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 ‚mis, peut
ne pas repr‚senter la position actuelle du ministŠre.
Principal Issues:
1. Whether subsection 84(3) or 142.5(1) takes precedence on a
redemption of shares held by a financial institution as mark-to-
market property.
2. If subsection 84(3) takes precedence, are the proceeds of
disposition reduced by the amount of the deemed dividend for the
purposes of subsection 142.5(1)?
3. If the answer to (2) is yes, can the financial institution
claim a loss created as a result of the reduced proceeds of
disposition?
4. If the financial institution reports the full redemption
amount as proceeds of disposition for the purposes of subsection
142.5(1) and applies subsection 248(28) to offset the deemed
dividend under subsection 84(3), can the financial institution
still claim a deduction under subsection 112(1) in respect of the
deemed dividend?
Position:
1. The legislation does not clearly provide that subsection
142.5(1) takes precedence over subsection 84(3) or vice versa.
However, in light of tax policy considerations, it is now our
view that subsection 84(3) should take precedence over subsection
142.5(1).
2. Yes. Given our current position that subsection 84(3)
should take precedence, it is our view that subsection 248(28)
would apply to reduce the proceeds by the amount of the deemed
dividend.
3. To the extent that a loss results on the redemption because
the cost of the share is greater than the reduced proceeds, it
would appear that a loss may be claimed by the financial
institution, subject to the stop-loss rule in subsection
112(5.2).
4. No. It is our view that where subsection 248(28) applies to
reduce a deemed dividend under subsection 84(3) in the
circumstances described, subsection 248(28) would also apply to
reduce the deduction under subsection 112(1).
Reasons: See above comments.
October 26, 1998
TORONTO NORTH TAX SERVICES OFFICE HEADQUARTERS
Industry Specialist Services J. Leigh
(613) 952-1505
Attention: D.W. Mitchell
Banking Specialist
980394
Redemption of Shares Held by Financial Institutions
This is further to our memorandum of June 6, 1997 and your e-mail of February 17, 1998, concerning the application of subsections 84(3) and 142.5(1) of the Income Tax Act (the "Act") to a redemption of shares held by a financial institution as mark-to-market property.
Subsection 84(3) or 142.5(1)
In our June 6, 1997 memorandum, we expressed the view that an argument could be made that subsection 142.5(1) of the Act took precedence over subsection 84(3) of the Act. We also believed that this interpretation was consistent with tax policy, particularly in light of the fact that the contrary view could lead to the claiming of a loss by a financial institution when it did not in fact suffer an economic loss. However, since the legislation is open to interpretation, we asked the Department of Finance to confirm the policy intent of the legislation and to make the necessary amendment to make it clear in the law that subsection 84(3) of the Act would not apply in circumstances where the mark-to-market rules apply to shares disposed of by a financial institution.
The Department of Finance has examined the issue and has determined that the right policy result would be to apply subsection 84(3) of the Act to deem the financial institution to have received a dividend on the redemption and to allow the financial institution to reduce its proceeds of disposition by the amount of such a dividend for the purposes of the mark-to-
market rules. As you know, the effect of this interpretation is that the financial institution's profit or loss for tax purposes will not accurately reflect the financial institution's economic
gain or loss on the redemption. However, the Department of Finance believes that, in most cases, the policy goal of preserving integration outweighs the policy goal of taxing the real economic gains and losses of financial institutions. They make the point that never reducing the proceeds of disposition by the amount of the deemed dividend in the calculation of the
financial institution's profit or loss seems to be inappropriate when one considers that part of the proceeds will represent earnings that were already taxed in the hands of the corporation deemed to have paid the dividend. When those earnings are distributed on the redemption, the earnings arguably should not be taxed again at the corporate level in the financial institution's hands.
Given the lack of clear legislative support for the position stated in our previous memorandum and the current views of the Department of Finance, we will be revising our position to allow subsection 84(3) of the Act to take precedence on a redemption of shares held by a financial institution as mark-to-market property. To the extent that an amount has been included in computing income as a deemed dividend under subsection 84(3) of the Act, it is our view that subsection 248(28) of the Act would apply to allow the financial institution to reduce its proceeds of disposition by the amount of the deemed dividend for the purposes of subsection 142.5(1) of the Act.
Loss on redemption
As noted above, the view that subsection 84(3) of the Act takes precedence may lead to the possibility of a financial institution being able to claim a loss on the redemption to the extent the proceeds are reduced below the original cost to the financial institution of the share even though it has not suffered an economic loss.
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Subsection 112(1)
In your e-mail, you asked for clarification whether a financial institution would still be entitled to a deduction under subsection 112(1) of the Act if the financial institution reports
the full redemption amount as proceeds of disposition for the purposes of subsection 142.5(1) of the Act and applies subsection 248(28) of the Act to reduce the deemed dividend to nil. In our view, to the extent that subsection 248(28) of the Act applies to reduce the deemed dividend, it would also apply to reduce the corresponding subsection 112(1) deduction. Accordingly, if the financial institution reduces the deemed dividend under 84(3) to nil, it would not be entitled to claim a subsection 112(1) deduction in respect of the deemed dividend.
For your information, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Legislation Access Database (LAD) on the Department's mainframe computer. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, they can be provided with the LAD version or they may request a copy severed using the Privacy Act criteria which does not remove client identity. Requests for this latter version should be made by you to Jackie Page at (613) 957-0682. The severed copy will be sent to you for delivery to the client.
We hope that our comments are of assistance.
Manager
Financial Institutions Section
Financial Industries Division
Income Tax Rulings and
Interpretations Directorate
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