Principal Issues: {TaxInterpretations translation]
1. What are the tax consequences of arm's length inter vivos gifts at less than FMV?
2. Is real property that was acquired by inheritance by an individual on the death of his father who carried on a farming business "qualified farm property" for purposes of the capital gains deduction under subsection 110.6(2) of the Act?
Position:
1. In this situation, subsection 69(1) of the Act applies. Therefore, the donor's proceeds of disposition are deemed to be equal to the fair market value of the gifted real property.
2. Yes, if the donor's father used the property in the course of carrying on a farming business, either in the year in which the individual disposes of the property or for at least five years during which the property is owned by such a person.
Reasons:
1. Application of subsection 69(1) of the Act.
2. Definition of "qualified farm property" is the requirements found in subparagraph 110.6(1)(vii).
2005-014241 XXXXXXXXXX Anne Dagenais (613) 957-2121 February 1, 2006
Dear Sir,
Subject: Request for written interpretation
This is in response to your letter of July 8, 2005, and our telephone conversation of December 30, 2005, with respect to your request for interpretive rulings in which you asked for our comments regarding inter vivos gifts of real property in the Particular Situation described below.
Unless otherwise indicated, all statutory references herein are to provisions of the Income Tax Act (the "Act").
Particular Situation
The Particular Situation as you have described it to us is as follows:
A person of XXXXXXXXXX years of age holding real estate wishes to donate it during that individual’s lifetime (the "Donor").
The Donor is Canadian and a resident of Quebec.
Case 1: Wooded land without buildings located on a lake
There are no buildings on the land.
The land would be donated to a couple of friends who reside in XXXXXXXXXX and who are citizens of XXXXXXXXXX (the "XXXXXXXXXX Couple").
The Donor and donees deal at arm's length.
Case 2: Principal residence and 6.5 acres of land surrounding it
The residence and land would be given to the Donor's grand-nephew (the "Grand-Nephew").
The Grand-Nephew is Canadian and a resident of Quebec.
The Donor received the land by inheritance upon the death of his father in 1952. Prior to his death, the Donor's father operated the land profitably for farming purposes.
The Donor has never farmed the land and the land has reforested itself.
Your Analysis:
Case 1:
Your supposition is that, since there is no relationship by marriage, adoption or parentage between the Donor and the donees, this gift would be presumed to be the equivalent of a sale for $1 and, therefore, would not generate a taxable capital gain.
You specified that the donees are not a corporation that can provide a charitable receipt for tax purposes.
You have assumed that Donor would suffer a capital loss equal to the fair market value ("FMV") of the property minus $1.
Furthermore, you stated that since the property is land and not a building, the capital loss that could be claimed with the Canada Revenue Agency would be 100% (and not 50%) of the FMV of the property less $1.
Case 2:
Your supposition is that the portion that exceeds 1/2 hectare of land surrounding the principal residence may be considered farmland eligible for the capital gains deduction of up to $275,000.
Our Comments:
As stated in paragraph 22 of Information Circular 70-6R5 dated May 17, 2002, it is the practice of the Canada Revenue Agency (the "CRA") not to issue written opinions on proposed transactions other than by way of advance rulings. Furthermore, when it comes to determining whether a completed transaction has received appropriate tax treatment, that determination is made first by our Tax Services Offices as a result of their review of all facts and documents, which is usually performed as part of an audit engagement. However, we can offer the following general comments that we hope may be helpful to you. These comments may, however, under certain circumstances, not apply to your particular situation.
Case 1:
Unfortunately, your supposition does not comply with the Canadian Income Tax Act.
We agree with you that the Donor and the XXXXXXXX Couple are not related to each other for the purposes of paragraph 251(2)(b), so the Donor and the XXXXXXXX Couple would not be deemed to not deal with each other at arm's length by paragraph 251(1)(a).
However, pursuant to paragraph 251(1)(c), whether unrelated persons are dealing at arm's length with each other at a particular time is a question of fact. Thus, unrelated persons may or may not be dealing at arm's length, depending on the facts and circumstances of a particular situation. In that regard, each transaction or series of transactions must be considered individually.
With respect to the particular situation, we are unable to determine whether the Donor and the XXXXXXXXXX Couple are dealing with each other at arm's length since such a determination would require an analysis of all the facts and circumstances surrounding a particular situation and your letter only briefly describes a hypothetical situation. However, we refer you to paragraphs 22 to 26 of Interpretation Bulletin IT-419R2, Meaning of Arm's Length, dated June 8, 2004, which set out the general guidelines followed by the CRA in determining whether or not persons are dealing with each other at arm's length at a particular time. Paragraph 23 of Interpretation Bulletin IT-419R states, inter alia, that the courts have applied the following criteria to determine whether a transaction was between persons dealing at arm's length:
- was there a common mind which directs the bargaining for both parties to a transaction;
- were the parties to a transaction acting in concert without separate interests; and
- was there “de facto” control.
Thus, based on the above, the CRA generally assumes that two parties are not dealing at arm's length in a gift situation. With respect to a $1 sale transaction, an analysis of all the facts and circumstances surrounding the Particular Situation may be necessary despite the appearance of third-party dealings.
Where parties do not deal at arm's length, the rules in subsection 69(1) apply. By virtue of paragraph 69(1)(b), where a taxpayer disposes of property to a person by way of an inter vivos gift, the donor is deemed to have received consideration equal to the FMV of the property at the time of the gift. A taxpayer who acquires property by way of gift is deemed to acquire it for an amount equal to its FMV, pursuant to paragraph 69(1)(c).
Furthermore, in a case where the consideration for the property is less than fair market value, paragraph 69(1)(b) deems the transferor's proceeds of disposition to be equal to fair market value. It should be noted that subsection 69(1 does not provide for an adjustment to the transferee's cost of acquisition.
In the first Particular Situation presented, the wooded land without buildings located on the shore of a lake is given without any consideration. It is therefore possible that subsection 69(1) would adjust the transferor's proceeds of disposition to deem them to be equal to the fair market value of the land, which could result in a capital gain (and not a capital loss equal to the FMV as you presented in your analysis). Furthermore, there is no provision in the Act that allows for the adjustment of the adjusted cost base of the land to the transferees to reflect the fair market value. The fact that the gift could be presumed to be the equivalent of a $1 sale does not affect the application of subsection 69(1).
With respect to your second question related to the present situation, the terms used in the deed of gift, i.e., "the gift of real property" or "the sale for $1 of real property", would not have the effect of automatically limiting the application of the rules in subsection 69(1).
Case 2:
First, as stated above, the CRA refers to the application of subsection 69(1) in any non-arm's length transfer. On the other hand, the CRA does not generally presume that there is a non-arm's length relationship between the parties in transactions involving uncles and nephews (grand-nephews). An uncle is not considered to be related to his nephews and nieces by blood or marriage. However, there may be a non-arm's length relationship (relationship in fact) by virtue of paragraph 251(1)(b).
As noted above, the question of whether two persons are not dealing with each other at arm's length requires an analysis of all the facts and circumstances surrounding a particular situation. However, it is our view that family relationships may be more likely to give rise to a non-arm's length relationship between particular persons.
Given that one of the provisions of subsection 69(1) applies and has the effect of adjusting the transferor's proceeds of disposition to deem them to be equal to the fair market value of the land, this could result in a significant capital gain.
Capital gain exemption for "qualified farm property
Where an individual acquired farm property before June 18, 1987, the property will qualify for the exemption under subsection 110.6(2) if it was used in the course of carrying on the business of farming by the individual, the individual's spouse, child, parent, personal trust or family farm corporation, either in the year in which the individual disposes of the property or for a period of not less than five years during which the property is owned by such a person.
The words "father" and "mother" are defined in subsection 252(2) and include a person whose child the taxpayer is within the meaning of subsection 252(1) or whose child the taxpayer had previously been within the meaning of paragraph 252(1)(b).
In the case you have submitted to us, since 1952, during the period of ownership by the son (the Donor), the property has not been used in a farming business carried on in Canada.
On the other hand, we are of the view that the Donor could benefit from the exemption for capital gains on qualified farm property when he disposes of the 6.5 acres of land surrounding the principal residence, i.e. when he gives it to his grand-nephew. Indeed, since the Donor acquired the property before June 18, 1987 and if we assume that his father used it in the course of carrying on a farming business for at least five years, the conditions set out in subparagraph 110.6(1)(a)(vii) of the definition would be satisfied. Consequently, the real property would be "qualified farm property" of the son (i.e., of the Donor).
Qualified farm property can qualify for a capital gains exemption of up to $500,000 for an individual who is resident in Canada throughout the year. The capital gains exemption available to the owner of the qualified farm property is for up to $250,000. The amount is fixed since February 27, 2000 and represents the maximum exemption amount on a taxable capital gain of $250,000 or a capital gain of $500,000 at 50%. (if it has never been utilized in the past).
Exemption for "principal residence”
The purpose of the principal residence exemption is to reduce or eliminate a gain on the disposition of a principal residence. Consequently, if the residence exemption completely eliminates the gain on the disposition of the residence, the taxable capital gain, which may be eligible for a capital gains deduction, would not include the gain on the residence. The term "principal residence" is defined in section 54 and the calculation of the principal residence exemption is set out in paragraph 40(2)(b).
We wish to inform you that a taxpayer may take advantage of the principal residence exemption when disposing of his residence despite the half-hectare rule under certain conditions. To do so, the taxpayer must establish that the excess of one half hectare is necessary for the use of his housing unit.
Paragraph (e) of the definition of "principal residence" in section 54 deems a taxpayer's principal residence to include the land subjacent to the housing unit and such portion of any immediately contiguous land as can reasonably be regarded as contributing to the use and enjoyment of the housing unit as a residence. However, where the total area of such land exceeds one-half hectare, the excess shall be deemed not to have contributed to the use and enjoyment of the housing unit as a residence unless the taxpayer establishes that it is necessary to such use.
Under Interpretation Bulletin IT-120R6, it is generally not necessary to demonstrate that one-half hectare or less of land, including the area on which the taxpayer's residence is situated, facilitates the use of the housing unit as a residence. Where the total area of land exceeds one-half hectare, restrictions on the minimum lot size or on the subdivision of land enacted by an Act or regulation of a municipality or province may be taken into account in determining the use of the excess land. Indeed, a taxpayer may be required by an Act or regulation respecting the size of a residential lot to acquire more than one-half hectare of land. However, paragraph 16 of Interpretation Bulletin IT-120R6 states that if the taxpayer could have made an application for severance of the excess land and it is likely that such a request would have been approved, the taxpayer would generally not be considered to have been required to acquire the excess land. The mere existence of such a municipal law or regulation on the date the taxpayer acquired the property does not necessarily mean that the taxpayer was required to acquire the excess land.
In general, the excess must be clearly necessary, not merely desirable, for the housing unit to perform its residential function properly. In all cases, however, the question of whether the excess is necessary for the use of the housing unit as a residence is a question of fact.
We hope that these comments are of assistance. Should you require additional information regarding the content of this document, please do not hesitate to contact us.
Finally, we regret the delay in responding to your request. Please accept our apologies.
Best regards,
Phil Jolie
Director
Business and Partnerships Division
Income Tax Rulings Directorate