounts - $114,000 - is deemed to have been claimed by the taxpayer as capital cost allowance. Where the taxpayer subsequently disposes of the property, we may apply subparagraph 13(7)(e)(iii) to determine whether the taxpayer must include an amount in income on account of recapture of capital cost allowance.
Application of these principles to the facts of this case
In 1990, the capital cost of the building to the taxpayer was $120,000. During the years 1991 to 1993 inclusive, the taxpayer claimed capital cost allowance in the amount of $20,369. Where the taxpayer reacquired the building under subsection 110.6(19), it was deemed to be acquired for $42,000 under clause 110.6(19)(a)(ii)(C). This is because the election amount is greater than 11/10 of the fair market value of the building at the time of the reacquisition. In addition, since the building is a non-qualifying real property, the capital cost of the property is reduced to $6,0003.
For depreciation purposes, therefore, we must apply subparagraph 13(7)(e)(iii) since, on the reacquisition of the property under subsections 110.6(19) and (21), the capital cost of the property to the transferee was less ($6,000) than the capital cost to the transferor ($120,000). Although the capital cost to the transferee is increased to $120,000, the transferee is still deemed to have claimed $114,000 as depreciation on the property. For the 1994 taxation year - and contrary to what was stated in Technical Interpretation 2003-000178 - the taxpayer will have to include an amount of $14,369 as recapture of depreciation:
|
Capital cost of the property in 1990 to the taxpayer for depreciation purposes: |
$120,000 |
|
less |
|
|
CCA claimed in the years 1991 to 1993 inclusive: |
$20,369 |
|
$99,631 |
|
|
less |
|
|
The lesser of the disposition proceeds and the |
$120,000 |
|
($20,369) |
|
|
plus |
|
|
Deemed capital cost under subparagraph 13(7)(e)(iii): |
$120,000 |
|
$99,631 |
|
|
less |
|
|
CCA deemed to have been claimed under |
$114,000 |
|
($14,369) |
|
|
Recapture to be included at the end of 1994: |
$14,369 |
Where the taxpayer disposes of the building in 1998, we confirm - as stated in Technical Interpretation 2003-000178 - that an amount of $58,452 must be included in the taxpayer’s income as recapture of depreciation:
|
UCC balance of the building in 1995: |
$0 |
|
less |
|
|
Proceeds from the disposal of the building in 1998: |
$58,452 |
|
Recovery to be included in the taxpayer's income for 1998: |
($58,452) |
With respect to the calculation of the capital gain realized in the circumstances described in Interpretation 2003-000178, we confirm that a capital gain of $52,452 will be realized on the disposition of the building in 1998 (i.e. the result of subtracting the adjusted cost base of $6,000 from the proceeds of disposition of $58,452)
At first glance, this appears to be double taxation. However, the wording of paragraph 39(1)(a) addresses this problem by excluding any portion of a capital gain that has already been included in the taxpayer's income under section 3 (including recapture of depreciation). In this case, since the entire gain is included in the taxpayer's income on a recapture basis, the result is a capital gain of $0. The taxpayer will only have recapture - in the amount of $58,452 - to include in the taxpayer’s income for the 1998 taxation year.
(2) Impact of the Holder decision
In Holder v. The Queen4, the taxpayer made an election in respect of non-qualifying real property. In addition, the amount reported on the taxpayer's election form was greater than the fair market value of the non-qualifying real property.
The Minister of National Revenue argued that subsections 110.6(21) and (22) (and, by implication, paragraphs 53(2)(u) and (v)) should each result in a $50,000 reduction in the adjusted cost base of the property in question. According to the Minister, the taxpayer's property should have had a negative adjusted cost base of $100,000.
The Federal Court of Appeal disagreed with the Minister's position. In effect, the Court expressed the view that the Minister's interpretation of the provisions at issue resulted in double taxation arising from the same transaction and in respect of the same property. In the absence of clear and unequivocal language, subsections 110.6(21) and (22) could not alter the presumption against double taxation contained in subsection 4(4) of the ITA.5
We do not believe that the findings in Holder by themselves alter our technical interpretation 2003-000178. Holder dealt with a particular set of facts where the amount the taxpayer elected resulted in a negative adjusted cost base of the property in question. In this case, the taxpayer's election reduced the capital cost of the building to $6,000. Since subsection 110.6(22) does not apply to further reduce the ACB of the building - the amount determined under paragraph 110.6(22)(a) not being greater than the amount determined under paragraph 110.6(22)(b) - we do not believe that the situation in this case falls within the scope of the findings in Holder.
For your information, unless exempted, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency's electronic library. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, the electronic library version can be provided. Alternatively, the client may request a severed copy using the Privacy Act criteria, which does not remove client identity. Requests for this latter version should be made by you to Ms. Jackie Page at (819) 994-2898. A copy will be sent to you for delivery to the client.
François D. Bordeleau, LL.B.
Individuals, Business and Partnerships Section
Income Tax Rulings Directorate
ENDNOTES
1 Holder v. The Queen, [2004] F.C.A. no 844
2 See subsection 110.6(3) which was repealed effective 1996.
3 The capital cost of the building is reduced by $36,000, which is the result of the calculation in paragraph 110.6(21)(b): 4/3 * the amount obtained in 110.6(21)(a).
4 See note 1, supra.
5 That provision is now repealed and replaced by subsection 248(28).