15 May 1998 Internal T.I. 9719587 - CAPITAL GAINS DEDUCTION ON 72(2)(C) RESERVE

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.

ISSUE:

Whether a transferee under paragraph 72(2)(b) is entitled to claim a capital gains deduction under section 110.6 with respect to the reserve, and more particularly, a deduction under 110.6(2.1).

Position: Yes.

Reasons:

Although 72(2)(b) does not deem a disposition of a particular capital property (i.e. the same property as disposed of by the deceased) by the transferee nor deem a disposition to occur on a particular day, it is not reasonable to deny a deduction under 110.6 of the Act given the 1988 amendment to 72(2)(b)(ii) of the Act and the explanation therefore in the Technical Notes. If a deduction is available, it should relate to the capital property which the deceased disposed of.

									May 15, 1998

LAVAL TAX SERVICES OFFICE HEADQUARTERS
G. H. Cloutier, Director P. Spice
(613) 957-8953
Attention: Frank D’Asti
Estates and Trusts Section
971958

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Capital Gains Deduction Claimed on Reserve Transferred Under 72(2)(c)

We apologize for the delay in responding to your memorandum of July 15, 1997, concerning the above-noted matter. You have asked whether it is our opinion that XXXXXXXXXX (the “taxpayer”) may claim a deduction under subsection 110.6(2.1) of the Income Tax Act (the “Act”) in relation to a reserve on a capital gain which was the subject of a joint election pursuant to subparagraph 72(2)(c)(ii) of the Act. Our understanding of the facts, excerpts from the applicable law relevant to the facts, and our analysis and opinion follow.

FACTS

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LAW APPLICABLE IN 1994 AND 1995

40(1)(a) - Except as otherwise expressly provided in this Part a taxpayer’s gain for a taxation year from the disposition of any property is the amount, if any, by which

(i) if the property were disposed of in the year, the amount, if any, by which the taxpayer’s proceeds of disposition exceed the total of the adjusted cost base ... and any outlays and expenses ...

(ii) if the property was disposed of before the year, the amount, if any, claimed by the taxpayer under subparagraph (iii) in computing the taxpayer’s gain for the immediately preceding year from the disposition of the property,

exceeds

(iii) ... such amount as the taxpayer may claim ... as a deduction, not exceeding the lesser of

(C) a reasonable amount as a reserve in respect of such of the proceeds of disposition of the property that are payable to the taxpayer after the end of the year ..., and

(D) an amount equal to the product obtained when (1/10) of the amount determined under subparagraph (i) in respect of the property is multiplied by the amount, if any, by which (9) exceeds the number of preceding taxation years of the taxpayer ending after the disposition of the property.

72(1)(c) - Where in a taxation year a taxpayer has died ... no amount may be claimed under subparagraph 40(1)(a)(iii) ... in computing any gain of the taxpayer for the year.

72(2) - Where property of a taxpayer that is a right to receive any amount has, on or after the death of a taxpayer and as a consequence thereof, been transferred or distributed to the taxpayer’s spouse described in paragraph 70(6)(a) ... (in this subsection referred to as the “transferee”), if (certain conditions are met) ...

(b) any amount in respect of the property that could, but for subparagraph (1)(c), have been claimed under subparagraph 40(1)(a)(iii) ... in computing the amount of any gain of the taxpayer for the year shall,

(i) notwithstanding paragraph (1)(c), be deemed to have been so claimed, and

(ii) for the purpose of computing the transferee’s income for the transferee’s first taxation year ending after the death of the taxpayer and any subsequent taxation year, be deemed to have been

(A) proceeds of the disposition of capital property disposed of by the transferee in that first taxation year, and

(B) the amount determined under subparagraph 40(1)(a)(i) ... in respect of the capital property referred to in clause (A), and

(c) notwithstanding paragraphs (a) and (b), where any property has been disposed of by the taxpayer, in computing the income of the transferee for any taxation year ending after the death of the taxpayer ...

(ii) the amount of the transferee’s claim under subparagraph 40(1)(a)(iii) ... in respect of the disposition of the property ...

shall be computed as if the transferee were the taxpayer who had disposed of the property and as if the property were disposed of by the transferee at the time it was disposed of by the taxpayer.

110. 6(1) “annual gains limit” of an individual for a taxation year means the amount determined by the formula

A - B

where

A is the lesser of

(a) the amount determined in respect of the individual for the year under paragraph 3(b) in respect of capital gains and capital losses, and

(b) the amount that would be determined in respect of the individual for the year under paragraph 3(b) in respect of capital gains and losses if

(I) the only properties referred to in paragraph 3(b) were properties disposed of by the individual after 1984 and, except where the property was at the time of the disposition a qualified small business corporation share ... of the individual, before February 23, 1994

(I.2) ... in determining the individual’s taxable capital gain for the 1995 taxation year from the disposition of a property (other than a qualified small business share ...), this Act were read without reference to subparagraphs 40(1)(a)(ii) ..., and

B (in this case will be nil).

110. 6(1) “cumulative gains limit” of an individual at the end of a taxation year means the amount, if any, by which

(a) the total of all amounts determined in respect of the individual for the year or a preceding taxation years that end after 1984 for A in the definition “annual gains limit”

exceeds the total of

(b) (in this case will be nil),

(c) (in this case will be nil),

(d) all amounts deducted under this section in computing the individual’s taxable incomes for preceding taxation years, and

(e) (in this case will be nil)

110. 6(2.1) - In computing the taxable income for a taxation year of an individual ... who disposed of a share of a corporation in the year or a preceding taxation year ... that, at the time of disposition, was a qualified small business corporation share of the individual, there may be deducted such amount as the individual may claim not exceeding the least of

(a) the amount, if any, by which $375,000 exceeds the total of,

(i) the total of all amounts each of which is an amount deducted by the individual under this section in computing the individual’s taxable income for a preceding taxation year,

(ii) (in this case will be nil)

(iii) (in this case will be nil)

(b) (in this case will be the individual’s cumulative gains limit)

(c) ( in this case will be the individual’s annual gains limit)

(d) the amount that would be determined in respect of the individual for the year under paragraph 3(b) ... in respect of capital gains and capital losses if the only properties referred to in that paragraph were qualified small business corporation shares disposed of by the individual after June 17, 1987.

110. 6(3) - In computing the taxable income for a taxation year of an individual ... who disposed of property (other than property the capital gain ... from the disposition of which is included in determining an amount under paragraph (2.1)(d)) there may be deducted such amounts not exceeding the least of ....

(a) the amount, if any, by which $75,000 exceeds the total of

(i) (in this case will be nil)

(ii) (in this case will be nil)

(iii) (in this case will be nil)

(b) the amount, if any, by which the individual’s cumulative gains limit at the end of the year exceeds the total of all amounts each of which is an amount deducted under subsection ... (2.1) in computing the individual’s taxable income for the year, and

(c) the amount, if any, by which the individual’s annual gains limit for the year exceeds the total of all amounts each of which is an amount deducted under subsection ... (2.1) in computing the individual’s taxable income for the year.

ANALYSIS

The effect of paragraph 72(2)(b) of the Act is that the transferee, in calculating her income for 1994 (the “first taxation year ending after the death”) and subsequent taxation years, is deemed to have proceeds of disposition of a capital property disposed of by her in 1994 equal to the amount of the reserve under subparagraph 40(1)(a)(iii) that the deceased could have claimed in 1994. Furthermore, in calculating her gain for the 1994 taxation year under subsection 40(1) of the Act, it is deemed to be equal to the reserve the deceased could have claimed in 1994.

Paragraph 72(2)(b) of the Act does not deem a disposition and in the case in hand the transferee has not in fact disposed of anything in the year ending after the year of death, whether it be a qualified small business corporation share or a right to receive any amount. The “right to receive any amount” is not the subject property to which subsection 72(2) applies. Rather the transfer to the spouse of that right is a condition precedent to the operation of subsection 72(2). If the condition is satisfied, the spouse and legal representative can make the election. Once the election is made subsection 72(2) applies to deem the amount deductible as a reserve to constitute certain amounts for purposes of applying certain provisions of the Act to the deceased and to the transferee.

Paragraph 72(2)(b) does not deem the capital property (from the disposition of which the transferee is deemed to have proceeds) to be of the same type as that of which the deceased disposed; nor does it specify the date of disposition, merely that it has occurred in the year ending after the death.

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The Technical Notes for the 1988 amendment to subparagraph 72(2)(b)(ii) indicate that the amendment was to permit reserves respecting certain dispositions “to qualify for the capital gains exemption”. Interpretation Bulletin IT-236R3 (“Reserves - Disposition of Capital Property”) at paragraph 13, states that the joint election under subsection 72(2) of the Act permits the deemed gain to qualify for the capital gains exemption and there is a cross-reference to paragraph 14 in which the example is to dispositions after 1984 of “qualified farm property”. The technical interpretation cited by you and the representative (E9107315) also refers to the ability of the transferee to claim a capital gains exemption for dispositions by the deceased occurring after 1984 but, as you note, does not distinguish between the types of capital properties. Both you and the taxpayer’s representative agree that the transferee is able to make a claim for a deduction under section 110.6 of the Act only differing on the type of deduction, subsection 110.6(2.1) or 110.6(3) of the Act, which is available. Note that we issued an earlier technical interpretation of February 28, 1991 (E9036745 available on Megatext) to the same effect as E9107315.

We agree with your comment that paragraph 72(2)(c) of the Act is irrelevant to a determination of the transferee’s right to a certain kind of section 110.6 deduction. It deems the transferee to have disposed of the subject property in the year the deceased disposed of it solely to ensure that there is no refreshing of the maximum 10 year period over which the reserve must be brought back into income in accordance with clause 40(1)(a)(iii)(D) of the Act.

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You might also wish to refer to two previous technical interpretations contained in Megatext documents E9427855 and E9710991. Both refer to the flow-through of capital gains by an employees profit sharing trust pursuant to subsection 144(4) of the Act. That provision deems an allocated capital gain of the trust from the disposition of any property to be a capital gain of the employee “from the disposition of that property for the taxation year” in which the allocation was made by the trust. The provision was amended in 1995 to add the words:

and, for the purposes of section 110.6, the property shall be deemed to have been disposed of by the employee on the day on which it was disposed of by the trust.

The reason for the amendment was to “ensure that a capital gain of such a trust that arose from a disposition of property that occurred on or before February 22, 1994 and that would, but for the elimination of the $100,000 lifetime capital gains exemption effective for dispositions that occur after that day, be eligible for the exemption in the hands of the employee beneficiaries to continue to be so eligible” (November 1994 Technical Notes).

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RECOMMENDATION

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We trust the foregoing comments assist.

for Director
Financial Industries Division
Income Tax Rulings &
Interpretations Directorate
Policy and Legislation Branch