24 July 2003 Internal T.I. 2003-0029727 - Net Capital Loss Carryback

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: (1) The timing of a disposition in the context of a share-for-share exchange where the shares of the acquiror corporation must be held by the exchanging shareholder for a minimum period of time due to applicable securities laws and (2) Whether a net capital loss arising in the 2001 taxation year may be deducted against capital gains arising in the 1996 taxation year on an administrative basis?

Position: (1) The disposition of the target's shares occurs when the exchanging shareholder becomes entitled to the shares of the acquiror. (2) Paragraph 111(1)(b) clearly provides that net capital losses may only be carried back to the three immediately preceding taxation years.

Reasons: The law.

SECTION: s. 54 "disposition"

XXXXXXXXXX
XXXXXXXXXX Tax Services Office
XXXXXXXXXX 2003-002972
J. MacGillivray
(613) 948-5274
July 24, 2003

Dear Sir:

Re: Net Capital Loss Carryback

Reference is made to our telephone conversations of July 11 and 14, 2003 (XXXXXXXXXX/MacGillivray) and your e-mail correspondence of July 14, 2003 in which you requested our views with respect to the completed transactions described below, which are presently being reviewed by your office.

In 1996, the taxpayer ("Mr. X"), an individual who at all relevant times was a resident of Canada for the purposes of the Income Tax Act (Canada) (the "Act"), held shares in the capital stock of a taxable Canadian corporation ("Canco Shares"). In 1996, Mr. X entered into and completed a transaction in which he exchanged his Canco Shares for shares of a non-resident corporation ("ForeignCo Shares"). Mr. X did not report a disposition of the Canco Shares in his 1996 Part I income tax return as he was not aware that the exchange was required to be reported. Had the exchange been reported as a disposition of capital property in Mr. X's 1996 income tax return, you advise that Mr. X would have included a taxable capital gain in his income since the proceeds of disposition for the Canco Shares exceeded the adjusted cost base of the Canco Shares.

Due to restrictions under United States securities laws, you have advised that Mr. X was prohibited from disposing of the ForeignCo Shares that he received in exchange for the Canco Shares for a 24-month period (i.e., Mr. X was unable to sell his ForeignCo Shares until 1998). Mr. X held the ForeignCo Shares until 2001, at which time he disposed of them, realizing a capital loss on the disposition.

Mr. X's 1996 income tax return has been reassessed, with the result that a taxable capital gain from the exchange of the Canco Shares has been added to his income. He has appealed such reassessment. In response to arguments raised by Mr. X's representatives, you wish to know whether the capital losses from the disposition of the ForeignCo shares in Mr. X's 2001 taxation year could be carried back to offset the capital gain realized by Mr. X on the disposition of Canco Shares pursuant to the exchange because (i) the restrictions from trading the ForeignCo Shares under United States securities laws postponed the disposition of the Canco Shares until 1998, thereby allowing the carryback of net capital losses arising in the 2001 taxation year, or (ii) given that Mr. X did not realize that the exchange of Canco Shares for ForeignCo Shares gave rise to a disposition of capital property for Canadian income tax purposes until it was too late to take advantage of the three-year net capital loss carryback period, administrative relief should be provided to allow for the carryback of net capital losses from the 2001 taxation year to the 1996 taxation year.

Our Comments

We do not agree that the net capital loss realized by Mr. X in 2001 by virtue of the disposition of the ForeignCo Shares can be carried back and applied against the capital gain arising from the disposition of Mr. X's Canco Shares that occurred as a result of the exchange.

At the time of the relevant transactions, the definition of the term "disposition" was contained in s. 54 of the Act. The definition read, in part, as follows:

'"disposition" of any property, except as expressly otherwise provided, includes

(a) any transaction or event entitling a taxpayer to proceeds of disposition...'

In the context of a "takeover" transaction, whereby shareholders of a corporation exchange their shares for shares of an acquiror, a disposition of property occurs when the shareholders who trade their shares for others are entitled to receive the shares of the other company.¹ We understand that Mr. X became entitled to receive the ForeignCo Shares in 1996. Therefore, a disposition of Mr. X's Canco Shares occurred in 1996, notwithstanding that Mr. X was prohibited under U.S. securities laws from disposing of the ForeignCo Shares until 1998.

To determine the point in time when Mr. X became entitled to the ForeignCo Shares under the exchange is a question of mixed fact and law. It would be necessary to review the relevant acquisition agreements entered into by ForeignCo, Canco, Mr. X and Canco's other shareholders in 1996 to answer the question. For instance, if the acquisition agreements provided that certain conditions beyond the control of the parties had to be fulfilled before the shareholders of Canco could receive ForeignCo Shares, the disposition of the Canco Shares would likely not have occurred until the conditions were fulfilled. However, based on the facts provided, we understand that the U.S. securities laws in question prohibited the transfer of the ForeignCo Shares until Mr. X held the Canco Shares for a 24-month period. If this holding period started in 1996, then it appears that Mr. X was unconditionally entitled to receive and did in fact receive the ForeignCo Shares in that year. Accordingly, it cannot be said that the disposition of Canco Shares took place in 1998 upon the expiry of the 24-month holding period. Therefore, the 2001 net capital loss cannot be carried back to offset Mr. X's capital gain from the disposition of the Canco Shares on the basis that the disposition occurred in 1998.

As for the second point, s. 111(1)(b) of the Act clearly states that net capital losses for the taxation years preceding a particular taxation year and for the 3 taxation years immediately following the taxation may be deducted in computing the taxpayer's taxable income for the particular taxation year. We do not see any basis for altering the clear implications of this rule even in circumstances where a taxpayer did not know that a capital gain had been realized in a preceding taxation year, thereby missing the opportunity to recognize capital losses that could have been carried back to offset the gain pursuant to s. 111(1)(b).

We trust that the foregoing comments are of assistance.

Yours truly,

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

ENDNOTES

¹ Nauss v. Minister of National Revenue, [1978] C.T.C. 3122 (T.R.B.), 78 D.T.C. 1796.