Principal Issues: Where subsection 100(2) adds the negative ACB of a partnership interest to the capital gain otherwise determined, can a reserve under 40(1)(a)(ii) be taken on the full amount?
Position: No
Reasons: Reserve is in respect of an amount that is payable after the end of the year. A negative acb addition to the capital gain is simply a calculation and not an amount payable after the end of the year.
2005-011608 XXXXXXXXXX C. Tremblay, CMA (613) 957-2139 June 23, 2005
Dears XXXXXXXXXX:
Re: Capital Gains reserve and Negative ACB for a General Partnership Interest
This is in reply to your letter of February 15, 2005 concerning the above subject. You describe a situation where a taxpayer disposes of an interest in a family farm partnership, which has a fair market value of $100,000 to a corporation under section 85 of the Income Tax Act (the "Act"), which will not be controlled directly, indirectly or in any manner by the taxpayer. At the time of disposition, the taxpayer has a negative adjusted cost base ("ACB") of $400,000 in his partnership interest. The taxpayer will take back a note payable for $99,000 payable over 5 years in 5 equal instalments plus interest and redeemable preferred shares of the corporation having an aggregate redemption amount of $1,000 for a total consideration of $100,000. The $500,000 capital gains deduction is fully available to the taxpayer for his interest in the family farm partnership.
You ask whether a reserve under subparagraph 40(1)(a)(iii) of the Act can be claimed for the entire gain amount of $500,000.
Our Comments:
Written confirmation of the tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R5, Advance Income Tax Rulings, dated May 17, 2002. Where the particular transactions are completed, the inquiry should be addressed to the relevant Tax Services Office. However, we offer the following general comments.
In a situation such as you describe, when a taxpayer disposes of his partnership interest that has a negative ACB, the partnership interest ACB is deemed to be nil. Assuming further that the fair market value of the partnership interest and the proceeds of disposition are $100,000, a capital gain of $100,000 will result pursuant to subparagraph 40(1)(a)(i) of the Act. Additionally, as in your example, the negative ACB of $400,000 will be added to this amount pursuant to subsection 100(2) of the Act. Accordingly, the total capital gain that would be recognized on the disposition pursuant to subsection 40(1) of the Act is $500,000.
In our view, in the situation described, the taxpayer would be entitled to a reasonable amount as a reserve under subparagraph 40(1)(a)(iii) of the Act in respect of the proceeds of disposition that are not due to the taxpayer until after the end of the year. As indicated in clause 40(1)(a)(iii)(C) of the Act, a reserve is allowed as a deduction but is not to exceed "...a reasonable amount as a reserve in respect of such of the proceeds of disposition of the property that are payable to the taxpayer after the end of the year ...". Since, in your example, the proceeds of disposition that are payable to the taxpayer after the end of the year can only be, in our opinion, the amount represented by the note payable, only that amount, that is the $99,000 would qualify for the reserve calculation under subparagraph 40(1)(a)(iii) of the Act.
We trust our comments are of assistance. However, as stated in paragraph 22 of Information Circular 70-6R5, this opinion is not a ruling and consequently, is not binding on the Canada Revenue Agency in respect of any particular situation.
Yours truly,
Steve Tevlin
For Director
Financial Sector and Exempt Entities Division
Income Tax Rulings Directorate
Policy and Planning Branch