Section 38.1

A taxpayer transfers capital property under s. 85(1) to a resource company in consideration for publicly listed common shares (the “Share”) of the resource company, and donates the Shares to a qualified donee. Although each Share is not a “flow-through share,” it is included in a “flow-through share class of property.” How does s. 38.1 apply? CRA provided the following general discussion:

Section 38.1 of the Act may apply where a taxpayer acquires a property (“acquired property”) that is included in a flow-through share class of property in certain tax-deferred transactions (such as the transfer of certain properties by a taxpayer to a taxable Canadian corporation in exchange for shares of the corporation under subsection 85(1) of the Act). In this regard, to the extent that paragraph 38.1(a) of the Act is applicable, the taxpayer is essentially required to include in the taxpayer’s exemption threshold for the acquired property, the taxpayer’s proportionate share of the amount by which the transferor's exemption threshold in respect of the flow-through share class of property immediately before the transfer exceeds the capital gain, if any, and the transferor’s exemption threshold for that property is reduced by the same amount.

Further, to the extent that paragraph 38.1(b) of the Act applies (generally if the transferor, in return, receives property that are shares of the taxpayer listed on a designated stock exchange or shares of a mutual fund corporation), those shares are deemed to be flow-through shares of the transferor for the purposes of section 38.1 and subsection 40(12) of the Act. In such circumstances, there will be an inclusion to the transferor’s exemption threshold in respect of the flow-through share class of property that includes the shares received, an amount equal to a proportion of the transferor’s exemption threshold for the property that was transferred.

///?p=13248">5 February 2013 T.I. 2012-0446211E5 is essentially the same): The taxpayer had acquired units in two flow-through share partnerships. Approximately two years after the offerings, the LPs would transfer their flow-through shares to a mutual fund corporation (MFC), presumably under s. 85(2), and the LPs would wind-up and distribute the flow-through shares to the taxpayer and other investors, presumably under s. 85(3). Alternatively, the LPs might simply wind-up (presumably under s. 98(3)) and distribute the flow-through shares to the former limited partners including the taxpayer.

In response to a query as to the consequences of a donation of the MFC shares or the flow-through shares, as the case may be, following such windings-up, CRA provided a general discussion, and stated that

It is a question of fact whether the special rules in section 38.1 of the Act apply in a particular situation.

CRA was asked to consider transactions in which a limited partnership holding flow-through shares transferred those shares to a mutual fund corporation in consideration for shares of the mutual fund corporation (presumably, under s. 85(2)), those shares (the "MFC shares") were distributed to the limited partners on the winding-up of the partnerships (presumably under s. 85(3)), and the MFC shares were donated by the former partners.

CRA noted that if s. 38.1(b) applies, the taxpayer is deemed to to have a new exemption theshold for the MFC shares, and then stated that "it is a question of fact whether the special rules in section 38.1...will apply in a particular situation."