What’s Your Tax Issue? 69 Problems

The Tax Issue:

As we speak, I’m studying for my corporate tax midterm and my teacher has told me something that doesn’t make much sense.

According to section 69, if a transaction with a non arms length person occurs at below fair market value (FMV), the adjusted cost base (ACB) to the purchaser will be the actual amount paid.

OK, fine.

Then, under subparagraph 13 (7)(e)(iii), the undepreciated capital cost (UCC) to the purchaser will be the FMV and the cost base will be the same ACB of the vendor, the difference between the two being deemed capital cost allowance (CCA)…

Say what?

Here’s an example of a building:

Capital cost to vendor: $325
FMV: $200
Actual sale price: $180.

Under section 69, the ACB of the purchaser will be $180; OK fine.

Now, under section 13 (7)(e)(iii), the UCC will be $200 with a capital cost of $325, the $125 being deemed CCA…

Don’t these provisions contradict themselves?

The Answer:

Since you are studying for your midterm, I’ll try to answer quickly.

Section 69 has been discussed in a previous post. It makes only a one-way adjustment to the proceeds to the seller in a non-arm’s length sale below FMV. It remains silent on the consequences to the purchaser. In a normal case of non-depreciable property, therefore, the cost to the purchaser remains the price paid as you have stated.

However, special rules for the purchaser kick in when he has purchased depreciable property. Subparagraph 13(7)(e)(iii) is there to ensure that a non-arm’s length purchaser does not turn a future recapture of depreciation (fully taxable) into a capital gain (half taxable).

First of all, if you read the preamble in paragraph 13(7)(e) it applies “notwithstanding any other provision of the Act”, so it overrides section 69.

Next, it doesn’t change the cost of the property to the purchaser, it simply designates it as UCC, and tacks the seller’s original capital cost on top so that a future sale triggers a recapture of depreciation to the extent that the original vendor would have a recapture, thus preserving the original tax treatment of capital cost.

In your example, the UCC will be the actual cost to the purchaser, being $180. This is true under both section 69 or under 13(7(e)(iii). The effect of 13(7)(e)(iii) is to deem the capital cost to be $325, so if the property is eventually sold for, say $400, there will be a recapture of $145 (325-180), which is fully taxable and a capital gain of only $75 (400-325), which is 50% taxable.

Good luck on your mid-term!!

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