Section 53

CRA indicated that a dividend arising on a paid-up capital increase to which s. 55(2) applied remains a dividend for s. 53(1)(b)(i) purposes but that such dividend was not permitted a deduction under s. 112(1), for purposes of the application of the basis reduction under s. 53(1)(b)(ii). Conversely, there is a reduction of cost under s. 53(1)(b)(ii) to deny cost on the amount of the dividend that exceeds safe income, and on which a deduction under s. 112(1) was obtained. Thus, cost will not be denied when a dividend on a paid up capital increase has been subject to s. 55(2). CRA stated:

The evolution of the role of subsection 55(2), as reflected in the 2015 legislative amendments to subsections 55(2), 52(3) and paragraph 53(1)(b), invites the conclusion that the application of subsection 55(2) to a dividend should not result in the denial of cost to the property that is received by the dividend recipient on the payment of the dividend.

Is an amount included in a corporation’s income under s. 34.2(2) added by virtue of s. 53(1)(e) to the adjusted cost base of its partnership interest? CRA responded:

[T]he amount included under subsection 34.2(2)… will not be included in the corporation's share of the partnership's income from any source. Therefore, for the purposes of subparagraph 53(1)(e)(i), there would be no addition to the ACB to the corporation of the partnership interest in an amount otherwise included in the income of the corporation under subsection 34.2(2).

Furthermore, there is no other provision in paragraph 53(1)(e) for adding, to the ACB of the partnership interest, the amount that would be included in computing the corporation's income under subsection 34.2(2).

Background

LPco (a wholly-owned Canadian subsidiary of Parentco) acquired all the shares of GPco (holding all the Class “A” units of a Canadian limited partnership, namely, the “Partnership”) and all the Class “B” and “C” Partnership Units in the Partnership in an arm’s length transaction. Income or loss of the Partnership is annually allocated to the two partners in proportion to their Units. Partnership holds depreciable property used in a Canadian business and also appreciated shares of a subsidiary (Aco).

Proposed transactions

1. LPco will transfer its Units to GPco under s. 85(1).
2. Upon such transfer, Partnership will legally cease to exist and all its property will be distributed to GPco, and GPco thereupon and thereafter will carry on alone the Partnership business.
3. GPco may make s. 98(5)(c) designations, e.g., for its Aco shares.

Rulings

Provided Partnership is a Canadian partnership at the time it ceases to exist and GPco continues to carry on the business of the Partnership, s. 98(5) will apply to the dissolution.

Pursuant to s. 99(1), Partnership’s fiscal period will be deemed to have ended immediately before the time that is immediately before the time Partnership ceased to exist. The income or loss of Partnership for its fiscal period so ended will, to the extent of a Partner’s share thereof, be included in computing the Partner’s ACB of its Partnership interest under s. 53(1)(e)(i) or 53(2)(c)(i). In particular: LPco’s share thereof will be included in determining its ACB of the LPco Partnership Interest immediately before its disposition to GPco; and GPco’s share thereof will be included in determining the ACB to GPco of the GPco Partnership Interest immediately before the time Partnership ceased to exist.

X Inc. and Y Inc. each hold "tracking units" in a Quebec general partnership ("SENC AB") which, in turn, holds the units of two subsidiary LPs ("SENC A," and "SENC B"). Their A and B units (which are held in different proportions) accord rights to the results of the investment in SENC A and SENC B, respectively. Would CRA consider that X Inc. and Y Inc. hold distinct interests in SENC AB and thereby have distinct ACBs for their A and B units? CRA responded (TaxInterpretations translation):

The CRA does not intend to change its long-standing position to the effect that an interest in a partnership constitutes a single and identical property irrespective whether the capital of the partnership has one or several classes of interest. Consequently, the ACB of the Class A units in the example submitted will not be distinct from the ACB of the Class B units.

Where a partner disposes of some of its units of a partnership during the year, is there an ACB adjustment for the entire amount of the income allocated to that partner for the fiscal period? After noting that "all of the units that a partner holds in a partnership constitute a single property, i.e. the partner's interest in the partnership" so that, for example, a disposition of "40% of its partnership units…constitutes a partial disposition of its partnership interest," CRA stated:

Where the partial disposition occurs during the fiscal period of the partnership and thus the ACB adjustment for that fiscal period is not reflected in the ACB of the partnership interest for purposes of computing the gain or loss on the partial disposition, it is our view that the ACB of the remaining partnership interest will be increased by that ACB adjustment. Accordingly, the partner would have an ACB adjustment for the entire amount of the income allocated to that partner for the fiscal period despite the partial disposition.

Since s. 53(1)(e)(i)(A) does not explicitly say that the Act is to be read without reference to s. 38(a.3), there is no authority for adding exempt capital gains pursuant to that paragraph in determining the ACB of a partnership interest.

CRA affirmed its position as follows:

… Income Tax Technical News No. 5 … states, in accordance with subparagraph 53(1)(e)(i), that in computing the adjusted cost base of a member's interest in a partnership at a particular time, only the income or loss of the partnership for fiscal periods already ended will be taken into account at that time.

Accordingly, the distribution in the year of a capital gain realized in the year by an LP triggered a negative ACB gain to a limited partner with a modest “outside” basis.

CRA indicated that until the amendment to s. 99(1) was passed, it intended to apply the law so that the income or loss of a partnership for its last taxation year before its dissolution would be taken into account in calculating the partnership interest.

In connection with a query on the implications of holding a preferred unit in a partnership, i.e., a unit that confers on its holder a preferred share of the partnership's profits or losses, CRA stated:

The total of the units held by a partner in a partnership constitutes a single property which is the partner's interest in the partnership. The aggregate of these units is therefore assigned an adjusted cost base (ACB) under the Act. The characterization of the taxpayer's shares into preferred and common units does not result in the creation of separate properties, but is merely a means of sharing the profits and losses of the partnership.

When presented with a situation where a taxpayer retired from a partnership on September 30, 2001 and at December 31, 2001 had a residual interest in the partnership with a negative ACB, CCRA noted that where the problem was not one of double taxation but rather, of the timing of the adjustment to the ACB of the taxpayer's partnership interest (which, in this instance, would result in a capital gain in 2001 and a capital loss in 2002). Accordingly, the administrative relief discussed in Income Tax Technical News Nos. 5 and 9 would not be available.

At the time of Mr. X’s immigration in 1988, he held an interest in a US rental property partnership (with no debt) which he had acquired in 1983 at a cost of US$300,000 and which had an FMV of Cdn.$650,000 at the time of his immigration. After immigration, he invested an additional Cdn.$50,000 in the partnership, which funded building additions. In 2001, the partnership sold the building at a capital gain of $300,000. The net income of the partnership was always nil and no tax depreciation was claimed.

CCRA indicated that Mr. X would be allocated his share of the capital gain – but that since the ACB of his partnership interest was increased to FMV under former s. 48(3) on his immigration and further increased by his capital contribution and his share of the capital gain, he would realize a capital loss on the partnership winding-up.

Where a limited partner leaves the partnership before the year end, so that s. 98.1(1)(b) deems the retired partner not to have disposed of its residual interest until the end of that fiscal period on the basis that it only receives payment for its partnership interest after it ceased to be a member, RC will treat the ACB of the disposed partnership as having been increased by the income for that year that is allocated to the partner.

Where an investment partnership provides that a partner who redeems his units partway through the year for their current fair market value shall have taxable income or capital gains allocated to him based on the appreciation in his units to the date of redemption, a partner who redeems a portion of his units partway through the year will be considered to have disposed of a portion of his partnership interest giving rise to a capital gain that will not reflect the addition under s. 53(1)(e)(i) to the adjusted cost base of his remaining partnership interest of the redemption-related allocation of income.

Where a partnership is wound-up under s. 98(5), the last fiscal period of the partnership will be considered to have ended immediately before the determination of the ACB of the partnership interests even though both times are "immediately before" the partnership ceasing to exist.

Where a corporation which has withdrawn from a partnership has the right to receive the amount in its capital account over time plus interest thereon, the interest will not represent a share of the partnership's income or capital, and will not be added to the ACB of the corporation's partnership interest.

Where B disposes of its partnership interest to the other partner, A, with the result that the partnership ceases to exist, B's share of the partnership profits for the fiscal period that is deemed (by virtue of s. 99(1)) to end immediately before that time will be included in the ACB of B's interest. However, this adjustment will not occur if B disposes of its partnership interest to C. Where B maintains the right to receive a nominal amount of partnership property, RC will question whether this amounts to a residual interest for purposes of s. 98.1 so that B will obtain the appropriate basis adjustment with respect to the second situation.

