This translation was prepared by Tax Interpretations Inc. The CRA did not issue this document in the language in which it now appears, and is not responsible for any errors in its translation that might impact a reader’s understanding of it or the position(s) taken therein. See also the general Disclaimer below.
Principal Issues: [TaxInterpretations translation]
1) For the purposes of subparagraph 50(1)(b)(i) of the Act, in what taxation year of the parent did the two subsidiary corporations become bankrupt?
2) If both subsidiaries became bankrupt in the parent's taxation year ending XXXXXXXXXX, can the parent make a subparagraph 50(1)(b)(iii) election for XXXXXXXXXX?
3) Are the capital losses that arise to the parent corporation from the deemed disposition of its shares in its two subsidiary corporations under subsection 50(1) business investment losses for XXXXXXXXXX?
1) Subsidiary corporations became bankrupt on the date of the filing of the Notice of Intention, i.e. during the taxation year of the parent corporation ending on XXXXXXXXXX.
3) Yes, provided that the subsidiary corporations were SBCs.
1) Application of, inter alia, subsection 50.4(8) of the Bankruptcy and Insolvency Act during the taxation years under review.
2) Application of the Act. Reference to the explanatory notes of the Ministry of Finance.
3) Application of the Act.
October 2, 2006
XXXXXXXXXX Income Tax Rulings Directorate
Validation and Enforcement Division Danielle Bouffard
XXXXXXXXXX (613) 590-2155
Paragraph 50(1)(b) of the Income Tax Act
This is in response to your letter of January 18, 2006, requesting our opinion on the above subject. We have taken into account the analysis and information provided by the taxpayers' accounting and legal representatives. We have also reviewed the information you sent us by fax on May 12, 2006.
Unless otherwise indicated, all statutory references below are to the provisions of the Income Tax Act (the "Act").
Designation of Parties and Abbreviations
In this memo, the names and business names of the taxpayers are replaced by the following names and business names:
Our understanding of the facts is as follows:
1. XXXXXXXXXX were two wholly owned subsidiaries of XXXXXXXXXX. The taxation year end of all three corporations was XXXXXXXXXX.
3. As a result of the financial difficulties that occurred during XXXXXXXXXX, staffing levels in XXXXXXXXXX and XXXXXXXXXX were reduced to a minimum and assets were put up for sale in XXXXXXXXXX. In XXXXXXXXXX, staff was hired to sell inventory and collect receivables, mainly contract holdbacks. The follow-up of the accounts receivable was carried out by the trustee XXXXXXXXXX. This procedure allowed the bank to realize on the inventory at market value rather than at liquidation value and to sell the assets in whole or in part as a business. On XXXXXXXXXX, given the threats of the corporation' creditors, XXXXXXXXXX filed a notice of intention under section 50.4 of the Bankruptcy and Insolvency Act ("BIA") to make a proposal.
4. The notice of intention of XXXXXXXXXX was renewed until XXXXXXXXXX. However, the trustee failed to file a proposal with the Official Receiver.
5. The inventory of XXXXXXXXXX was taken on XXXXXXXXXX. At that time, the bank laid off the workers who were still employed by XXXXXXXXXX.
6. The XXXXXXXXXX notice of intention of XXXXXXXXXX was not renewed within 30 days of its filing.
7. XXXXXXXXXX made an election under subsection 50(1) of the Act when filing its income tax return for its fiscal period ended XXXXXXXXXX for shares held in XXXXXXXXXX and XXXXXXXXXX to be deemed to have disposed of those shares. The capital losses resulting from the deemed dispositions totalled $XXXXXXXXXX. XXXXXXXXXX treated those losses as business investment losses ("BIL").
We have answered your questions in the order in which you asked them.
For the purposes of subparagraph 50(1)(b)(i), in what taxation year did XXXXXXXXXX respectively become a bankrupt?
Section 50(1) reads, in part, as follows:
Debts established to be bad debts and shares of bankrupt corporation
50 (1) For the purposes of this subdivision, where
b) a share … of the capital stock of a corporation is owned by the taxpayer at the end of a taxation year and
(i) the corporation has during the year become a bankrupt (within the meaning of subsection 128(3)),
(iii) at the end of the year,
(A) the corporation is insolvent,
(B) neither the corporation nor a corporation controlled by it carries on business,
(C) the fair market value of the share is nil, and
(D) it is reasonable to expect that the corporation will be dissolved or wound up and will not commence to carry on business
and the taxpayer elects in the taxpayer’s return of income for the year to have this subsection apply in respect of the debt or the share, as the case may be, the taxpayer shall be deemed to have disposed of the debt or the share, as the case may be, at the end of the year for proceeds equal to nil and to have reacquired it immediately after the end of the year at a cost equal to nil.
As subsection 128(3) was repealed for bankruptcies occurring after April 26, 1995, reference should be made to the definitions in subsection 248(1), where the term "bankrupt" is defined as follows: "has the meaning assigned by the Bankruptcy and Insolvency Act.”
The terms "bankrupt" and "bankruptcy" are defined in section 2 of the BIA as follows:
“bankrupt” means a person who has made an assignment or against whom a bankruptcy order has been made or the legal status of that person;
“bankruptcy” means the state of being bankrupt or the fact of becoming bankrupt;
In addition, the term "time or date of bankruptcy" is defined in section 2.1 of the BIA as follows
Time or date of bankruptcy
2.1 For the purposes of this Act, the bankruptcy or putting into bankruptcy of a person occurs at the time or date of
(a) the granting of a bankruptcy order against the person;
(b) the filing of an assignment by or in respect of the person; or
(c) the event that causes an assignment by the person to be deemed.
According to paragraph 3 of the facts above, XXXXXXXXXX filed a notice of intention to submit a proposal in XXXXXXXXXX. The notice of intention is dealt with in section 50.4 of the BIA which reads, in part, as follows:
Before lodging a copy of a proposal with a licensed trustee, an insolvent person may file a notice of intention, in the prescribed form, with the official receiver in the insolvent person’s locality, stating
(a) the insolvent person’s intention to make a proposal,
If the trustee fails to file the proposal with the official receiver within 30 days after the filing of the notice of intention under subsection 50.4(1) of the BIA (or within the longer period allowed by subsection 50.4(9) of the BIA), the insolvent person is deemed to have made an assignment of his or her property as of the date of the filing of the notice of intention pursuant to subsection 50.4(8) of the BIA.
The taxpayers' legal representatives are of the opinion that the words "became bankrupt" used by the legislator in the BIA have a specific purpose, and that it is such moment that triggers the "state of bankruptcy", with retroactivity for the date of bankruptcy before 1997. They are therefore of the opinion that XXXXXXXXXX became a bankrupt at the time it made an assignment of its property, i.e. on XXXXXXXXXX. No opinion is given as to when XXXXXXXXXX became a bankrupt. On the other hand, the accounting representatives mention in their submissions the following regarding XXXXXXXXXX: "XXXXXXXXXX".
We are of the view that the feedback provided by Parliament in 1996, in particular, in subsection 50.4(8) of the BIA, for the years under review, cannot be ignored and, consequently, XXXXXXXXXX are deemed to have made an assignment of their property on XXXXXXXXXX respectively. According to the definition of "date of the initial bankruptcy" in section 2 of the BIA, the bankruptcy of these two corporations would have occurred on XXXXXXXXXX for XXXXXXXXXX and on XXXXXXXXXX for XXXXXXXXXX, with the result that they became bankrupt on that date within the meaning of the BIA and the Act. Consequently, XXXXXXXXXX became bankrupt in XXXXXXXXXX's taxation year ending on XXXXXXXXXX.
If XXXXXXXXXX became bankrupt in XXXXXXXXXX's taxation year ending on XXXXXXXXXX can it make an election pursuant to subparagraph 50(1)(b)(iii) at XXXXXXXXXX?
Paragraph 50(1)(b) permits a taxpayer to recognize a deemed disposition of shares of a corporation held by the taxpayer at the end of a taxation year if the corporation satisfies the conditions of any of subparagraphs (i) to (iii) and the taxpayer elects in the taxpayer's return for the year to have subsection 50(1) apply to the shares.
XXXXXXXXXX made an election under subsection 50(1) of the Act in respect of its shares held in XXXXXXXXXX and in XXXXXXXXXX to XXXXXXXXXX. That election was made on the basis that XXXXXXXXXX had, according to the representatives, become bankrupt on XXXXXXXXXX, i.e. in XXXXXXXXXX's taxation year that ended on XXXXXXXXXX. Furthermore, given the very close relationship between XXXXXXXXXX with respect to their business operations, it was determined that XXXXXXXXXX did not cease carrying on its business until XXXXXXXXXX ceased carrying on its business, and therefore XXXXXXXXXX's investment was written off by XXXXXXXXXX in its taxation year ending XXXXXXXXXX.
The taxpayer's accounting representatives are of the view that XXXXXXXXXX had available to it the making of the election in the year in which all the conditions of paragraph 50(1)(b) were satisfied, or in a subsequent taxation year. They refer to the comments of the judges in Lindsay D. Anderson v. The Queen (TCC), 92 DTC 2296 and James D. Dietrich v. The Queen (TCC), 2005 DTC 290. We do not repeat the facts that were described in part in their submissions. However, we wish to make the following comments. The Anderson case arose in the 1985 to 1987 taxation years and concerned the application of subparagraph 50(1)(b)(iii) and the transitional rules in the Act, in order for the taxpayer to elect for that period. In that case, Mr. Anderson held shares in a corporation that had not gone bankrupt. As you know, subparagraph 50(1)(b)(iii) sets out four conditions that must be satisfied at the end of the taxpayer's taxation year ("the initial year") to crystallize a loss on the shares. It is our view that, provided these four conditions are still satisfied at the end of a subsequent taxation year, there is nothing to prevent the taxpayer from making the election in that subsequent year instead of in the initial year.
