25 February 2005 Internal T.I. 2005-0113531I7 - 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

									2005-011353

This is in response to your fax dated January 27, 2005, concerning transactions whereby a capital loss has been claimed by the taxpayer as a result of a series of transactions designed to eliminate the tax payable on a capital gain realized by the taxpayer.

You ask whether this file should be accorded the same treatment as file 2003-004744. More specifically, you ask whether it would be appropriate for the Minister to designate the two trusts as being the same individual under subsection 104(2) of the Income Tax Act (the "Act") with the result that the loss triggered by the transfer of shares by one of those trusts to the other will be denied.

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

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

3- On XXXXXXXXXX, Trust 1 controls XXXXXXXXXX. The latter owns XXXXXXXXXX common shares of XXXXXXXXXX ("Offsetco"), but the latter is controlled by XXXXXXXXXX. Offsetco controls XXXXXXXXXX ("Highlowco").

4- On XXXXXXXXXX, Offsetco realizes a capital gain by selling shares of XXXXXXXXXX ("Gainco") to XXXXXXXXXX in consideration for shares having a high adjusted cost base and low paid up capital.

5- On XXXXXXXXXX, Highlowco declares a stock dividend of preferred shares having a high redemption value and a nominal stated capital on the shares held by Offsetco.

6- Offsetco sells its shares in Highlowco described in point 4 to Trust 2 for a nominal amount, thereby triggering a capital loss which fully offsets the capital gain described in point 4.

7- After the sale, Offsetco still controls Highlowco. Trust 2 currently still owns the Highlowco shares described in point 6.

8- During XXXXXXXXXX, Highlowco sells Gainco shares and incurs a capital loss.

The loss incurred by Offsetco described in point 6 above results from the fact that the value of the common shares of Highlowco was transferred to the preferred shares described in point 5. Subsections 40(3.3) and (3.4) of the Act provides that the loss will be considered to be nil if Trust 2 is affiliated to Offsetco. That condition is not met because Offsetco is controlled by XXXXXXXXXX and not by Trust 2. A designation made under subsection 104(2) of the Act in respect of this transaction or of other transactions would not make those provisions applicable.

However, we recommend applying GAAR to deny the tax benefit that resulted from the loss described in point 6. 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