19 November 1990 Income Tax Severed Letter

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.

Toronto District Office                 Rulings Directorate
                                        Don Sommerfeldt
Attention: L. Driffield                 957-2110
Audit Review Section                    900592

          19(1)

SUBJECT: Subsections 4(4) and 112(4)

This is in response to your memorandum dated March 1990 to Ian Rathwell of the Audit Applications Division and forwarded to us by K.R. Warren, Director, in which you requested an opinion as to whether subsection 4(4) of the Income Tax Act (Canada) (the "Act") precludes the application of subsection 112(4) of the Act in the circumstances which you described. (In this memorandum all subsequent statutory references are to the Act).

FACTS

It is our understanding that the relevant facts are as follows:

          24(1)

24(1)

The issue which has been raised is whether subsection 4(4) or some other provision of the Act precludes subsection 112(4) from being applied so as to:

(a) reduce the losses reported by 19(1) to nil, or

(b) create a "negative loss" (i.e., income).

SUMMARY

It is our opinion that:

     (a)  subsection 4(4) does not preclude the application of subsection
          112(4);

     (b)  the effect of subsection 112(4) is only to reduce the amount of a
          loss as otherwise determined, and not to create an income
          inclusion; and

     (c)  the draft legislation released by the Minister of Finance on July
          13, 1990 (the "Draft Legislation") will likely have a remedial
          application to 19(1) situation.

ANALYSIS

Except where otherwise stated, the comments under this heading are based on the current, rather than the proposed, wording of subsections 4(4) and 112(4).

The reasons for which we are of the opinion that subsection 4(4) does not preclude the application of subsection 112(4) in circumstances are as follows:

          19(1)

1. As you have pointed out, subsection 4(4) does not apply where a contrary intention is evident. Subsection 112(3) specifically states that the stop-loss rule contained therein applies only to the extent that the particular dividend is deductible from the recipient's income. Since subsection 112(4) does not contain such a limitation, it appears that the intention of Parliament was that the subsection should apply even where a dividend included in income does not qualify for a deduction under subsection 112(1).

2. The portion of subsection 4(4) which is relevant for our purposes is:

          ... no provision of this Part shall be read or construed to
          require the inclusion ... in computing the income of a taxpayer
          for a taxation year or his income or loss for a

taxation year from a particular source ... of any amount to the
          extent that amount has been included ... in computing such income
          or loss under, in accordance with or by virtue of any other
          provision of this Part:

Thus, for subsection 4(4) to apply, there must be two statutory provisions each of which includes the same amount in computing income or in computing a loss. Strictly read, subsection 4(4) does not apply where one statutory provision includes an amount in computing income and another provision includes the same amount in computing a loss. In the present situation paragraph 12(1)(k) (read in conjunction with section

          24(1)

However, subsection 112(4) does not also require such dividends to be included in his income; rather, it requires certain of those dividends to be subtracted from the amount that would otherwise be his loss from 24(1). Accordingly, paragraph 112(1)(k) and subsection 112(4) may both apply, without offending subsection 4(4).

3. Subsection 4(4) applies only where there are two provisions of Part I of the Act which each require the inclusion or permit the deduction of the same amount in computing a taxpayer's income or loss. While paragraph 12(1)(k) (read in conjunction with section 90)

          24(1)

---- --- --- expressly distinguishes between income and taxable income, it follows that subsection 4(4) does not preclude the application of subsection 112(4).

We appreciate that the above analysis may lead to a harsh result, as illustrated by the following example. Assume that an individual acquires, as inventory, a share of a foreign corporation, for a cost of $25. He receives a dividend of $5 on the share, and then, after owning it for less than 365 days, disposes of it for $20. Paragraph 12(1)(1) (read in conjunction with section, 90) requires that he include the $5 dividend in income. His loss otherwise determined from trading in the share is $5; however, pursuant to subsection 112(4), this loss is reduced to nil. Hence, while the individual, for net economic purposes, has realized neither a gain nor a loss, he is required to pay tax on $5 of income. While there may be policy reasons for avoiding such a result, we do not believe that the wording of subsection 4(4) goes so far as to provide the appropriate relief.

          21(1)(b)

21(1)(b)

We are of the view that subsection 4(4) does not preclude the application of subsection 112(4) to 19(1) situation. However, we do not believe that subsection 112(4) applies in such a manner as to "create" income. We are not certain as to the basis on which Table A (attached to your memorandum) was drafted; however, it appears that the table might be construed as suggesting that subsection 112(4) should be applied in such a manner that the "subsection 112(4) amounts" will not only reduce 19(1) losses to nil, but will also, to the extent that they exceed such losses, be included in his, income. If such is the intent of Table A, we are of the opinion that this is an inappropriate application of subsection 112(4) for the following reasons:

1. If subsection 112(4) contains an algebraic formula, section 257 provides that any amount or number determined or calculated thereunder that would otherwise be a negative amount or number is deemed to be nil.

2. If subsection 112(4) does not contain an algebraic formula, it would seem that the word "minus", as used therein, should be given its ordinary, non-technical meaning, which, according to Canterra Energy Ltd. v. The Queen [1987] 1 CTC 89 at 94 (FCA), implies a subtraction of something from the whole and does not contemplate the result being a negative amount.

3. Given the structure of the Act, subsection 112(4) does not appear to be a charging provision.

A further issue that arises is the manner in which the amount of a loss to which subsection 112(4) applies should be "otherwise determined". There are several possibilities to consider, as illustrated algebraically by certain formulas, where:

L - the amount of the loss otherwise determined;

P - the proceeds of disposition of the share;

C - the cost of the share;

     I -  the amount of any interest paid on money borrowed to acquire the
          share; and

     E -  the amount of any expenses, other than interest, relating to the
          sale transaction, e.g., brokerage fees.

Three possible, formulas for otherwise determining "the amount of any loss of the taxpayer arising from transactions with reference to the share" (which is the amount that is affected by subsection 112(4)) are:

1. L - P - C

2. L - P - (C + E)

3. L - P - (C + E + I)

We are of the view that the first formula is not appropriate since it ignores the various expenses that may be incurred by a taxpayer in selling the share. With respect to the second and third formulas, we are of the view that the phrase "the amount of any loss of the taxpayer arising from transactions with reference to the share" suggests that the loss is to be computed by reference to specific transactions or events, such as a purchase and subsequent sale, rather than by reference to a continuous period, such as a taxation year. It is significant that subsection 112(4) does not use a phrase such as "the amount of any loss of the taxpayer for a taxation year in which he disposes of the share". Since the concept of interest connotes a period of time, rather than a specific transaction or event, we prefer the second, rather than the third, of the above formulas. A further argument in support of this position is that anomalous results occur where the third formula is applied to situations where two or more taxpayers buy and later sell identical shares for the same purchase and selling prices but incur different amounts of interest, perhaps because they borrowed at different rates or because their respective loans were outstanding for different periods of time. Thus, it is our view that, where subsection 112(4) applies, the appropriate procedure is first to "otherwise determine" the amount of the loss by subtracting the cost to the taxpayer of the share and his selling expenses from his proceeds of disposition, then to reduce this loss by subtracting the amount of the dividend which is the subject of subsection 112(4), and finally to deduct any interest that may be deductible under paragraph 20(1)(c).

          21(1)(b)

CONCLUSION

We trust that the foregoing fully responses to the inquiries which you

have raised. If you have any questions, or would like to discuss this matter further, please feel free to contact us.

for Director Reorganizations and Non-Resident Division Rulings Directorate Legislative and Intergovernmental Affairs Branch