Presentation Material - McCarthy Tétrault

Current Issues Forum:
Pipeline Planning; Subsection 164(6) Circularity Issue; Eligible Dividend Designations
INTRODUCTION 2
Chris Falk
Stefanie Morand 1
As a companion piece to the paper on current issues presented at the 2012 Ontario Tax
Conference by Gabriel Baron, this paper addresses a number of legislative and administrative
developments in the income tax area that are of current interest to owner-managers and their
tax advisors but are not addressed in detail in other sessions of the conference. The topics
addressed in this paper are:
• pipeline planning;
• subsection 164(6) capital loss carry-back planning and the application of subsections
40(3.6) and (3.61); and
• eligible dividend designations following Budget 2012.
In respect of the topics addressed in this paper, the authors note as follows:
Pipeline Planning
“Pipeline planning”, described below, has for many years been one of the basic tools employed
by tax practitioners to relieve against double taxation where shares of a private corporation have
been deemed by the provisions of the Income Tax Act (Canada) (the “Act”) 3 to be disposed of
for proceeds of disposition equal to their fair market value (“FMV”) upon the death of a taxpayer.
Such planning has generally been considered by planners to be non-controversial and
consistent with the overall scheme of the Act. However, over the past few years, the Canada
Revenue Agency (the “CRA”) has taken the position that very standard pipeline planning may
give rise to a deemed dividend to the estate of the deceased taxpayer pursuant to the
provisions of subsection 84(2). In the authors’ view, the CRA’s position is likely wrong as a
matter of law.
In a paper presented at the 2011 British Columbia Tax Conference, 4 the authors commented
generally on the manner and the circumstances in which pipeline planning has typically been
employed, outlined recent comments by the CRA in respect of pipeline planning and
1
2
3
4
The authors note that the views expressed in this paper are their own and do not necessarily represent the views
of McCarthy Tétrault LLP.
This paper assumes that an estate is a trust for purposes of the Act, notwithstanding the recent decision in
Lipson v. The Queen, 2012 DTC 1064 (TCC).
Except as otherwise noted, all section references are to the provisions of the Act and all monetary references are
to Canadian dollars.
Chris Falk and Stefanie Morand, "Current Issues Forum: Pipeline Planning; Section 159 Clearance Certificates;
Charitable Sector; and Non-Profit Organizations," 2011 British Columbia Tax Conference, (Vancouver:
Canadian Tax Foundation, 2011), 1B:1-61.
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Chris Falk
Stefanie Morand
McCarthy Tétrault LLP
commented on the CRA’s position in light of the provisions and the scheme of the Act. This
paper updates that discussion to take into account subsequent CRA statements, as well as the
decisions of the Tax Court of Canada in MacDonald 5 and McClarty Family Trust 6 released
earlier this year.
Subsection 164(6) Capital Loss Planning
Subsection 164(6) capital loss carry-back planning is another technique employed by tax
practitioners to relieve against the double taxation that can arise under the Act as a result of the
deemed disposition on death.
In concept, the planning involves the creation of a capital loss in the estate’s first taxation year
which is carried back to offset the capital gain on death. The planning typically involves the
winding-up of the corporation owned by the estate and/or a redemption of all or some portion of
the estate’s shares therein. 7
Subsection 164(6) is an exceptional provision in that it allows, in some circumstances, the
capital loss sustained by the estate on the wind-up or redemption to be carried back to the
deceased’s terminal return and applied against the capital gain that arose as a consequence of
the deemed disposition on death. 8 The provision requires that the loss be sustained in the
estate’s first taxation year, and is subject to numerous stop-loss rules.
At the 2012 Society of Trust and Estate Practitioners (“STEP”) Round Table, the CRA was
asked to comment on the interaction of subsections 40(3.6), 40(3.61) and 164(6) and, in so
doing, expressed a view that could render subsection 164(6) capital loss carry-back planning
unavailable for many estates.
This paper comments generally on the issue raised at the STEP Round Table and the CRA’s
response.
Eligible Dividend Designations Following Budget 2012
This paper concludes with a brief update on two relieving measures enacted following Budget
2012.
* * *
5
6
7
8
MacDonald v. The Queen, 2012 DTC 1145 (TCC), under appeal by the Crown to the Federal Court of Appeal
[“MacDonald”].
McClarty Family Trust v. The Queen, 2012 DTC 1123 (TCC) [“McClarty Family Trust”].
For purposes of this paper, a reference to a redemption includes a purchase for cancellation.
The term “exceptional” is used since the provision permits the loss of one taxpayer (i.e., the estate) to be applied
against the gain of another (i.e., the deceased).
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Chris Falk
Stefanie Morand
McCarthy Tétrault LLP
PIPELINE PLANNING
Background – Post-Mortem Tax Planning
Various post-mortem tax planning techniques have been developed and refined over the years
to relieve against double taxation that can arise under the Act as a result of the deemed
disposition on death.
Where an individual dies owning shares of a private corporation, 9 the shares 10 are generally
deemed to be disposed of by the deceased immediately prior to death at their then FMV (in the
absence of a rollover to a spouse or spouse trust). 11 If the FMV of the shares exceeds their
adjusted cost base (“ACB”) 12 as is commonly the case, a capital gain will be realized in the
deceased’s terminal year.
As a consequence of the deemed disposition at FMV, where the shares of the private
corporation are acquired by a person (e.g., the deceased’s estate 13 ), that person is deemed to
have acquired the shares at a cost equal to the FMV immediately before death. However, the
deemed disposition does not vary the ACB of the assets owned by the corporation or permit
assets to be distributed from the corporation to its shareholders without additional shareholder
level tax. Accordingly, in the absence of tax planning, the same economic gain that was taxed
in the hands of the deceased may be taxed again in the hands of the corporation (and its
shareholders) when the corporation’s assets are ultimately disposed of (and the net proceeds
are distributed to shareholders).
The two principal techniques for relieving against this form of economic double taxation are:
• Capital loss carry-back planning, using the provisions of subsection 164(6) to create a
loss in the deceased’s estate within the estate’s first taxation year, which capital loss the
Act permits to be used to offset the capital gain arising on death; and
• “Pipeline planning”, in which a new corporation is used to create a so-called “pipeline” of
debt or high paid-up capital (“PUC”) shares that allows assets to be distributed to the
estate (or its beneficiaries) without additional tax payable by the recipient. 14
These techniques are sometimes used independently but are often combined with a view to
optimizing the after-tax result.
9
10
11
12
13
14
These comments assume, as would normally be the case, that such shares were capital property of the
deceased taxpayer for purposes of the Act. Subsection 248(1) and section 54 define what constitutes a
taxpayer’s “capital property”.
As well as other properties owned by the deceased.
Subsection 70(5) provides for the deemed disposition of capital property at FMV; subsection 70(6) generally
provides for a rollover to a spouse or spouse trust. The rollovers in section 70 for family farming corporations
and family fishing corporations transferred to children of a deceased are ignored for purposes of this paper.
Subsection 248(1) and section 54.
More precisely, the deceased’s executor or executrix in his or her capacity as executor or executrix.
Pipeline planning is sometimes combined with “bump” planning. In concept, the corporation is wound-up into a
new corporation and the provisions of paragraphs 88(1)(c) and (d) are relied on to increase the ACB of the
corporation’s non-depreciable capital property. Alternatively, instead of a tax-deferred winding-up undertaken
pursuant to subsection 88(1), an amalgamation (e.g., a short-form vertical amalgamation) under section 87 could
be undertaken.
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Chris Falk
Stefanie Morand
McCarthy Tétrault LLP
How and When Capital Loss Carry-Back Planning and Pipeline Planning are Used
As noted above, capital loss carry-back planning typically involves the winding-up of the
corporation owned by the estate and/or a redemption of all or some portion of the estate’s
shares therein, within the first taxation year of the estate. In effect, pursuant to the provisions of
subsection 164(6), the capital gain realized on the deceased’s death can be offset wholly or in
part by a capital loss triggered in the estate’s first taxation year on the winding-up or
redemption. The winding-up or redemption will generally trigger corporate level tax on the
disposition of assets and deemed dividends to the shareholders; however, where such
dividends can be paid on a tax-efficient basis (e.g., paying capital dividends out of the
corporation’s capital dividend account or paying dividends that give rise to a dividend refund to
the corporation), capital loss carry-back planning is frequently beneficial.
If dividends cannot be paid on a tax-efficient basis, a pipeline strategy may be more effective,
particularly if the corporation in question has cash or other assets with nominal gains. 15
Pipelines may be particularly attractive in Ontario where there is a very substantial difference
between the highest marginal rate applicable to an individual on capital gains (i.e., 23.99%,
given the 50% inclusion rate on capital gains and the top marginal rate of 47.97%) and on
16, 17
dividends that are not eligible dividends (i.e., 34.52%).
In concept, pipeline planning preserves the capital gain on death while permitting assets of the
corporation to be effectively distributed to the ultimate shareholder without adverse tax
consequences to the shareholder. The planning may be illustrated by way of a simple
example: 18
• Mr. X dies owning all of the shares of a private corporation, XCo.
