25 February 2005 Internal T.I. 2005-0113521I7 - Artificial 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.

Principal Issues: Whether the stop loss rules or GAAR apply to deny the tax benefit resulting from a loss which is created through a series of transactions including the issuance of shares having a high redemption value and a low paid up capital.

Position: We recommend applying GAAR.

Reasons: Previous positions from the GAAR committee.

									February 25, 2005

	Kathie Cameron						HEADQUARTERS
	Tax Avoidance Section Kitchener/				Income Tax Rulings
	Waterloo Tax Services TSO					  Directorate
	166 Frederick Street						Yves Moreno
	Kitchener ON							(613)952-1764

									2005-011352

This is in response to your fax dated January 27, 2005, concerning transactions whereby a capital gain and an offsetting capital losses have been triggered.

You ask whether this file can get the same treatment as file 2003-004744. More specifically, you ask whether the designation of two trusts as being the same individual according to subsection 104(2) of the Income Tax Act (the "Act") will result in the denial of a loss triggered by the transfer of shares by one of those trusts to the other.

The facts which are relevant to that determination can be summarized as follows:

1- The XXXXXXXXXX ("Trust 1") is settled in XXXXXXXXXX by the father of XXXXXXXXXX.

2- The beneficiaries of Trust 1 are XXXXXXXXXX, his wife and his children.

3- On XXXXXXXXXX ("Lossco") is incorporated. Trust 1 controls Lossco.

4- On XXXXXXXXXX, the father of XXXXXXXXXX also settles XXXXXXXXXX ("Trust 2"). The beneficiaries of Trust 2 are the children of XXXXXXXXXX.

5- On XXXXXXXXXX, Trust 1 subscribes for common shares of Lossco by using a daylight loan. Trust 1 uses the proceeds of the daylight loan to purchase shares of Lossco. The stated capital of those shares is then reduced to a nominal amount and the amount of that reduction is added to the contributed surplus of Lossco. The latter then lends money to XXXXXXXXXX who uses it to repay the daylight loan.

6- On XXXXXXXXXX, Lossco declares a stock dividend of preferred shares having a high redemption value and a nominal stated capital on the shares described in point 5.

7- On XXXXXXXXXX, Trust 1 sells shares in Lossco to Trust 2, thereby triggering a capital loss. That loss was presumably used to offset a capital gain realized in XXXXXXXXXX.

8- Trust 2 still owns all the shares described in point 6 above.

According to your statement of facts, both trusts have the same settlor. Also, both trusts have common beneficiaries, being the children of the settlor's son. Trust 1 has additional beneficiaries, namely the settlor's son and the latter's wife.

We consider that the rationale described in document 2003-004744 can be applied to this case to support a designation of both trusts as being the same individual for the purposes of subsection 104(2) of the Act. Therefore, if the Minister makes the designation described in that subsection, the trustees of both trusts will be deemed to be the same individual. That would make both trusts affiliated because an individual is considered to be affiliated with himself. Accordingly, provided that such designation is made by the Minister, subsection 40(3.4) of the Act would deny the loss that was triggered by the disposition of the shares described in point 8 above. That loss will be deemed to be realized at the time that is immediately before those shares are disposed of to a person who is not affiliated with the transferor.

We also recommend applying GAAR to deny the tax benefit that would result from the loss described in point 8 if subsection 40(3.4) of the Act did not apply. A file involving the issuance of high/low preferred shares to trigger a capital loss without an economic loss was submitted to the attention of the GAAR committee on February 15, 2005. The submission indicates that the GAAR committee recommended the application of GAAR in similar cases on

November 23, 2004, May 5, 2004 and in decisions 98122, 96111 and 95094.

The above comments represent our general views with respect to the subject matter of your letter and are provided in accordance with paragraph 22 of Information Circular 70-6R5.

Yours truly,

T. Murphy
for Director
International & Trusts Division
Income Tax Rulings Directorate
Policy and Planning Branch