5 February 2013 External T.I. 2012-0446211E5 - Donation of flow-through shares

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: The taxpayer requested clarification of the rules relating to the donation of publicly-listed flow-through shares to qualified donees.

Position: General comments provided.

Reasons: Legislation.

XXXXXXXXXX
2012-044621
Bob Naufal

February 5, 2013

Dear XXXXXXXXXX:

Re: Donation of flow-through shares

We are writing in response to your email dated May 4, 2012 wherein you requested clarification of the rules relating to donations of publicly-listed flow-through shares.

Briefly, based on our understanding of the information provided in your email, an individual acquires units in a limited partnership (the "LP"). Generally, the LP enters into an agreement with a resource company whereby the LP subscribes for shares of the resource company that are listed on a designated stock exchange. Each share of the resource company is a "flow-through share" as defined in subsection 66(15) of the Income Tax Act (the "Act"). Within a specified period (estimated to be 2 years), the LP would exchange the flow-through shares for shares of a mutual fund corporation (the "MFC"). The LP would wind-up and distribute the MFC shares to the limited partners. A limited partner may donate the MFC shares received on the wind-up of the LP to a registered charity. You have requested our comments on the income tax implications of the donation and the effective date for computing the exemption threshold of a partnership interest.

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. Depending on a taxpayer's particular circumstances, the potential income tax implications arising from the donation of flow-through shares or MFC shares may be complex. In this regard, taxpayers may wish to seek professional tax advice. However, we can offer the following general comments which may be of some assistance.

Our Comments

In general, paragraph 38(a) of the Act provides that a taxpayer's taxable capital gain from the disposition of property is one-half of the taxpayer's capital gain for the year from the disposition of the property. However, subparagraph 38(a.1)(i) of the Act provides for an exemption from capital gains tax when a taxpayer makes a donation to a qualified donee of certain types of securities such as publicly-listed flow-through shares as well as shares of a MFC. A qualified donee is defined in subsection 149.1(1) of the Act and includes registered charities.

Whether a gain on the disposition of a property is on account of income or on account of capital is generally a question of fact that can only be determined on a case-by-case basis.

As a result of certain measures announced in the 2011 Budget and enacted on December 15, 2011, the availability of the above-described exemption from capital gains tax on donations of flow-through shares may be limited. In general terms, where a taxpayer donates shares acquired pursuant to a flow-through share agreement, the taxpayer is deemed to have a capital gain which will not qualify for the exemption from capital gains tax until such time as the cumulative capital gains from the disposition of such shares exceed the original cost of the shares. These measures (described in the sections that follow) generally apply to donations of shares that were issued pursuant to a flow-through share agreement entered into on or after March 22, 2011. A donation of flow-through shares that were issued pursuant to a flow-through share agreement entered into before March 22, 2011 will generally not be subject to these measures. A flow-through share agreement is one that is described in the definition of "flow-through share" in subsection 66(15) of the Act.

Deemed capital gain

Generally, subsection 40(12) of the Act 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) 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.

As a result, the taxpayer will report, in computing income, a taxable capital gain equal to one-half of this additional capital gain.

Flow-through share class of property

Generally, a "flow-through share class of property" as defined in section 54 of the Act, means a group of properties comprised of all shares of a class if any share of the class is at any time a "flow-through share" (as defined in subsection 66(15) of the Act) to any person. The definition also includes rights to acquire a share of such a class.

A flow-through share class of property also means a group of properties, each of which is 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.

Exemption threshold

The term "exemption threshold" is also defined in section 54 of the Act and is used to determine the deemed gain, if any, of a taxpayer under subsection 40(12) of the Act. The exemption threshold of a taxpayer at a particular time in respect of a particular flow-through share class of property is generally a pool of the actual cost to the taxpayer of flow-through shares issued to the taxpayer on or after the later of March 22, 2011 and the taxpayer's "fresh-start date", less prior capital gains of the taxpayer from the disposition of shares of the class.

As noted above, a flow-through share class of property may include an interest in a partnership. Generally, the exemption threshold in respect of such partnership interest includes the total of each amount that would be the adjusted cost base to the taxpayer of the partnership 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), but only if the taxpayer made a contribution of capital to the partnership on or after August 16, 2011 or the taxpayer acquired the partnership interest on or after the taxpayer's "fresh-start date" (and was not obligated, before August 16, 2011, to acquire that interest, pursuant to the terms of a written agreement) and certain other conditions are met.

Generally, where a taxpayer acquires an interest in a partnership after March 21, 2011 and before August 16, 2011, the taxpayer does not have an exemption threshold in respect of that partnership interest. However, if the taxpayer subsequently disposes of the partnership interest in exchange for property that is included in a flow-through share class of property and the special rule in paragraph 38.1(a) of the Act applies, the taxpayer may have an exemption threshold in respect of the acquired property.

Fresh-start date

The term "fresh-start date" is also defined in section 54 of the Act and is relevant to calculating a taxpayer's "exemption threshold" (as described above). The fresh-start date of a taxpayer at a particular time in respect of a flow-through share class of property is, in the case of a partnership interest, the later of August 16, 2011 and the last day, if any, before the particular time, on which the taxpayer held an interest in the partnership. In the case of any other property that is included in a flow-through share class of property, a taxpayer's fresh-start date is the date that is the later of March 22, 2011 and the last day, if any, before the particular time, on which the taxpayer disposed of all property included in the flow-through share class of property.

Tax-deferred transactions

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 (such as the transfer of certain properties by a partnership to a taxable Canadian corporation in exchange for shares of the corporation under subsection 85(2) of the Act). To the extent that paragraph 38.1(a) of the Act is applicable, the taxpayer is essentially required to include in the taxpayer's exemption threshold for the acquired property an amount equal to a proportion of the transferor's exemption threshold for that property, and the transferor's exemption threshold for that property is reduced by the same amount.

Further, to the extent that paragraph 38.1(b) of the Act applies (generally if the transferor, in return, receives property that is publicly-listed shares of the taxpayer or shares of a MFC), 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. In such circumstances, there will be an inclusion to the transferor's exemption threshold in respect of the flow-through share class of property that includes the shares received an amount equal to a proportion of the transferor's exemption threshold for the property that was transferred.

Therefore, if the transferor donates the publicly-listed shares or MFC shares, as the case may be, the transferor may recognize a capital gain on the donation. It is a question of fact whether the special rules in section 38.1 of the Act apply in a particular situation.

We trust that our comments will be of assistance to you.

Yours truly,

Jenie Leigh
Section Manager
for Division Director
Financial Industries and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch