Anonymised, illustrative composite. A related-party equipment purchase, paid at fair market value, and a capital-cost ceiling that had nothing to do with what was actually paid.
At a glance
A father had run a precision machine shop as a sole proprietor for over twenty years. His son, who had worked in the shop since his teens, wanted to take it over and grow it, and the family agreed the cleanest way to do that was for the son to incorporate a new company and have that company buy the equipment outright — five CNC machines, a fabrication line and assorted tooling — rather than the son simply inheriting or being gifted an interest in an unincorporated business.
An independent equipment appraiser valued the machinery at $420,000. The company paid that amount in full, financed partly through a term loan and partly through the father taking back a small vendor note. Nobody in the transaction thought there was anything to plan around: a fair price, paid in cash and debt, for equipment the buyer genuinely needed.
The company's accountant, setting up the fixed-asset schedule for the first year-end, could not simply put $420,000 into the relevant capital cost allowance class. Father and son do not deal at arm's length, and the equipment was depreciable property that was capital property of the father immediately before the sale. That combination pulls the transaction into a special basis rule that overrides the price the parties actually agreed and paid.
The rule does not touch what the father reports. His own disposition is computed on the real $420,000 he received. It only limits what the buying company gets to add to its own capital cost — and the two numbers are not the same.
Price paid: $420,000, in cash and a vendor note, at an independently appraised fair market value.
Father's original capital cost of the equipment: $180,000. His economic gain on the sale: $240,000.
The company's capital cost for depreciation purposes was capped at $300,000 — $180,000 (the father's cost) plus half of $240,000 (his gain). The other $120,000 of the price paid is basis that belongs to no one: not depreciable by the company, and not reflected as a cost anywhere on the father's return either.
ITA s.13(7) is titled, in the Act's own marginal note, simply “Rules applicable” — it is a chapeau covering several distinct basis-adjustment paragraphs, and paragraph (e) is the one that governs a non-arm's-length transfer of depreciable property. Where the transferor is an individual resident in Canada, s.13(7)(e)(i) provides that the capital cost of the property to the buyer “shall be deemed to be the amount that is equal to the total of (A) the cost or capital cost… of the property to the transferor immediately before the particular time, and (B) 1/2 of the amount, if any, by which… the transferor's proceeds of disposition of the property exceed… the cost or capital cost… to the transferor immediately before the particular time”.
Applied here: the father's capital cost was $180,000, his proceeds were $420,000, and half of the $240,000 difference is $120,000. $180,000 + $120,000 = $300,000. That is the ceiling on the company's capital cost, full stop — not a starting point for negotiation, and not affected by an independent appraisal supporting the higher price.
Read the unit. This paragraph governs the buyer's capital cost. It does not reduce, defer or otherwise touch the transferor's proceeds of disposition, which are computed under the ordinary recapture and capital-gain rules in s.13(1) and Subdivision C using the real $420,000. The father is taxed as though he received the full price; the son's company is depreciating as though it paid $120,000 less. Both are correct, simultaneously, because the two computations are governed by different provisions with different purposes.
The clause the file turns on, s.13(7)(e)(i), applies specifically where the transferor is an individual resident in Canada (or a partnership with such a member). A separate clause, (ii), produces a similar half-gain add-back where the transferor is not an individual — a corporation, for instance — and clause (iii) handles the reverse case, where the transferor's own cost exceeded the buyer's price. None of the three clauses ever simply lets the buyer's actual cash cost stand as its capital cost once the parties are related.
There was no way to unwind it after the fact and no election available to fix it — s.13(7)(e) is not elective. The accountant booked $300,000 into the relevant CCA class, and $120,000 sat outside the depreciation system permanently. The company's annual capital cost allowance claim, and therefore its taxable income in every year it owns the equipment, is calculated as though it paid $120,000 less than it actually did.
The family's later planning adjusted for it rather than fighting it: knowing the gap was permanent, they priced the vendor note's interest rate and the company's early-year distributions to the father around the real after-tax cash flow, rather than around the CCA schedule they had originally assumed.
The alternative some advisors reach for on a related-party sale — simply pricing the equipment at the father's own cost or capital cost, so there is no gap to create — would have understated the transaction and left the father with no economic recovery of the equipment's real value at all, since ITA s.69(1) would then have deemed him to receive fair market value proceeds regardless of what the invoice said. Paying a genuine appraised price was the right call. The $120,000 gap is simply what s.13(7)(e) makes structurally unavoidable once the transferor is an individual and the parties are related — it is not a planning failure, it is the rule working exactly as written.
The tell here was not a red flag in diligence; it was a false sense of safety in a clean appraisal. Everyone assumed that because an independent third party had set the price, the tax basis would simply follow the price, the way it does in an arm's-length deal. A fair, arm's-length-equivalent valuation answers the commercial question — what should the buyer pay — and has no bearing on the separate statutory question of what the buyer gets to depreciate once the seller is related.
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