13 April 2010 Internal T.I. 2010-0358541I7 - Annual gains limit

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.

Principal Issues: Whether the amount of net capital losses deducted under paragraph 111(1)(b) that is referred to in subparagraph (a)(i) of the description of parameter B of the definition of annual gains limit in subsection 110.6(1) should be the amount deducted under paragraph 111(1)(b) in computing taxable income or the said amount but adjusted to reflect the provisions of subsection 104(21).

Position: The amount of net capital losses adjusted to reflect the provisions of subsection 104(21)

Reasons: see response

    							 	April 13, 2010

	Ottawa Tax Services Office			HEADQUARTERS
	Appeals Division 					Income Tax Rulings
			   					Directorate
	Attention : Tina Tingson 			S. Parnanzone
								(613)957-2133

								2010-035854

XXXXXXXXXX
Notice of Appeal - Tax Court of Canada - Informal Procedure

This is in reply to your email of February 23, 2010, and is further to your telephone conversations with Robin Maley and Sandy Parnanzone of this office, concerning the calculation of the "cumulative gains limit," an expression defined in subsection 110.6(1) of the Income Tax Act ("Act").

Our understanding of the facts follows:

1. XXXXXXXXXX ("Taxpayer") filed a Notice of Appeal to the Tax Court of Canada in respect of the reduction by the Canada Revenue Agency ("CRA") of his cumulative gains limit ("CGL"), which in turn caused a reduction of the Taxpayer's capital gains deduction in the XXXXXXXXXX taxation year. The basic disagreement between the Taxpayer and the CRA concerns the amount of net capital losses claimed in XXXXXXXXXX for purposes of the computation of the CGL.

2. The Taxpayer claimed a capital gains deduction in his XXXXXXXXXX taxation year pursuant to subsection 110.6(2.1) of the Act in respect of qualified small business corporations shares ("QSBCS"). For the relevant year(s), the QSBCS are the only property of the Taxpayer that is eligible for the capital gains deduction under section 110.6 of the Act. The CRA decreased the Taxpayer's capital gains deduction by $XXXXXXXXXX , which represents a decrease of the Taxpayer's CGL from the amount of $XXXXXXXXXX the Taxpayer reported to the CRA revised amount of $XXXXXXXXXX .

3. In computing his income for the XXXXXXXXXX taxation year, the Taxpayer included therein taxable capital gains of $XXXXXXXXXX , pursuant to paragraph 3(b) of the Act. The amount of $XXXXXXXXXX includes a taxable capital gain of $XXXXXXXXXX allocated to the Taxpayer by the Family Trust and Mutual Funds and designated pursuant to subsection 104(21) of the Act.

4. In computing his taxable income for the XXXXXXXXXX taxation year, the Taxpayer deducted net capital losses of $XXXXXXXXXX , pursuant to paragraph 111(1)(b) of the Act. However, for the purpose of computing the annual gains limit (defined in subsection 110.6(1)), which affects the computation of the CGL, the Taxpayer used the amount of $XXXXXXXXXX as being the net capital losses deducted under paragraph 111(1)(b); this amount is the excess of the amount of $XXXXXXXXXX included in computing income under paragraph 3(b) over the amount of $XXXXXXXXXX designated by the trust under subsection 104(21).

At issue is whether the amount of net capital losses deducted in XXXXXXXXXX that is to be taken into account in computing the amount referred to in subparagraph (a)(i) of parameter B in the definition of the "annual gains limit" ("AGL") in subsection 110.6(1), which amount in turn affects the amount determined for paragraph (b) of the definition of CGL, should be $XXXXXXXXXX , as suggested by the CRA, or $XXXXXXXXXX (i.e., $XXXXXXXXXX less $XXXXXXXXXX ), as contended by the Taxpayer's representative, XXXXXXXXXX ("Rep").

Taxpayer Position

The Rep is of the view that the amount of net capital losses to be taken into account in computing the CGL is $XXXXXXXXXX . As explained by Ottawa TSO's Appeals Division, the Rep's position after reviewing the calculation in the TSO's schedule is as follows:

"XXXXXXXXXX "

Our Comments

In our view, the amount of net capital losses deducted under paragraph 111(1)(b) in XXXXXXXXXX that is to be taken into account in computing the amount referred to in subparagraph (a)(i) of parameter B in the definition of the AGL in subsection 110.6(1) , which amount in turn affects the amount determined for paragraph (b) of the definition of CGL, should be $XXXXXXXXXX (i.e., $XXXXXXXXXX less $XXXXXXXXXX ).

The amount deductible under subsection 110.6(2.1) is the least of four amounts, one of which is determined with reference to the CGL. In respect of the Taxpayer's XXXXXXXXXX taxation year, the least of the four amounts under subsection 110.6(2.1) was the CGL.

The CGL at the end of a taxation year is defined in subsection 110.6(1) in part with reference to the amounts used in the computation of the AGL for the year or preceding taxation years ending after 1984. In particular, paragraphs (a) and (b) of the definition of CGL consist of the amount computed for a taxation year for parameters A and B, respectively, of the definition of AGL.

The amount for parameter A of the definition of AGL is the lesser of the amount computed under paragraph 3(b) of the Act (i.e., essentially the net amount of taxable capital gains) and the amount that would be determined under paragraph 3(b) in respect of capital gains from the disposition of certain properties eligible for the capital gains deduction ("qualifying properties"). On the other hand, the amount computed for parameter B of the definition of AGL is made up of two amounts, only one of which is relevant in the Taxpayer's case. The relevant amount is that referred to in paragraph (a) of the description of parameter B, which reads as follows:

"B is the total of

(a) the amount, if any, by which

(i) the individual's net capital losses for other taxation years deducted under paragraph 111(1)(b) in computing the individual's taxable income for the year

exceeds

(ii) the amount, if any, by which the amount determined in respect of the individual for the year under paragraph 3(b) in respect of capital gains and capital losses exceeds the amount determined for A in respect of the individual for the year, and

(b) all of the individual's allowable business investment losses for the year;"

In determining the amounts for parameters A and B of the definition of AGL, one must take into account the wording of the post-amble of subsection 104(21) of the Act. The post-amble of subsection 104(21) indicates that the portion of net taxable capital gains designated by a trust in respect of a beneficiary is deemed to be a taxable capital gain from the disposition of capital property of the beneficiary "for the purposes of section 3 and 111, except as they apply for the purpose of section 110.6."

There is no dispute between the Rep and the CRA regarding the amount computed for parameter A of the definition of AGL. Since there were no dispositions of qualifying properties in XXXXXXXXXX , the lesser of the two amounts under paragraphs (a) and (b) of the description of parameter A is zero (i.e., the lesser of the paragraph (a) amount of $XXXXXXXXXX , being the amount of $XXXXXXXXXX determined under paragraph 3(b) less the amount of $XXXXXXXXXX designated by the trust pursuant to subsection 104(21), and the paragraph (b) amount of zero, being the amount that would be determined under paragraph 3(b) in respect of capital gains from dispositions of qualifying properties of which there were none in XXXXXXXXXX ).

However, there is disagreement between the Rep and the CRA regarding the computation of the amount for parameter B of the definition of AGL. Although the Rep and the CRA agree that the amount computed under subparagraph (a)(ii) of parameter B of the definition of AGL is $XXXXXXXXXX [i.e., ($XXXXXXXXXX - $XXXXXXXXXX ) - XXXXXXXXXX ], the Rep and the CRA disagree as to whether the expression "net capital losses of other taxation years deducted under paragraph 111(1)(b)" contained in subparagraph (a)(i) of parameter B of the definition of AGL quoted above is equal to $XXXXXXXXXX or $XXXXXXXXXX .

In our view, the net capital losses of other taxation years deducted under paragraph 111(1)(b) for purposes of subparagraph (a)(i) of parameter B of the definition of AGL should be $XXXXXXXXXX because of the application of the wording "for the purposes of sections 3 and 111, except as they apply for the purpose of section 110.6" in the post-amble of subsection 104(21). This quoted wording effectively requires that the taxable capital gain of $XXXXXXXXXX designated by the trust pursuant to subsection 104(21) be ignored in determining, for the purposes of subparagraph (a)(i) of parameter B of the definition of AGL, the amount of net capital losses claimed under paragraph 111(1)(b), which amount is determined also taking into account the provisions of subsection 111(1.1). This occurs as explained below.

