5 November 2010 Internal T.I. 2010-0364411I7 - Effect of election under subsection 14(1.01)

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 capital dividend election filed under subsection 83(2) of the Income Tax Act should continue to be considered excessive despite the election under subsection 14(1.01) of the Income Tax Act filed with the tax return deeming the disposition of eligible capital property to be a disposition of capital property.

Position: Yes.

Reasons: Extent of a deeming provision.

									November 5, 2010

	Assessment and Benefit Services Branch		HEADQUARTERS
	T2 Assessing and Processing Program			Income Tax Rulings
			  							Directorate
	Attention: Mr. Doug Schober				André Gallant
									(613) 957-8961

									2010-036441

Interaction between subsections 14(1.01) and 83(2) of the Income Tax Act ("Act")

This is in response to your fax of April 20, 2010, and is further to our telephone conversation (Gallant/Schober) and your subsequent email dated July 20, 2010, regarding the above-noted issue.

Our understanding of the facts is as follows:

1. A corporation has a XXXXXXXXXX taxation year-end.

2. In XXXXXXXXXX , the corporation disposed of an eligible capital property ("ECP") in respect of which the corporation could elect to apply the rules in subsection 14(1.01).

3. The corporation filed a valid election (T2054) under subsection 83(2) of the Act in respect of a dividend payable on XXXXXXXXXX and paid on that date.

4. At the time of filing the subsection 83(2) election on XXXXXXXXXX , the corporation intended to file an election under subsection 14(1.01) to deem the disposition of the ECP to be a disposition of a capital property in XXXXXXXXXX . The election under subsection 14(1.01) could also have been filed, pursuant to the wording of subsection 14(1.01), together with the capital dividend election (T2054), but the corporation chose to file the election with the return of income for XXXXXXXXXX instead, as also permitted pursuant to the wording of subsection 14(1.01).

5. The amount of dividends in respect of which the T2054 election was filed was found to be in excess of the balance of the capital dividend account ("CDA") immediately prior to the particular time at which the dividend became payable by the corporation. Accordingly, the Canada Revenue Agency ("CRA") sent the corporation a proposal letter advising of the excessive capital dividend election and of the tax exigible under Part III of the Act (section 184) on the excessive election.

6. The proposal letter was essentially based on the position set out in document
2003-0030245. In document 2003-0030245, at issue was whether, in a situation where the taxpayer files the election under subsection 14(1.01) with the tax return for the year, the taxpayer could add an amount to the CDA at the time of the disposition of the ECP or must wait until the election under subsection 14(1.01) of the Act is filed with the return of income for the year. In document 2003-0030245, it was concluded that until the required election under subsection 14(1.01) of the Act has been made and filed with the taxpayer's return of income for the year, no amount can be added to the CDA.

7. There is no disagreement that had the corporation filed the election under subsection 14(1.01) together with the capital dividend election under subsection 83(2), there would not have been an excessive capital dividend election.

8. You have now received representations from the corporation's lawyer (Rep) contending that the position in document 2003-0030245 is not supported under the Act. The Rep argues that when a taxpayer files an election under subsection 14(1.01), the taxpayer is deemed, pursuant to paragraph 14(1.01)(b), to have disposed of a capital property at the time when the ECP was actually disposed of. In other words, by filing the subsection 14(1.01) election in XXXXXXXXXX , the corporation is deemed to have disposed of a capital property in XXXXXXXXXX . According to the Rep, the deemed disposition would give rise to a capital gain that would be added to the CDA in XXXXXXXXXX , resulting in no excess capital dividends being paid on XXXXXXXXXX and accordingly no Part III tax being exigible.

Your question concerns whether the position in document 2003-0030245 continues to be valid with the result that the corporation's capital dividend election should be considered excessive despite the election under subsection 14(1.01) to treat the disposition of ECP to be a disposition of a capital property.

OUR COMMENTS

Based on a textual, contextual and purposive analysis of subsection 14(1.01) of the Act and the provisions related to the capital dividend election (the definition of "capital dividend account" in subsection 89(1), and subsections 83(2) and 184(2)), we would answer in the affirmative to your question.

Subsection 14(1.01) is a deeming provision, which has been defined by Beetz J. as follows in R. v. Verrette, [1978] 2 S.C.R. 838 at 845 (SCC):

"...a statutory fiction; as a rule it implicitly admits that a thing is not what it is deemed to be but decrees that for some particular purpose it shall be taken as if it were that thing although it is not or there is doubt as to whether it is."

One of the main issues with deeming provisions is determining the extent to which the statutory fictions created by those provisions may be applied.

Deeming provisions were canvassed by the Federal Court of Appeal in La Survivance v. Canada, 2006 FCA 129. (footnote 1) In La Survivance, the Court made clear that the deeming provision in question, subsection 256(9) of the Act,

"...must be construed in its entire context, in accordance with the grammatical and ordinary sense of the words, harmoniously with the scheme of the Act, the object of the Act, and the intention of Parliament."

While this comment was made with reference to the particular deeming provision in subsection 256(9), one can infer that this approach must be taken in considering the effect of any deeming provision in the Act, including subsection 14(1.01). However, the court also stated that

"[i]nsofar as subsection 256(9) effectively alters reality, its meaning should be limited to what is clearly expressed. A deeming provision cannot otherwise modify the actual situation that obtains."

