29 August 1997 External T.I. 9707345 - EXPIRY OF EXEMPT CAP GAINS BALANCE ON DISP OF UNITS

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:

expiry of the exempt capital gains balance on the disposition of the individual's entire interest in a particular flow-through entity & whether it can be resurrected by reacquiring the shares

Position:

while the exempt capital gains balance is deemed to be nil for all taxation years following the year of disposition, proposed 53(1)(r) permits an adjustment to the cost base of the remaining units of the entity immediately prior to the disposition so that the expected benefit from the 110.6(19) election is not lost. If the units are reacquired within 30 days of the disposition, any capital loss realized on that disposition is deemed to be nil and the loss is added to the ACB of the repurchased units

Reasons:

39.1(7) deems ecgb to be nil on the disposition of an individual's entire interest in a particular flow-through entity, proposed 53(1)(r) addresses the issue of what happens if the remaining units are sold before using up the ecgb and 40(2)(g) deems any resulting loss to be nil if it is a superfical loss as defined in 54

A. Humenuk
XXXXXXXXXX		                              970734

Attention: XXXXXXXXXX

August 29, 1997

Dear Sirs:

Re: Exempt Capital Gains Balance

We are replying to your letter dated August 22, 1996 addressed to the Ottawa Tax Services Office, in which you ask for our comments with respect to a situation involving an inadvertent sale of units in a mutual fund. As we mentioned in our telephone conversation of April 11, 1997 (XXXXXXXXXX\Humenuk), we have no record of receiving your original request. We apologize for the delay in our response.

In the situation you describe, an individual made a capital gains election under subsection 110.6(19) of the Income Tax Act (the "Act") in respect of units of a mutual fund owned by that individual on February 22, 1994. All of the units were sold in 1996 and the disposition resulted in a capital loss. Since the disposition occurred as a result of an administrative error on the part of the trust company holding the units for the individual, you ask whether the individual could use the exempt capital gains balance created by the capital gains election, if units of that particular mutual fund were repurchased by the individual within a reasonable timeframe. You also ask whether the capital loss incurred on the disposition of the units could be applied to offset any future capital gains realized on the sale of other units or shares of flow-through entities. Finally, you ask for confirmation of your calculation of the capital loss.

When an individual disposes of all his or her holdings in a mutual fund corporation or other flow-through entity in a particular taxation year, subsection 39.1(7) of the Act deems the exempt capital gains balance in respect of that entity to be nil for each taxation year that begins after that year. As a result, the exempt capital gains balance prior to the disposition is not available to be applied against capital gains allocated or realized in the year following the disposition of the units. However, if the individual reacquires units in that entity before the end of the year in which the disposition takes place, the individual may apply his or her exempt capital gains balance under subsection 39.1(3) of the Act, to reduce any capital gains allocated by the entity before the end of the year in respect of the repurchased units. The individual may also apply his or her exempt capital gains balance under subsection 39.1(4) of the Act, to reduce any capital gains realized on the disposition, if any, of the repurchased units before the end of the year.

However, provided that paragraph 53(1)(r) is passed in substantially the same form as proposed in the Notice of Ways and Means Motion issued November 20, 1996, an individual who disposes of all of his or her interests in a particular flow-through entity before 2005 must add a proportionate share of the unused exempt capital gains balance to the adjusted cost base of each interest held in that flow-through entity immediately before the disposition. For the purpose of determining the unused portion of an individual's exempt capital gains balance, the balance for the year is reduced by the total of all reductions claimed in the year under subsections 39.1(2) and (3) of the Act, such that an individual's exempt capital gains balance can be applied to any capital gain realized by or allocated to that individual for that taxation year before making the 53(1)(r) adjustment to the cost base of the remaining interests. The increase in the adjusted cost base of an individual's interest in an entity under proposed paragraph 53(1)(r) ensures that the benefit of the election under subsection 110.6(19) of the Act is not lost when the individual disposes of his or her remaining interests in an entity before using up the exempt capital gains balance in respect of that entity. Although an individual may dispose of his or her units for an amount exceeding their acquisition cost, the individual may nevertheless incur a capital loss as a result of the adjustment under proposed paragraph 53(1)(r).

While we cannot comment on the accuracy of your calculations in the situation described above, it would appear that the capital loss incurred by the individual arose by reason of the adjustment to the adjusted cost base of the units under proposed paragraph 53(1)(r), rather than by reason of a disposition of the units for an amount less than their acquisition cost. As a result of the increase in the adjusted cost base of the individual's units, the benefit of the unused exempt capital gains balance in respect of these units was not lost.

Please note, however, that if a property, such as units in a mutual fund, is reacquired within 30 days of the date of its disposition, any capital loss resulting from the disposition would be a superficial loss within the meaning of section 54 of the Act and would be deemed to be nil by reason of paragraph 40(2)(g) of the Act. As explained in paragraph 11 of Interpretation Bulletin IT-456R, Capital property ( Some adjustments to cost base, the amount of any loss which is forfeited in this manner would be added to the adjusted cost base of the substituted or reacquired property, under paragraph 53(1)(f) of the Act.

We note that you calculated the gain in respect of the units held on February 22, 1994 separately from the loss on the units acquired after that date. As provided in section 47 of the Act, when an individual owns identical properties, such as units in a mutual fund, the adjusted cost base of each unit is determined based on the average cost of each unit to the individual. In addition, until such time as an individual's exempt capital gains balance for a particular flow-through entity is reduced to nil, the individual can use the exempt capital gains balance to reduce capital gains realized on the disposition of interests in that flow-through entity or taxable capital gains allocated under subsection 104(21) of the Act, regardless of whether the interests were acquired prior to or after February 22, 1994. Therefore, there is no need to calculate the capital gain or loss on the units separately. If your client would like assistance in determining the amount of capital gain or loss on the disposition of these particular units, he or she should contact the Ottawa Tax Services Office located at 333 Laurier Street.

If paragraph 40(2)(g) of the Act does not apply and, as a result of the adjustment to the adjusted cost base of the units in the mutual fund, the disposition of the units results in a net capital loss for the year, the individual may apply this loss to other taxation years to the extent provided by section 111 of the Act. In this respect, we refer you to page 25 of the 1996 Capital Gains Guide and Interpretation Bulletin IT-232R2, Non-capital losses, net capital losses, restricted farm losses, farm losses and limited partnership losses.

We trust that our comments will be of assistance to you.

Yours truly,

C. Chouinard
for Director
Business and Publications Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch