12 July 2011 External T.I. 2010-0391621E5 - Capital Gains Distributions

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Principal Issues: Whether the distributions from a United States non-diversified closed-end management investment company ("NCMIC") are treated as capital gains or dividend income.

Position: The distributions are treated as dividend income

Reasons: A distribution by a corporation to its shareholders on a pro rata basis constitutes a dividend. Thus, section 90(1), would include amounts in the income of the taxpayer.

XXXXXXXXXX
					2010-039162
					J. Nichols

July 12, 2011

Dear XXXXXXXXXX :

RE: Capital Gains Distributions

This is in response to your letter dated December 30, 2010 wherein you requested clarification on how certain amounts received by a Canadian individual from two separate non-diversified closed-ended management investment companies ("NCMIC") are treated for Canadian income tax purposes. Our understanding of the relevant facts is as follows:

1. Each NCMIC is a corporation resident in the United States.
2. The individual taxpayer owns shares in two separate NCMICs.
3. The taxpayer's NCMIC shares are held through a brokerage account with a stock broker (the "Broker").
4. The NCMICs realized certain capital gains from the disposition of their investments.
5. The NCMICs made announcements to their respective shareholders. The announcements stated that they had declared capital gains and net investment distributions and that the capital gains distributions are comprised of their "long-term capital gains" and "short-term capital gains" (setting out the amount per share of each).
6. The Broker received the distributions from the NCMICs on behalf of the taxpayer and issued T5s wherein it included the distributions in box 15, which is used for reporting foreign income.

You request our views as to the appropriate characterization of the distributions for Canadian income tax purposes.

Our Comments

We believe the appropriate characterization of a distribution from an NCMIC as described above is dividend income and not capital gains. NCMIC gains and income were allocated to each shareholder on a pro rata basis, as a result the distributions are considered dividends and since they were received from a non-resident corporation subsection 90(1) of the Income Tax Act (Canada) (the "Act") applies to include such dividend amounts in income. The taxpayer never sold his shares in either NCMIC, which could trigger a capital gain or loss in the shareholder's hands and the proceeds would be treated accordingly.

Our view is supported by the decision in the case Moyes v The Queen 2010 FCA 18 ("Moyes"). In Moyes, as in this case, the taxpayer received distributions in respect of capital gains realized by certain foreign corporations, which were paid to shareholders on a pro rata basis. None of the amounts received by the taxpayer resulted from the disposal of his shares or units in these corporations. The judge dismissed the taxpayer's appeal because she was of the view that the Minister and the Tax Court of Canada were correct in concluding that the foreign distributions of income to the appellant were dividends for the purposes of the Act.

Although, the NCMICs did make public announcements that they had declared capital gains and net investment income distributions, that, in and of itself, is not sufficient to warrant the treatment of those distributions as capital gains in the hands of the unit holders for the purposes of the Act. The amounts were received from non-resident corporations, and were distributed on a pro rata basis to the shareholders of the NCMICs, thus subsection 90(1) of the Act applies to include these distributions as dividend income from non-resident corporations. Subsections 126(1) or 20(12) of the Act could apply to permit a foreign tax credit or deduction, as the case may be, with respect to any U.S. withholding tax paid on behalf of the Canadian shareholders in respect of such dividend distributions.

For greater certainty, subsection 131(1) of the Act does permit certain Canadian resident corporations to elect in specified circumstances to flow through capital gains dividends to their shareholders if they qualify as a "mutual fund corporation" as defined in subsection 131(8) of the Act. However, a corporation resident in the United States cannot qualify as a "mutual fund corporation" under that definition.

We trust our comments will be of assistance.

Yours truly,

Olli Laurikainen
Manager
International Section II
Income Tax Rulings Directorate
Legislative Policy & Regulatory Affairs Branch