26 November 2020 STEP Roundtable Q. 5, 2020-0847181C6 - Subsections 40(3.61) and 164(6)

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: Review of documents 2012-0449801C6 and 2012-0462941C6. Does the wording of subsection 40(3.61) create a circular grind of the capital loss referred to in subsection 164(6)?

Position: No. Revised position, as subsection 40(3.61) provides that subsection 40(3.4) or 40(3.6) only applies to the capital loss that remains in the estate’s hands after an election pursuant to 164(6) is made.

Reasons: A strict textual reading of subsection 40(3.61) could otherwise produce an iterative "grind", which is contrary to the intended relief of the provision.

2020 STEP CRA Roundtable – November 26, 2020

QUESTION 5. Subsections 40(3.61) and 164(6)

Question 5 of the 2012 STEP CRA Roundtable (document 2012-0449801C6) (footnote 1) discussed a situation in which an estate elects under subsection 164(6) to apply a capital loss resulting from the disposition of shares of the capital stock of a corporation to the terminal T1 return of the deceased individual. The CRA noted that based on a technical reading of the provisions 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.”

CRA also noted that they had not seen an actual situation and that they would review the issue further on a case-by-case basis.

Consider the following example:

• Mr. X (the “taxpayer”) owned all of the common shares of the capital stock of a private corporation (“PrivateCo”) at his death.
• The capital gain on the deemed disposition of the common shares of PrivateCo pursuant to subsection 70(5) and reported on the taxpayer’s terminal T1 return was $4.9 million.
• The taxpayer also owned an investment portfolio.
• Capital gains were realized in the portfolio both prior to the date of death and between the date of death and December 31.
• Capital gains of $30,000 were attributable to the period after the taxpayer’s death. Accordingly, these gains were reported in the estate’s T3 return for its first taxation year.
• As part of the post mortem tax planning, a portion of the common shares of PrivateCo would be redeemed. The redemption of the common shares would create a capital loss of $1 million in the estate which would be applied to the taxpayer’s terminal T1 return by virtue of the legal representative electing pursuant to subsection 164(6).

In applying the CRA’s 2012 position to this situation, the $30,000 of capital gains realized by the estate in its first taxation year would grind the capital loss available for purposes of the subsection 164(6) election. The grind effected by the interaction of subsections 40(3.61) and 40(3.6) and the netting of the estate’s capital gains and capital losses in paragraph 164(6)(a) would be iterative, such that the estate’s $1 million capital loss would ultimately be reduced to nil.

Can the CRA comment on the appropriateness of the result?

CRA Response

Subsection 164(6) of the Act allows the estate of a deceased taxpayer to elect to have all or part of its capital losses (to the extent they exceed its capital gains) that are realized in its first taxation year to be deemed to be capital losses of the deceased. The election, which results in the carry back of the elected amount to the final T1 return of the deceased, can be useful in addressing potential double taxation which may arise where the deceased held shares of the capital stock of a corporation with accrued gains at the time of death.

Subsection 40(3.6) of the Act is a stop-loss rule that applies if a taxpayer disposes of a share of the capital stock of a corporation to the corporation, and the taxpayer is affiliated with the corporation immediately after the disposition. When subsection 40(3.6) applies, the taxpayer’s loss from the disposition is deemed to be nil. Prior to the introduction of subsection 40(3.61), if the estate and the corporation were affiliated immediately after the disposition (typically, on the redemption of shares by the corporation), the capital loss would be stopped, and could not be carried back to be applied on the terminal T1 return.

In general, subsection 40(3.61) was introduced to override the effect of the stop-loss rules in subsections 40(3.4) and (3.6) where an estate's capital loss is being carried back pursuant to subsection 164(6). Subsection 40(3.61), which applies if the estate elects pursuant to subsection 164(6) in respect of a capital loss on the disposition of a share of a corporation, provides that subsections 40(3.4) and (3.6) apply “in respect of the loss only to the extent that the amount of the loss exceeds the portion of the loss to which the election applies.”

The CRA has reconsidered its earlier view and notes that an iterative grind of the estate’s capital loss would yield a result which is contrary to the purpose of the relief provided by subsection 40(3.61). Accordingly, the CRA will not apply subsection 40(3.61) as described in documents 2012-0449801C6 and 2012-0462941C6. The CRA is of the view that pursuant to subsection 40(3.61):

• the subsection 164(6) election applies first, and the capital loss available for the election is determined without reference to subsection 40(3.4) or 40(3.6), and
• the stop loss rules in subsections 40(3.4) or 40(3.6) apply to any capital loss of the estate that is not the subject of the subsection 164(6) election.

Applying this to the example above, the estate’s capital loss for the purpose of the subsection 164(6) election is $1 million. Paragraph 164(6)(a) limits the amount of the election to the net amount of the estate’s capital losses and capital gains, or $970,000. Assuming the legal representative elects on this amount, the $970,000 amount will be deemed to be a capital loss of the deceased taxpayer for the deceased taxpayer’s last taxation year (terminal T1 return) and $30,000 of the estate’s capital loss will remain in the estate. Accordingly, the relieving measure in subsection 40(3.61) preserves the estate’s capital loss that can be applied to the deceased taxpayer’s terminal T1 return. Subsection 40(3.6) would apply to any capital loss of the estate that remains after the election is made – in this case, the remaining capital loss of $30,000 would be deemed to be nil.

In summary, the estate would be taxed on its $30,000 of capital gains because the capital loss that remains in the estate after the election is nil and, in accordance with paragraph 40(3.6)(b), would be added to the adjusted cost base of the common shares of PrivateCo held by the estate after the disposition. A similar result would occur where the estate makes the subsection 164(6) election for an amount that is less than the result of the paragraph 164(6)(a) calculation (for example, if the estate elected for less than $970,000).

It is important to note that the relief provided by subsection 40(3.61) is only in respect of a disposition of a share of the capital stock of a corporation. For example, where the estate has a capital loss from the disposition of property other than shares to an affiliated person such that subsection 40(3.4) applies, for the purposes of computing the amount of the capital loss that is available for the election under subsection 164(6), the exemption in subsection 40(3.61) would not apply. Subsection 40(3.4) would apply and the amount of the capital loss available for the paragraph 164(6)(a) calculation would be deemed to be nil and would be suspended until the earliest of certain events described in paragraph 40(3.4)(b) occurs.

Laura Monteith
Steve Fron
2020-084718

FOOTNOTES

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1 See also document 2012-0462941C6