16 January 1995 External T.I. 9425905 - EPSP - CAPITAL GAINS ELECTION

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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues:

Whether there is a technical problem with the draft legislation regarding the capital gains election, in that the deemed capital gain of an employee who is a member of an employees profit sharing plan is computed on the basis of the accrued gains of the trust and not on the basis of the accrued gains in each employee's member account.

Position TAKEN:

There is no technical problem.

Reasons FOR POSITION TAKEN:

Employees who are members of a trust governed by an employees profit sharing plan have but a beneficial interest in the trust and do not own directly any property of the trust. Direct ownership of any property of the trust by an employee would preclude the existence of the employees profit sharing plan, since all property of an employees profit sharing plan must be held by a trustee. Therefore, the property owned by the employees on February 22, 1994 is an interest in a trust governed by an employees profit sharing plan and not specific properties of the trust. Hence, the election filed by the employees is in respect of such interest, the rules for which are contained in paragraph 110.6(19)(c) of the proposed legislation.

		5-942590
XXXXXXXXXX	 C.Chouinard

Attention: XXXXXXXXXX

January 16, 1995

Dear Sir:

Re: EPSPs - Capital Gains Election

We are writing in reply to your letter of September 30, 1994, wherein you requested our comments regarding the application of the proposed capital gains election to beneficiaries under employee profit sharing plans.

In your opinion, there is a technical problem with the proposed legislation regarding the capital gains election, in that the deemed capital gain of the elector is computed on the basis of the accrued gains of the trust and not on the basis of the accrued gains in each member's account. You query whether such a result was intended and propose two different methods of resolving what you consider to be an anomaly.

Our Comments

The essential requirements of an employees profit sharing plan are given in subsection 144(1) of the Income Tax Act (the "Act"). Although there are no requirements in the Act as to the form of the trust deed, it is nevertheless a requirement that there be a plan or arrangement under which payments are made by the employer to a trustee for the benefit of the employer's employees. In our view, employees have but a beneficial interest in a trust governed by an employees profit sharing plan and do not own directly any property of the trust. Direct ownership of any property of the trust by an employee would preclude the existence of the employees profit sharing plan, since all property of an employees profit sharing plan must be held by a trustee.

As regards the proposed capital gains election, according to the explanatory notes of November, 1994, the rules in paragraph 110.6(19)(c) of the proposed legislation apply to trusts governed by employees profit sharing plans. Where an election is made in respect of an interest in such a trust, there is no deemed disposition of the interest. Rather, the elector is deemed to have a capital gain from the disposition of property on February 22, 1994 equal to the amount designated in the election in respect of the interest. That capital gain cannot, however, exceed what would have been the elector's net capital gains if the trust had disposed of all its capital properties and the capital gains and losses arising therefrom were allocated among the beneficiaries in proportion to their share thereof.

Hence, the rules of paragraph 110.6(19)(c) of the proposed legislation give an employee flexibility by enabling him or her to choose the amount of the gain that is recognized through the election. However, since an employee's interest in an employees profit sharing plan is but a beneficial interest, the amount designated in the election should not exceed his or her share of the accrued gain in the trust's property. The above-mentioned rules ensure that an employee does not designate an amount greater than his or her share of the accrued gain in the trust.

As we indicated above, in our view, an employee does not own the trust's property directly and, accordingly, the ACB of an employee's interest in the trust is nil, unless the interest was acquired for consideration. In an employees profit sharing plan, the flow-through of losses and gains results from an allocation by the trustee of the gains and losses associated with the trust's property and not, from a loss or gain associated with the employee's property.

If the property owned by the trust had been distributed in kind to the employees on or before February 22, 1994, the employees could file the capital gains election in respect of such property. As you indicated, the employees would determine the ACB of each property distributed in accordance with the provisions of subsection 144(7.1) of the Act. However, if the trust's property was not so distributed, the property owned by the employees on February 22, 1994 consisted of an interest in a trust governed by an employees profit sharing plan and not specific properties of the trust. Therefore, the election filed by the employees will be in respect of such interest, the rules for which are contained in paragraph 110.6(19)(c) of the proposed legislation.

Therefore, as regards your first suggestion, we would only consider each member account as a separate employees profits sharing plan if it complied with the requirements of subsection 144(1) of the Act. In our opinion, where there is but one trust, there can be but one employees profit sharing plan. With respect to your second suggestion, as we indicated above, subparagraph 110.6(19)(c)(ii) of the proposed legislation is intended to ensure that the amount designated in the election in respect of the interest does not exceed what would have been the elector's net capital gains if the trust had disposed of all its capital properties and the capital gains and losses arising therefrom, as can reasonably be considered to represent the elector's share, were allocated to or designated in respect of the elector. Although the August 1994 draft legislation referred to capital gains and capital losses "allocated or designated in respect of the beneficiaries under the trust in proportion to their interests therein", the November 24, 1994 proposed legislation reads as follows: "arising from the dispositions as can reasonably be considered to represent the elector's share thereof were allocated to or designated in respect of the elector". Accordingly, in our opinion, it would be acceptable to use the accrued gains in each employee's member account for purposes of the capital gains election, if the capital gains and capital losses in a member's account "can reasonably be considered to represent the (member's) share" of the capital gains and capital losses which would arise if the trust had disposed of all of its capital properties at the end of February 22, 1994.

We will not be referring this matter to the Department of Finance since, in our view, there is no technical problem or anomaly in paragraph 110.6(19)(c) of the proposed legislation.

We trust that these comments will be of assistance.

Yours truly,

R.A. Albert
for Director
Business and General Division
Rulings Directorate
Policy and Legislation Branch