Re consequences where the partnership is the beneficiary of a life insurance policy in one of the three individual partners; or where the deceased partner's estate will receive all the insurance proceeds.

In the latter case, the ACB of the deceased partner cannot be increased because he is deemed to dispose of his partnership interest immediately before his death and is not a partner at the time the proceeds are received.

Where all the partners of a partnership are corporations the partnership carries life insurance on the individuals who were the voting shareholders of the partners, and the corporation owned by a deceased shareholder receives all the proceeds of the life insurance policy in satisfaction of its interest in the partnership, it is only the ACB of that corporation's interest in the partnership that is increased.

Where the partnership agreement provides for an income allocation to the retiring partner in the year of death equal to the life insurance proceeds received by the partnership, s. 96(1.1) will apply to include the amount of the allocation in the deceased partner's estate's income and the ACB of the partnership interest of the remaining partners will be increased under s. 53(1)(e)(iii).

Rather than making current distributions of its cash flow to a limited partner, those sums are lent by the LP to the limited partner – then at the beginning of the following year the LP effects a distribution of the applicable share of the previous year’s profits to the limited partner by issuing a demand note to it and pays that note by way of set-off against the loans owing by the limited partner. After finding that the loans might have given rise to an immediate gain under s. 40(3.1), CRA went on to state:

[T]he profits of a limited partnership in a situation such as that described would not be considered as contributions of capital for the purposes of subsection 40(3.13). …

The concept of a contribution of capital to a general partnership (SENC) or limited partnership is not limited to what is mentioned in…your letter. For example, the CRA considers that the assumption by a partner of a partnership debt can constitute a form of contribution of capital.

A partnership was wound-up under s. 98(5) as a result of the limited partner transferring its interest under s. 85(1) to the general partner. Immediately before this happened, the general partner assumed a debt that was owing to it by the partnership, with the result that the debt was extinguished by operation of law.

CRA ruled that the ACB of the general partner’s interest for s. 98(5) purposes was increased by the amount of such assumed debt, and that a forgiven amount did not arise on the extinguishing of the debt.

After addressing the usual case where a capital gains distribution by a limited partnership (“SEC”) would be respected as such for ITA purposes, but also noting that “where it can be concluded that the amounts paid by SEC to the Limited Partner are in return for services rendered, it would be possible at that time to consider the inclusion of such amounts in computing the partner's business income pursuant to subsection 9(1) to the extent that the services are provided by the Limited Partner in the course of carrying on a business that is separate from the business operated by the SEC,” CRA then stated:

Otherwise, the fair market value of any service contribution by the Limited Partner would be added to the ACB of its partnership interest.

The 100 units of a limited partnership (LP), which on an FMV basis has a deficit of $108,000 (i.e., liabilities of $110,000 and assets of $2,000), are held as to 99 and 1 by Partner Inc. and its wholly-owned subsidiary GP Inc., respectively. In order to pay off the bank debt, Partner Inc. subscribes for 100 units of LP for $100,000, so that such debt is discharged and the deficit reduced to $8,000.

(a) Does such subscription represent an acquisition of property by Partner Inc. for purposes of s. 69(1)(a), or is it a "contribution of capital" for s. 53(1)(e)(iv) purposes?

(b) If s. 69(1)(a) so applies, would the difference between the cost of acquiring the additional 100 units and their FMV, i.e., $100,000, be a "contribution of capital" for s. 53(1)(e)(iv) purposes?

CRA responded:

[W]e believe that the partner, in consideration for the $100,000 payment, acquired a greater interest in the partnership by acquiring part of a property. We believe that subsection 69(1) could apply to the acquisition of part of a property, especially since the wording of that provision uses the word "anything".

In this case, to the extent that Partner Inc. has not conferred a benefit on GP Inc. by subscribing for LP units, if the units issued have a value that is less than their issue price, that value (in this case $0), determined in accordance with paragraph 69(1)(a), will be added to the cost of the units. The difference between the amount paid and the value of the units will be added to the ACB of the interest pursuant to paragraph 53(1)(e)(iv).

CRA confirmed that the following statement from IT-338R2, para. 12 continues to represent its position, notwithstanding the archiving of the Bulletin:

To the extent the former partner has assumed the liabilities of the partnership, that former partner is considered to have made a contribution of capital to the partnership immediately before the partnership ceases to exist. For purposes of subparagraph 98(5)(a)(i), this results in an increase to the ACB of the former partner's interest in the partnership under subparagraph 53(1)(e)(iv).

On a winding-up of a partnership, "for the purposes of determining the ACB to each Partner of that Partner's interest in the Partnership for the purposes of subsection 98(3), the Partner's share of the net income of the Partnership for the fiscal period that commenced on XXXXXXXX and will end immediately before 'that time' will be added to the ACB of that Partner's interest in the Partnership as of the time immediately prior to 'that time' pursuant to subparagraph 53(1)(e)(i)".

In determining the ACB to a partner of its interest in a partnership for the purposes of s. 98(3), that ACB will be increased by liabilities of the partnership assumed by the partner immediately before that time.

Where a debt owing to a partner is converted into capital, the amount of such "contribution" and, therefore, the quantum of the resulting increase in ACB of the partner's interest, will be a question of fact.

Where, in connection the dissolution of a partnership under s. 98(3) and the recontribution of the property to a new partnership under s. 97(2), a partner borrows money to make a contribution to the old partnership immediately before its dissolution and receives a corresponding distribution of capital shortly after the formation of the new partnership, GAAR will be applied so as to prevent this avoidance of a capital gain on the dissolution of the partnership.

In considering a situation where all the assets of a resource partnership are distributed on a pro-rata basis to the partners without an election being made under s. 98(3), RC indicated that "amounts referred to in subparagraph 53(1)(e)(viii) of the Act will not increase the ACB of the partner's interest in the partnership until after the end of the relevant fiscal period of the partnership". However, a favourable result would still obtain if the fiscal period of the partnership ends after the distribution of partnership assets to the partner and prior to the partnership interest being disposed by the partner on dissolution of the partnership.

Canco and a US resident who each held a 50% interest in a US partnership each advanced US$1 million to the partnership and then converted those advances to partnership units at a time that the Canadian dollar had depreciated (from a 1.2 to 1.4 exchange rate) relative to the exchange rate at the time of advance. CRA found that such conversion generated a capital loss to the partnership of $400,000 under s. 39(2) of which $200,000 was allocated to Canco, and that Canco realized a capital gain of $200,000 on its disposition of the advance.

Although Canco acquired an addition to the cost of its partnership interest equaling its proceeds of disposition, the ACB of its interest was reduced by the $200,000 capital loss allocated to it, so that the net effect was no change in the ACB of its overall interest in the partnership.

When will CRA treat loans from a limited partnership received by a limited partner in order to avoid a gain under s. 40(3.1) as a distribution of partnership capital or profits per s. 53(2)(c)(v), so that such negative-ACB gain is not avoided?

CRA responded that it “will generally” not do so where the following five tests are satisfied:

1. “The loan is not made on account of or in full or partial payment of a withdrawal of a limited partner's capital contribution.”

2. The total amount of all loans received by the limited partner in respect of a fiscal period of the partnership does not exceed the total of (i) the limited partner's share of the adjusted net income of the partnership for the fiscal period (i.e., s. 53(1)(e)(i) additions minus 53(2)(c)(i) year losses), and (ii) the ACB of the limited partner's interest at the end of the fiscal year - “or, if there is an excess amount, it is not material in the circumstances”.

3. “Shortly after the end of the fiscal period, the partnership declares a distribution payable to the limited partner in an amount equal to the total amount of the loans received by the limited partner during the fiscal period and the distribution is used to settle the loans to the limited partner (in cash or by way of set-off).”

4. The loan (made in lieu of the cash payment of the distribution) is made primarily for the purpose of avoiding a deemed gain to the limited partner pursuant to s. 40(3.1) that would be realized at the end of the fiscal period of the partnership caused solely by the difference between the time of the addition of the limited partner's share of the adjusted net income of the partnership for the fiscal period, and the time of the deduction of distributions to the limited partner for the fiscal period pursuant to s. 53(2)(c)(v) (other than the mooted loans).

5. The partnership interest is not a tax shelter, and this is not part of a larger series of transactions that includes an avoidance transaction to which s. 245(2) should apply.

CRA indicated that whether a payment made by a limited partnership to a limited partner that was styled as a loan was to be treated as a loan for purposes of ss. 96(2.2)(c) and 53(2)(c)(v) (rather than as a distribution) was to be determined based on the laws of Ontario.

Regarding the common law, the Directorate stated (adverting to the Rye v. Rye/ Klein line of cases):

It is well established at common law that a man cannot contract with himself and that a partner cannot contract with a partnership of which he is a member. Therefore, it is necessary to determine whether a limited partnership can make a loan to a limited partner pursuant to statutory law, thereby overriding such long-standing common law rule.

CRA had earlier referred to s. 60(1) of the Partnership Act (B.C.), which provides that “A limited partner may lend money to, borrow money from and transact business with the limited partnership,” and noted that such a loan therefore can be valid.

Although, on its analysis, this was the very provision at issue, it curiously did not go on to refer to s. 12 of the Limited Partnerships Act (Ontario), which provides a truncated (but likely not maimed) version of s. 60(l) of the B.C. Act: “A limited partner may loan money to and transact other business with the limited partnership … ” (i.e., s. 12 does not specifically refer to limited partner borrowings). However, CRA indicated that the doubts expressed in 2016-0637341E5 as to whether it was possible under the civil law for a limited partnership to make loans to a limited partner were not meant to apply to Ontario limited partnerships.

Rather than making current distributions of its cash flow to a limited partner, those sums are lent by the LP to the limited partner – then at the beginning of the following year the LP effects a distribution of the applicable share of the previous year’s profits to the limited partner by issuing a demand note to it and pays that note by way of set-off against the loans owing by the limited partner. Does this approach avoid negative ACB gains under s. 40(3.1)?

CRA referred to the “general principle of civil law to the effect that a person cannot make a contract with itself,” so as to suggest that a partnership loan to a partner may not be valid and went on to state:

Should it not be possible for a limited partnership to make loans to the limited partner…the amounts styled as loans…would be treated by the CRA as amounts received in lieu of or in full or partial payment of the distribution of the taxpayer’s share of the limited partnership profits under subparagraph 53(2)(c)(v).

CRA also stated:

[T]he scope of subparagraph 53(2)(c)(v) is very broad and could in theory…apply in respect of the loan amount (on the assumption that the loans were permitted under the civil law)… .

[T]he Courts…have given a very wide scope to the terms "on account of" and "in lieu of"…, which are also used in subparagraph 53(2)(c)(v).

The partnership agreement for a services partnership provides that a partner who has withdrawn will be paid over five years an amount respecting work-in-progress and paid at a formula-based rate over five years, with the parties agreeing that such amounts paid as income allocations under s. 96(1.1). After noting that if the partnership net income for a year was nil, no income could be allocated to the retired partner under s. 96(1.1) (or (1)), CRA indicated that if an amount was paid to the retired partner notwithstanding the nil income:

[T]his amount would constitute a withdrawal by the other partners. That would result in a proportionate reduction in the adjusted cost base of their interest in the partnership pursuant to subparagraph 53(2)(c)(v).

What is the tax treatment of an allowance paid by a partnership to a partner for the use of the partner’s automobile in the course of the partner’s duties; and what if the partnership reimbursed certain expenses incurred by the partners? The Directorate stated:

Generally, an allowance paid by a partnership to a partner does not qualify as an expense of the partnership but rather represents a way of distributing the profits or capital of the partnership to its partners. From the perspective of the partner receiving such an allowance, it constitutes a distribution that reduces the adjusted cost base (ACB) of the partner's interest in the partnership pursuant to subparagraph 53(2)(c)(v) … .

[I]f the reimbursement to the partner is for a partnership expense that was incurred for the purpose of earning income from the partnership, the reimbursement will be deductible by the partnership and there will be no impact on the partner. If the reimbursement is instead related to a personal expense of the partner or if it is anticipated that the partner will personally incur certain expenses, such as automobile expenses, then the reimbursement will not be deductible by the partnership. For the partner, this payment will be treated as a distribution and an adjustment to the ACB will be required pursuant to subparagraph 53(2)(c)(v) … .

Prior to the enactment of ss.40(3.1) and (3.2), it had been agreed that excess revenues generated by a limited partnership would be distributed to the limited partners in order to permit them to retire bank loans used to finance their acquisition of the limited partnership interests, rather than being used to pay off bank project financing of the limited partnership. However, in order to avoid a capital gain on a negative ACB arising from such distributions, it was acceptable to agree that such revenues instead would be used to acquire investments, with the investments being legally owned by the bank "in order to provide the bank with some element of security".

Where the Canadian partners of a U.S. partnership enter into currency feature contracts to close on the anticipated date of distribution of income in U.S. dollars from the partnership and convert the U.S. dollar distribution received to Canadian dollars upon receipt, the exchange rate that will govern for purposes of the adjustment to the ACB of the partnership interest will be that prevailing at the time they receive the distribution. The hedge transaction will be considered to be a separate transaction.

Background

Subco, which is held by Parent (also a Canadian corporation), owns all the units of Trust 1 which, in turn, holds all the units of Holding LP (previously acquired by it in connection with a reorganization in which it transferred assets including appreciated assets to Holding LP and subsidiary LPs, with gains being potentially limited or quantified through s. 97(2) elections).

Proposed transactions

1. Trust I will transfer, at FMV, all its Holding LP Units to Subco in consideration for a non-interest bearing promissory note (Subco Note), so that its remaining assets will consist of a loan to Subco (the “Subco Loan”), the Subco Note, interests in sub trusts and cash.
2. Trust I will distribute the Subco Loan and the Subco Note as the consideration for the purchase for cancellation of substantially all of the Trust 1 units (the “Subco Cancelled Units.”) Subco (or New Parent as successor of Subco) will continue to hold the remaining units of Trust I for an undetermined period of time. The amount of the income allocated to New Parent (as successor of Subco) in respect of this distribution will be equal to the total of Trust I’s income for its current taxation year (including from the drop-down transactions referenced above under “Background”). Subco will realize a capital loss on the cancellation of the Subco Cancelled Units.
3. Subco will amalgamate with Parent to form New Parent.
4. In filing its return for its current taxation year, Trust I will deduct under s. 104(6)(b) an amount equal to the income as became payable to Subco. New Parent (as successor of Subco) will include such amount under s. 104(13)(a) in computing its income.
5. Trust I will designate pursuant to s. 104(21) in respect of New Parent (as successor of Subco) that the net taxable capital gains for the current taxation year of Trust I be deemed to be a taxable capital gain of New Parent from the disposition of capital property by New Parent for its XX taxation year.

Rulings

Include: The amount of the taxable capital gains referred to in 3 will be deemed to be a taxable capital gain of New Parent under s. 104(21).

Ss. 53(2)(h)(i.1)(A) and 53(2)(h)(i.1)(B)(I) will apply such that the ACB of the Trust I Units to Subco will not be reduced for the amount included in New Parent's income (as successor to Subco), as described in 4, and for an amount equal to the amount designated by Trust I in 5.

Units of a unit trust (“UT”) that does not qualify as a mutual fund trust (“MFT”) are issued for FMV monetary consideration to arm’s length subscribing unitholders, with the proceeds invested in real estate. After noting that although s. 75(2) could apply, CRA noted that, depending on the circumstances, it likely would not apply s. 75(2), and then stated:

It [thus] is not clear to us in what commercial circumstances the CRA would consider the annual income of an UT otherwise payable to the beneficiaries to be income of the beneficiaries under subsection 75(2), rather than under subsection 104(13).

In the event that subsection 75(2) were to apply in respect of monetary consideration received by the UT in consideration for the issuance of units to a taxpayer, the technical application of subparagraph 53(2)(h)(i.1) would involve the deduction of an amount against the ACB of the taxpayer's capital interest equal to the income designated under subsection 75(2) for a particular year that is otherwise payable to the taxpayer under the trust indenture. This is so because the designated income is not an amount included in the taxpayer's income under subsection 104(13).

Thus … the application of these provisions is likely to result in double taxation for the taxpayer for any taxation year in which subsection 75(2) applies or for a taxation year subsequent thereto, on the disposition of all or part of the taxpayer's capital interest or under subsection 40(3). [However] … IT-369R [, para. 10, provides] that income subject to the application of subsection 75(2) is not otherwise included in the income of a beneficiary or trust, as the case may be.

… [T]he CRA could extend this position so that no reduction to the ACB of a beneficiary's capital interest would be made by virtue of subparagraph 53(2)(h)(i.1).

Where a corporation with an October 31 year end receives income distributions from an income trust in February and March 2007 and sells its units in April 2007, the distributions so received by it will reduce the adjusted cost base of its units because the corresponding income allocated to it by the income fund will not be included in its income until its October 31, 2008 taxation year, i.e., at the time of the disposition of the units it was not the case that the amount of the distributions "was included in the taxpayer's income" (s. 53(2)(h.1)(A)). In this regard, CRA stated:

Assuming that the amounts payable are ultimately determined to be part of the trust's income for its taxation year, the amounts will, under paragraph 104(13)(a) of the Act, be income amounts of the beneficiary. However, paragraph 104(13)(a) of the Act requires the beneficiary to include those income amounts payable only for the beneficiary's taxation year in which the trust's taxation year ends. ...

[T]he amounts paid in February and March 2007...will not be included in income until October 2008 and therefore, because of the use, in clause 53(2)(h)(i.1)(A), of the past tense in the expression "was included in the taxpayer's income", these amounts are not described in clause (A).

In light of the provision in s. 39(1) that a capital gain will not include an amount otherwise included in income, the corporation at the time of filing its 2008 return (in which it included the distributions in income under s. 104(13)) would be able to refile ints 2007 return to reduce the capital gain reported in that return.

This contemplated the winding-up of an income fund (the "Fund") following its acquisition by a "Bidco" in which the Fund sold its assets (mostly an LP interest) for a Bidco note, distributed that note to Bidco in satisfaction of a capital distribution and capital gains distribution declared by the Fund trustees and then redeemed its units for nominal proceeds. Ruling that the amount of the net capital gains allocation that was (separately) paid to the unitholder did not reduce the ACB of its units.

Beginning structure

The Fund, a listed mutual fund trust held units and debt of Trust, which held all the units (being B units) of a Canadian limited partnership (LP1) and the shares of its general partner (GPco 1). LP1 holds all the units of a Canadian limited partnership (LP2) and the shares of its general partner (GPco 2).

Fund takeover transactions

Newco (owned and funded by Holdco) acquired all the Fund units for cash and subscribed for Class B LP1 units and GPco 1 shares to fund debt repayments. Newco acquired the shares of “Target Subsidiaries.” Newco amalgamated with GPco 1, GPco 2, and the Target Subsidiaries to form Newco-Amalco.

Proposed transactions

1. The Trust will transfer all of its Class B LP1 Units to Newco-Amalco for a promissory note, payable on demand (the "Newco-Amalco Note").
2. The Trust will distribute the Newco-Amalco Note to the Fund as payment of the taxable capital gain realized in 1, repayment of Trust notes and a capital distribution (including non-taxable portion of capital gain realized).
3. The Trust will make a s. 104(21) designation in its current year’s return.
4. The Trust will redeem all of the Trust Units for nominal proceeds, thereby recognizing a capital loss.
5. The Fund will declare a distribution payable to Newco-Amalco with such distribution to be paid by delivery of a promissory note, payable on demand (the "Fund Note"). The Fund Note will constitute a payment of the taxable capital gain deemed to be realized under 2 and 3 and of a capital distribution.
6. The Fund Note and the Newco-Amalco Note will be set off against each other.
7. The Fund will make a s. 104(21) designation in its current year’s return.
8. Newco-Amalco and Holdco will amalgamate.

Rulings

Include: on the distribution in 2, the Fund will be deemed by s. 107(2.1) to have acquired the Newco-Amalco Note at a fair market value cost and the Fund will not be deemed to have any proceeds of disposition of the Trust Units.

Ss. 53(2)(h)(i.1)(A) and 53(2)(h)(i.1)(B)(I) will apply such that the ACB of the Trust Units to the Fund, and of the Fund Units to Newco-Amalco, will not be reduced for the amount included in the Fund's or Newco-Amalco’s income under 2 or 5, and for the s. 104(21) amounts in 3 or 7.

Where a mutual fund unitholder receives a cash distribution of interest income, a taxable capital gain and of the non-taxable portion of the capital gain, such distribution does not reduce the ACB of the unitholder’s units by virtue of s. 53(2)(h)(i.1), whereas the ACB would be reduced by a return of capital. Where the distribution is in the form of additional units, then the cost of such units to the unitholder is deemed by s. 248(25.3) to equal the amount of the distribution, whereas otherwise the same results would obtain.

Where a corporation under-reported the capital gain on the disposition of mutual fund trust units because it did not receive T3 reporting of a distribution that had been received on the units until after it had filed its tax return for its June 30 taxation year, CRA indicated that it should request a return amendment to the TSO and, if it wished a cancellation of interest, to follow the guidelines in IC 92-2.

Where an s. 104(13.2) designation is made in order that net capital losses of prior taxation years of a unit trust are used to shelter the taxable portion of capital gains paid out to unitholders, the net effect (as illustrated in a numerical example) is that the ACB of units in the trust will be reduced by the amount of the net capital losses.