23 April 2012 Internal T.I. 2012-0436921I7 - Capital Losses

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 taxpayer is entitled to claim a "foreign exchange" loss on its subsidiary's redemption of the shares held by the taxpayer

Position: No.

Reasons: Since subsection 40(3.6) of the Act applies, the taxpayer is not considered to have sustained a loss for the purposes of subsection 39(1) or 39(2) of the Act

									April 23, 2012

	XXXXXXXXXX							HEADQUARTERS
	Large File Case Manager				Income Tax Rulings
	XXXXXXXXXX Tax Services Office	  		Directorate
									A. Seidel
	Attention: XXXXXXXXXX					(613) 957-2058

									2012-043692

Loss on Share Redemption

We are writing in response to your e-mail requesting our comments on the application of subsections 39(1), 39(2) and 40(3.6) of the Income Tax Act (the “Act”) in the situation described below.

Background

Our understanding of the facts is as follows:

1. On XXXXXXXXXX XXXXXXXXXX (“Parent”) recorded a subscription for US$XXXXXXXXXX of XXXXXXXXXX Shares (the “Shares”) of XXXXXXXXXX (“U.S. Subsidiary”), a controlled foreign affiliate of Parent.

2. On XXXXXXXXXX Parent recorded the redemption of such Shares by U.S. Subsidiary for US$XXXXXXXXXX. Immediately after the redemption, U.S. Subsidiary was still a controlled foreign affiliate of Parent.

3. Due to the fluctuation in the exchange rate between the Canadian dollar and the U.S. dollar between XXXXXXXXXX and XXXXXXXXXX, Parent recorded a foreign exchange loss of $XXXXXXXXXX and, for Canadian tax purposes, recorded a $XXXXXXXXXX taxable capital loss.

4. Additional capital restructuring of U.S. Subsidiary resulted in Parent directly owning all of the issued and outstanding shares of U.S. Subsidiary on XXXXXXXXXX. However, U.S. Subsidiary remained a controlled foreign affiliate of, and was “affiliated”, within the meaning of that term in section 251.1 of the Act, with, Parent throughout the period XXXXXXXXXX to XXXXXXXXXX.

Issue

Does subsection 40(3.6) of the Act apply to deem Parent’s loss on the redemption of the Shares by U.S. Subsidiary to be nil such that subsections 39(1) and/or 39(2) do not apply to the redemption.

Our Comments

In general, subsection 39(1) of the Act provides that, for the purposes of the Act, a taxpayer’s capital gain or capital loss for a taxation year from the disposition of any property is the taxpayer’s gain or loss for the year determined under Subdivision c of Division B of Part I of the Act. However, subsection 39(2) provides that, notwithstanding subsection 39(1), where, by virtue of any fluctuation after 1971 in the value of the currency or currencies of one or more countries other than Canada relative to Canadian currency, a taxpayer has made a gain or sustained a loss in a taxation year, a gain or loss shall be computed pursuant to the rules in paragraphs 39(2)(a) or (b), as the case may be, and such gain or loss shall be deemed to be a capital gain or capital loss of the taxpayer for the year from the disposition of currency of a country other than Canada.

It has been the CRA’s long-standing position that section 40 of the Act will determine whether or not a taxpayer has “made a gain” or “sustained a loss” as a result of the disposition of a property. It is only after a gain or loss has been determined under the provisions of section 40 that one looks to section 39 to compute the capital gain or capital loss.

Pursuant to subsection 40(3.6) of the Act, where at any time a taxpayer disposes, to a corporation that is affiliated with the taxpayer immediately after the disposition, of a share of a class of the capital stock of the corporation (other than a share that is a distress preferred share),

(a) the taxpayer’s loss, if any, from the disposition is deemed to be nil; and

(b) in computing the adjusted cost base to the taxpayer after that time of a share of a class of the capital stock of the corporation owned by the taxpayer immediately after the disposition, there shall be added the proportion of the amount of the taxpayer’s loss from the disposition (determined without reference to paragraph (2)(g) and this subsection) that

(i) the fair market value, immediately after the disposition, of the share

is of

(ii) the fair market value, immediately after the disposition, of all shares of the capital stock of the corporation owned by the taxpayer.

In the situation described above, Parent is deemed, pursuant to subsection 84(9) of the Act, to have disposed of the Shares of U.S. Subsidiary to U.S. Subsidiary at the time that U.S. Subsidiary redeemed the Shares. Since Parent disposed of the Shares to U.S. Subsidiary at a time when it was still affiliated, within the meaning thereof in subsection 251.1(1) of the Act, with U.S. Subsidiary immediately after the redemption of the Shares by U.S. Subsidiary, paragraph 40(3.6)(a) of the Act applies to deem any loss incurred by Parent on U.S. Subsidiary’s redemption of the Shares held by Parent to be nil. Since Parent’s loss is deemed to be nil because of the application of subsection 40(3.6), Parent cannot be considered to have “sustained a loss” at the time that U.S. Subsidiary redeemed the Shares and neither of subsections 39(1) nor 39(2) of the Act would apply to Parent’s disposition of the Shares.

Although Parent’s loss on the redemption of the Shares is deemed to be nil under paragraph 40(3.6)(a) of the Act, Parent may, pursuant to paragraph 40(3.6)(b), have been entitled to increase the adjusted cost base of any other shares of U.S. Subsidiary that it owned immediately after the redemption of the Shares. However, if Parent did not directly own any other shares of U.S. Subsidiary immediately after the redemption of the Shares, paragraph 40(3.6)(b) would not apply to add the denied loss to the adjusted cost base of any remaining issued and outstanding shares of U.S. Subsidiary. Furthermore, there is no provision in the Act that would permit Parent to increase the adjusted cost base, by the amount of the loss previously denied under paragraph 40(3.6)(a), of the shares of U.S. Subsidiary that Parent acquired on September 28, 2007.

We trust that these comments are of assistance. If you wish to discuss any of the above, please contact the writer.

for Director
International Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch