Translation disclaimer
This translation was prepared by Tax Interpretations Inc. The CRA did not issue this document in the language in which it now appears, and is not responsible for any errors in its translation that might impact a reader’s understanding of it or the position(s) taken therein. See also the general Disclaimer below.
Principal Issues: [TaxInterpretations translation]
1) Are capital losses realized by the estate reduced by taxable dividends and capital dividends allocated to the 4 trusts?
2) From a general point of view, is it possible to clarify what each of clauses 112(3.2)(a)(ii)(A), (B) and (C) means by referring to the distinctions between each of them? Specifically, should clause 112(3.2)(a)(ii)(A) include only the portion of the amount of the taxable dividend received by the trust that has not been distributed to the beneficiaries?
3) If a dividend received by a trust has been fully distributed to beneficiaries that are trusts that satisfy the conditions set out in clause 112(3.2)(a)(ii)(C), does clause 112(3.2)(a)(ii)(C) take precedence over clause (A)?
4) If a dividend received by a trust has been fully allocated to beneficiaries that are trusts that do not satisfy the conditions set out in clause 112(3.2)(a)(ii)(C), is the dividend required to be declared in any of clauses (A), (B) or (C)?
Position:
1) Yes, reduced in part. 2) Yes. 3) Yes. 4) No.
Reasons:
Interpretations of the Act.
March 5, 2010
XXXXXXXXXX Headquarters
Technical Advisor Income Tax Rulings Directorate
XXXXXXXXXX TSO Danielle Bouffard
(613) 590-2155
2009-034626
Application of subsection 112(3.2) of the Income Tax Act (the "Act")
This is in response to your internal memo of October 27, 2009, in which you asked us various questions regarding the above subject. We have taken into account the additional information you faxed to us in December 2009.
Unless otherwise stated, all references to a statutory section or included provision in this letter are to a section of the Act or one of its provisions.
Designation of parties and abbreviations
In this document, the names and business names of taxpayers, as well as certain terms, are replaced by the following names, business names and abbreviations:
Mr. X: XXXXXXXXXX
Estate: Estate of the late XXXXXXXXXX
Trust A: XXXXXXXXXX Trust
Trust B: XXXXXXXXXX Trust
Trust C: XXXXXXXXXX Trust
Trust D: XXXXXXXXXX Trust
Executors/Trustees: XXXXXXXXXX
Corporation X: XXXXXXXXXX
Representatives: XXXXXXXXXX
CRA: Canada Revenue Agency
Facts of the Particular Situation
1. Mr. X died on XXXXXXXXXX. He was a widower.
2. Under his will, Mr. X left the residue of his estate in equal shares to his 4 children, which shares are to be kept in 4 separate trusts for the benefit of each of his 4 children, namely: Trust A, Trust B, Trust C and Trust D. The estate includes inter alia XXXXXXXXXX Class D preferred shares of Corporation X. Two of the children and a lawyer unrelated to the deceased or the children are Executors of the Estate and Trustees of the 4 trusts. The first fiscal year of the Estate ended on XXXXXXXXXX.
3. Since Mr. X was deemed by subsection 70(5) to have disposed of the shares of Corporation X immediately before his death, a capital gain of $XXXXXXXXXX was added to his income in his final return.
4. Pursuant to 3 resolutions of the Board of Directors of Corporation X dated XXXXXXXXXX and signed by the three Trustees/Executors, Corporation X has proceeded with 3 purchases for cancellation of Class D shares: XXXXXXXXXX. The third resolution also stated Corporation X's election under subsection 83(2), dated XXXXXXXXXX, to have the deemed dividend resulting from the purchase of the Class D shares paid and payable on that date out of its capital dividend account ("CDA").
5. According to the information provided in an Appendix entitled "XXXXXXXXXX" and signed by one of the Trustees/ Executors of the Estate, XXXXXXXXXX.
XXXXXXXXXX.
6. Taking into account the facts of paragraph 5, the deemed dividends resulting from these redemptions as reported by the Estate are as follows:
XXXXXXXXXX.
7. The Executors/Trustees made an election under subsection 164(6) to deem the capital losses totalling $XXXXXXXXXX, realized by the Estate on the 3 redemptions of the shares of Corporation X, to be deemed to be Mr. X's capital losses resulting from the disposition of said shares and to be claimed on his final return.
8. Dividends totalling $XXXXXXXXXX were allocated and paid on XXXXXXXXXX by the Estate to Trusts A, B, C and D. The taxation year of the Trusts A, B, C and D is from XXXXXXXXXX to XXXXXXXXXX.
9. The application of transitional relief under paragraph 131(11)(b) of the Act to Amend the Act, 1997 (Bill C-28, assented to June 18, 1998) does not apply to these facts.
Questions
1. Are capital losses realized by the Estate totalling XXXXXXXXXX reduced by taxable dividends and capital dividends distributed to the 4 trusts?
2. From a general point of view, is it possible to clarify what each of clauses 112(3.2)(a)(ii)(A), (B) and (C) means by describing the distinctions between each of them? Specifically, should clause 112(3.2)(a)(ii)(A) include only the portion of the amount of the taxable dividend received by the trust that has not been distributed to the beneficiaries?
3. If a dividend received by a trust has been fully allocated to beneficiaries that are trusts meeting the conditions in clause 112(3.2)(a)(ii)(C), is the amount of the dividend required to be recognized pursuant to clause 112(3.2)(a)(ii)(A) and clause 112(3.2)(a)(ii)(C)?
4. If a dividend received by a trust has been fully allocated to beneficiaries that are trusts which do not meet the conditions in clause 112(3.2)(a)(ii)(C), must the dividend be recognized pursuant to any of clauses (A), (B) or (C)?
Subsection 112(3.2) provides a stop-loss mechanism regarding losses incurred by a taxpayer that is a trust on a disposition of shares after April 26, 1995.
The Act does not provide a method for identifying an order for the disposition of identical shares for the purposes of subsection 112(3.2). As stated in Technical Interpretation 2003-0032501E5, where a taxpayer elects to dispose of a number of shares that are identical properties in separate transactions, the CRA's position is to adopt the order of disposition of shares chosen by the taxpayer for the purposes of subsections 112(3) and 112(3.2).
For the purposes of subsection 112(3.2), the reduction of a capital loss is calculated on a share-by-share basis. In the 1996 Ontario Tax Conference (document 9621950), the CRA also indicated that the reduction of a capital loss, as determined under subsection 112(3.2), is calculated for each transaction that generated a capital loss.
As specified in paragraph 4 of the Facts of the Particular Situation, the 3 resolutions of Corporation X indicate that the Class D shares have been the subject of separate XXXXXXXXXX redemptions as follows:
Number of shares redeemed
Dividends
Capital Losses
1st redemption
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
1st redemption
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
2nd redemption
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
3rd redemption
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
TOTAL
XXXXXXXXXX
XXXXXXXXXX
By virtue of 112(3.2)(a), losses realized by an estate on the disposition of shares may be reduced by the amount of dividends from the CDA (received on a share that has been subject to the election under subsection 83(2)). By virtue of paragraph 112(3.2)(b), losses realized by an estate on the disposition of shares may be reduced by the amount of taxable dividends received on a share of a corporation if those dividends are designated to a corporation or conduit (partnership or trust). Since the first and second redemptions resulted in taxable dividends, it is paragraph 112(3.2)(b) that is relevant to the calculation of the loss reduction. Thus, the dividends resulting from the first and second redemptions reduce the losses realized by the estate under paragraph 112(3.2)(b) since the dividends were designated in respect of beneficiaries that were trusts. Since the taxable dividends are equal to the amounts of the losses, the losses are reduced to nil.
The third redemption resulted only in a dividend out of the CDA. Therefore, paragraph 112(3.2)(a) is relevant in calculating the reduction in the loss. This provision essentially provides that the loss realized by the trust is to be reduced by the amount of the capital dividend (subparagraph (i)), but not by more than the amount of the loss remaining after deducting the total of certain taxable dividends (subparagraph (ii)), i.e., any taxable dividend that is taxed: in the hands of the trust (clause (A)), in the hands of a beneficiary under the trust who is an individual (clause (B)), or in the hands of a beneficiary under the trust who is either a corporation, partnership or other trust (clause (C)) where both conditions of subclauses (C)(I) and (C)(II) are satisfied. The lesser of the amount in subparagraphs (i) and (ii) may then be reduced by the amount in subparagraph (iii) and the result is the amount of the loss reduction. In the circumstances of the third redemption, it appears to us that the loss from the disposition of the shares must be reduced by the lesser of the amount in subparagraphs (i) and (ii) and the reduction permitted by subparagraph (iii). Since the amounts in subparagraphs (i) and (ii) are identical, the amount by which the amount calculated in subparagraph (i), being the dividend out of the CDA ($XXXXXXXXXX), exceeds the amount calculated in subparagraph (iii) ($XXXXXXXXXX) is reduced by the amount calculated in subparagraph (iii) ($XXXXXXXX).
Taking the above into account, our answers to your questions are as follows:
Question 1
Are capital losses realized by the Estate totalling XXXXXXXXXX reduced by taxable dividends and capital dividends allocated to the 4 trusts?
Response
As described in paragraphs 4 and 6 of the Particular Situation, three blocks of Class D shares were redeemed in three separate redemptions for the purpose, inter alia, of designating the dividends resulting from the 1st redemption as eligible dividends and reducing the CDA of Corporation X by the dividends resulting from the 3rd redemption. Since each redemption of a block of shares resulted in the realization of a capital loss, the provisions of subsection 112(2.3) applied to each of the losses to reduce, where applicable, the amount of the loss otherwise computed. Consequently, based on our calculations (set out in the attached schedules), the capital losses totalling $XXXXXXXXXX (resulting from three separate redemptions) realized by the Estate should be reduced to $XXXXXXXXXX. Since the Estate designated the taxable dividends from the first two share redemptions to the four trusts, these dividends reduced the capital losses otherwise calculated from the two redemptions under paragraph 112(3.2)(b). On the other hand, the capital dividend designated to the beneficiaries of the Estate partly reduced the capital loss arising on the third redemption under paragraph 112(3.2)(a).
The Estate representatives considered the application of subsection 112(3.2). According to their calculations, the otherwise-computed capital loss of $XXXXXXXXXX realized by the Estate as a result of the redemptions of Class D shares (and not the capital loss computed for each block of shares redeemed) is not reduced on the basis that "all taxable dividends received are taxed at the level of the individuals and there are no life insurance capital dividends". As a result, based on their calculations, no taxable dividends appear to have been designated under subsection 104(19) to a beneficiary that is a trust for the purposes of paragraph 112(3.2)(b) of the Act. Since we have already stated the CRA's positions regarding the application of subsection 112(3.2) to the disposition of identical properties, it remains to comment on the portion of the response relating to the designated taxable dividends received being "taxed at the level of the individuals."
Based on the facts of the particular situation, the Class D Shares held by the Estate executors were required to be divided equally among 4 trusts for the benefit of each of the 4 children of Mr. X, respective beneficiaries of their personal trust. The Trustees for the 4 trusts are the same as the Estate Executors. Finally, the T3 return, filed for the Estate for its taxation year ending XXXXXXXXXX, shows that taxable dividends totalling $XXXXXXXXXX, resulting from the redemptions of the Class D shares, were allocated to the beneficiaries and paid on XXXXXXXXXX. (endnote 1)
In both common law and civil law contexts, a trust does not in itself constitute a legal entity. Article 1260 of the Civil Code of Québec (the "CCQ") sets out the essential conditions for the creation of a trust in Québec. According to that article "[a] trust results from an act whereby a person, the settlor, transfers property from his patrimony to another patrimony constituted by him which he appropriates to a particular purpose and which a trustee undertakes, by his acceptance, to hold and administer.” That being said, by enacting subsection 104(2), Parliament intended, in our opinion, to dissociate itself, for the purposes of the Act, from private law with respect to the treatment and characterization of a trust. Thus, contrary to what the CCQ provides, subsection 104(2) stipulates that for the purposes of the Act, "a trust shall… be deemed to be in respect of the trust property an individual… .” In other words, although under civil law a trust does not in itself constitute a separate legal entity, Parliament has chosen, for the purposes of applying the Act, to disregard these legal effects and instead treat the trust as a separate tax entity with ownership of the property it holds. In addition, subsection 104(1) provides, inter alia, that, for the purposes of the Act, and unless the context otherwise requires, a reference to a trust or estate is to be read to include a reference to the trustee, executor, administrator, liquidator of a succession, heir or other legal representative having ownership or control of the trust property.
The combined application of subsections (1) and (2) of section 104 means that, for the purposes of the Act, both the trust and the trustee(s) (or executor(s)) of the trust may be considered to be an individual in respect of the trust property and thus to own or control the trust property, regardless of the applicable private law. The definition "beneficiary" in subsection 108(1) defines beneficiaries of a trust to include persons beneficially interested in the trust. The Act does not otherwise define "beneficiary". Therefore, for any concept not otherwise defined in the Act, including those in subsection 248(25), recourse must be had to the provisions of the CCQ dealing, for the purposes hereof, with estates constituted in Quebec.
We are of the view that a testamentary trust can qualify as a beneficiary of an estate. Consequently, the conditions in paragraph 112(3.2)(b) are satisfied where taxable dividends allocated to a testamentary trust result from the redemption of shares of capital stock held by an estate and the estate has incurred capital losses.
Question 2
From a general point of view, is it possible to clarify what each of clauses 112(3.2)(a)(ii)(A), (B) and (C) means by describing the distinctions between each of them? Specifically, should clause 112(3.2)(a)(ii)(A) include only the portion of the amount of the taxable dividend received by the trust that has not been distributed to the beneficiaries?
Response
The stop loss rule in subsection 112(3.2) provides that a loss from the disposition of a share by a trust (or estate) may be reduced by certain dividends received by the trust.
The distinctions made in each of clauses 112(3.2)(a)(ii)(A), (B) or (C) are referred to in these terms in the Explanatory Notes published by the Department of Finance:
"Under amended paragraph 112(3.2)(a) a trust's loss will also be reduced by the lesser of …:
...;
the trust’s loss minus certain taxable dividends paid on the share disposed of. (The taxable dividends which count for this purpose are those received and taxed in the trust’s hands, designated by the trust in respect of a beneficiary who is a natural person, or designated to other beneficiaries where the trust establishes that the dividends were received on a share that was held for 365 days or more and received when the trust, the beneficiary and persons non-arm's length with the beneficiary owned less than 5 % of any class of the capital stock of the corporation.)"
In light of the above, for the purposes of clause 112(3.2)(a)(ii)(A), only taxable dividends that are not designated and that are taxed in the trust are subject to clause 112(3.2)(a)(ii)(A). Taxable dividends that are designated by the trust under subsection 104(19) to a beneficiary who is an individual are subject to clause 112(3.2)(a)(ii)(B). Finally, taxable dividends designated by the trust under subsection 104(19) to a beneficiary that is a corporation, partnership or other trust are subject to clause 112(3.2)(a)(ii)(C) to the extent that the holding-period conditions referred to therein are satisfied.
Question 3
If a taxable dividend received by a trust on a share has been fully allocated to a beneficiary that is a trust satisfying the conditions in clause 112(3.2)(a)(ii)(C), is the amount of the dividend required to be recognized under clause 112(3.2)(a)(ii)(A) and clause 112(3.2)(a)(ii)(C)?
Response
The amount of the dividend must be recognized only under clause 112(3.2)(a)(ii)(C) if the holding-period conditions are satisfied.
Question 4
If a taxable dividend received by a trust on a share has been fully allocated to a beneficiary that is a trust that does not satisfy the conditions in clause 112(3.2)(a)(ii)(C), under which of clause (A), (B) or (C) should the dividend be recognized?
Response
The taxable dividend does not have to be recognized under any of these clauses.
For your information, if the taxpayer requests a copy of this letter, you may provide a severed copy under the criteria of the Privacy Act with the taxpayer's name on it, which you may request from Ms. Jackie Page at (819) 994-2898. The Privacy Act-severed copy will then be sent to you so that you can deliver it to the taxpayer.
We hope that these comments are of assistance. Should you require additional information regarding the contents of this document, please do not hesitate to contact us.
Alain Godin, Manager
for the Director
International Operations and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch.
ENDNOTES
1 According to point 4 of the memorandum, dated 27 November 2009, prepared by the representatives, it is stated that "XXXXXXXXXX".
According to point 4 of their memorandum dated 7 December 2009, it also states the following: "XXXXXXXXXX".
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