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 93(4) applies to FA shares received in the course of a liquidation and dissolution of another FA?
Reasons: Textual, contextual and purposive reading of 93(4).
September 5, 2018
Ms. Inder Kiran HEADQUARTERS
International Auditor Income Tax Rulings
Toronto Centre TSO Directorate
1 Front Street West International Division
Toronto, ON M5J 1X5 John Meek
Interpretation of subsection 93(4) in the context of a liquidation and dissolution of a foreign affiliate (“FA”)
Dear Ms. Kiran:
This letter is in response to a memorandum that was attached to your email dated April 6, 2017 in which you requested the Income Tax Rulings Directorate’s (“Rulings”) views on the questions you raised in the memorandum with respect to the various issues (“Issues”) you describe. Your main question is whether subsection 93(4) of the Income Tax Act (the “Act”) applies in the context of a liquidation and dissolution (“L&D”) of a foreign affiliate (“FA1”) of a corporation resident in Canada (“ACo”). Unless otherwise indicated, all statutory references herein are to the Act and all dollar amounts are expressed in Canadian dollars.
While the Issues described and questions raised in your memorandum arise in respect of a particular taxpayer and that taxpayer’s particular facts, these Issues and questions can be discussed and analyzed based on the following reasonably simple hypothetical example (the “Assumed Facts”):
(A) Prior to the L&D of FA1, ACo owned 100% of FA1, and FA1 owned (i) 100% of the shares of two other foreign affiliates (“FA2” and “FA3”) of ACo and (ii) other assets.
(B) Each of ACo and FA1 had a December 31 taxation year.
(C) On XXXXXXXXXX, FA1 adopted a “Plan of Complete Liquidation and Dissolution” (“Plan of L&D”).
(D) On XXXXXXXXXX, pursuant to the Plan of L&D (i) FA1 distributed to ACo (as a shareholder) its FA2 and FA3 shares as well as all of its other assets and (ii) ACo assumed FA1’s actual and contingent liabilities.
(E) The formal dissolution of FA1, including the cancellation of all of FA1’s shares held by ACo, occurred on XXXXXXXXXX.
(F) The rules in subsections 88(3) to (3.5) applied to the L&D of FA1.
(G) For purposes of applying the rules in subsections 88(3) to (3.5), the L&D of FA1 was not a “qualifying liquidation and dissolution” (as that term is defined in subsection 88(3.1)). Accordingly, FA1 is considered to have disposed of all of its properties at their fair market value (other than possibly the FA3 shares). (footnote 1)
(H) Prior to the L&D of FA1, FA2 had paid exempt dividends (as that term is defined in subsection 93(3)) to FA1, and FA1 had paid exempt dividends to ACo.
(I) If subsection 93(4) had no application, Canco would have realized a capital loss of $1 million (after the application of subsection 93(2.01), which reduced the amount of the otherwise determined capital loss by exempt dividends previously paid by FA1) in respect of its disposition of the shares of FA1.
(J) Immediately prior to the L&D of FA1, the FA2 shares were not excluded property (as that term is defined in subsection 95(1)), and their FMV at that time was $100,000. As such, ACo acquired the shares of FA2 at an ACB of $100,000.
(K) The FA2 shares were sold by ACo on XXXXXXXXXX to a third party for cash of $110,000.
(L) With respect to the sale of the FA2 shares in (K), ACo filed a subsection 93(1) election, and designated an amount of $10,000 to be a dividend rather than proceeds of disposition.
You have framed the question in Issue #1 as follows:
“Since the FA2 and FA3 shares were acquired by ACo at a time that was prior to the time FA1 was formally dissolved, does subsection 93(4) apply to deem ACo’s $1 million otherwise determined loss on the disposition of its FA1 shares to be $ nil?”
Rulings response to Issue #1
The Act contains a number of stop-loss rules that are designed to preclude a taxpayer from generating a capital loss from internally generated transactions. Subsection 93(4) provides such a stop-loss rule, as do rules in other provisions such as subsections 40(3.3), (3.4) and (3.5), paragraph 88(3)(e), and sub-subclause 95(2)(e)(iv)(A)(II)1.
Issue #1 revolves around the interpretation of the preamble of subsection 93(4), and this preamble reads in part as follows:
“93(4) Loss on disposition of shares of foreign affiliate — If a taxpayer resident in Canada … has acquired shares of the capital stock of one or more foreign affiliates …. of the taxpayer ….. on a disposition of shares …. of the capital stock of any other foreign affiliate of the taxpayer …, the following rules apply
The question to be answered in Issue #1 is, “did ACo acquire the shares of FA2 and FA3 on the disposition of the FA1 shares?” In our view the answer to this question is “Yes”. The wording of the definition of “hybrid surplus” in Regulation 5907(1) (more specifically (iii) of the description of variable B in that definition) confirms that subsection 93(4) might apply to deny a loss on the disposition of shares of a corporation that is liquidated and dissolved. In the Assumed Facts, ACo acquired the shares of FA2 and FA3 as part of the process of liquidating and dissolving FA1, which included ACo disposing of its shares of FA1. In our view, the distribution of the property of FA1 to ACo was “on” the disposition of the shares of FA1.
Consequently, ACo’s otherwise determined capital loss of $1 million on the disposition of its FA1 shares is deemed by paragraph 93(4)(a) to be nil. The denied capital loss is added by paragraph 93(4)(b) to the ACB to ACo of the shares of FA2 and FA3 that ACo acquired on the disposition in proportion to their respective fair market values.
You have framed the question in Issue #2 as follows:
“If subsection 93(4) applies to deem ACo’s otherwise determined loss of $1 million on the disposition of its FA1 shares to be $ nil, and if the portion of that denied loss that would be added to the ACB of the FA2 shares pursuant to paragraph 93(4)(b) was $50,000 (resulting in ACo’s ACB of the FA2 shares becoming $100,000 + $50,000 = $150,000), would the rules in subsection 93(2.01) apply to determine ACo’s loss on the disposition of the FA2 shares on XXXXXXXXXX?”
Rulings response to Issue #2
In our view the answer to this Issue #2 question is “Yes”. Absent the subsection 93(2.01) loss limitation rule, ACo would have an otherwise determined (capital) loss of $40,000 (i.e. $110,000 - $150,000) arising on its disposition of its FA2 shares on XXXXXXXXXX. As such, paragraph 93(2)(a) mandates the application of subsection 93(2.01), and the $40,000 loss is limited by the exempt dividends previously paid on the FA2 shares or on shares for which the FA2 shares were substituted.
You have framed the question in Issue #3 as follows:
“If pursuant to your response to Issue #2, ACo has either no gain or loss on the disposition of the FA2 shares, or has a loss, would the subsection 93(1) election filed by ACo (Fact L) have any impact on the determination of ACo’s loss on that disposition?”
Rulings response to Issue #3
In our view the answer to this Issue #3 question is “No”.
Based on ACo’s view that subsection 93(4) did not apply to their acquisition of the FA2 and FA3 shares, and as a consequence, to their view that the disposition of the FA2 shares on XXXXXXXXXX resulted in ACo having an otherwise determined capital gain of $10,000, ACo filed a subsection 93(1) and designated $10,000 as the “elected amount”. Under subparagraph 93(1)(a)(ii) the “elected amount” reduces ACo’s proceeds of disposition.
However, under paragraph 93(1)(a), the “elected amount” cannot exceed the amount of the taxpayer’s otherwise determined gain. Based on our response to Issues #1 and #2, ACo has no gain on the disposition of the FA2 shares, in which case ACo’s elected amount would become $ nil. As such, ACo’s filing of a subsection 93(1) election would have no effect on the determination of ACo’s otherwise determined loss on the disposition of the FA2 shares.
For your information, unless exempted, a copy of this letter will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency's electronic library. A severed copy will also be distributed to the commercial tax publishers, following a 90-day waiting period (unless advised otherwise), for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should the taxpayer request a copy of this letter, they may request a severed copy using the Privacy Act criteria, which does not remove taxpayer identity. Requests for this latter version should be e-mailed to: ITRACCESSG@cra-arc.gc.ca. In such cases, a copy will be sent to you for delivery to the taxpayer.
We trust that these comments will be of assistance.
Sherry E. Thomson, CPA, CGA
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
Note to reader: Because of our system requirements, the footnotes contained in the original document are shown below instead:
1 If the FA3 shares are excluded property, they would have been disposed of for proceeds of disposition equal to the relevant cost base (within the meaning assigned by subsection 95(4)) to FA1.
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