Principal Issues: Is a capital gains reserve under subparagraph 40(1)(a)(iii) claimed at the partner or partnership level?
Position: Partnership level.
Reasons: Based on wording of the provisions.
XXXXXXXXXX 2015-059547
Chrys Tzortzis, CPA, CA
November 16, 2015
Dear XXXXXXXXXX:
Re: Partnerships and the capital gains reserve
This is in response to your email sent June 26, 2015 in which you requested a technical interpretation involving partnerships and the claiming of a capital gains reserve under subparagraph 40(1)(a)(iii) of the Income Tax Act (the “Act”). We also acknowledge our telephone conversation of October 27, 2015 (Tzortzis/XXXXXXXXXX).
In your email, you describe a hypothetical situation where a general partnership (ABC Partnership) has three partners (Partner A, B and C) each of whom is entitled to a one-third share of any income, loss, capital gain or capital loss of the partnership. Additionally, the following scenario is described:
- In Year 1, the ABC Partnership sells a capital property which gives rise to a capital gain of $750,000 before claiming a capital gains reserve. As the proceeds of disposition are payable after the end of the year, the ABC Partnership claims a capital gains reserve of $600,000, resulting in a capital gain for the year of $150,000 with each partner’s share being $50,000.
- In Year 2, the ABC Partnership claims a reserve of $450,000, resulting in a capital gain for the year of $150,000 (i.e. the prior year’s reserve of $600,000 minus the current year’s reserve of $450,000) with each partner’s share being $50,000. At the end of Year 2, Partner C sells his interest in the ABC Partnership to Partner A and ceases to be a member of the partnership. As of Year 3, Partner A becomes entitled to a two-thirds share of any income, loss, capital gain or capital loss of the partnership. Partner B retains a one-third share.
In Year 3, the proceeds of disposition are paid to the ABC Partnership and, therefore, no further reserve is available. As such, the ABC Partnership has a capital gain for the year of $450,000 (i.e. the prior year’s reserve) with Partner A’s share being $300,000 and Partner B’s share being $150,000.
You seek confirmation that the capital gains reserve under subparagraph 40(1)(a)(iii) is claimed at the partnership level. Additionally, you ask whether the adjusted cost base (ACB) of the partner’s interest in the partnership is increased by the partner’s share of the capital gain (net of the reserve).
This technical interpretation provides general comments about the provisions of the Act and related legislation (where referenced). It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination. The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R6, Advance Income Tax Rulings and Technical Interpretations.
Our Comments
As part of the general rules under subsection 96(1), a partner’s income for a taxation year is computed as if the partnership were a separate person resident in Canada, the taxation year of the partnership were its fiscal period, each partnership activity (including the ownership of property) were carried on by the partnership as a separate person and a computation were made of the amount of each taxable capital gain and allowable capital loss of the partnership from the disposition of property for each taxation year of the partnership. As a result, the gain computation under subsection 40(1) is made at the partnership level. As a claim under subparagraph 40(1)(a)(iii) for a capital gains reserve is part of the computation of the gain, the capital gains reserve is also computed at the partnership level. Please note that a capital gains reserve under subparagraph 40(1)(a)(iii) is only available where any of the proceeds of disposition are payable after the end of the year and the available reserve is computed with reference to such proceeds that are payable after the year end (subject to a limiting rule). In the case of a partnership, such proceeds of disposition would be payable to the partnership. Based on the foregoing, the amount of the capital gains reserve under subparagraph 40(1)(a)(iii) would be determined at the partnership level and not by each partner individually.
In computing the ACB of a partnership interest at a particular time, subparagraph 53(1)(e)(i) provides that the ACB is increased by the partner's share of the income of the partnership for each fiscal period ending before that time, computed as if the Act were read without reference to, amongst other things, the fraction set out in paragraph 38(a) that determines the taxable portion (i.e. 50%) of the capital gain. As such, the partner’s share of the full amount of the partnership’s capital gain (as opposed to only the taxable capital gain) is added to the ACB of the partner’s interest in the partnership. Where a partnership claims a capital gains reserve, the partner’s share of the resulting capital gain (net of the reserve) would be added to the ACB of the partner’s interest in the partnership. To illustrate, in the scenario described above, the ACB of Partner A’s interest in the ABC Partnership would be increased by $50,000 for Year 1, $50,000 for Year 2 and $300,000 for Year 3 for an overall total of $400,000, representing Partner A’s share of the ABC Partnership’s total capital gain of $750,000 from the disposition of the property.
In your correspondence, you also raised concerns with the manner of reporting of the capital gains reserve claimed by partnerships and the information contained in certain Guides and related forms. In that regard, we note that your email has been forwarded to the Assessment, Benefit and Service Branch for further consideration.
We trust the above comments will be of assistance.
Yours truly,
G. Moore for Director
Partnerships & Corporate Financing Section
International Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch