12 June 1998 External T.I. 9713925 - AFFILIATED PERSONS, ESTATE, & STOP LOSS

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.

XXXXXXXXXX 						L. Holloway
							971392
Attention: XXXXXXXXXX 

June 12, 1998

Dear Sirs/ Mesdames:

Re: Request for Technical Interpretations
Subsections 164(6) and 104(19) of the Income Tax Act (the "Act “)

This is in response to your letter of May 21, 1997 requesting a technical interpretation on the operation of subsections 164(6) and 104(19) to a particular fact situation. We apologize for the delay in our response. The scenario outlined in your letter follows:

1. Mrs. X died on XXXXXXXXXX. She owned all of the non-voting preferred shares of a holding company ("Holdco") with a fair market value of $XXXXXXXXXX at the time of Mrs. X's death. Her adult daughter, Miss X, owns all the common shares of Holdco.

2. Miss X and the family lawyer are the executors of Mrs. X's estate. All decisions of the executors must be unanimous. The lawyer deals at arm's length with Miss X.

3. Apart from some relatively small cash bequests, Miss X is the sole beneficiary of the estate.

4. Holdco does not own any life insurance, but it has a capital dividend account of $XXXXXXXXXX which arose as a result of capital gains that it realized on dispositions of publicly traded shares.

5. Immediately before her death, Mrs. X's preferred shares had paid-up capital and adjusted cost base of nil. As a result of the deemed disposition of Mrs. X's preferred shares on her death, Mrs. X realized an $XXXXXXXXXX capital gain and the adjusted cost base of the shares to the estate became $XXXXXXXXXX.

6. During the first taxation year of the estate, Holdco will redeem the preferred shares. Pursuant to subsection 84(3) the estate will be deemed to have received a dividend of $XXXXXXXXXX, and the necessary elections will be made whereby $XXXXXXXXXX of the dividend will be treated as a capital dividend and $XXXXXXXXXX as a taxable dividend.

7. Paragraph (j) of the definition of "proceeds of disposition" in section 54 provides that the proceeds of disposition do not include an amount that is deemed by subsection 84(2) or (3) to be a dividend received. Accordingly, on the redemption of the preferred shares the estate would realize a capital loss of $XXXXXXXXXX. The executors wish to carry back this loss against Mrs. X's capital gain on death pursuant to subsection 164(6).

8. The executors are also contemplating a designation pursuant to subsection 104(19) whereby the taxable dividend will be deemed a taxable dividend of Miss X. Subsection 104(19) provides that if the designation is made, the dividend is deemed, for the purposes of the Act, not to have been received by the trust.

You have asked specifically whether the Department would interpret subsection 104(19) to preclude the estate from deducting the amount of the deemed dividend in calculating its proceeds of disposition in section 54 of the Act.

Our Comments

Subsection 104(19) reads:

(19) Taxable Dividends. Such portion of a taxable dividend received by a trust in a taxation year throughout which it was resident in Canada on a share of the capital stock of a taxable Canadian corporation as

a) may reasonably be considered (having regard to all the circumstances including the terms and conditions of the trust arrangement) to be part of the amount that by reason of subsection (13) or (14) or section 105, as the case may be, was included in computing the income for a particular taxation year of a beneficiary under the trust, and

b) was not designated by the trust in respect of any other beneficiary under the trust

shall, if so designated by the trust in respect of the beneficiary in the return of its income for the year under this Part, be deemed, for the purposes of this Act, other than Part XIII, not to have been received by the trust and to be a taxable dividend on the share received by the beneficiary in the particular year from the corporation.

Note that in the preamble to this subsection a taxable dividend must first have been received by the trust in order for subsection 104(19) to apply. Under subsection 84(3), a dividend upon the redemption, acquisition or cancellation of a share is deemed to have been received by the person who held such shares equal to the excess of the amount paid by the corporation over the paid-up capital of those shares. Notwithstanding that subsection 104(19) states that the dividend, if so designated will “be deemed, for the purposes of this Act, other than Part XIII, not to have been received by the trust and to be a taxable dividend on the share received by the beneficiary”, the taxable dividend must be received by the trust first in order for this designation to be made. Therefore we agree with the comments in your letter that the provisions should not be interpreted so as to preclude the estate from deducting the dividend in calculating its proceeds of disposition. Subsection 112(3.2) would also have application in the current arrangement. As the estate will have disposed of shares acquired by it on death, a capital loss arising from the disposition of the shares (ie. on the redemption) and deemed by subsection 164(6) to be a loss of the Mrs. X for the taxation year in which Mrs. X died will be reduced only to the extent that capital dividends received on the shares exceed 1\4 of the lesser of the individual’s capital gain arising as a result of the deemed disposition on death and the estate’s capital loss otherwise determined.

We trust the above is of assistance.

Yours truly,

T. Murphy
for Director
Resources, Partnerships and
and Trusts Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch