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J. Gregory Tel. (613) 957-2115
November 5, 1986
Dear Sirs:
Re: Subsection 98(5) of the Income Tax Act
This is in reply to your letter of July 2 1986 requesting a written ruling on certain tax consequences of the dissolution of a partnership. We regret that we are unable to provide rulings except with respect to proposed transactions where the ruling request is in the form described in Information Circular 70-6R, dated December 18, 1978. Nevertheless, we will express an opinion on the tax consequences of the transaction described in your letter. An opinion is not a ruling and is therefore not binding on Revenue Canada, Taxation, as explained in paragraph 24 of the Information Circular.
In your letter you described the following situation. A partnership is formed between two arm's length parties, Partner "A" and Partner "B". Partner "A" contributes certain assets to the partnership while Partner "B" contributes cash in an amount equal to the fair market value of the assets. After a period of time the partners decide to dissolve the partnership. Partner "A" receives a cash payment from the partnership equal to 19% of the current fair market value of the partnership assets in satisfaction of his interest in the partnership. Partner "B" receives the remaining partnership property in satisfaction of his interest in the partnership, and continues to use this property to carry on the business formerly carried on by the partnership.
In our opinion, the tax consequences on dissolution of the partnership are as follows:
a) Partner "A" will be considered to have disposed of his interest in the partnership for proceeds of disposition equal to the cash received by him from the partnership. Assuming Partner "A" holds his partnership interest as capital property, he will realize a capital gain or loss equal to the amount by which the proceeds of disposition exceed or fall short of his adjusted cost base ("ACB") of the partnership interest. If the amounts required by subsection 53(2) of the Act to be deducted in computing his ACB exceed the aggregate of his original cost and the amounts required by subsection 53(1) to be added in computing his ACB, such excess will be deemed by paragraph 98(1)(c) of the Act to be a gain of Partner "A" from disposition of his partnership interest and will be added to the capital gain otherwise determined.
b) Assuming both Partner "A" and Partner "B" are residents of Canada, subsection 98(5) of the Act will govern the tax consequences to Partner "B". The proceeds of disposition of his partnership interest will be deemed by paragraph 98(5)(a) to equal the greater of the ACB of his partnership interest and the aggregate cost amounts to the partnership of the partnership property received by him. The cost to Partner "B" of each partnership property will be deemed by paragraph 98(5)(b) to be the cost amount of the property to the partnership plus the amount of any "bump" permitted by paragraphs 98(5)(c) or (d). If the ACB of his partnership interest exceeds the aggregate cost amounts of the partnership property received by him, Partner "B" way allocate the excess among the capital property received by him as a "bump" to the cost amount of each property. The "bump" may not result in a cost amount which exceeds the fair market value of a particular property, and in the case of depreciable property only one-half of the excess may be utilized in the "bump". Finally, where the partnership's capital cost of a depreciable property exceeds the cost of the property to Partner "B" (as determined under paragraph 98(5)(b)), Partner "B" will be deemed by paragraph 98(5)(e) to have a capital cost equal to the partnership's capital cost, and to have claimed the capital cost allowance previously claimed by the partnership. Accordingly, Partner "B" may realize recapture of the capital cost allowance previously claimed by the partnership on a future disposition of the depreciable property.
c) Since partner "A" receives only cash from the partnership, subsection 98(5) will also govern the tax consequences to the partnership on dissolution. The partnership will be deemed by paragraph 98(5)(f) to dispose of each partnership property distributed to Partner "'B" for proceeds equal to the cost amount to the partnership. In addition, the fiscal period of the partnership will be deemed by subsection 96(1) of the Act to have ended immediately before dissolution. Any profit or loss of the partnership for this "stub" period will be allocated to Partner "A" and Partner "B" under subsection 96(1), and will enter into the computation of the ACB's of their partnership interests.
We draw to your attention the proposed amendments to subsection 98(5) contained in the Notice of Ways and Means Motion to Amend the Income Tax Act and a related Act tabled in the House of Commons on October 31, 1986. If the proposed amendments are enacted into law, paragraph 98(5)(d) of the Act will be repealed with the result that no "bump" will be permitted to the cost amount of depreciable property. Generally speaking, the proposed repeal of paragraph 98(5)(d) will take effect for partnership dissolutions where the partnership property was acquired by the partnership, or the partnership interest was acquired by the partner, after December 4, 1985.
We also wish to caution you that our comments are based on the assumption that the contribution of cash and assets to the partnership followed by a dissolution of the partnership is not a disguised sale of the assets. If the partnership is merely an intermediary in the transfer of assets from partner "A" to Partner "B", the transaction may be more properly characterized as a purchase and sale for income tax purposes.
Yours truly,
for Director Reorganizations and Non-Resident Division Specialty Rulings Directorate Legislative and Intergovernmental Affairs Branch JG/ss