Presentation Material - McCarthy TÃ©trault

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Chris Falk Stefanie Morand <strong>McCarthy</strong> Tétrault LLP • 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. 560600/422632 MT DOCS 11864055v1G 20
Chris Falk Stefanie Morand <strong>McCarthy</strong> Tétrault LLP 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. 560600/422632 MT DOCS 11864055v1G 21
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