1993 Administrative Letter 9321716 F - Business Investment Loss and Estate

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.

January 24, 1994

Appeals Branch	Head Office
Appeals & Referrals Division	Rulings Directorate
Pat Murphy, Section Chief	957-8953

Attention:  Neil Wilson

The Estate of XXXXXXXXXX Subparagraph 39(1)(c)(vi)

We are writing in reply to your memorandum of July 28, 1993, wherein you requested our comments on the application of subparagraph 39(1)(c)(vi) of the Income Tax Act (the "Act") to the fact situation outlined below. We apologize for the delay in replying to your memorandum.

In particular, the words in question (the "Exception") in that subparagraph are:

"...except that this subparagraph shall not apply in respect of a share or substituted share that was acquired after 1971 from a person with whom the taxpayer was dealing at arm's length."

If the Exception applies, a business investment loss on shares issued before 1972 is not reduced by taxable dividends received on those shares after 1971.

Our understanding of the facts of the situation is as follows:

Facts

XXXXXXXXXX

Comments of the Taxpayer's Representative

A) Interpretation and Intent of the Provision

The taxpayer's representative stated that the Exception does not specifically require that a share be acquired by the taxpayer from a person with whom the taxpayer was dealing at arm's length. Consequently, the ABIL should be allowed in the situation where a share was acquired by anyone after 1971, if the vendor (i.e., the first vendor) in that transaction was dealing at arm's length with the taxpayer that suffered the loss. In this case, XXXXXXXXXX acquired the shares from a person with whom the Estate was dealing at arm's length. Thus, subparagraph 39(1)(c)(vi) of the Act should not apply to deny the ABIL to the Estate.

From a fairness perspective, had XXXXXXXXXX disposed of the shares while alive, subparagraph 39(1)(c)(vi) of the Act would not apply and the full amount of the capital loss would be an ABIL. In addition, had the Company, which was inactive prior to 1975, been incorporated in 1975, the shares would not have been subject to that subparagraph. The representative also provided quotes from several court cases, Golden et al., Stubart Investments, and Matilda Macklin (no citations were given), which indicated that an interpretation of the Act should fall within the object and spirit of the provision.

B) Non-arm's length relationship between a deceased and his/her estate

The arguments presented above, presume that XXXXXXXXXX and his Estate were not dealing at arm's length. An alternative position, presented in a letter dated February 10, 1993 from the taxpayer's representative, is that XXXXXXXXXX and his Estate are dealing at arm's length with the result that no reduction to the ABIL would be required. As support for this position, the representative referenced paragraphs 17 and 18 of IT-419 which indicate that the relationship between the settlor of a trust and a trust can be at arm's length under certain circumstances.

In the court case Estate of Karna May, 88 DTC 1189, (TCC), the court concluded that, as a question of fact, the transfer of property from the late Karna May to her estate was between parties not dealing at arm's length. The court's decision was based on non-arm's length concepts found in the case Estate of Thomas Rodman Merritt, 69 DTC 5159 (FCA), which itself was based on the case Sheldon's Engineering, Ltd., 55 DTC 1110, (SCC). The reason for the court doing so is unclear, since in the Sheldon case there was an ongoing relationship between the company and the shareholder whereas there is no such ongoing relationship between a trustee and a deceased person. In addition, the court held that the will of Karna May dictated both sides of the transaction and those conditions could not be altered. However, in reality, the terms of a will can be altered by the courts when there is an appeal by a dissatisfied person. The acquisition of property by an estate upon the death of a deceased person results in the trustee of the estate incurring a fiduciary responsibility to the beneficiaries named in the deceased's will, and not in a non-arm's length acquisition of property. For these reasons, the validity of the decision in the court case must be questioned.

In determining a question of fact non-arm's length relationship (pursuant to paragraph 251(1)(b) of the Act), persons must be dealing with each other at a particular time and the transaction under consideration must be a real transaction rather than a deemed transaction. In an actual transaction between two parties, there is a simultaneous disposition and acquisition of the property being transferred. However, the deemed disposition of property under paragraph 70(5)(a) of the Act by a deceased person and the subsequent acquisition of property by an estate under paragraph 70(5)(b) of the Act are two separate deemed transactions occurring at different points in time. Pursuant to subsection 70(5) of the Act, the relationship test must be applied to the deemed acquisition by an estate and not to the actual acquisition. This deemed disposition/acquisition could only be on a non-arm's length basis if there were a provision deeming it to be so. In addition, since the acquisition of property occurs at the time of the death of a person, as a question of fact, the trustee can not deal at non-arm's length with that person.

Comments of  XXXXXXXXXX

The comments expressed in your memo and in the memo from the XXXXXXXXXX dated March 4, 1993 are summarized as follows:

A) Interpretation and Intent of the Provision

The intent of subparagraph 39(1)(c)(vi) of the Act is to prevent the creation of an ABIL on shares with a high V-day value, although this subparagraph will not apply in cases where the shares were acquired after 1971 in an arm's length transaction. When XXXXXXXXXX purchased the shares of the Company in an arm's length transaction in 1975, there was no V-day value concern. Consequently, it appears that the intent of the Exception has been complied with.

It appears that the application of subparagraph 39(1)(c)(vi) of the Act has had an unintended tax consequence. Treating shares issued pre-1972 differently than those issued post-1971 seems unreasonable in this circumstance considering that the Company was a shell company when it was acquired by XXXXXXXXXX Yet, the literal interpretation of the Act strongly suggests that consideration should be given only to the transaction in which the taxpayer acquired the shares and not to any previous transaction. However, the literal interpretation appears to be neither within the spirit nor the object of the provision. Therefore, this subparagraph should be interpreted, at least in this fact situation, to exclude shares which were acquired at any time, by anyone, in an arm's length transaction after 1971.

B) Non-arm's length relationship between a deceased and his/her estate

The court case May Estate deals with the application of paragraph 39(1)(c) of the Act in a situation where the shares were issued before 1972 and transferred from Karna May to her estate upon her death in 1982. Based on the reasoning in the court case, XXXXXXXXXX has agreed that the shares were acquired by the Estate of XXXXXXXXXX in a non- arm's length transaction. However, perhaps the fact situation could be distinguished from the findings in the court case since Karna May acquired her shares in a non-arm's length transaction whereas XXXXXXXXXX acquired his shares in an arm's length transaction.

Our Comments:

A) Interpretation and Intent of the Provision

While there are numerous approaches or principles of interpretation popular with the courts over the years, the current most widely held approach is the modern principle of statutory construction as summarized by E.A. Driedger in The Construction of Statutes (2nd edition), Butterworths, Toronto, 1983 at page 87:

"Today there is only one principle or approach, namely the words of an Act are to be read in their entire context in their grammatical and ordinary sense harmoniously with the scheme of the Act, the object of the Act and the intention of Parliament."

This principle was accepted in the court case Stubart Investments Ltd., 84 DTC 6305, (SCC) at pages 6323-24 and repeated in several subsequent cases, e.g., Canterra Energy Ltd, 85 DTC 5245, (FCTD) and Lor-Wes Contracting Ltd., 85 DTC 5310, (FCA).

The basic method of construction using the modern rule summarized by Driedger at page 105 indicates, among other things:

"1. The Act as a whole is to be read in its entire context so as to ascertain the intention of Parliament (the law as expressly or impliedly enacted by the words), the object of the Act (the ends sought to be achieved), and the scheme of the Act (the relation between the individual provisions of the Act).

2.      The words of the individual provisions to be applied to the particular case under consideration are then to be read in their grammatical and ordinary sense in light of the intention of Parliament embodied in the Act as a whole, the object of the Act and the scheme of the Act, and if they are clear and unambiguous and in harmony with the intent, object and scheme and with the general body of the law, that is the end.

3.      If the words are apparently obscure or ambiguous, then a meaning that best accords with the intention of Parliament, the object of the Act and the scheme of the Act, but one that the words are reasonably capable of bearing, is to be given to them.

4.      If, notwithstanding that the words are clear and unambiguous when read in their grammatical and ordinary sense, there is disharmony within the statute, statutes in pari materia, or the general law, then an unordinary meaning that will produce harmony is to be given to the words, if they are reasonably capable of bearing that meaning."

Therefore, we note that although the object and spirit of a provision is one consideration to be taken into account in interpreting the words of a provision, it is not the only consideration.

As far as the intent of the legislation, the 1980 Budget stated that:

"This amendment is designed to prevent taxpayers from paying dividends to reduce the value of their shares and then recognizing a business investment loss with respect to the disposition of those shares."

The Department of Finance's Notice of Ways and Means Motion accompanying the October 1980 Budget, dealing with subparagraph 39(1)(c)(vi) of the Act, explained:

"... the definition of business investment loss (is) amended to ensure that, with respect to a disposition by a taxpayer after December 11, 1979 of a share issued before 1972 (other than a share acquired by the taxpayer in an arm's length transaction after 1971) or a share substituted for such share,

(a)      the taxpayer's loss be reduced by the amount of any taxable dividends that were paid on such share after 1971 and before or upon the disposition...." (underlining is ours)

XXXXXXXXXX

The Department of Finance's Technical Notes to Bill C-84, dated November 26, 1985, concerning subparagraph 39(1)(c)(vi) of the Act, stated:

"Paragraph 39(1)(c) of the Act defines the business investment loss that is available with respect to shares and debt issued by a Canadian- controlled private corporation ("CCPC"). A special rule requires taxable dividends received after 1971 to be deducted in determining the business investment loss from the disposition of a share of a CCPC that was issued before 1972. An exception is provided where the share was acquired by the taxpayer after 1971 in an arm's length transaction." (underlining is ours)

Ward's Tax Law and Planning on page 62.12 described the purpose as follows:

"The purpose of the reduction is presumably to prevent taxpayers from creating losses in respect of shares owned at the end of 1971 that have an adjusted cost base equal to their value on Valuation Day by taking taxable dividends out of the corporation and then disposing of the shares for less than Valuation Day value."

The statements made by Ward's Tax Law and XXXXXXXXXX provide support as to why, in general, it is reasonable to treat shares issued pre-1972 differently from those issued post-1971 given the object of the provision. However, it should be noted that the explanation provided in the 1980 Budget does not indicate that the legislation was intended to be effective only in situations involving shares that had an adjusted cost base based on V-day value.

Since the Exception does not use the words- `by the taxpayer', the taxpayer's representative has argued that the wording could be met where the shares were acquired by anyone after 1971, if the vendor in that transaction was dealing at arm's length with the taxpayer that suffered the loss. However, the explanations provided by the Department of Finance (i.e., the underlined words `by the taxpayer') clearly provide evidence that it was intended that the arm's length test be applied to the taxpayer calculating the ABIL; in this case - the Estate. As discussed in principle 3 above of the modern principle of interpretation, the wording of the Exception must be read in its entirety. The only implied wording that would make the entire phrase meaningful is the acquisition of the shares by the taxpayer.

While it is true that subparagraph 39(1)(c)(vi) of the Act would not apply had the shares been issued after 1971, the facts of the situation cannot be ignored nor can alternative courses of action be considered in interpreting the provision. Based on the object of the provision expressed by Ward and XXXXXXXXXX there appears to be an unintended tax result in the application of the provision to this fact situation. However, based on the intention expressed by the Department of Finance and the application of the modern principle of statutory construction, it is our opinion that the words of the Exception:

1)     do not support the alternative interpretation suggested by the taxpayer's representative or by Appeals Division;

2)     can not be interpreted to provide an exception for this particular fact situation; and

3)     must be interpreted to require that the shares be acquired by the taxpayer, i.e., the Estate, after 1971 in an arm's length transaction.