The amount determined for subparagraph (a)(i) of the description of parameter B of the definition of AGL is equal to the net capital losses deducted in XXXXXXXXXX under paragraph 111(1)(b). The net capital losses that may be claimed under paragraph 111(1)(b) is restricted by the provisions of subsection 111(1.1). Subsection 111(1.1) restricts the net capital losses that may be claimed to the total of two amounts; in the Taxpayer's case, one of these amounts is XXXXXXXXXX and the other amount is the amount determined under paragraph 111(1.1)(a), which reads as follows:

"111(1.1) Net capital losses - Notwithstanding paragraph (1)(b), the amount that may be deducted under that paragraph in computing a taxpayer's taxable income for a particular taxation year is the total of

(a) the lesser of

(i) the amount, if any, determined under paragraph 3(b) in respect of the taxpayer for the particular year, and
(ii) the total of all amounts each of which is an amount determined by the formula

A x B/C

where

A is the amount claimed under paragraph (1)(b) for the particular year by the taxpayer in respect of a net capital loss for a taxation year (in this paragraph referred to as the "loss year"),

B is the fraction that would be used for the particular year under section 38 in respect of the taxpayer if the taxpayer had a capital loss for the particular year, and

C is the fraction required to be used under section 38 in respect of the taxpayer for the loss year; and"

Taking into account the wording in the post-amble of subsection 104(21), the amount determined under paragraph 3(b) for XXXXXXXXXX for purposes of subparagraph 111(1.1)(a)(i) is equal to $XXXXXXXXXX (i.e., the amount of $XXXXXXXXXX determined under paragraph 3(b) for purposes of computing net income less the amount of taxable capital gain of $XXXXXXXXXX designated by the trust under subsection 104(21)).

The amount under subparagraph 111(1.1)(a)(ii) must also be computed taking into account the wording of the post-amble of subsection 104(21). The formula calculation in subparagraph 111(1.1)(a)(ii) provides for an adjustment of the net capital losses deducted where the inclusion rate for capital gains and losses for the year in which the loss is realized differs from the inclusion rate for the year in which it is deducted. Since the amount determined under paragraph 111(1.1)(a) is the lesser of the two amounts computed under subparagraphs (i) and (ii) thereof, one amount of which is the $XXXXXXXXXX noted above, and since the Taxpayer deducted net capital losses of $XXXXXXXXXX (adjusted as required by subparagraph 111(1.1(a)(ii)) under paragraph 111(1)(b) in computing his XXXXXXXXXX taxable income, the lesser of the two amounts is $XXXXXXXXXX . That is, this amount of $XXXXXXXXXX , which represents the amount of taxable capital gains (determined under paragraph 3(b) for purposes of paragraph 111(1.1)(a)) that can be reduced by net capital losses under paragraph 111(1)(b), in effect also determines the amount referred to by the wording "net capital losses of other taxation years deducted under paragraph 111(1)(b)" in subparagraph (a)(i) of the description of parameter B in the definition of AGL.

The communications between the Rep and the TSO raised the issue of whether the amount of $XXXXXXXXXX suggested by the CRA or the amount of $XXXXXXXXXX suggested by the Rep better reflects the intent of the wording "net capital losses of other taxation years deducted under paragraph 111(1)(b)" contained in subparagraph (a)(i) of parameter B of the definition of AGL. Thus, the issue that arises is whether the conclusion of using the amount of $XXXXXXXXXX of net capital losses claimed under paragraph 111(1)(b) for purposes of the computation of the AGL, which in turn affects the computation of CGL, is consistent with tax policy. Although we are unable to comment on tax policy since it is the responsibility of the Department of Finance, we would venture to say that a net capital loss amount of $XXXXXXXXXX appears to be consistent with the Department of Finance's explanatory notes to subsection 110.6(1) of May 1994 [S.C. 1994, c. 21 (Bill C-27)], which state:

"The definitions of "annual gains limit" and "cumulative gains limit" were amended by Chapter 24 of the Statutes of Canada, 1993 (Bill C-92), effective for the 1988 and subsequent taxation years, to provide that the annual gains limit and the cumulative gains limit of an individual were to be reduced by net capital losses of one year carried over and deducted in another year only to the extent that such losses were deducted against gains eligible for inclusion in the annual gains limit and the cumulative gains limit of the individual. This amendment extends this relief to the 1985 and subsequent taxation years." (Emphasis added)

In XXXXXXXXXX the Taxpayer did not have dispositions of qualifying properties and accordingly had no gains eligible for inclusion in the annual gains limit and the cumulative gains limit. Therefore, according to the explanatory notes, the net capital losses claimed in XXXXXXXXXX should not reduce the annual gains limit and the cumulative gains limit. Using the amount of net capital loss of $XXXXXXXXXX for subparagraph (a)(i) of parameter B of the definition of AGL, determined as explained above, would be consistent with the explanatory notes because such losses would be reduced to XXXXXXXXXX by subtracting the amount of $XXXXXXXXXX computed for subparagraph (a)(ii) of parameter B of the definition of AGL. As a result, the net capital losses would not reduce the annual gains limit and the cumulative gains limit in XXXXXXXXXX .

If you have any question, please call the undersigned.

S. Parnanzone
For Director
Business and Partnerships Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch