Income Tax Interpretation Bulletin

Disposition of and Transactions Involving Eligible Capital

NO: IT-123R4

DATE: May 30, 1985

SUBJECT: INCOME TAX ACT
Disposition of and Transactions Involving Eligible Capital Property

REFERENCE:
Section 14 (also section 24, paragraphs 20(1)(b), 20(1)(p). 54(d) and 89(1)(b) and section 21 of the Income Tax Application Rules, 1971 (ITAR))

This bulletin cancels and replaces Interpretation Bulletin IT-123R3 dated December 4, 1978. current revisions are designated by vertical lines.

1. This bulletin discusses transactions involving eligible capital property generally and in particular the provisions of the Act which apply to the inclusion in income under subsection 14(1) of "negative cumulative eligible capital" (see 2 below) and the computation of an "eligible capital amount" pursuant to subparagraph 14(5)(a)(iv).

2. Subsection 14(1) provides that where at the end of a taxation year the calculation of the "cumulative eligible capital" pursuant to the rules in paragraph 14(5)(a) (see 3 below) results in a negative balance, that amount (negative cumulative eligible capital) is to be included in the taxpayer's income for that year.

3. The cumulative eligible capital of a taxpayer at any given time after March 31, 1977 is made up of

less the aggregate of the following amounts,

The effect of the definition of eligible capital property in paragraph 54(d) is to include all property the cost of which was or, had it been acquired after 1971, would be an eligible capital expenditure under the provisions of paragraph 14(5)(b) (see IT-143R2).

4. Subject to the exception discussed in 6 below, the "amount . . . payable" referred to in the definition of eligible capital amount set out in subparagraph 14(5)(a)(iv) is considered to be synonymous with "due" meaning a present obligation to pay. Thus, only one half of the amounts which became due and payable in a particular year under the terms of a transaction (including amounts actually paid in the year) are included in the calculation of cumulative eligible capital pursuant to subparagraph 14(5)(a)(iv). Where for instance the goodwill of a business is sold under an agreement calling for a down payment followed by 3 annual instalments, only the down payment is considered an "amount . . . payable" pursuant to subparagraph 14(5)(a)(iv), one half of which is included in the calculation of cumulative eligible capital in the year of the sale. Each of the 3 annual instalments also becomes an "amount . . . payable" for purposes of subparagraph 14(5)(a)(iv) in the year it becomes due or is paid (if that is sooner).

5. Where in a particular taxation year a taxpayer has reported a disposition of an eligible capital property (other than a deemed disposition) or any other event producing an eligible capital amount on the basis previously accepted (the former basis) in which the "amount . . . . payable" was always considered to be the total proceeds of disposition, and subsequently requests reassessment on the basis now adopted (current basis), the policy set out in Information Circular 75-7R3 applies and the request for reassessment will be considered if the time for filing a notice of objection for that year has not expired.

6. Where an amount is, by any provision of the Act, deemed to be a taxpayer's proceeds of disposition of any eligible capital property, subsection 14(2) deems the whole amount to have become payable at the time of the deemed disposition and therefore one half of the amount is included in the cumulative eligible capital calculation in the year of disposition. This includes, by way of example, the deemed proceeds of disposition under sections 68 (part consideration for disposition of property), 69 (inadequate consideration), 85 (transfer of property to a corporation by a shareholder), 88 (winding-up), and 97 (contribution of property to a partnership).

7. Subsection 14(6) provides for an election where a taxpayer disposes of an eligible capital property in a particular taxation year and acquires another eligible capital property as a replacement in the year following the year of disposition. Where an amount becomes payable to a taxpayer in the particular taxation year in respect of the disposition, the taxpayer may elect to exclude part or all of such amount (not exceeding the amount payable less related outlays or expenses) as is used to acquire a replacement property in the later year in calculating cumulative eligible capital for that year. One half of the amount so excluded is added to the amount otherwise determined under subparagraph 14(5)(a)(iv) for the following year. The election is to be filed with the taxpayer's return for the year in which the replacement property is acquired (see IT-259R).

8. In order to qualify as a replacement property for purposes of subsection 14(6), a property must have been acquired for the same or a similar use as the use to which the former property had been put and for the purpose of gaining or producing income from the same or a similar business in which the former property had been used. Where a taxpayer was not resident in Canada at the time that a particular property was acquired, that property, in order to qualify as a replacement property, must not only meet the foregoing requirements but must also have been acquired for use in a business carried on by the taxpayer in Canada.

9. It should be noted that the "eligible capital amount", "eligible capital expenditures", and "cumulative eligible capital" are all in respect of a business; thus if a taxpayer carries on more than one business (see IT-206R), these items must be accounted for separately for each business.

10. Schedule A illustrates the composition of the cumulative eligible capital calculation as affected by the various provisions of section 14.

Transitional Provisions

11. Subsection 21(1) of the ITAR reduces in certain circumstances the "amount . . . payable" that would otherwise be determined by section 14, for dispositions occurring in the calendar years 1972 to 1983 inclusive. Subsection 21(1) of the ITAR only applies where the amount payable to the taxpayer on the disposition of the eligible capital property is "in respect of a business carried on throughout the period commencing January 1, 1972 and ending immediately after the transaction occurred". The words "ending immediately after the transaction occurred" refer to the period covered and do not imply that the business must cease after the sale. Where the above condition is met, subsection 21(1) of the ITAR applies, regardless of whether the eligible capital property in question was acquired by the vendor before or after December 31, 1971.

12. Where subsection 21(1) of the ITAR is applicable, the "amount . . . payable" for the purpose of section 14 is deemed to be a percentage (the relevant percentage) of the actual amount payable. The relevant percentage is 40 percent in the calendar year 1972 and increases by 5 percentage points for each full calendar year thereafter up to and including the full calendar year last ending before the transaction occurs, or until it reaches 100 percent for 1984 and subsequent years. The Department's view of "amount . . . payable" as set out in 4 above also extends to amounts subject to section 21 of the ITAR. However, for purposes of calculating the "amount . . . payable" in the case of a transaction carried out pursuant to an agreement calling for periodic instalments, the relevant percentage of the amount payable is determined as of the date of the "transaction" and remains constant over the period covered by the agreement.

13. On the disposition or expiration of a government right (as defined in paragraph 21(3)(a) of the ITAR), the deemed amount payable as calculated in 12 above may not exceed the excess of the actual amount over the greater of:

Where the terms of the transaction call for periodic payments, it is the Department's view that the cost and fair market value of the government right applicable to each instalment that becomes payable is that fraction of the total cost or fair market value that the amount of the particular instalment is of the total proceeds.

14. Where a person who owned a particular government right referred to in subsection 21(1) of the ITAR at the end of 1971, subsequently disposes of it to a transferee with whom that person does not deal at arm's length, subsection 21(2.1) of the ITAR provides that the rules described in 12 above will be available also to the transferee if the transferee in turn disposes of, or allows the expiry of, that particular government right or any other government right acquired for the purpose of effecting the continuation of rights that are substantially similar to the rights previously acquired under that particular government right.

15. For the purposes of section 21 of the ITAR, an amalgamation (within the meaning of section 87 of the Act) of two or more taxable Canadian corporations is deemed to be a transaction between persons not dealing at arm's length.

16. Pursuant to subsection 21(2) of the ITAR, the amount deemed to have become payable to the vendor (see 12 above) in a non-arm's length transfer of eligible capital property becomes the amount of the eligible capital expenditure of the purchaser, thus the purchase price in excess of that amount is not eligible for inclusion in the cumulative eligible capital of the non-arm's length purchaser.

Capital Dividend Account

17. A corporation may include a portion of the proceeds on the disposition of eligible capital property in its capital dividend account by virtue of paragraph 89(1)(b). The portion so included is equal to the amount by which

exceeds

18. Schedule B illustrates the application of the provisions mentioned in 12 and 17 above in the transitional years 1972 to 1983.

Bad Debts on Sale of Eligible Capital Property

19. Where all or part of a debt that has arisen on the sale of eligible capital property has become a bad debt in a taxation year, a deduction in respect of that debt may be made in that year pursuant to paragraph 20(1)(p) to the extent that an amount in respect of the debt has been included in the income of the taxpayer by subsection 14(1). No deduction is allowed in respect of the amount of the debt credited to the cumulative eligible capital of the business. For taxation years ending after March 31, 1977, a negative balance in the "cumulative eligible capital" at the end of a taxation year is to be included in the taxpayer's income for the year (see 2 above) and it is a question of fact to what extent the amount included in income represents a debt for purposes of paragraph 20(1)(p).

20. To the extent that the bad debt is not deductible under paragraph 20(1)(p), it may be deductible as a capital loss arising from the application of subsection 50(1). However, subparagraph 40(2)(g)(ii) would deny any such deduction unless the debt was interest-bearing.

Amount Not Due until Later Year

21. Where a disposition of an eligible capital property was included in income under the former basis (see 5 above) and some part of the sale price is due in a later year, a reserve under paragraph 20(1)(n) is not permitted as the sale of an eligible capital property is not viewed by the Department as a sale of property "in the course of the business".

Averaging

22. Where amounts included in the income of individuals after 1981 by virtue of subsection 14(1) contribute to a significant increase in income levels over earlier years, a forward averaging election (section 120.1) may be beneficial. Prior to 1982 the general averaging provisions of section 118 may have applied in such situations. The deduction in respect of payments made by an individual for the purchase of an income averaging annuity contract has been phased out and, subject to some transitional rules, is no longer available after November 12, 1981.

Terminal Allowance

23. A taxpayer who has ceased to carry on a business is entitled to claim a deduction for the balance of the cumulative eligible capital in respect of that business in accordance with subsection 24(1). Subparagraph 39(1)(b)(ii) precludes claims for capital losses on the disposition of eligible capital property whether or not the business has ceased. For a detailed discussion of this topic, refer to IT-313R.

Eligible Capital Property of a Deceased Taxpayer

24. The status of goodwill and other eligible capital property on the death of a taxpayer and the rules applicable to circumstances where eligible capital property of a deceased taxpayer is acquired by another person are considered in IT-344.

Schedule A

Cumulative Eligible Capital
Example of Calculation (applicable any time after March 31, 1977)

Assume the taxpayer commenced business on April 1, 1975, and has a March 31 year end. As a result, the special transitional rules are not applicable.

NOTE 1: Taxpayer sold ECP purchased in 1980 for $120,000 payable as follows:

Sale completed and down payment received on	January 31, 1981	$60,000
Annual instalment	January 31, 1982	$60,000
		$120,000

Schedule B

DISPOSITION OF PROCEEDS ON THE SALE OF AN ELIGIBLE CAPITAL PROPERTY IN TRANSITIONAL YEARS 1972-1983

Assumptions:
(1) The amount payable to the taxpayer on the cash sale of the eligible
capital property is $100,000.
(2) The amount had become payable "in respect of a business carried on by him throughout the period commencing January 1, 1972 and ending immediately after the transaction" as provided by section 21 of the ITAR.