27 October 1993 Administrative Letter 9326846 F - Minimum Tax & Net 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.

Assessment of Returns Directorate Personal and General J.M. Legault, Director Section T1 Programs Division

Attention:  Nancy Kelly, Chief T1 Assessment Section

Minimum Tax and the Application of Non-deductible Net Capital Losses

We are replying to your memorandum of September 20, 1993 concerning the minimum tax adjustment relating to net capital losses and our previous letter to your Directorate of May 10, 1991 addressed to R. Ouimet of the former Individual Assessing Section.

Clause 127.52(1)(i)(ii)(A) of Act imposes one of the limitations on the amount of net capital losses that can be deducted for minimum tax purposes. This limitation is

"the aggregate of all amounts each of which is an amount that can reasonably be considered to be the amount that (the taxpayer) would have deducted under (paragraph 111(1)(b)) had (paragraph 127.52(1)(d)) been applicable in computing the amount deductible under that paragraph".

This clause involves making reasonable assumptions as to the actions of a taxpayer in a hypothetical situation. It should be kept in mind that while a reasonable assumption is a rebuttable assumption, it is generally accepted that a taxpayer will ordinarily wish to minimize the amount of tax payable. We note that the examples given in your memorandum did not provide any information as to why the taxpayer claimed a lesser amount of net capital loss than was available to be applied and thus it is difficult to establish a reasonable assumption as to what that taxpayer would have done in other circumstances.

The three most obvious reasons why a taxpayer would not fully claim the net capital losses available to him in a particular taxation year are that

a)     the taxpayer wishes to take advantage of the capital gains deduction under paragraph 110.6 of the Act,

b)     the taxpayer's taxable income has already been reduced to nil by means of other deductions or

c)     the net capital loss arises in a subsequent year and is not carried back to the taxation year in which the minimum tax arises.

Where a taxpayer has claimed the maximum net capital loss permitted under the Act or where the taxpayer has claimed such portion of net capital losses as is needed to reduce taxable income to nil, it is reasonable to assume that the taxpayer would have minimized his minimum tax liability by reducing the net capital gain inclusion to the extent of any net capital losses as determined by clause 127.52(1)(i)(ii)(B) of the Act.

However, where the taxpayer has claimed a capital gains deduction, it is reasonable to assume that the taxpayer would only have claimed the net capital losses necessary to reduce the net amount of capital gains to be included in income for minimum tax purposes to the amount claimed as a capital gains exemption. For example, if a taxpayer had a capital gain of $1,000, $750 of which was taxable and claimed a capital gains exemption of $600 and a net capital loss of $150, it is reasonable to assume that the same taxpayer would have claimed a net capital loss of $400 if the taxable portion of the gain was $1,000 and he had sufficient net capital losses available. In both situations, the taxpayer would claim a capital gains exemption of $600 and the net amount of capital gain to be taxed would be nil.

However, if the restriction in clause 127.52(1)(i)(ii)(A) were not applied, a taxpayer with available net capital losses as determined by clause 127.52(1)(i)(ii)(B) would be able to claim net capital losses to the extent of any capital gain included in income for minimum tax purposes, irrespective of any capital gains deduction actually claimed for regular tax purposes. Since the reasonable assumptions must take into account what the taxpayer actually did for regular tax purposes, it would appear that clause 127.52(1)(i)(ii)(A) of the Act prevents a taxpayer from offsetting other minimum tax adjustments with the pool of adjusted net capital losses created for minimum tax purposes. Consequently, where the taxpayer claimed both a capital gains exemption and a portion of the available net capital losses to fully offset the taxable portion of the capital gain as in the example above, it is unreasonable to assume that the taxpayer would have claimed a lesser amount of capital gains exemption in order to claim a greater amount of net capital loss under the assumed rules of clause 127.52(1)(i)(ii)(A) of the Act.

In the example given above where the net capital loss arises in a subsequent taxation year, a great variety of reasons exist as to why a taxpayer might not apply the loss back to the year in which minimum tax arose. For example, a taxpayer may apply the subsequent year net capital loss to another taxation year (which, for the sake of this example, is not subject to minimum tax). Because clause 127.52(1)(i)(ii)(B) of the Act increases the pool of available net capital losses for minimum tax purposes (by eliminating the fraction used in the calculation of an allowable capital loss), a portion of this subsequent year net capital loss will be available for application to the year which is subject to minimum tax, notwithstanding that the net capital loss is not applied to that year for regular purposes. Under the assumption that a taxpayer wants to minimize any minimum tax payable, it is reasonable to assume that any excess net capital loss would have been applied to the year in question.

In the calculation used by the accountant, it would appear that the assumption used to calculate the restriction is that a taxpayer who has claimed a lesser amount of net capital loss than was available to be applied would not have claimed any greater net capital loss had the taxable portion of the gain been higher. While this may be true if the taxpayer's reason for not claiming a greater amount for regular purposes was that the taxpayer was unaware of the existence of a greater net capital loss, such an assumption is easily rebuttable.

Accordingly, in the examples we have reviewed, it seems reasonable to assume that the taxpayer would have tried, to the maximum extent possible, to reduce the amount of capital gain, net of any capital gains deduction, to be taxed under minimum tax. Should you encounter a situation where this assumption seems unreasonable, we would be pleased to review the situation and offer further comments.

E. Wheeler A/DirectorBusiness and General DivisionRulings DirectorateLegislative and Intergovernmental Affairs Branch