This comment seems to acknowledge that some degree of clarity must exist before a deeming provision can be relied upon to create a particular statutory fiction. That being said, the Federal Court of Appeal in La Survivance went on to find that an explicit legal fiction also created an implicit legal fiction. While subsection 256(9) of the Act only states that an acquisition of control of a corporation is deemed to occur at the commencement of a day (in the absence of an election by the corporation that the provision not apply), the court determined that the wording of the provision implied that the shareholder who previously controlled the corporation must be considered to have ceased to control the corporation at the commencement of that day. In effect, the court drew an inference from the wording of the deeming provision not explicitly contained in its wording.

In coming to this conclusion, the Federal Court of Appeal in La Survivance distinguished subsection 256(9) from the old paragraph 251(5)(b) that was applicable in the Exchequer Court decision in Viking Food Products Ltd. v. M.N.R., 67 DTC 5067. In Viking Foods, the taxpayer-corporation argued that the predecessor to old 251(5)(b), which deemed a person with rights to acquire control to be in the same position vis-à-vis control of the corporation had such rights been exercised, had the effect of stripping control from the actual majority shareholder for the purposes of determining which other corporations were associated with the taxpayer-corporation. In rejecting this argument, President Jackett of the Exchequer Court examined the context surrounding the enactment of the predecessor to paragraph 251(5)(b) and concluded that the provision was enacted as a supplement to the concept of corporate control and therefore did not remove the majority shareholder from its position of de jure control.

In the present case, we are of the view that the deeming rule in subsection 14(1.01) of the Act should be limited to what is strictly expressed in subsection 14(1.01): a disposition of capital property is deemed to have occurred on the date of the disposition of ECP. While this deeming provision changes the reality with respect to the disposition of ECP, it cannot also change the reality of the other tax provisions (subsections 83(2) and 184(2)) in this particular case. The legal fiction in subsection 14(1.01) cannot change the fact that when the corporation in fact elected under subsection 83(2) (before the election under subsection 14(1.01) was made in the subsequent year), the additional tax on an excessive election in subsection 184(2) was created. The deeming rule in subsection 14(1.01) cannot apply as far as cancelling the additional tax provided by subsection 184(2) or as changing the reality that the additional tax under that provision was indeed created.

The present case is distinguishable from the case in La Survivance. The implicit legal fiction in La Survivance in interpreting subsection 256(9) (i.e., the vendor shareholder ceased to control the corporation at the commencement of the day) is not as removed from the explicit legal fiction of subsection 259(9) (i.e., a purchaser's acquisition of control of a corporation is deemed to occur at the commencement of the day, in the absence of an election that the provision of subsection 256(9) not apply) as the legal fiction in subsection 14(1.01) would be if it were applied for the purposes of subsection 184(2). In this case, while the capital gain resulting from the disposition of a capital property deemed to occur under subsection 14(1.01) in the particular year might be added to the CDA, this addition should only be considered for the capital dividend election under subsection 83(2) in the following year when the subsection 14(1.01) election is filed with the corporation's tax return.

The explanatory note to subsection 14(1.01) dated February 2007 further supports the conclusion that the election under subsection 14(1.01) only affects the election under subsection 83(2) once the subsection 14(1.01) election is filed; if the election under subsection 14(1.01) is filed with the return in the following year, the deemed capital gain can only affect a capital dividend election in the subsequent year. Here is the relevant passage from this explanatory note:

"The amended provision will allow a taxpayer to elect in the taxpayer's return of income for the taxation year of the disposition, or with an election under subsection 83(2) of the Act. This allows a taxpayer to consider the resulting capital gain when making a capital dividend election."

The amendment referred to in this passage was to add the possibility of filing the subsection 14(1.01) election together with a capital dividend election under subsection 83(2), instead of only having the option to file the subsection 14(1.01) election with the return of income.

Our conclusion would not change in a situation where a taxpayer had not filed an excessive capital dividend election in the year of the ECP disposition, but later requested an amendment to its capital dividend election under subsection 83(2) once the subsection 14(1.01) was filed with the return of income in the following year. In such a case, the resulting capital gain from the subsection 14(1.01) election could still only be considered with a capital dividend election filed in a year following the year in which there was the ECP disposition. XXXXXXXXXX If such a situation were allowed, XXXXXXXXXX it could XXXXXXXXXX cause legal uncertainties for any taxpayers relying on the CRA exercising its discretion to allow an amended election under subsection 220(3.2) of the Act. In exercising its discretion, the CRA would have to consider all the relevant circumstances, which could probably include the fact subsection 14(1.01) now permits the filing of the subsection 14(1.01) election together with a capital dividend election under subsection 83(2).

XXXXXXXXXX

We trust that these comments will be of assistance.

For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the CRA's electronic library. 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 electronic library version, or they may request a severed copy using the Privacy Act criteria, which does not remove client identity. You should make requests for this latter version to Mrs. Céline Charbonneau at (613) 957-2137. A copy will be sent to you for delivery to the client.

Yours truly,

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

FOOTNOTES

Note to reader: Because of our system requirements, the footnotes contained
in the original document are shown below instead:

1 The general concepts of La Survivance were more recently applied with respect to the deeming rule in paragraph 87(7)(d), which generally applies to corporate amalgamations: Canada v. Dow Chemical Canada Inc., 2008 FCA 231.
2 While the administrative burden on the CRA would have been higher before the 2007 amendment to subsection 14(1.01) if such a situation was allowed, we are of the view there would still be cases where the taxpayer forgot to or chose not to file their subsection 14(1.01) election together with their capital dividend election in the year of the ECP disposition.