The taxpayer's representative argued that had the XXXXXXXXXX disposed of the shares while alive, subparagraph 39(1)(c)(vi) of the Act would not apply (i.e., the Exception would apply) and the full amount of the loss would be an ABIL. This remark fails to recognize two points. First, had XXXXXXXXXX received a taxable dividend of $XXXXXXXXXX before disposing of the shares (as the Estate did), there would have only been an ABIL of $XXXXXXXXXX available to XXXXXXXXXX This result is calculated as follows. As a consequence of paying the dividend, the proceeds of disposition received from the subsequent sale of the shares would take into consideration the value of the dividends paid and the proceeds of disposition received by the Estate of $XXXXXXXXXX would represent the amount that would also be received by XXXXXXXXXX Since the adjusted cost base of the shares is $XXXXXXXXXX the ABIL would have been $XXXXXXXXXX (proceeds of disposition $XXXXXXXXXX less adjusted cost base $XXXXXXXXXX). Second, had the Estate disposed of the shares at their fair market value without having received a dividend (which would be the situation similar to XXXXXXXXXX disposing of the shares while alive but before a dividend was paid), it is true that subparagraph 39(1)(c)(vi) of the Act would not have applied. However, a capital loss on the sale of the shares would not have arisen since the fair market value of the shares would equal their deemed adjusted cost base pursuant to paragraph 70(5)(b) of the Act.

Alternatively, had the Company redeemed the shares from the Estate for the amount of $XXXXXXXXXX the Estate would have a deemed dividend of $XXXXXXXXXX pursuant to subsection 84(3) of the Act (actual dividend of $XXXXXXXXXX less assumed paid-up capital of $XXXXXXXXXX). The amount of such dividend would reduce the proceeds of disposition (pursuant to paragraph 54(h)(x) of the Act) so that the revised proceeds of disposition would be $XXXXXXXXXX and a capital loss of $XXXXXXXXXX would have resulted (proceeds of $XXXXXXXXXXless fair market value at the date of death of $XXXXXXXXXX). No ABIL would have been available because the Estate would not have complied with subparagraph 39(1)(c)(ii) of the Act, i.e., the Estate which controlled the Company, would not have disposed of the shares to a person with whom it was dealing at arm's length.

B) Non-arm's length relationship between a deceased and his/her estate

XXXXXXXXXX

XXXXXXXXXX

As previously noted, the taxpayer's representative has expressed a number of concerns about the reasoning in the case, XXXXXXXXXX that the case represents the law on this issue at this time and hence, a deceased person and his/her estate do not deal at arm's length as a question of fact. This position is consistent with the position in paragraph 6 of IT-132R - that a deceased person and a trust created under his/her will do not deal at arm's length.

The comments in paragraph 18 of IT-419 concerning the settlor losing the usual rights of ownership and the settlor's influence on the trustee appear to relate to an inter vivos trust as opposed to a testamentary trust since in a testamentary trust the settlor will always lose the right of ownership to the property and can not exercise influence over the trustee, other than by what is written in the will.

The memo from the XXXXXXXXXX refers to the following passage in May Estate (on page 1191): "In light of the definition of business investment loss, the appellant (the estate) must, to succeed in his appeal, establish both that the shares were acquired from the Late Karna May in an arm's length transaction (as required in the Exception) and that the sale of these shares to the corporation also occurred at arm's length (as required in subparagraph 39(1)(c)(ii) of the Act)." (underlining is ours) The underlined words were omitted in the memo from the D.O. and it appears that the XXXXXXXXXX officer misunderstood this comment to refer to the original sale (or transfer) of the shares to Karna May. In considering the case, the court reviewed the nature of the transaction in which the trust acquired the shares from the deceased (on page 1192). The fact that the shares had been received by Karna May from her father's trust was not relevant in the court's decision. On pages 1191 and 1192, the court examined the relationship between the trust and the corporation to which the trust sold the shares and decided that those two parties were dealing at arm's length for the purposes subparagraph 39(1)(c)(ii) of the Act.

Summary

In summary, it is our position that, on a technical basis, subparagraph 39(1)(c)(vi) of the Act has been correctly applied to the fact situation to deny the ABIL calculated by XXXXXXXXXX Estate.

We trust that our comments will be of assistance.

for A/Director Rulings Directorate Legislative and Intergovernmental Affairs Branch