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560600/422632 MT DOCS 11864055v1G 24 Chris Falk Stefanie Morand <strong>McCarthy</strong> 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 <strong>McCarthy</strong> 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. 560600/422632 MT DOCS 11864055v1G 25
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