14 November 2002 Internal T.I. 2002-0161447 - 40(3.6)

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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CCRA.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.

Principal Issues:

Where a taxpayer is affiliated with a corporation immediately after the redemption of its shares in the corporation, which redemption would result in a capital loss to the taxpayer, whether the CCRA's administrative practice as described in an algebraic formula in the document # 2001-0088155 relating to subsections 40(3.3) & (3.4) would be extended to subsection 40(3.6)?

Position: No.

Reasons:

There is no basis for extending our administrative practice relating to subsections 40(3.3) and (3.4) to subsection 40(3.6).

November 14, 2002

Ottawa Tax Services Office Income Tax Rulings Directorate
Tax Avoidance Section Daniel Wong
280 Slater Street, 15th Floor (613) 954-4949
Ottawa ON

Attention: Dan Rivet
Team Leader 2002-016144

Subsection 40(3.6) of the Income Tax Act (the "Act")

This is in reply to your memorandum of September 6, 2002, wherein you advised that a legal representative ("Representative") of an estate ("Estate") approached the Ottawa TSO and inquired as to whether the Canada Customs and Revenue Agency (the "CCRA") would extend its administrative practice as described in document # 2001-0088155 relating to subsections 40(3.3) and (3.4) to subsection 40(3.6) in the following scenario. You referred the Representative's request to us for our comments. You also indicated that you would wait for our reply before you would respond to the Representative's request.

A taxpayer ("Deceased") died on XXXXXXXXXX. All of his assets, which included XXXXXXXXXX shares of Holdco, were passed on to the Estate. Immediately before his death, the Deceased's XXXXXXXXXX Holdco shares had an aggregate fair market value of $XXXXXXXXXX. The executors of the Estate ("Executors") were XXXXXXXXXX.

On XXXXXXXXXX, the Estate transferred its XXXXXXXXXX Holdco shares at their fair market value (being $XXXXXXXXXX) to Canco pursuant to subsection 85(1) of the Act. As sole consideration for such transfer, Canco issued XXXXXXXXXX of its shares to the Estate with an aggregate fair market value of $XXXXXXXXXX. On the same day, Canco redeemed XXXXXXXXXX of its shares held by the Estate for a redemption price of $XXXXXXXXXX. The redemption of the Canco shares held by the Estate resulted in a deemed dividend in the amount of approximately $XXXXXXXXXX and a capital loss of the same amount to the Estate. The Estate controlled Canco before and immediately after the redemption of its XXXXXXXXXX Canco shares.

The Executors elected to carry back the Estate's capital loss of $XXXXXXXXXX to the Deceased's T1 terminal return pursuant to subsection 164(6). The Estate has had no other acquisitions or dispositions of Canco shares since the redemption of its XXXXXXXXXX Canco shares as described above.

However, the Representative was concerned that the Estate's capital loss of $XXXXXXXXXX might be denied under the stop-loss rules in subsection 40(3.6), as the Estate controlled Canco immediately after the redemption of its Canco shares, which control would make the Estate and Canco affiliated with each other at that time. Consequently, paragraph 40(3.6)(a) would, on its face, appear to apply.

The Representative referred to our technical interpretation #2001-0088155 (dated July 4, 2001) ("Document") wherein a taxpayer (a trust) purchased 100 common shares of XYZ Co. on January 1, 2000, and sold 99 XYZ Co. common shares on January 25, 2000, incurring a capital loss from the disposition. The taxpayer had no other purchases or dispositions of the XYZ Co. common shares during the period that begins 30 days before and ends 30 days after the January 25 disposition. In the Document, we administratively allowed the taxpayer to use an algebraic formula (as described therein) to determine which portion of the capital loss should be allowed and which portion should be denied under subsection 40(3.4).

The Representative queried as to whether we would extend our administrative practice relating to subsections 40(3.3) and (3.4) to subsection 40(3.6) such that, if allowed, only XXXXXXXXXX of the Estate's capital loss from the disposition of its XXXXXXXXXX Canco shares would be denied under the stop-loss rules in subsection 40(3.6).

In your memorandum, you indicated that the Verification and Enforcement Division of the Ottawa TSO has not verified the amounts identified in the Representative's letter. In particular, you expressed concern as to why the XXXXXXXXXX Canco shares, that had an aggregate fair market value of approximately $XXXXXXXXXX on XXXXXXXXXX, were redeemed for $XXXXXXXXXX on that day. We share your concern in this regard.

Our Comments

Subsection 40(3.6) denies a taxpayer's capital loss from the disposition, by the taxpayer to a corporation, of its shares in the corporation, where the taxpayer and the corporation are affiliated with each other immediately after the disposition. Paragraph 40(3.6)(a) states:

"40(3.6)-Where at any time a taxpayer disposes, to a corporation that is affiliated with the taxpayer immediately after the disposition, of a share of a class of the capital stock of the corporation (other than a share that is a distress preferred share as defined in subsection 80(1)),

(a) the taxpayer's loss, if any, from the disposition is deemed to be nil;".

In our view, there is no basis for extending our administrative practice relating to subsections 40(3.3) and (3.4) to subsection 40(3.6).

Finally, although, as stated above, paragraph 40(3.6)(a) would apply to deny the Estate's loss from the disposition of its Canco shares, paragraph 40(3.6)(b) would add the loss to the adjusted cost base of the Estate's remaining XXXXXXXXXX Canco shares after the disposition.

For your information, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Legislation Access Database (LAD) on the Department's mainframe computer. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, they can be provided with the LAD version or they may request a copy severed using the Privacy Act criteria which does not remove client identity. Requests for this latter version should be made by you to Jackie Page at (819) 994-2898. The severed copy will be sent to you for delivery to the client.

We trust that our comments will be of assistance.

for Director
Reorganizations and Resources Division
Income Tax Rulings Directorate
Policy and Legislation Branch