Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.
Principal Issues: Is the transfer of land by a land developer to a golf club builder for nil proceeds a barter transaction?
Position: While we agree with the view that this transaction otherwise meets the definition of a "barter" transaction", it is our view that a developer would be not be required to recognize a gain on the disposal provided that the developer consistently reallocates the cost of the transferred land to the remaining land inventory (to be expensed as the relevant lots are subsequently sold and income is recognized).
Reasons: Previous positions taken.
September 9, 2011
XXXXXXXXXX Tax Services Office Income Tax Rulings Directorate
Audit Division Andrea Boyle, CGA
Attention : XXXXXXXXXX
2011-039811Disposal of Land for No Proceeds
I am replying to your email dated March 7, 2011 in which you asked for our views on the correct treatment for income tax purposes of a disposal of land for no proceeds in the circumstances described below. We apologise for the delay in our response.
THE FACTS
You have provided us with copies of the Agreement which details the terms of the transfer, your audit proposal letter and a response letter from the taxpayer's representative, from which the following facts were ascertained:
1. On XXXXXXXXXX , 2005 a land developer, XXXXXXXXXX ("the Land Developer") entered into an agreement dated with an arm's length party, XXXXXXXXXX ("the Golf Club Builder"), whereby the Land Developer agreed to transfer XXXXXXXXXX hectares of land for no proceeds to the Golf Club Builder.
2. On XXXXXXXXXX , 2005 title to the land was transferred.
3. The fair market value of the property at the time of transfer was $XXXXXXXXXX ; the cost of the land was $XXXXXXXXXX .
4. The transferred land was adjacent to land which the Land Developer was developing and the land was transferred as an incentive or inducement for the Golf Club Builder to build an 18-hole golf course.
5. The agreement included a restrictive covenant stating that the transferred land could only be used as a golf course.
6. Also, the Land Developer obtained the following privileges under the terms of the agreement:
a. The Land Developer maintained the right to have input on the final design of the golf course and design input on the clubhouse.
b. The Land Developer had the opportunity to bid on the construction of the clubhouse and any other building of the golf club as well as assisting as needed, in negotiations with the City, the Province and XXXXXXXXXX to allow the project to move forward.
c. The Golf Club Builder agreed to work with the Land Developer to provide incentives in the form of discounts on golf club dues and advance tee-time reservations for the residents that purchased a lot or home.
7. Under the agreement, the Land Developer agreed to provide funding in the amount of $XXXXXXXXXX towards the golf course development which consisted of the land valued at $XXXXXXXXXX and cash of $XXXXXXXXXX .
8. The cash component of $XXXXXXXXXX was to be paid at a minimum of $XXXXXXXXXX per year for 2005, 2006, 2007, 2008, and 2009: in 2005, $XXXXXXXXXX was provided upon execution of the agreement; $XXXXXXXXXX upon confirmation that additional financing had been obtained; and an additional $XXXXXXXXXX was paid on or before XXXXXXXXXX , 2005; for years 2006 to 2009 payments were to be paid on the basis of $XXXXXXXXXX per lot sold with a minimum payment of $XXXXXXXXXX per year.
9. According to the taxpayer's representative from XXXXXXXXXX , these incentive amounts were paid in 2005, 2006, and 2007 and have been allowed as a deduction for those years.
10. The primary business of the Land Developer was the development and sale of residential building lots. The development of the golf course would improve the saleability and value of lots owned by the Land Developer and would therefore be expected to increase future revenue or profit.
ISSUE
The issue is the determination of the appropriate treatment for income tax purposes of the transfer of land for no proceeds between the two arm's length parties.
THE TAXPAYER'S POSITION
The taxpayer has expensed the cost of the transferred land ($XXXXXXXXXX ) for both accounting and tax purposes in 2005.
The taxpayer's position is that no valuable consideration, other than the agreement to develop a golf course, was received by the Land Developer for the transfer of the property and that they believe that they have therefore adopted an appropriate accounting treatment to record the land transfer for no proceeds.
The taxpayer's representative also argues that if the cash incentives paid to the Golf Club Designer under the agreement have been allowed as a deduction, the cost of the transferred land should similarly be allowed as a deduction.
THE AUDITOR'S POSITION
Your view is that the transfer of the land for no proceeds is a "barter" transaction as described in CRA Interpretation Bulletin IT-490 Barter Transactions. As indicated in that document, in a barter transaction the price that the taxpayer would normally have sold the property for must be brought into income. Therefore, your position is that the profit on the disposal of the land should be recognized by including the fair market value of the land ($XXXXXXXXXX ) in income in the year of the transfer (2005).
Barter Transactions
Where parties contract in the normal course of business and property is transferred between the arm's length parties for consideration that is considerably less than fair market value, there is a general inference that the transaction is in the nature of a barter transaction. CRA Interpretation Bulletin IT-490 Barter Transactions expresses the view that, "(i)n the case of goods bartered by a taxpayer for either goods or services, the value of those goods must... be brought into the taxpayer's income if they are business-related." The courts have taken the view that, for the purpose of computing income to the taxpayer, the value of what is received has to be taken into consideration even though it is neither realized nor realizable.
Where a taxpayer has made an arm's length business decision to transfer an asset, the taxpayer is presumably transferring that asset with the understanding that he is receiving something of value ("consideration") in return. Under these circumstances, it is reasonable to conclude, in the absence of evidence to the contrary, that the taxpayer is receiving consideration which is worth the fair market value of the asset transferred.
Generally speaking, when beneficial ownership of a property is transferred from a taxpayer to another party in exchange for consideration, the profit on a sale should be recognized at the time of the disposition.
However we have previously considered whether the transfer of land by a developer to a municipality in order that the developer may obtain a development permit must be recognized as a barter transaction. In that instance we expressed the view that, where a taxpayer consistently reallocates any costs incurred in respect of the land transferred to land which is retained by the developer, and expenses those costs as the developer sells the remaining parcels of real estate, we would generally not challenge this tax treatment.
We are of the same view in the current fact situation: in our view, if the Land Developer reallocates the cost of the transferred land to the remaining land in inventory and expenses the costs as the lots are sold, we would not treat this transaction as a barter transaction.
Capitalization in Inventory vs. Expensing the Cost of the Transferred Land
In Canderel Ltd. v The Queen 98 DTC 6100, the Supreme Court of Canada considered whether tenant inducement payments were deductible from income entirely in the year in which they were incurred or whether the Minister of National Revenue was entitled to insist that they be amortized over the terms of the leases to which they related. More broadly, the Court examined the fundamental principles of profit computation under the Income Tax Act.
The court opined that, in ascertaining profit, the taxpayer is free to adopt any method which is not inconsistent with the provisions of the Income Tax Act, established case law principles, and well-accepted business principles. The court indicated that, on reassessment, once the taxpayer has shown that he has provided an accurate picture of income for the year which is consistent with the Income Tax Act, case law, and well-accepted business principles, the onus shifts to the Minister to show either that the figure provided does not represent an accurate picture, or that another method of computation would provide a more accurate picture.
The court's view in the Canderel case was that the tenant inducement payments were not principally referable to any particular items of income. Since the payments qualified as running expenses, to which the matching principle does not apply, the payments could be deducted entirely in the year in which they were incurred and therefore did not need to be amortized over the terms of the leases which they induced.
In our view the current situation differs from the Canderel case because the cost of the transferred land is not a "running cost" to which the matching principle does not apply. Additionally, we feel that reallocating the cost of the transferred land to the remaining land in inventory and expensing the costs as the lots are sold is a method of computation which provides a more accurate picture of profit.
This view is supported by The Queen v Metropolitan Properties Co Ltd 85 DTC 5128 (FCTD). In this case, the court considered whether costs which a land developer incurred as part of development agreements which had been entered into with a municipality could be expensed for income tax purposes. In this case the title to the "streets, lanes, avenue, roads, parks, and other reserves of real property" vested to the city without cost.
The court found that the cost of the land which vested to the city should have been capitalized and taken into account in determining the costs of defendant's inventory on hand at the end of its taxation year rather than being deducted from income as an expense item in that year. The court concluded that allocating the cost to the inventory of remaining land, and expensing these amounts when the houses or the lots were sold would present a truer picture of defendant's net income in any given year and was in accordance with GAAP principles (and that GAAP principles should only be departed from if something in the Income Tax Act specifically requires or authorizes the departure).
This same principle is reflected in paragraph 13 of CRA Interpretation Bulletin IT-153R3 Land Developers - Subdivision on development costs and carrying charges on land which reads in part:
... Where a portion of the property in the subdivision area is transferred from the land developer to a municipality or other government body under the requirements of the subdivision authorization, the cost of such land, including the applicable portion of the above-mentioned installation costs, should be reallocated on a reasonable basis to the remaining parcels of land for the purposes of subsection 10(1).
In our view, it appears that there is little support for the taxpayer to simply expense the cost of the transferred land in the year of the transfer. For GAAP purposes, this treatment does not result in a matching of income with expenses and there is no provision of the Income Tax Act which otherwise suggests that the amount should be deductible in the year.
CONCLUSION
We disagree with the treatment adopted by the Land Developer in which the developer chose to expense the cost of the transferred land for accounting and income tax purposes. We feel that the better treatment would be for the Land Developer to reallocate the cost of the transferred land to the remaining land inventory. The amount would then be expensed as the relevant lots are subsequently sold.
Finally, while you did not ask us to address this issue, as per "fact" number nine (as listed above), under the agreement, a cash component of $XXXXXXXXXX was to be paid at a minimum of $XXXXXXXXXX per year for 2005, 2006, 2007, 2008, and 2009. According to the taxpayer's accountant, these incentive amounts were paid in 2005, 2006, and 2007 and have been expensed for income tax purposes in the years that they were paid. In our view, it is questionable whether simply expensing these amounts is the appropriate tax treatment for these payments; these amounts should likely also be added to the cost of land inventory and expensed as lots are subsequently sold.
For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the CRA's electronic library. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, they can be provided with the electronic library version, or they may request a severed copy using the Privacy Act criteria, which does not remove client identity. You should make requests for this latter version to Mrs. Céline Charbonneau at (613) 957-2137. A copy will be sent to you for delivery to the client.
We trust that these comments will be of assistance.
Yours truly,
Guy Goulet CA, M.Fisc.
Manager
for Director
Ontario Corporate Tax Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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