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: Would subsection 40(12) of the Income Tax Act apply to a specific set of transactions?
Position: General comments provided.
Reasons: Such a determination is a question of fact.
May 14, 2012
Re: Donation of Flow-through Shares
This is in response to your email of November 2, 2011, wherein you requested confirmation on whether subsection 40(12) of the Income Tax Act (“the Act”) would apply to a hypothetical scenario.
In the scenario described in your email, you briefly outlined a series of transactions that include the issuance of flow-through shares to a limited partnership, the exchange of such flow-through shares for shares of a mutual fund corporation (MFC), the distribution of the MFC shares on the winding-up of the partnership, and the subsequent donation of the MFC shares by a partner.
Written confirmation of the tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R5, Advance Income Tax Rulings, dated May 17, 2002. While we are unable to provide any definitive comments, we can offer the following general comments which may or may not be relevant to the scenario described.
Budget 2011 announced certain measures enacted on December 15, 2011 that impact the income tax treatment resulting from transactions involving the donation of publicly-listed flow-through shares. Generally, under these new provisions, if shares of a class of the capital stock of a corporation are issued to a taxpayer under a flow-through share agreement entered into on or after March 22, 2011, the exemption from capital gains tax on a subsequent donation of shares of that class will be available only to the extent that the capital gain on the donation exceeds a threshold amount (the “exemption threshold”). Essentially, under these new provisions, the taxpayer will be required to pay tax at normal capital gains rates on capital gains realized on dispositions of flow-through shares whether the shares are sold for consideration or donated to a qualified donee. Those capital gains will reduce the balance of the taxpayer’s exemption threshold. To the extent that the exemption threshold is reduced to nil, a capital gain from the donation of publicly-listed shares to a qualified donee is exempt from income tax.
This result is achieved by the addition of subsection 40(12) of the Act which deems a taxpayer to have a capital gain (from another property) where the taxpayer disposes of property that is included in a “flow-through share class of property” and subparagraph 38(a.1)(i) or (iii) of the Act applies to the disposition. The deemed capital gain is equal to the lesser of:
- the amount of the taxpayer’s “exemption threshold” in respect of the flow-through share class of property, and
- the total capital gains from the disposition of the actual property.
The term “flow-through share class of property” is defined in section 54 of the Act to generally include a class of shares of the capital stock of a corporation if any share of the class or any right to require a share of the class is at any time a flow-through share (as defined in subsection 66(15) of the Act). In addition, the definition of flow-through share class of property includes an interest in a partnership, if at any time more than 50% of the fair market value of the partnership’s assets is attributable to property included in a flow-through share class of property.
The term “exemption threshold” is also defined in section 54 of the Act. Generally, the exemption threshold of a taxpayer at a particular time in respect of a particular flow-through share class of property is the amount by which:
- the sum of the original cost to the taxpayer of all flow-through shares of the particular class (i.e., determined without reference to the deemed zero cost of flow-through shares under subsection 66.3(3) of the Act) issued to the taxpayer on or after the taxpayer’s “fresh-start date” (as defined in section 54 of the Act), and before the particular time,
- the amount of each capital gain realized by the taxpayer on a disposition of any flow-through shares of that class after the taxpayer’s fresh-start date and before the particular time, not exceeding the taxpayer’s exemption threshold in respect of that class immediately before the time of disposition.
As noted above, a flow-through share class of property may include an interest in a partnership. The exemption threshold in respect of a partnership interest is generally the total of each amount that would be the adjusted cost base to the taxpayer of that interest (computed without reference to any deductions for Canadian exploration and development expense or Canadian exploration expenses that might be available to the taxpayer in respect of flow-through shares held by a partnership).
We note that the special rules in section 38.1 of the Act may apply where a taxpayer acquires a property (“acquired property”) that is included in a flow-through share class of property in certain tax-deferred transactions. To the extent that paragraph 38.1(a) of the Act is applicable, the taxpayer is essentially deemed to have an exemption threshold for the acquired property equal to the proportion of the transferor’s exemption threshold for that property, and the transferor’s exemption threshold is reduced by the same amount. Further, under paragraph 38.1(b) of the Act, if the transferor receives property in return that is publicly-listed shares or shares of a mutual fund corporation, those shares are deemed to be flow-through shares of the transferor for the purposes of section 38.1 and subsection 40(12) of the Act, and the transferor is deemed to have a new exemption threshold for the shares received equal to the proportion of the transferor’s exemption threshold for the acquired property that is determined under paragraph 38.1(a) of the Act or that would be determined under that paragraph if that paragraph applied to the taxpayer. It is a question of fact whether the special rules in section 38.1 of the Act will apply in a particular situation. If you have a specific proposed transaction in mind, we would be prepared to consider it in the context of an advance income tax ruling request.
We trust that our comments will be of assistance.
for Division Director
Financial Industries Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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