18 February 2003 External T.I. 2002-0180915 - CAPITAL LOSS

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: Can a corporation claim a capital loss with respect to shares which have decreased in value?

Position: Question of fact.

Reasons: General discussion of subsections 50(1), 40(3.3), 40(3.4) and the definition of a "superficial loss".

XXXXXXXXXX 	2002-018091
		Karen Power, CA
(613) 957-8953
February 18, 2003

Dear XXXXXXXXXX:

Re: Capital Loss

We are writing in response to your facsimile of December 19, 2002 wherein you requested our comments regarding a taxpayer's ability to claim a capital loss under the Income Tax Act (the "Act"). Specifically you describe a situation in which a corporation (the "Corporation") has invested in shares of a company listed on a prescribed stock exchange. The Corporation's monthly brokerage statements indicate that the fair market value of the publicly traded shares is NIL. You enquire whether the Corporation may claim a capital loss on such shares. We assume for the purpose of our comments that the securities are capital property.

Our Comments

Your request appears to relate to an actual situation. Confirmation of the income tax consequences of transactions or events involving specific taxpayers will only be provided in response to a request for an advance income tax ruling submitted in accordance with the guidelines set out in Information Circular 70-6R5 Advance Income Tax Rulings dated May 17, 2002. However, if the situation relates to a completed transaction, it is the responsibility of the local Tax Services Office. We can, however, provide the following general comments.

Generally, a shareholder can only claim a capital loss when he or she disposes of the share to an unaffiliated person. However, as discussed in paragraph 6 of Interpretation Bulletin IT-484R2 "Business Investment Losses" subsection 50(1) of the Act deems a taxpayer to have disposed of a debt or a share of a corporation at the end of a taxation year for nil proceeds and to have reacquired it immediately thereafter at a cost of nil if:

(a) in the case of a debt (other than a debt from the sale of personal-use property), the debt is owing to the taxpayer at the end of the taxation year and it is established by the taxpayer to have become a bad debt in the year; and

(b) in the case of a share (other than a share received as consideration from the sale of personal-use property), the taxpayer owns the share of the corporation at the end of the taxation year and the corporation:

(i) has become a bankrupt (as defined by the Bankruptcy and Insolvency Act) in the year;

(ii) is a corporation referred to in section 6 of the Winding-up Act that is insolvent (within the meaning of that Act) and for which a winding-up order under that Act was made in the year; or

(iii) at the end of the year, is insolvent, and neither the corporation, nor a corporation it controls, carries on business. Also, at that time, the share has a fair market value of nil and it is reasonable to expect that the corporation will be dissolved or wound-up and will not commence to carry on business.

A taxpayer must elect to have subsection 50(1) apply in respect of a debt or a share. If subsection 50(1) applies, the taxpayer is deemed to have disposed of the property for nil proceeds, as noted above, and a capital loss may arise. Amounts subsequently realized on the actual disposition of the shares are taxed as capital gains. In your particular situation, we are unable based on the information provided to determine whether any of the conditions in (i) through (iii) above have been met.

Where the Corporation is unable to claim a capital loss without an actual disposition, you enquire whether the Corporation can trigger the capital loss by disposing of its publicly traded shares for proceeds of $1 to a minor child of the sole shareholder of the Corporation.

Subsections 40(3.3) and (3.4) of the Act operate to defer the recognition of capital losses on certain dispositions of non-depreciable capital property. Where the conditions set out in subsection 40(3.3) are satisfied, subsection 40(3.4) deems the transferor's capital loss, if any, from the disposition to be nil (the "denied loss") until the earliest of several possible events described in subsection 40(3.4) occur. In general terms, subsection 40(3.3) provides that subsection 40(3.4) applies when:

(a) a corporation, trust or partnership disposes of a particular capital property;

(b) during the period that begins 30 days before and ends 30 days after the disposition, the transferor or a person affiliated with the transferor acquires a property (referred to as "substituted property") that is, or is identical to, the particular property; and

(c) at the end of the period, the transferor or a person affiliated with the transferor owns the substituted property.

When these stop-loss rules apply, generally the transferor's denied loss will only become available for deduction by the transferor when the substituted property (or a property that is identical to the substituted property and was acquired during the period discussed in paragraph 40(3.4)(b) of the Act) is no longer held by the transferor or a person who is affiliated with the transferor.

Where subsection 40(3.4) does not apply to deny a loss, one must determine whether the "superficial loss" rules contained in section 54 of the Act could apply to deny the loss. 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 of the same or identical property as provided in paragraph 53(1)(f) of the Act. 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.

Persons affiliated with a taxpayer are defined in subsection 251.1(1) of the Act. Paragraph (b) of the definition provides that a corporation is affiliated with :

(i) a person by whom the corporation is controlled,

(ii) each member of an affiliated group of persons by which the corporation is controlled, and

(iii) a spouse or common-law partner of a person described in subparagraph (i) or (ii).

In the situation you describe, the minor child of the sole shareholder of the Corporation would not be affiliated with the Corporation. Consequently, the "superficial loss" rules contained in section 54 of the Act and the stop-loss rules of subsections 40(3.3) and 40(3.4) would not apply to deny the capital loss incurred on disposition of the publicly traded shares to a minor child.

It should be noted that in order for a capital loss to occur in respect of a property, there must be a "disposition" of the property. Accordingly, the tax consequences of the situation you describe will depend on whether they result in a disposition of the shares to the child. Paragraph (e) of the definition of the term "disposition" in subsection 248(1) of the Act generally provides that a disposition will not occur as a result of any transfer of property as a consequence of which there is no change in the beneficial ownership thereof. Is it a question of fact whether there has been a change in the beneficial ownership. In this regard, reference should be made to paragraphs 2 to 5 of Interpretation Bulletin IT-437R, Ownership of Property (Principal Residence), which generally discuss beneficial ownership.

We trust our comments will be of assistance to you.

Yours truly,

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

- 4 -