6 February 2003 External T.I. 2002-0177105 - SUPERFICIAL LOSS V. CHILD

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: If a parent transfers shares to his or her child in order to trigger an accrued capital loss on the shares, does the superficial loss rule apply to the parent's capital loss and is any future capital gains realized by the child attributed to the parent?

Position: Superficial loss does not apply. Capital gains realized by the child are not attributed to the parent, except in circumstances involving ITA 75.1

Reasons: A superficial loss may arise if "affiliated persons" are involved; however, a parent and child are not affiliated under ITA 251.1. Under ITA 74.2, capital gains are not attributed from a child to the parent; however, attribution of capital gains realized by a child not of age 18 may occur in respect of certain farm-related properties if ITA 75.1 applies.

XXXXXXXXXX 2002-017710
S. Parnanzone
February 6, 2003

Dear XXXXXXXXXX:

Re: Technical Interpretation Request: Capital Losses

This is in reply to your undated letter and further to our letter to you of December 3, 2002 regarding the above-noted subject.

As we understand your situation, you are contemplating what to do with shares you own which have fallen in value below their acquisition cost. You enclosed with your letter a copy of an article by Tim Cestnick in the Globe and Mail of October 19, 2002. The article discusses the carryover period of net capital losses. It also indicates that a parent can give investments that have dropped in value to his or her children in order to trigger the recognition of accrued capital losses and pass the future growth on the investments to the children, so that the children, rather than the parent, are taxed on that growth. The article explains that a capital loss triggered by a parent giving investments to his or her children can be claimed by the parent and will not be denied under the superficial loss rules because "your kids aren't "affiliated" with you" under Canadian income tax law.

Your question concerns whether you can trigger a capital loss by transferring ownership of your depreciated shares to your child and claim such loss in your tax return. You also would like confirmation that if the value of the shares rises after the shares are disposed of to your child, the child will be responsible for reporting any capital gains.

Our Comments

The particular circumstances in your letter on which you have asked for our views appear to be a factual situation involving a specific taxpayer. As explained in Information Circular 70-6R5, it is not this Directorate's practice to comment on proposed transactions involving specific taxpayers other than in the form of an advance income tax ruling. Should your situation involve a completed transaction, you should submit all relevant facts and documentation to the appropriate tax services office for their views. However, we are prepared to offer the following general comments, which may be of assistance.

In order to confirm the tax consequences arising from a particular transaction or series of transactions, it is necessary to have complete details. Since the situation you have described is general in nature, our comments below are also general and may or may not be applicable to transactions you may undertake in respect of your shares.

Our comments below are based on the assumption that your shares are capital property and any gain or loss from their disposition constitutes a capital gain or a capital loss. Nevertheless, we would note that whether gains or losses from shares transactions are on capital account (i.e., capital gains or capital losses) or on income account (i.e., business income or loss) is a determination of fact based on the circumstances of the case under review. This is discussed in Interpretation Bulletin IT-479R, Transaction in Securities, as amended by the special release IT-479RSR. We also assume that the shares you are referring to are shares listed on prescribed stock exchange.

In general, a taxpayer's allowable capital loss incurred in a particular taxation year is applied against taxable capital gains realized in that year and any excess is included in the computation the "net capital loss" for the particular year. A net capital loss can be applied against net taxable capital gains in the carryover period. The carryover period is the 3 years immediately preceding and any year following the particular taxation year. However, a claim of a capital loss is denied if the loss meets the definition of "superficial loss".

In general terms, the Income Tax Act (the "Act") provides that a loss from the disposition of property that is considered to be a superficial loss cannot be deducted immediately, but rather must be added to the "adjusted cost base" (i.e., basically the cost for tax purposes) of the same or identical property acquired within a prescribed period of time. These rules operate to defer the recognition of losses for income tax purposes.

Section 54 of the Act sets out the circumstances in which a loss will be a superficial loss. Generally, a superficial loss will occur when a taxpayer disposes of capital property at a loss and:

? the taxpayer, or a person affiliated with the taxpayer, acquires the same or identical property (referred to as "substituted property") during the period starting 30 days before the disposition and ending 30 days after the disposition; and

? the taxpayer, or a person affiliated with the taxpayer, still owns, or has a right to acquire, the substituted property 30 days after the disposition.

For purposes of the definition of "superficial loss," a right to acquire a particular property is generally deemed to be property that is identical to the particular property.

If the taxpayer or a person affiliated with the taxpayer does not own a substituted property, or does not have a right to acquire such property, at the end of the 30-day period following the disposition, the loss would not be a superficial loss.

Under the rules of section 251.1 of the Act, persons affiliated with a taxpayer may include, for example, the taxpayer's spouse or common-law partner, a corporation that is controlled by the taxpayer or the taxpayer's spouse or common-law partner, or a partnership in which the taxpayer is a majority-interest partner. However, under these rules, a child is not considered affiliated with his or her parent, as noted in the article to which you refer.

Under the Act, there are situations when the income from, or capital gain and losses realized on the disposition of, transferred property by the transferee is attributed back to the transferor of property. These rules are discussed in Interpretation Bulletins IT-510, Transfers and Loans of Property Made After May 22, 1985 to Related Minor and IT-511R, Interspousal and Certain Other Transfers and Loans of Property. The general rule is that capital gains realized by a child on capital property transferred to the child by a parent is not attributed back to the parent but are reported by the child. One exception to this is provided by section 75.1 of the Act. This exception applies to capital gains and capital losses in respect of certain farm-related properties and does not appear to apply to the situation described in your letter.

The subject of capital gains is discussed in more details in the T4037, Capital Gains guide.

While capital gains are generally not attributed back from a child to a parent, it should be noted that subsection 74.1(2) of the Act generally provides that where an individual, in this case the parent, has transferred or loaned property to a related minor, any income (e.g., interest and dividends) or loss for a taxation year from the property or property substituted therefor is deemed to be income or loss of the parent. This attribution rule does not apply in the case where the minor attained the age of 18 years before the end of the year.

Finally, we would like to mention that there are rules in the Act governing transactions between persons who are not dealing at arm's length with each other. Generally speaking and as discussed in Interpretation Bulletin IT-405, Inadequate Considerations - Acquisitions and Dispositions, the rules address transactions that do not occur at fair market value and ensure, amongst other things, that the transferor of property does not artificially reduce the proceeds of disposition and the transferee does not inflate the cost of acquisition. However, certain transactions are allowed to take place, for tax purposes, at other than fair market value under special rules such as, for example, the rollover provisions in subsections 73(3) and (4) relating to certain farm-related properties. Persons considered not to deal at arm's length include individuals who are connected by blood relationship, marriage or common-law partnership or adoption. A parent and his or her child are treated as not dealing at arm's length with each other.

The publications referred to above can be found on the Internet at www.ccra-adrc.gc.ca or can be obtained from the local tax services office.

We trust that the foregoing comments are of assistance.

Yours truly,

Milled Azzi, CA
For Director
Business and Partnerships Division
Income Tax Rulings Directorate
Policy and Legislation Branch

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