However, if the condition in subparagraph 50(1)(b)(i) is satisfied in a year and the taxpayer does not elect to recognize a deemed disposition for that year, it will not, in our view, be able to make the election in a subsequent year. As you mentioned in your comments, the Explanatory Notes to Bill C-139 (Royal Assent: September 13, 1988, S.C. 1988, c. 55) state in part:
New subparagraph 50(1)(b)(iii) provides that shareholders of a corporation that has ceased to carry on business and is insolvent during the year will be treated as having disposed of their shares at the end of the year where certain conditions are met. These conditions provide that the fair market value of the shares at the end of the year be nil and that it must be reasonable to expect that the corporation will be dissolved or wound-up and will not commence to carry on business. As well, the corporation must not commence to carry on a business in the year or within 24 months after the end of the year. Where these conditions are met, new subparagraph 50(1)(b)(iii) will allow shareholders of an insolvent corporation that has not become bankrupt to realize a capital loss on the shares of the corporation. New subparagraph 50(1)(b)(iii) is applicable to the 1988 and subsequent taxation years and, where the taxpayer notifies the Minister of National Revenue in writing, to the 1985, 1986 or 1987 taxation year. (emphasis added)
Given that the legal status of a taxpayer differs depending on whether it is bankrupt or merely insolvent, in our view, the provisions of subparagraph 50(1)(b)(iii) are not intended to cover the situation of a taxpayer who has become bankrupt. Otherwise, Parliament could have made this clear.
The Dietrich case arose in the 1998 and 1999 taxation years and involved, inter alia, the application of paragraph 50(1)(a). The taxpayer did not file an election under subsection 50(1), and his appeal, therefore, failed. We quote from the judgment of the Honourable Justice Campbell:
I believe the facts of this case establish that the debt owing became a bad debt in the year. However there is no evidence one way or the other as to whether the Appellant made the necessary election as required by subsection 50(1). Without the evidence and with the onus on the Appellant, I must dismiss the appeals on this basis. Nevertheless, I believe it is open to the Appellant to submit an application to the Minister pursuant to subsection 220(3.2) requesting an extension of time to file an election for each of the 1998 and 1999 taxation years. Under Regulation 600, subsection 50(1) is in fact a prescribed provision as referred to in subsection 220(3.2). If the Minister were to deny such an application, the Appellant could instead file his election in respect to the current taxation year. (emphasis added)
To our knowledge, neither the Appeals Branch nor we have issued any opinion on the comments of the Honourable Justice Campbell. Paragraph 50(1)(a) refers to a debt held by a taxpayer that "is established by the taxpayer to have become a bad debt in the year". A creditor's determination that a debt is uncollectible in a particular taxation year must be supported by all relevant facts. As stated in paragraph 10 of Interpretation Bulletin IT-159R3: “Generally, a debt will not be uncollectible at the end of a particular taxation year unless the creditor has exhausted all legal means of collecting it or where the debtor has become insolvent and has no means of paying it.” Since, for the purposes of paragraph 50(1)(a), a debt must have become uncollectible in a year, we are of the view that the deemed disposition election must be made in that year and not in a subsequent year. We therefore disagree on this point with the comments of the Honourable Justice Campbell.
As noted above, since XXXXXXXXXX became bankrupt on XXXXXXXXXX, we are of the view that the conditions of subparagraph 50(1)(b)(i) were satisfied in XXXXXXXXXX's taxation year ending on XXXXXXXXXX and it had to elect on that date to be deemed to have disposed of its shares in its two subsidiaries. Consequently, for the reasons described above, XXXXXXXXXX would not be able to avail itself of the provisions of subparagraph 50(1)(b)(iii) for its taxation year ending XXXXXXXXXX.
Are the capital losses, that arose to XXXXXXXXXX from the deemed disposition of its shares in XXXXXXXXXX and XXXXXXXXXX under subsection 50(1), BILs for XXXXXXXXXX?
A BIL is defined in paragraph 39(1)(c) as the taxpayer’s capital loss for the year from a disposition, to which subsection 50(1) applies, of a share of the capital stock of a small business corporation ("SBC"). The test to be met by XXXXXXXXXX for the purposes of the definition of a SBC is, inter alia, that all or substantially all of the fair market value ("FMV") of its assets were attributable at a particular time between XXXXXXXXXX to assets that were used principally in a business that XXXXXXXXXX or XXXXXXXXXX (a related corporation) carried on primarily in Canada. We have very little information about the operations of the two corporations during this period or the assets still held that could have been used in the operation of their business. If the facts show that this test was met, the capital losses arising to XXXXXXXXXX from the deemed disposition of its shares as a result of the subsection 50(1) election would be BILs for XXXXXXXXXX.
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We hope that these comments are of assistance. Should you require additional information regarding the content of this document, please do not hesitate to contact us.
For the Director
International Operations and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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