• The shares of XCo were held by Mr. X as capital property for purposes of the Act and
had an ACB to Mr. X of $100,000 and an FMV immediately prior to Mr. X’s death of
$1,000,000. Accordingly, the deemed disposition of the XCo shares would give rise to a
$900,000 capital gain in Mr. X’s terminal year (assuming no rollover to Mr. X’s spouse or
to a spouse trust).
• To create a “pipeline”, Mr. X’s estate would incorporate a new corporation, Newco, for
nominal consideration. The estate would sell the shares of XCo to Newco for
$1,000,000 (assuming no accrued gain or loss in the estate since Mr. X’s death). 19 The
15
16
17
18
19
Pipeline planning may also be more effective where a “bump” can be used to increase the ACB of nondepreciable
capital assets. See note 14, above.
The highest marginal rate on eligible dividends is 31.69% in Ontario for 2012. These rates include the 2% surtax
on income above $500,000. Prior to the introduction of the 2% surtax, the highest marginal rates in Ontario were
46.41% on interest and regular income, 23.21% on capital gains (given the 50% inclusion rate), 29.54% on
eligible dividends and 32.57% on non-eligible dividends. These rates continue to apply for income over
$132,406 up to $500,000.
Private corporations that are or were formerly carrying on business and that have significant retained earnings
(that did not give rise to capital dividends or to refundable tax) are often corporations in respect of which pipeline
planning can be attractive.
In this example, XCo and Newco are assumed to be taxable Canadian corporations as defined in subsections
248(1) and 89(1).
A section 85 rollover could, of course, be used if there were an accrued gain in the hands of the estate.
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Chris Falk
Stefanie Morand
McCarthy Tétrault LLP
sale proceeds payable by Newco would be a non-interest bearing demand promissory
note payable by Newco in the amount of $1,000,000. 20
• XCo would be wound-up into Newco on a tax-deferred basis. 21
• Newco would use cash-on-hand (or other assets with only nominal gains) to repay all or
part of the promissory note held by the estate.
But for recent comments from the CRA suggesting that such a transaction might trigger a
deemed dividend to the estate, tax practitioners had generally understood that the estate would
receive proceeds on the promissory note on a tax-free basis given that the promissory note
would have an ACB to the estate equal to its face amount.
CRA’s Position Regarding Pipelines
Concern that the CRA might take the position that a basic pipeline such as that described above
could give rise to a deemed dividend to the estate pursuant to subsection 84(2) was raised in a
CRA Round Table at the 2009 APFF Conference. 22 In the Round Table, the CRA did not take
the position that subsection 84(2) applied in the example considered but, rather, declined to
comment on the possible application of subsection 84(2) in the absence of more detailed facts
than had been provided.
The example considered in the Round Table assumed that a taxpayer, immediately prior to
death, owned all of the shares of a taxable Canadian corporation, ACo, which had an FMV of
$100,000 and an ACB of $100. ACo was assumed to have cash of $100,000, no liabilities,
$100 in capital stock and $99,900 in retained earnings.
Given the lower rates applicable to capital gains, it was proposed to use a pipeline in which the
shares of ACo would be sold to a new taxable Canadian corporation, BCo, incorporated by the
estate, for a non-interest bearing demand note in the amount of $100,000. Thereafter, ACo
would be wound up into BCo, BCo would repay the $100,000 note payable to the estate and
BCo would be dissolved.
The pipeline transactions were intended to result in the estate acquiring the $100,000 subject
only to tax on the capital gain on the ACo shares in the hands of the deceased taxpayer, as
opposed to the estate receiving and being taxable upon a $99,900 deemed dividend if capital
loss carry-back planning had instead been undertaken by way of a simple winding up of ACo
into the estate pursuant to subsection 88(2). 23
20
21
22
23
This example assumes that the $1,000,000 ACB to the estate is “hard ACB” for purposes of section 84.1 (i.e.,
generally ACB not derived from pre-1972 gains or through the use of the capital gains exemption (subsection
84.1(2))). Instead of a promissory note, Newco could issue redeemable, retractable preferred shares with a
redemption amount and stated capital of $1,000,000.
Alternatively, an amalgamation such as a short-form vertical amalgamation under section 87 could be
undertaken.
CRA Document No. 2009-0326961C6, dated October 9, 2009.
Simplified, if ACo were wound up into the estate, assuming that the shares of ACo had PUC for purposes of the
Act of $100, subsection 84(3) would deem the estate to have received a dividend of $99,900 (i.e., the $100,000
paid less the $100 PUC). This deemed dividend would be excluded from the estate’s proceeds of disposition
pursuant to the provisions of section 54 and, accordingly, the estate would have a capital loss of $99,900 given
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Chris Falk
Stefanie Morand
McCarthy Tétrault LLP
In declining to comment on the possible application of subsection 84(2) in this example, the
CRA noted that the provision requires that funds or property of a particular corporation must
have been distributed or otherwise appropriated in any manner whatever to or for the benefit of
the shareholders on the winding-up, discontinuance or reorganization of the business of the
particular corporation (i.e., ACo) (in which case a deemed dividend would result to the extent
that the redemption proceeds exceeded the PUC of the shares).
The CRA noted that while it had ruled favourably in prior advance rulings on the non-application
of subsection 84(2) (in addition to ruling favourably on section 84.1 and the general antiavoidance
rule in subsection 245(2) (“GAAR”)), 24 the ruling applications in those cases provided
that:
• the corporation in question (e.g., the equivalent of ACo and XCo in the examples set out
above) would remain a separate and distinct entity for at least one year (i.e., that it would
not be wound up into or amalgamated with another corporation);
• during this period, the corporation would continue to carry on its business in the same
manner as before; and
• only thereafter would the note be repaid (or would PUC of shares be reduced), on a
progressive basis.
The CRA indicated that, in these circumstances, it was reasonable to conclude that the
conditions for the application of subsection 84(2) had not all been satisfied.
While the CRA declined to comment on the application of subsection 84(2) in the example
considered, the CRA noted, from the perspective of tax planners perhaps somewhat hopefully,
that the three conditions summarized above that had been referred to in the favourable rulings
were facts submitted by the taxpayers in question and could not be considered CRA
requirements. 25
While the CRA’s position remained uncertain following this Round Table discussion, the
discussion placed tax planners on notice that the CRA might take the position that subsection
84(2) could give rise to a deemed dividend in a pretty typical pipeline plan.
Subsequently, in a withdrawn ruling request in respect of a proposed post-mortem pipeline plan
involving a holdco that was inactive and owned only liquid assets (which assets were possibly
only cash), the CRA took the position that the holdco’s surplus would be subject to dividend
24
25
its $100,000 ACB. Provided that this capital loss was triggered in the estate’s first taxation year, subsection
164(6) would generally permit the executor or executrix to elect to have the capital loss treated as a capital loss
of the deceased in his or her terminal year rather than a capital loss of the estate. This capital loss could then be
used to offset the capital gain arising in the deceased’s terminal year by reason of the deemed disposition on
death.
CRA Document Nos. 2002-0154223, dated November 13, 2002, and 2005-0142111R3, dated November 2,
2005.
The CRA had previously explained these rulings in a similar manner in a technical interpretation (CRA Document
No. 2006-0170641E5, dated June 29, 2006).
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McCarthy Tétrault LLP
treatment in the hands of the estate (although the CRA noted that capital loss carry-back
planning could be undertaken to avoid double taxation). 26
The CRA revisited this issue at the 2010 Canadian Tax Foundation (“CTF”) Annual Conference.
While the PowerPoint questions and responses distributed by the CRA were not definitive, in
the discussions the CRA seemed to suggest that subsection 84(2) would be applied to a postmortem
pipeline of a corporation that held all cash.
In 2011, the issue was again revisited at the STEP Conference, the British Columbia Tax
Conference and the CTF Annual Conference.
At the 2011 British Columbia Tax Conference, the CRA stated that “pipeline planning is not
dead…but the potential application of anti-avoidance provisions of s. 84.1 and s. 84(2) must be
reviewed” (emphasis original).
As for “facts and circumstances” that would lead to the application of subsection 84(2), the CRA
stated as follows at the 2011 CTF Annual Conference:
[…] in the context of a series of transactions designed to implement a post-mortem pipeline
strategy, some of the additional facts and circumstances that in our view could lead to the
application of subsection 84(2) and warrant dividend treatment could include the following:
• The funds or property of the original corporation would be distributed to
the estate in a short time frame following the death of the testator.
• The nature of the underlying assets of the original corporation would be
cash and the original corporation would have no activities or business
(“cash corporation”). 27
At the 2011 STEP Conference and the 2011 CTF Annual Conference, the CRA recognized the
potential for double taxation arising as a consequence of the deemed disposition on death but
stated that the double taxation which pipeline planning is intended to address could be
“avoided” or “mitigated” with the implementation of “the subsection 164(6) capital loss carryback
strategy”. As discussed below, in the authors’ view, to suggest that capital loss planning is
the appropriate remedy is not – from a policy perspective – a reasonable approach given the
provisions of the Act, nor does it accord with the fairness concerns which underscored Mr.
Justice Hershfield’s decision in MacDonald, discussed below, and the Supreme Court of
Canada’s decision in Canada Trustco. 28,29
26
27
28
29
CRA Document No. 2010-0389551R3, from 2010.
These same “facts and circumstances” were identified at the 2011 STEP Conference and the 2011 British
Columbia Tax Conference.
Canada Trustco Mortgage Co. v. The Queen, 2005 DTC 5523 (SCC) [“Canada Trustco”].
Subsection 164(6) requires that the loss be sustained in the estate’s first taxation year, and is subject to
numerous stop-loss rules. In many circumstances (e.g., where the validity of a will is contested, underlying facts
are uncertain or planners are simply not contacted in time), it may not be feasible to trigger the loss within the
time allowed. Further, in some circumstances, the deceased will have sufficient loss carryforwards or tax credits
to shelter the gain on death such that the subsection 164(6) loss carry-back is of no benefit to the deceased.
Since the deceased’s credits cannot be carried forward to offset income in the estate (including income arising
on the wind-up or redemption), significant inequities could arise if pipeline planning is not possible or if it is
possible only in the limited circumstances in which CRA is prepared to rule favourably.
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Stefanie Morand
McCarthy Tétrault LLP
Also in 2011 and thus far in 2012, the CRA has issued a number of favourable rulings dealing
with the non-application of subsection 84(2) in the post-mortem context. 30 However, the
proposed transactions have been generally similar to those on which the CRA previously ruled
favourably and the statement of proposed transactions in each of these rulings has provided
that:
• the corporation in question would remain a separate and distinct entity for one year or
longer;
• during this period the corporation would continue to carry on its business; and
• only thereafter would the note be repaid (or the pipeline shares be redeemed or PUC on
the pipeline shares be returned), on a progressive basis.
Given the CRA’s statement at the 2009 APFF Conference that these three factors were not
“CRA requirements”, it is noteworthy that, in the reasons given for one of these more recent
rulings, the CRA stated that “[t]he proposed pipeline transaction satisfies the administrative
requirements established by the CRA in previous rulings issued in respect of similar
arrangements” (emphasis added). 31
Provisions and Scheme of the Act Relevant to Pipelines
In considering whether a deemed dividend may arise on a pipeline transaction in the example
set out above, the relevant provisions to consider, in addition to GAAR, are subsection 84(2),
section 84.1 and paragraph 88(1)(d.1).
Simplified, subsection 84(2) provides for a deemed dividend in circumstances in which:
[…] funds or property of a corporation resident in Canada have […] been distributed or
appropriated in any manner whatever to or for the benefit of the shareholders of any class […]
on the winding-up, discontinuance of reorganization of its business […]
Where subsection 84(2) applies, the shareholders are deemed to have received a dividend
equal to the amount by which the FMV of the funds or property distributed exceeds the PUC of
the shares.
Section 84.1 applies in respect of surplus stripping transactions involving the transfer of shares
of one corporation to another in circumstances in which the FMV of the non-share consideration
and the increase in the PUC of the shares of the purchaser corporation exceed the greater of:
• the ACB (as adjusted for purposes of section 84.1 (the ACB as so adjusted, the “Hard
ACB”)); and
• the PUC of the shares of the transferee corporation transferred to the purchaser
corporation.
30
31
CRA Document Nos. 2012-0435131R3, from 2012; 2011-0401811R3, from 2012; 2010-0388591R3, from 2011;
and 2011-0403031R3, from 2011 (supplemented by CRA Document No. 2011-0417741R3, from 2011).
CRA Document No. 2011-0403031R3, from 2011.
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McCarthy Tétrault LLP
In the view of the authors, the language and clear policy of section 84.1 permit pipeline
transactions, provided that the aggregate of the FMV of the non-share consideration and of the
increase in PUC of the shares of the purchaser corporation does not exceed the Hard ACB of
the shares of the transferee corporation.
For purposes of section 84.1, ACB is generally reduced in respect of both pre-1972 gains and
capital gains exemptions claimed on the share (or a share for which the share was substituted)
of the taxpayer or a person with whom the taxpayer did not deal at arm’s length. In the pipeline
transaction contemplated in the example above, provided that pre-1972 gains and capital gains
exemption claims are not in issue, section 84.1 would appear to be intended to permit the form
of surplus stripping contemplated (i.e., where the estate has “Hard ACB” by reason of the
deemed disposition on death).
Subsection 88(1) governs the winding-up of XCo into Newco in the example contemplated. On
such a wind-up, paragraph 88(1)(d.1) provides that subsection 84(2) does “not apply to the
winding-up of the subsidiary”.
In light of the above provisions, the CRA’s position that subsection 84(2) may apply in respect of
a basic pipeline appears to be doubtful in the example contemplated for the following reasons:
• Subsection 84(2) is expressly made inapplicable to the winding-up of XCo into Newco by
reason of paragraph 88(1)(d.1).
• On its face, subsection 84(2) applies to distributions or appropriations “to or for the
benefit of the shareholders […] on the winding-up” of XCo. On the winding-up of XCo,
XCo’s sole shareholder is Newco (and subsection 84(2) should not apply to deem there
to be a dividend triggered on the winding-up of Newco into the estate to the extent that
$100,000 is paid on the note rather than on the Newco shares). 32
• The provisions of section 84.1, which govern transactions of the type contemplated in a
basic pipeline, permit the extraction of “Hard ACB” such as the estate’s ACB in the XCo
shares.
• Where the Act has deemed there to be a disposition at FMV by reason of a taxpayer’s
death, particularly given the provisions of section 84.1, in the authors’ view, at least in
the ordinary course, the estate should not be regarded as an “accommodation party” that
has been inappropriately used to extract corporate assets. Therefore, GAAR should not
normally be engaged.
• Further, subsection 84(2) can apply only where assets have been distributed or
appropriated “on the winding-up, discontinuance or reorganization of [… XCo’s]
business”. Accordingly, where XCo is not carrying on a business (and, if it was formerly
carrying on a business, where the distribution does not occur on the winding-up,
32
It is acknowledged that some jurisprudence has taken a broad view of this aspect of subsection 84(2) (see, for
example, RMM Canadian Enterprises Inc. et al v. The Queen, 97 DTC 302 (TCC) [“RMM”], but see also Collins
& Aikman Products Co. et al v. The Queen, 2009 DTC 1179 (TCC), affirmed 2010 DTC 5164 (FCA)).
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discontinuance or reorganization of that business), subsection 84(2) should not apply in
any case. 33
In suggesting that subsection 84(2) may be engaged in a typical pipeline transaction, the
authors respectfully suggest that the CRA may in effect be seeking to tax an estate based upon
a transaction that the estate might have undertaken rather than the transaction actually
undertaken. Clearly subsection 84(2) should not apply to deem the estate to have received a
dividend in the example set out above and, it is suggested, GAAR should generally not be
engaged in light of the provisions of section 84.1 and the circumstances in which the estate
acquired its Hard ACB.
Recent Jurisprudence
In 2012, the Tax Court of Canada released two decisions which are not “pipeline” decisions per
se, but should nonetheless be of interest to anyone who has been following the discussion
about whether subsection 84(2) applies in the context of traditional pipeline planning. As
discussed below, these decisions provide support for the proposition that subsection 84(2)
should not be engaged in a typical post-mortem pipeline.
McClarty Family Trust 34
In McClarty Family Trust, the Tax Court of Canada considered a series of transactions whereby
a taxpayer was able to split income with his minor children through the use of a family trust
notwithstanding the “kiddie tax” provisions in section 120.4. Simplified, in each of 2003 and
2004, a holding company paid a stock dividend to the trust, the trust sold the stock dividend
shares to Mr. McClarty, Mr. McClarty sold the shares to another company and the holding
company redeemed the shares owned by the other company. Since the stock dividend shares
received by the trust had low cost (as well as low PUC), the trust realized a capital gain on the
sale to Mr. McClarty. In reassessing, the Minister invoked the GAAR to treat as dividends the
capital gains that were realized by the trust and were allocated by the trust to its minor
beneficiaries. At trial, the Crown argued in the alternative that subsection 84(3) applied to deem
the trust (rather than the company that owned the shares at the time of the redemption) to have
received a dividend in each of the relevant years.
Simplified, subsection 84(3) provides for a deemed dividend where “a corporation resident in
Canada has redeemed, acquired or cancelled in any manner whatever […] any of the shares of
any of its capital stock”.
In making its alternative argument, the Crown relied on the decision of the Tax Court of Canada
in RMM 35 for the proposition that the wording “in any manner whatever” found in subsections
84(2) and 84(3) is to be interpreted broadly such that a person (in this case, the trust) who did
33
34
35
Some commentators have also suggested that even if the CRA were correct that subsection 84(2) could
otherwise apply on a pipeline, as the deemed dividend would be inconsistent with the treatment accorded by
section 84.1, the more specific wording of section 84.1 should govern. See, for example, Manu Kakkar and Nick
Moraitis, “Post Mortem Planning: Does the “Pipeline” Work” (2011) 11:1 Tax for the Owner Manager, 6-7; and
Stuart Bellefer, “Summary of the CRA Round Table Held at the 13 th National STEP Canada Conference” (August
2011) 199 CCH Estate Planner Newsletter, 4-6.
Supra, note 6.
Supra, note 32.
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not hold shares immediately prior to their redemption nonetheless falls within the scope of the
words “each person” in subsection 84(3). Mr. Justice Angers rejected this interpretation. He
stated that the wording in subsection 84(3) (at paragraph 63):
would warrant an analysis of how the shares in question were actually redeemed, acquired or
cancelled in that the method of redemption, acquisition or cancellation could have an impact on
who the actual persons are who hold the shares. The manner in which each person who holds
the redeemed, acquired or cancelled shares came to be in possession of the shares is not what
needs to be determined under subsection 84(3). (emphasis added)
In other words, Mr. Justice Angers rejected the Crown’s argument that subsection 84(3) could
apply to deem someone other than the shareholder to have received a dividend on the
redemption.
Accordingly, while 2011 amendments to section 120.4 have rendered obsolete the planning
which enabled Mr. McClarty to split income with his minor children, the decision in McClarty
Family Trust is nonetheless of current relevance for the Tax Court of Canada’s rejection of the
Crown’s attempt to rely on RMM to support what, in the authors’ view, is an unduly broad
interpretation of section 84. The decision is also noteworthy for its taxpayer-friendly GAAR
analysis.
The Crown has not appealed the decision.
MacDonald 36
In MacDonald, the issue was whether subsection 84(2) applied to recharacterize as dividends
amounts received by a former shareholder qua creditor in the context of a surplus strip. Mr.
Justice Hershfield held in favour of the taxpayer and noted that he favoured the approach to
subsection 84(2) adopted in McNichol 37 to that adopted in RMM.
The decision in MacDonald is especially noteworthy since:
• the transactions implemented were similar to those used in pipeline planning;
• the Court devotes nearly a dozen paragraphs to pipeline planning specifically and is
critical of the CRA’s recent position; and
• the Court concludes that the GAAR – and not subsection 84(2) – is the appropriate
provision to consider.
More generally, the decision is of interest for the Court’s overall concern for fairness in
determining whether GAAR should apply, as well as for its acceptance, on the facts in issue, of
the use of an accommodation party to permit a shareholder to, in effect, indirectly access a
corporation’s retained earnings as a capital gain rather than as dividends.
36
37
Supra, note 5. For a more detailed discussion of the decision in MacDonald, see the authors’ article “Pipeline
Planning Alive and Well After All” (July 5, 2012) 2104 Tax Topics 1-8. Many of the comments that follow are
based on that article.
McNichol v. The Queen, 97 DTC 111 (TCC) [“McNichol”].
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The Facts
The taxpayer was a medical doctor who practiced in Canada through a wholly-owned
professional corporation (“Canco”), the shares of which had nominal cost and PUC. In the early
2000s, the taxpayer decided to emigrate to the United States. The taxpayer was advised by his
accountant that the departure could result in double taxation since the taxpayer would be
deemed to have disposed of the Canco shares for Canadian tax purposes on leaving Canada
but would not obtain a corresponding step-up in cost for US tax purposes. 38 While the taxpayer
could use his personal capital losses and loss carry-forwards (the “Losses”) to offset the capital
gain in Canada arising on the deemed disposition, doing so would be an inefficient use of the
Losses since the same economic gain would be subject to tax in the United States on any
subsequent disposition of the shares.
Given the potential for double taxation, a plan was devised to use the Losses while preventing a
second taxable realization in the United States. As discussed more particularly below, an
important component of the plan was the involvement of the taxpayer’s brother-in-law
(“Brother”) who agreed to purchase the shares of Canco. Brother was given a complete
indemnity and a $10,000 spread between what he could extract from Canco and what he would
have to pay for the shares.
Simplified:
• in the months leading up to June 25, 2002:
o
o
the taxpayer caused Canco to liquidate its assets;
Brother incorporated a new holding company (“Holdco”);
• on June 25, 2002:
o
o
o
o
o
the taxpayer and Brother entered into an agreement whereby Brother purchased
the Canco shares from the taxpayer in exchange for a promissory note (the
“Brother Note”) in the amount of $525,068;
Brother transferred the Canco shares to Holdco in exchange for shares of Holdco
and a promissory note (the “Holdco Note”) in the same principal amount as the
Brother Note;
Canco declared dividends and issued cheques in partial payment of the
dividends;
Holdco endorsed the cheques to Brother as partial payment of the Holdco Note;
Brother endorsed the cheques to the taxpayer as partial payment of the Brother
Note;
38
The fifth protocol, signed September 21, 2007, has since addressed the double tax issue for dispositions after
September 17, 2000. See Article XIII(7) of the Canada-US tax treaty.
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o
the taxpayer, Brother, Canco and Holdco entered into a further agreement
confirming the transactions and providing that on September 1, 2002:
• Canco would pay a final dividend to Holdco equal to Canco’s then
remaining cash balance less all liabilities;
• Holdco would direct that the amounts owed by Canco to Holdco be paid
to Brother as payment of the remaining balance of the Holdco Note, and
Brother would, in turn, direct that such amounts be paid to the taxpayer
as payment of the remaining balance of the Brother Note;
o
the taxpayer crossed the border, moving to the United States;
• on July 15, 2002, Canco paid Holdco $10,000;
• on September 1, 2002, Canco declared a final dividend as contemplated in the June 25,
2002 agreement and Canco booked the amount as being owed to the taxpayer pursuant
to directions from Holdco and Brother.
In completing his tax return for the 2002 taxation year, the taxpayer reported a capital gain on
the disposition of the Canco shares equal to $524,967 39 and applied the Losses to offset the
gain. In 2008, the Minister reassessed the taxpayer to include in his income for the 2002
taxation year a taxable dividend in the amount of $524,967. 40 In so doing, the Minister relied
upon subsection 84(2) and, alternatively, the GAAR in maintaining that the transactions
triggered a deemed dividend to the taxpayer. The Minister also maintained that the transactions
were a sham such that, on this basis as well, the taxpayer received dividends or deemed
dividends.
At trial, the principal issues were whether subsection 84(2) or the GAAR applied to recharacterize
as a dividend the amount received by the taxpayer for the Canco shares. 41,42
Comparables
Before reviewing the Tax Court of Canada’s decision, it is useful to consider the Canadian
income tax consequences that would have arisen under several alternative arrangements.
Had the taxpayer simply sold the shares to an arm’s length party, he would have realized a
capital gain equal to the amount by which his proceeds of disposition exceeded his ACB of
$101; however, the decision reports that there was no market for the shares of Canco, either as
a professional corporation or a holding company.
As noted above, had the taxpayer emigrated from Canada while he still owned the Canco
shares, he would have been deemed to have disposed of the shares on leaving Canada and
39
40
41
42
The amount of the Brother Note less the taxpayer’s ACB of $101.
The Minister also revised the capital gain from $524,967 to $10,000. This revision was consequential upon the
inclusion of the deemed dividend.
The sham basis for the assessment was abandoned at trial.
In the event that the Court were to determine that subsection 84(2) or the GAAR applied, the taxpayer asked the
Court to find that he was not a resident of Canada at the time of any deemed dividends.
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could have applied the Losses to offset the capital gain. If the taxpayer then wound-up Canco
so as to access the value of the underlying assets, he would have been deemed to have
received a dividend equal to the amount by which the FMV of the property distributed on the
winding-up exceeded $101 (i.e., the PUC of the shares). This deemed dividend would have
been subject to Part XIII withholding tax. While the wind-up would have resulted in a capital
loss to the taxpayer, subsection 40(3.7) would have applied to deny the loss to the extent of the
deemed dividend. 43
If, after having emigrated from Canada, the taxpayer instead transferred the shares of Canco to
a Canadian corporation with which he did not deal at arm’s length in exchange for a promissory
note equal to the FMV of the shares, subsection 212.1(1) would have applied to deem the
taxpayer to have received a dividend equal to the amount by which the promissory note
exceeded $101 (i.e., the PUC of the shares). Again, this deemed dividend would have been
subject to Part XIII withholding tax.
If, prior to emigrating from Canada, the taxpayer by-passed Brother and simply transferred the
shares to Holdco in exchange for a promissory note, section 84.1 would have deemed the
taxpayer to have received a dividend equal to the amount by which the promissory note
exceeded $101 (i.e., the PUC and ACB of the shares).
If the taxpayer wound-up Canco prior to emigrating from Canada, subsection 84(2) would have
deemed the taxpayer to have received a dividend equal to the amount by which the FMV of the
property distributed on the winding-up exceeded $101 (i.e., the PUC of the shares).
Accordingly, in each alternative (other than a third-party sale which was not available), the
taxpayer would have been deemed to have received a dividend taxable under either Part I or
Part XIII of the Act.
The Decision – Subsection 84(2)
The first issue considered by Mr. Justice Hershfield was whether subsection 84(2) applied to recharacterize
as a dividend the amount received by the taxpayer for the Canco shares.
As summarised by Mr. Justice Hershfield, the Crown advanced three arguments in support of its
position that subsection 84(2) applied in the circumstances. Specifically, the Crown relied on:
• the phrase “in any manner whatever” in the preamble of subsection 84(2);
• the Tax Court of Canada’s earlier decision in RMM; and
• a “purposive rather than literal construction of the subject provision”. 44
Each of these arguments was rejected by Mr. Justice Hershfield.
43
44
Provided the shares were still taxable Canadian property at the time of the wind-up, section 119 would have
applied to permit a credit of Part XIII withholding tax paid in respect of the winding-up dividend against the tax, if
any, payable by the taxpayer on the capital gain that arose on the deemed disposition of the shares on
emigration.
Supra, note 5, at para. 47.
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In response to the Crown’s first argument, Mr. Justice Hershfield concluded that the express
language of subsection 84(2) “ensures that it is only a shareholder at the time of the distribution
or appropriation who can be deemed to be the recipient of the dividend”. 45
In the case at bar, the property that the taxpayer received at the beginning of the series of
transactions was the Brother Note, which was not property of Canco. When amounts were
subsequently paid by Canco to the taxpayer, the taxpayer was no longer a shareholder of
Canco and the taxpayer received the amounts qua creditor. Further, Canco’s property was
distributed by way of dividend to Holdco. Mr. Justice Hershfield held that the phrase “in any
manner whatever” relied on by the Crown does not have the effect of “redirecting” to whom
dividends are paid; rather, “[i]t is the manner of effecting the distribution to the shareholder at
the time of that distribution that the subject provision is aimed”. 46 Accordingly, it was not
relevant that the Brother Note was repaid using Canco funds.
As for the Crown’s reliance on RMM where Mr. Justice Bowman, as he then was, concluded
that subsection 84(2) applied, Mr. Justice Hershfield acknowledged that the facts in RMM were
not easily distinguished from the case at bar. However, he noted that the decision in RMM
stands in contrast to Mr. Justice Bonner’s decision in McNichol where the facts were also similar
to those in issue. While Mr. Justice Bowman sought to distinguish McNichol in RMM, Mr.
Justice Hershfield rejected the distinction and concluded that “the McNichol approach which
was to look to section 245 when subsection 84(2) does not apply on a strict construction of its
language, is the correct approach”. 47
In respect of the Crown’s third argument, Mr. Justice Hershfield concluded that a “purposive
contextual analysis” of subsection 84(2) did not support a less literal interpretation of the
provision. He stated (at paragraphs 66 and 67):
In my view, there is nothing in the language of subsection 84(2) that warrants a finding of a
rationale other than liquidating distributions out of a corporation’s earnings to its shareholders –
holding a particular class of shares – are to be treated as dividends to the extent the distribution
exceeds the paid-up capital of the particular class of shares held by persons receiving the
distribution. […]
[…] The surplus strip here was having the Appellant’s shares acquired with corporate funds
funnelled through a related corporation as a tax-free dividend. This classic strip in the old
system was subject to a specific anti-avoidance provision; namely section 138A of the old, pre-
1972 Act. That provision was replaced in 1972 with section 247 which was repealed in 1988.
The section that survived is, of course, section 245. That is the provision to look at in these
circumstances. Essentially that is what Justice Bonner concluded in McNichol and I agree.
(italics original)
And later (at paragraph 82):
In the circumstances of this case, there is nothing in subsection 84(2) of the Act that invites the
CRA or this Court to change either who the recipient of the benefit is, or the legal status or
capacity of the recipient. To re-characterize or ignore the Appellant’s legal status in this case
invites consideration of the application of section 245 of the Act. Subsection 245(5) allows just
45
46
47
Ibid., at para. 50 (emphasis added).
Ibid., at para. 48 (emphasis added).
Ibid., at para. 59.
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that in certain circumstances. In those circumstances, and only in those circumstances, should
the subject transactions be recharacterized. Put another way, where GAAR would not apply to
re-characterize the legal effect of a series of transactions, other provisions of the Act should not
be too readily stretched to give that result where a strict reading of them does not invite such a
result. (emphasis added)
Before moving on to a discussion of whether GAAR applied, Mr. Justice Hershfield addressed
the CRA’s position in respect of pipeline planning. While the reader is referred to the text of the
decision for the complete discussion which spans nearly a dozen paragraphs, it suffices to note
for purposes of this paper that Mr. Justice Hershfield stated, in part, as follows (at paragraphs
77 through 80):
[…] The post-mortem pipeline, like the case at bar, attempts to avoid dividend treatment by
employing steps that ensure that the tax planner receives the liquidating dividend qua creditor.
The choice is made to accept capital gains treatment on death as opposed to dividend treatment
on the estate's receipt of corporate assets.
The CRA has issued advance income tax rulings that such post-mortem pipeline transactions
will not be subject to subsection 84(2) if the liquidating distribution does not take place within
one year and the deceased's company continues to carry on its pre-death activities during that
period.
This post-mortem plan clearly parallels the Appellant’s tax plan in the case at bar. Both plans
provide access to a corporation’s earnings in a manner that avoids dividend treatment. As well,
both situations deal with a time of reconciliation – death and departure from Canada. The
conditions imposed on the post-mortem transactions, if imposed in the case at bar, would show
that the CRA’s assessing practice was consistent in trying to apply subsection 84(2). The
message seems to be: do the strip slowly enough to pass a contrived smell test and you will be
fine.
This is not a satisfactory state of affairs in my view. The clearly arbitrary conditions imposed are
not invited by the express language in subsection 84(2). I suggest that they are conditions
imposed by the administrative need not to let go of, indeed the need to respect, the assessing
practice seemingly dictated by RRM. Make it “look” less artificial and the threat of subsection
84(2) disappears. This unsatisfactory state of affairs more properly disappears once it is
accepted that subsection 84(2) must be read more literally in all cases and GAAR applied in
cases of abuse. (emphasis added; footnotes omitted)
While these comments were not necessary to Mr. Justice Hershfield’s conclusion that
subsection 84(2) did not apply in the context of the case at bar and, strictly speaking, are obiter,
they should nonetheless be pleasing to post-mortem planners.
The Decision – GAAR
It is trite law that three requirements must be established to permit the application of the GAAR:
• there must be a “tax benefit”;
• the transaction giving rise to the tax benefit must be an “avoidance transaction”; and
• the avoidance transaction must be “abusive”.
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If Mr. Justice Hershfield’s GAAR analysis in MacDonald seems less tightly reasoned than his
comments on subsection 84(2), this may be attributable to the manner in which the parties
framed the arguments in respect of GAAR. As stated by Mr. Justice Hershfield (at paragraph
30):
Nowhere in the Reply does the Respondent expressly identify the “tax benefit” that needs to be
identified for the purposes of section 245. Implicitly, however, given the assumption in […] the
Reply […], the benefit must be taken to be the use of capital losses and loss carry forwards that
could not have been used had subsection 84(2) applied. That was certainly the position taken
at trial although the general avoidance of dividend treatment sought to be imposed under
subsection 84(2), regardless of the particular tax benefit achieved by avoiding it, seems to be an
underlying and relevant concern to the Respondent in this case.
Mr. Justice Hershfield begins his GAAR analysis by commenting that to look beyond the clear
tax benefit identified by the Crown (i.e., the creation of a capital gain enabling the use of capital
losses which resulted in a reduction of tax payable) would not be consistent with the analytical
approach set out by the Supreme Court of Canada in Canada Trustco and Copthorne. 48 As
such, readers may have expected a comment similar to Madam Justice Woods’ admonition in
Global Equity 49 to the effect that readers should be cautious before concluding that the GAAR
does not apply to transactions of this type since the result may have been different if different
arguments had been raised by the Crown. However, Mr. Justice Hershfield instead engaged in
a sort of two-track GAAR analysis, considering both the use of the Losses and “the issue of
surplus stripping per se”. As stated by Mr. Justice Hershfield (at paragraphs 100 and 101):
It was clearly open to the Minister to assess the subject transactions on the basis that the tax
benefit was the elimination of Part XIII tax.
Reliance could readily have been made on the comparable to the Appellant moving to the
United States without engaging in the share sale, using his capital losses, then winding up PC
after the move. […] However, that comparable is not the subject of this appeal. […] Still, as I
have suggested before, I am not satisfied that my analysis will be complete if all I do is focus on
the tax benefit relied upon by the Minister in this case. The GAAR analysis will only be
complete, in my view, if I address the Respondent’s underlying concern in this appeal head-on,
namely the issue of surplus stripping per se.
While the reader is referred to the text of the decision for details of the GAAR analysis and the
basis on which the Court concluded that GAAR did not apply in the case at bar, the authors note
that Mr. Justice Hershfield:
• concluded that it was “doubtful whether in an integrated corporate/shareholder tax
system, a surplus strip per se can be said to abuse the spirit and object of the Act read
as a whole”; 50
48
49
50
Copthorne Holdings Ltd. v. The Queen, 2012 DTC 5007 (SCC) [“Copthorne”].
Global Equity Fund Ltd. v. The Queen, 2011 DTC 1350 (TCC) [“Global Equity”]. Global Equity was not a
surplus stripping case; rather, the decision considered whether GAAR applied to a series of transactions
designed to generate a business loss that was applied to eliminate most of the taxpayer’s tax payable for the
1999, 2000 and 2001 taxation years.
Supra, note 5, at para. 101.
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• did not consider the use of related party transactions on substantially arm’s length terms
or the use of Canco funds to repay the Brother Note to be relevant factors in his
determination that the impugned transactions were not abusive; and
• noted that the GAAR framework should achieve a fair result. 51
The Crown has appealed the decision in respect of both subsection 84(2) and the GAAR.
Relevance of the Decision
As noted above, Mr. Justice Hershfield’s obiter comments in respect of pipeline planning should
be pleasing to post-mortem planners. However, the real significance of Mr. Justice Hershfield’s
decision is likely his conclusion that “subsection 84(2) must be read more literally in all cases
and GAAR applied in cases of abuse”. 52 If this conclusion – which the authors think is correct –
is confirmed by the Federal Court of Appeal, it should be a significant victory for post-mortem
planners regardless of the Federal Court of Appeal’s decision on GAAR since the arguments
against the application of the GAAR in the context of post-mortem planning are – in the view of
the authors – significantly stronger than those in MacDonald. 53
Practical Advice Regarding Pipelines in Light of CRA’s Position
While the authors are of the view that, in the normal course, the CRA’s position that subsection
84(2) may apply to deem the estate to have received a dividend in a typical pipeline transaction
is not well-founded, they note as follows:
• In many cases, where the deceased did not wholly-own the corporation (e.g., where a
prior estate freeze had been undertaken), it may be possible to implement a pipeline
without it being necessary to wind up, discontinue or reorganize any business carried on
by the corporation.
• To avoid the audit risk, where viable in implementing a pipeline, it is preferable to fall
within the circumstances in which the CRA has ruled favourably. 54
• Where this is not viable, it may be helpful to structure pipeline transactions such that
they include a subsection 88(1) wind-up so that subsection 84(2) is expressly stated not
to apply on the wind-up. 55
51
52
53
54
See, for example, paragraph 139 of the decision where Mr. Justice Hershfield stated as follows:
In closing, I add that in not applying GAAR to the share sale I am mindful of what was
enunciated on more than one occasion in Canada Trustco; namely, the analysis of GAAR
requires consideration of fairness. Indeed in the opening paragraph of Canada Trustco, the
Supreme Court of Canada said the GAAR framework should achieve fair results. The
allowance of this appeal ensures a fair result. A tax plan that ensures the reconciliation of
genuine capital losses should not be the subject of a GAAR assessment, at least in these
circumstances, unless the Act expressly denies it.
Supra, note 5, at para. 80.
See supra, note 36.
E.g., keeping the corporation in existence as a separate entity for at least a year and having it continue its
business, and only thereafter repaying the promissory note progressively over time.
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• Recent commentary suggests that in appropriate cases it may be helpful to complete the
transactions within the estate’s first taxation year so that subsection 164(6) capital loss
carry-back planning may be available as a “fallback” option. 56
SUBSECTION 164(6) CAPITAL LOSS CARRY-BACK PLANNING
Background
As discussed above, subsection 164(6) capital loss carry-back planning is another technique
employed by tax practitioners to relieve against the double taxation that can arise under the Act
as a result of the deemed disposition on death.
Subsection 164(6) is an exceptional provision in that it allows, in some circumstances, a capital
loss sustained by the estate to be carried back to the deceased’s terminal return and applied
against the capital gain that arose as a consequence of the deemed disposition on death. The
provision requires that the loss be sustained in the estate’s first taxation year, 57 and is subject to
numerous stop-loss rules.
In a 2006 Tax for the Owner-Manager article, 58 Nick Moraitis and Manu Kakkar discussed a
potential circularity problem with estate loss carry-backs owing to the drafting of subsections
40(3.6), 40(3.61) and 164(6). This summer at the 2012 STEP Round Table, the CRA was
asked to comment on the interaction of these provisions and, in so doing, expressed a view that
could render subsection 164(6) capital loss carry-back planning unavailable for many estates.
The authors comment below on the issue raised at the 2012 STEP Round Table and the CRA’s
response. In summary, it is the authors’ view that:
• given the text, context and purpose of subsections 40(3.6), 40(3.61) and 164(6), the
provisions should be interpreted in a manner which does not give rise to the circularity
issue identified in the Moraitis/Kakkar Article and addressed in the CRA’s recent
response;
• if, however, contrary to what in the authors’ view is the better interpretation, the
provisions are to be interpreted so as to give rise to the circularity issue due to a
technical flaw in the drafting of subsection 40(3.61), a legislative fix is required so as not
to frustrate the underlying purpose and policy of the provisions; and
55
56
57
58
Paragraph 88(1)(d.1). In this case, the issue should then focus on GAAR; whether there has been a misuse or
abuse for purposes of section 245 notwithstanding: (i) the deemed disposition on death; (ii) the provisions of
section 84.1; and (iii) that the estate should not normally be regarded as an “accommodation party” in facilitating
a surplus strip.
Stuart Bellefer, “Summary of the CRA Round Table Held at the 13th National STEP Canada Conference”
(August 2011) 199 CCH Estate Planner Newsletter, 4-6 (which notes that it would generally be necessary to latefile
the subsection 164(6) designation, which would require that a fairness request be brought by the taxpayer
pursuant to subsection 220(3.2) and Income Tax Regulation 600(b)).
The provision does not refer to the first calendar year following the death of the deceased. Planners should be
careful not to inadvertently trigger an early taxation year by, for example, running afoul of the “anti-stuffing” rules
in the proposed amendments to the definition of “testamentary trust” in subsection 108(1).
Nick Moraitis and Manu Kakkar, “Potential Circularity Problem with Estate Loss Carryback”, (July 2006) 6:3 Tax
for the Owner-Manager (ctf.ca) (the “Moraits/Kakkar Article”).
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• if the provisions are to be interpreted iteratively, the CRA’s suspicion that the incidence
of the circularity issue is “likely quite limited” is incorrect and, as discussed below, may
be based on an incomplete understanding of the issue.
Subsections 40(3.6) and (3.61)
Where a taxpayer disposes a corporation’s shares to that corporation, the taxpayer’s loss is
generally deemed to be nil pursuant to the provisions of subsection 40(3.6) if the corporation is
“affiliated” 59 with the taxpayer immediately after the disposition.
However, subsection 40(3.6) is subject to subsection 40(3.61). Subsection 40(3.61) provides
that where an election is made under subsection 164(6) to treat all or any portion of an estate’s
capital loss (determined without reference to subsections 40(3.4) and (3.6)) from the disposition
of a share as a capital loss of the deceased taxpayer, subsections 40(3.4) and (3.6) will apply to
the estate only to the extent that the amount of the capital loss exceeds the loss to which the
election applies. 60
The purpose of subsection 40(3.61) is to provide relief from subsections 40(3.4) and (3.6) in the
context of subsection 164(6) capital loss-carry back planning. As stated in the December 2004
Technical Notes:
Section 40 provides rules for determining a taxpayer's gain or loss from the disposition of a
property. The Act contains a number of rules that defer recognition of a loss in certain
circumstances, such as the rules set out in subsections 40(3.4) and (3.6). In broad terms these
defer a taxpayer's loss where, despite a disposition by the taxpayer, the loss property remains
within—or an identical property is acquired by—the population of persons who are affiliated with
the taxpayer.
Proposed amendments to subsection 251.1(1), concerning when a person is affiliated with a
trust, could in some typical estate and post-mortem arrangements cause these loss-deferral
rules to apply. For example, an individual who is the majority interest beneficiary of the estate of
a deceased taxpayer will be affiliated with the estate under the proposed amendments, as would
be the estate and a corporation controlled by that individual. As a result, a loss arising, for
instance, from a redemption by the corporation of a share held by the estate would be deemed
to be nil by subsection 40(3.6). This would include a loss arising in the course of administering
the estate that would otherwise be capable of being carried back under subsection 164(6). That
subsection allows a deceased taxpayer's legal representative to elect to treat certain losses of
the taxpayer's estate for its first taxation year as losses of the taxpayer for the taxpayer's last
taxation year.
New subsection 40(3.61) will ensure that subsections 40(3.4) and (3.6) do not apply to any
portion of an estate's capital loss carried back under subsection 164(6). (emphasis added)
Interaction of Subsections 40(3.6), 40(3.61) and 164(6) – the “Circularity” Issue
As discussed in more detail in the Moraitis/Kakkar Article, if subsections 40(3.6), 40(3.61) and
164(6) are applied iteratively, the realization by the estate of any capital gain in the estate’s first
59
60
Section 251.1.
Subsection 40(3.4) is another stop-loss rule which may apply to defer the recognition of a capital loss sustained
by a corporation, trust or partnership in circumstances where the transferred property (or property identical to
such property) is acquired by the transferor or a person affiliated with the transferor within a specified period.
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taxation year will have the effect of grinding to nil the amount of the loss that can be carried
back pursuant to subsection 164(6), even if the loss is substantial and the gain is only nominal.
By way of example, assume the following:
• Ms. Y dies owning:
o
a portfolio of managed publicly-traded securities, which securities are assumed
(for illustrative purposes) not to have had any accrued gain or loss on death; and
o all of the shares of a private corporation, YCo, with PUC of $100,000.
• The shares of YCo were held by Ms. Y as capital property for purposes of the Act and
had an ACB to Ms. Y of $100,000 and an FMV immediately prior to Ms. Y’s death of
$1,000,000. Accordingly, the deemed disposition of the YCo shares gives rise to a
$900,000 capital gain in Ms. Y’s terminal year.
• In the estate’s first taxation year, YCo redeems 50% of the shares held by the estate for
$500,000. 61 As a result of the redemption, the estate sustains a $450,000 capital loss.
The estate is also deemed to have received a $450,000 dividend (i.e., the amount by
which the redemption proceeds exceed the PUC of the shares that were redeemed).
The estate should be entitled to elect pursuant to subsection 164(6) to apply the loss sustained
on the redemption against the gain realized on the disposition on death.
However, assume further that, in the ordinary course, a nominal capital gain (e.g., $1) is
realized on the publicly-traded securities such that the net capital loss of the estate in its first
taxation year is $449,999 rather than $450,000.
Prior to the application of subsection 40(3.6), the maximum amount that the estate would be
able to elect to carry back pursuant to subsection 164(6) is $449,999 (i.e., the estate’s net
capital loss for its first taxation year assuming that subsection 40(3.6) does not apply).
Subsection 40(3.61) provides that subsection 40(3.6) will apply in respect of the loss on the
redemption to the extent that the amount of the loss (i.e., $450,000) exceeds the portion of the
loss to which the subsection 164(6) election applies (i.e., $449,999). As a consequence, $1 of
the loss on the redemption is denied pursuant to subsection 40(3.6).
If subsections 40(3.6), 40(3.61) and 164(6) are interpreted iteratively (i.e., in a manner giving
rise to the circularity concern), one must recalculate the amount of the subsection 164(6)
election to account for the amount of the loss denied pursuant to subsection 40(3.6). This
recalculation, in turn, will affect the subsection 40(3.61) calculation and so on, with the end
result that no amount may be carried back pursuant to subsection 164(6).
As discussed in more detail below under the heading “Statutory Interpretation”, in the authors’
view, this interpretation should be rejected since it leads to an absurd result that is clearly
contrary to the context and purpose of subsections 40(3.61) and 164(6).
61
As YCo’s sole shareholder, the estate is affiliated with YCo pursuant to section 251.1 both prior to and following
the redemption.
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Chris Falk
Stefanie Morand
McCarthy Tétrault LLP
2012 STEP Conference
At the 2012 STEP Conference, the CRA was asked whether it would administratively ignore
subsections 40(3.6) and (3.61) when determining the net capital loss for purposes of subsection
164(6).
The specific question posed to the CRA and the CRA’s response were as follows:
QUESTION 5
There can be an issue when an estate elects under subsection 164(6) to apply a capital loss to
the terminal return of the deceased. It is possible to create “circularity” under 164(6), when an
estate carries back a loss but then realizes a capital gain on other assets in its first taxation
year. See Nick Moraitis and Manu Kakkar's Taxfind article "Potential Circularity Problem with
Estate Loss Carryback" published by the CTF. How would CRA interpret 164(6) in such
circumstances Would you administratively ignore subsections 40(3.6) and 40(3.61) when
determining the net capital loss for purposes of 164(6)
CRA Response
[…]
We have reviewed the article referred to in your question and agree, based on a technical
reading of the above provisions, that it is possible for a circularity issue to arise. If the estate
realizes capital gains during its first taxation year, those gains must be applied against the loss
on the share disposition, in accordance with the requirements of subsection 164(6), in order to
determine the amount that can be carried back. Where this occurs, the application of subsection
40(3.61) will result in an amount of loss stopped pursuant to subsection 40(3.6), which in turn
will reduce the amount available for the subsection 164(6) election, and the circular nature of
these provisions becomes an issue.
To date, however, the Income Tax Rulings Directorate has not been informed of an actual case
in which this issue has arisen. We suspect that the incidence of this potential circularity issue is
likely quite limited, for a number of reasons:
1. One would expect that typically, estates should not realize significant gains in their
first taxation years, as assets acquired at the time of death would generally be acquired
at fair market value pursuant to subsection 70(5).
2. The ability to distribute assets of the estate to its beneficiaries on a rollover basis
pursuant to subsection 107(2), where applicable, would avoid the generation of gains in
the estate in respect of such asset dispositions.
3. Given that the issue was identified in the above-referenced article, many practitioners
are no doubt aware of it and are ensuring that capital gains are deferred beyond the first
taxation year of the estate.
We would appreciate if any of your members encounter such an example, that it be provided to
CRA, so that we can review the issue further on a case-by-case basis.
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Chris Falk
Stefanie Morand
McCarthy Tétrault LLP
Statutory Interpretation
The principles governing the interpretation of tax statutes have been considered in a number of
decisions of the Supreme Court of Canada. 62 In Canada Trustco, the Court summarized the
approach to statutory interpretation as follows (at paragraph 10):
It has been long established as a matter of statutory interpretation that “the words of an Act are
to be read in their entire context and in their grammatical and ordinary sense harmoniously with
the scheme of the Act, the object of the Act, and the intention of Parliament”: see 65302 British
Columbia Ltd. v. Canada, 1999 CanLII 639 (S.C.C.), [1999] 3 S.C.R. 804, at para. 50. The
interpretation of a statutory provision must be made according to a textual, contextual and
purposive analysis to find a meaning that is harmonious with the Act as a whole. When the
words of a provision are precise and unequivocal, the ordinary meaning of the words play a
dominant role in the interpretive process. On the other hand, where the words can support
more than one reasonable meaning, the ordinary meaning of the words plays a lesser role. The
relative effects of ordinary meaning, context and purpose on the interpretive process may vary,
but in all cases the court must seek to read the provisions of an Act as a harmonious whole.
(emphasis added.)
The Court added the caution that “[e]ven where the meaning of particular provisions may not
appear to be ambiguous at first glance, statutory context and purpose may reveal or resolve
latent ambiguities”. 63
More recently, in Placer Dome, 64 the Supreme Court of Canada affirmed the statements in
Canada Trustco and provided the following guidance regarding the appropriate role of legislative
purpose in statutory interpretation (at paragraphs 22 and 23):
[W]here the words of a statute give rise to more than one reasonable interpretation, the ordinary
meaning of words will play a lesser role, and greater recourse to the context and purpose of the
Act may be necessary: Canada Trustco, at para. 10. Moreover, as McLachlin C.J. noted at
para. 47, “[e]ven where the meaning of particular provisions may not appear to be ambiguous at
first glance, statutory context and purpose may reveal or resolve latent ambiguities.” The Chief
Justice went on to explain that in order to resolve explicit and latent ambiguities in taxation
legislation, “the courts must undertake a unified textual, contextual and purposive approach to
statutory interpretation”.
The interpretive approach is thus informed by the level of precision and clarity with which a
taxing provision is drafted. Where such a provision admits of no ambiguity in its meaning or in
its application to the facts, it must simply be applied. Reference to purpose of the provision
“cannot be used to create an unexpressed exception to clear language” […] Where, as in this
case, the provision admits of more than one reasonable interpretation, greater emphasis must
be placed on the context, scheme and purpose of the Act. Thus, legislative purpose may not be
used to supplant clear statutory language, but to arrive at the most plausible interpretation of an
ambiguous statutory provision. (emphasis added)
The meaning of the text of subsection 40(3.61), even without regard to context and purpose, is
uncertain. Subsection 40(3.61) clearly contemplates that subsection 164(6) applies before
62
63
64
See, for example, Antosko v. The Queen, 94 DTC 6314 (SCC); Canada Trustco, supra, note 28; and Placer
Dome, infra, note 64.
Supra, note 28, at para. 47.
Placer Dome Canada Ltd. v. Ontario (Minister of Finance), 2006 DTC 6532 (SCC).
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Chris Falk
Stefanie Morand
McCarthy Tétrault LLP
subsection 40(3.6) is considered. In the authors’ view, it is not self-evident that the combination
of subsections 40(3.6), 40(3.61) and 164(6) requires an iterative reading of the provisions (i.e., a
reading which seems absurd even without regard to context and purpose). Rather, given the
provisions of subsection 40(3.61), even without regard to context and purpose, the provisions
are arguably intended to be read with subsection 164(6) determining the carry-back and
subsection 40(3.6) denying the portion of the loss that is not carried back (the “Alternative
Reading”).
