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: Does subsection 40(12) or section 38.1 apply where a taxpayer donates a share that is part of a "flow-through share class of property" to a qualified donee?
Position: General comments provided.
January 19, 2018
Re. Subsection 40(12) and Section 38.1
This is in reply to your letter of January 16, 2017 in which you asked for our views about the application of subsection 40(12) and section 38.1 of the Income Tax Act (“the Act”) in certain circumstances. We apologize for the delay in responding to your inquiry.
Briefly, based on our understanding of the information provided in your letter, you describe two situations where a taxpayer receives a publicly listed common share from treasury of a resource company (the “Share”) as follows:
(a) The taxpayer subscribes for the Share for cash consideration.
(b) The taxpayer transfers a capital property to the resource company in exchange for the Share. Each of the taxpayer and resource company elect under subsection 85(1) with respect to the transfer.
In each situation, the taxpayer subsequently donates the Share to a qualified donee. You advise that although the Share itself, is not a “flow-through share” as defined in subsection 66(15) of the Act, it will be considered a property that would be included in a “flow-through share class of property” in section 54 of the Act by virtue of another person owning a flow-through share of that class. You have asked what impact, if any, subsection 40(12) and section 38.1 of the Act will have on the taxpayer with respect to the donation of the Share to the qualified donee.
This technical interpretation provides general comments about the provisions of the Act and related legislation (where referenced). It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination. The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R7, Advance Income Tax Rulings and Technical Interpretations.
In general terms, 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 that a taxpayer’s taxable capital gain is equal to zero where a taxpayer makes a donation to a qualified donee of certain types of securities such as a share listed on a designated stock exchange. 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.
Where a taxpayer disposes of one or more capital properties that are included in a “flow-through share class of property” and subparagraph 38(a.1)(i) of the Act applies to the disposition, subsection 40(12) of the Act deems the taxpayer to have a capital gain from a disposition of another capital property. 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.
A “flow-through share class of property,” is defined in section 54 of the Act and generally 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 to any person. The definition also includes rights to acquire a share of such a class, as well as 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 and is used to determine the deemed gain, if any, of a taxpayer under subsection 40(12) of the Act. In general terms, the exemption threshold of a taxpayer at a particular time in respect of a particular flow-through share class of property is a pool of the actual cost to the taxpayer of flow-through shares issued to the taxpayer on or after the taxpayer’s “fresh-start date” (as defined in section 54 of the Act), less prior capital gains of the taxpayer from the disposition of shares of the class.
In our view, it may be possible for the taxpayer to own a share (as capital property) that is included in a flow-through share class of property without ever having owned a flow-through share (or a right to acquire a flow-through share) by virtue of another person owning a flow-through share of that class. However, it is necessary for the taxpayer to have acquired a flow-through share (or certain partnership interests, as described herein) in order for a taxpayer to have an exemption threshold in respect of a flow-through share class of property to which subsection 40(12) of the Act would apply. Accordingly, where a taxpayer has no exemption threshold (i.e., exemption threshold is zero) with respect to a flow-through share class of property, the deemed capital gain from a disposition of a capital property included in that flow-through share class of property referred to in subsection 40(12) would likely be zero, being the lesser of the amounts referred to in that provision.
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 taxpayer to a taxable Canadian corporation in exchange for shares of the corporation under subsection 85(1) of the Act). In this regard, 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, the taxpayer’s proportionate share of the amount by which the transferor's exemption threshold in respect of the flow-through share class of property immediately before the transfer exceeds the capital gain, if any, 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 are shares of the taxpayer listed on a designated stock exchange 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. 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.
It is a question of fact whether the rules in section 38.1 of the Act apply in a particular situation.
We trust that our comments will be of assistance to you.
Financial Institutions Section
Financial Industries and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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