Having regard to the context and purpose of subsections 40(3.61) and 164(6), the authors are
of the view that:
• the iterative reading clearly leads to an absurd result;
• in interpreting the provisions, it should be assumed that the absurd result was not
intended unless no other reading is possible;
• another reading (i.e., the Alternative Reading) is possible and should be preferred since
it better gives effect to context and purpose.
Extent of the Issue
The authors do not agree with the CRA’s statement that the incidence of the circularity issue is
“likely quite limited” if the iterative reading applied.
Further, in the authors’ view, the reasons given by the CRA in support of this statement suggest
that the CRA’s assessment of the prevalence of the issue may be based on an incomplete
understanding of the issue. More particularly, the authors note as follows:
• Reason 1. “One would expect that typically, estates should not realize significant gains
in their first taxation years, as assets acquired at the time of death would generally be
acquired at fair market value pursuant to subsection 70(5).”
Comment: As noted above, it is immaterial whether the estate realizes
“significant” gains. The concern is that given the drafting of the provisions, even
a nominal gain may preclude the estate from carrying back any amount pursuant
to subsection 164(6) if the provisions are interpreted iteratively.
• Reason 2. “The ability to distribute assets of the estate to its beneficiaries on a rollover
basis pursuant to subsection 107(2), where applicable, would avoid the generation of
gains in the estate in respect of such asset dispositions.”
Comment: In many cases, estate assets must be liquidated in order to fund
estate expenses or to comply with instructions set out by the testator.
Furthermore, a tax-deferred rollover pursuant to subsection 107(2) is generally
not available in respect of distributions to beneficiaries who are not resident in
Canada for purposes of the Act.
• Reason 3. “Given the issue was identified in the above-referenced article, many
practitioners are no doubt aware of it and are ensuring that capital gains are deferred
beyond the first taxation year of the estate.”

Chris Falk
Stefanie Morand
McCarthy Tétrault LLP
Comment: Often practitioners are not contacted until months after the death of
the taxpayer and it is not uncommon for the estate to have realized capital gains
in the interim. The realization of gains is especially common in circumstances in
which the assets of the estate include a portfolio of publicly-traded securities.
Need for a Legislative Fix
As noted above, given the text, context and purpose of subsections 40(3.6), 40(3.61) and
164(6), it is the authors’ view that the provisions should be interpreted in a manner which does
not give rise to the circularity issue identified in the Moraitis/Kakkar Article and commented on
by the CRA at the 2012 STEP Round Table.
If, however, contrary to what in the authors’ view is the better interpretation, the provisions are
to be interpreted so as to give rise to the circularity issue due to a technical flaw in the drafting
of subsection 40(3.61), a legislative fix is required so as not to frustrate the underlying purpose
and policy of the provisions. To this end, the need for such a fix would be especially acute
having regard to:
• the widespread nature of the issue;
• the impracticalities of requiring that the estate not realize any capital gains in its first
taxation year;
• the draconian consequences if even a nominal gain is realized;
• the fact that the purpose of subsection 164(6) planning is to relieve against double
taxation; and
• the recent positions of the CRA taking a relatively narrow view as to the availability of
pipeline planning.
In any event, assuming that the authors are correct in their interpretation of the provisions (i.e.,
assuming that the Alternative Reading governs such that the circularity issue does not arise), a
legislative fix might nonetheless be appropriate in respect of two related issues – namely:
• whether the entire gross capital loss should be available for carry-back rather than just
the net amount (i.e., $450,000 rather $449,999 in the example set out above); and
• whether subsection 40(3.61) should be extended to apply to subsection 70(6) spouse
trusts, alter ego trusts and joint spousal or common-law partner trusts as recommended
by the CBA-CICA Joint Committee on Taxation in February 2005. 65
Practical Advice Regarding Subsection 164(6) in Light of CRA’s Position
While the CRA’s position in respect of subsections 40(3.6), 40(3.61) and 164(4) remains
uncertain, the 2012 STEP Conference response has placed tax practitioners on notice that the
65
See also question 8 of the 2012 British Columbia Tax Conference CRA Round Table where the CRA was asked
whether it had any comments or further information to add in respect of the Committee’s submission.
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Stefanie Morand
McCarthy Tétrault LLP
CRA might take the position that even a nominal capital gain will have the effect of grinding to
nil the amount of the loss that can be carried back pursuant to subsection 164(6).
While the authors are of the view that this interpretation should be rejected since it leads to an
absurd result that is clearly contrary to the context and purpose of subsections 40(3.61) and
164(6), they note as follows:
• the CRA has invited practitioners who encounter scenarios where the grind might apply
to contact CRA so that the issue can be reviewed further on a case-by-case basis; 66
• if an advisor is consulted in respect of a possible post-mortem plan, the advisor:
o
o
should counsel the executors/trustees to avoid incurring any capital gains if
possible until after the estate’s first taxation year; and
will need to assess the risk of the grind applying in assessing planning
alternatives;
• the discussion highlights the fact that subsection 164(6) is a highly technical provision
that will not be available in all circumstances; 67
• the relief (if any) afforded by subsection 40(3.61) does not apply in respect of subsection
70(6) spouse trusts, alter ego trusts and joint spousal or common-law partner trusts; and
• consideration could be given to structuring the planning to fit within subsection 69(5). 68
More generally, practitioners are reminded that post-mortem planning can be complicated,
expensive and time-sensitive, but can be greatly facilitated by advance planning. To this end, it
is difficult to overstate the importance of good corporate and tax records, as well as the
importance of having an integrated estate plan that is reviewed regularly in light of changing
circumstances.
ELIGIBLE DIVIDEND DESIGNATIONS FOLLOWING BUDGET 2012
Prior to Budget 2012, the Act required that the recipient of a dividend from a Canadiancontrolled
private corporation (a “CCPC”) be notified at the time the dividend was paid that the
dividend was an eligible dividend. Late designations were not permitted, even where the
corporation had sufficient income taxed at the general corporate rate to make an eligible
dividend designation. Further, the Act did not permit a corporation to designate only a portion of
a dividend paid as an eligible dividend.
Budget 2012 proposed two helpful relieving measures which have since been enacted.
66
67
68
The authors note that they have made a general submission in this respect.
Note also that, in some circumstances, the deceased will have sufficient loss carryforwards or tax credits to
shelter the gain on death such that the subsection 164(6) loss carry-back is of no benefit to the deceased.
Subsection 69(5) provides, in part, that where property of a corporation has been appropriated in any manner
whatever to, or for the benefit of, a shareholder, on the winding-up of the corporation, subsections 40(3.4) and
(3.6) do not apply in respect of any property disposed of on the winding-up.
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Chris Falk
Stefanie Morand
McCarthy Tétrault LLP
Pursuant to subsection 89(14), it is now possible for a corporation paying a taxable dividend to
designate, at the time it pays the dividend, any portion of the dividend as an eligible dividend. 69
The portion of the dividend so designated will qualify for the enhanced dividend tax credit
(“DTC”) and the remaining portion will qualify for the regular DTC.
Pursuant to subsection 89(14.1), late designations are possible provided that: (i) the designation
is made within three years of payment of the dividend, and (ii) the Minister is of the opinion that
the circumstances are such that it would be just and equitable to accept the designation.
* * *
69
A corporation designates a portion of a dividend it pays at any time to be an eligible dividend by notifying in
writing at that time each person or partnership to whom the dividend is paid that the portion of the dividend is an
eligible dividend.
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TABLE OF CONTENTS
INTRODUCTION ........................................................................................................................ 1
Pipeline Planning .................................................................................................................. 1
Subsection 164(6) Capital Loss Planning............................................................................ 2
Eligible Dividend Designations Following Budget 2012 ..................................................... 2
PIPELINE PLANNING ................................................................................................................ 3
Background – Post-Mortem Tax Planning ........................................................................... 3
How and When Capital Loss Carry-Back Planning and Pipeline Planning are Used ....... 4
CRA’s Position Regarding Pipelines ................................................................................... 5
Provisions and Scheme of the Act Relevant to Pipelines .................................................. 8
Recent Jurisprudence ........................................................................................................ 10
McClarty Family Trust ......................................................................................................... 10
MacDonald 11
The Facts 12
Comparables ....................................................................................................................... 13
The Decision – Subsection 84(2) ....................................................................................... 14
The Decision – GAAR ......................................................................................................... 16
Relevance of the Decision .................................................................................................. 18
Practical Advice Regarding Pipelines in Light of CRA’s Position ................................... 18
SUBSECTION 164(6) CAPITAL LOSS CARRY-BACK PLANNING ........................................ 19
Background ......................................................................................................................... 19
Subsections 40(3.6) and 40(3.61) ....................................................................................... 20
ELIGIBLE DIVIDEND DESIGNATIONS FOLLOWING BUDGET 2012 .................................... 26
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