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: The shares owned by the deceased (Class A shares) were converted into two classes of shares (Class B and Class C shares) under section 51 following the death. Subsequently, a loss was realized on some of the shares (Class C shares) when they were redeemed. Subsection 112(7) has no application in this particular situation. 1. In determining the amount of the loss reduction under subsection 112(3.2) in respect of the Class C shares, must the capital gain realized by the deceased on the shares held at the time of death be allocated among the classes of shares received by the estate as a result of a section 51 conversion of the shares held at death? Such an allocation would result in less than the full amount of the taxable capital gain on death being used to limit the loss reduction on the shares that gave rise to the capital loss of the estate.
2. If the answer to the first question is yes, how should the capital gain realized on a Class A share be allocated between the Class B and Class C shares received on the conversion?
Position: 1. Yes 2. Based on the relative adjusted cost base of each share, in a manner consistent with the approach used in paragraph 4 of IT328 for the allocation of dividends received on the former shares.
Reasons: 1. The stop loss reduction under subsection 112(3.2) and the conversion under section 51 are each computed on a share by share basis. 2. The Class A shares were converted into a combination of Class B and Class C shares such that the ACB of the Class A shares was allocated between the Class B and Class C shares according to the formula in section 51. The auditor allocated the capital gain realized by the deceased on the same basis. The auditor's calculation is consistent with the procedure shown in paragraph 4 of IT-328 for the allocation dividends received on the old shares where a conversion has taken place.
May 30, 2007
Montreal Tax Services Office HEADQUARTERS
Verification and Enforcement Annemarie Humenuk
Attention: Helen Price
2007-022437
Capital Loss Reduction under Subsection 112(3.2)
This is in response to your email of February 14, 2007, concerning the application of the stop-loss rules in subsection 112(3.2) in determining the amount of capital loss that can be applied in computing the income of the deceased as permitted by subsection 164(6). All statutory references in this memorandum are references to the provisions of the Income Tax Act, R.S.C. 1985 (5th supp.) c. 1, as amended (the "Act").
The relevant facts are as follows:
The taxpayer died on XXXXXXXXXX and realized a capital gain of $XXXXXXXXXX on the deemed disposition of XXXXXXXXXX Class A shares and XXXXXXXXXX Class E shares of a private corporation under subsection 70(5).
On XXXXXXXXXX, the private corporation was reorganized such that all of the Class A shares held by the estate (XXXXXXXXXX) were converted into XXXXXXXXXX Class B shares and XXXXXXXXXX Class C shares and all of the Class E shares held by the estate (XXXXXXXXXX) were converted into XXXXXXXXXX Class C shares.
Section 51 applies to the conversions such that the estate realizes no disposition as a result of the conversion and the adjusted cost base of the Class B shares immediately following the conversion was $XXXXXXXXXX and the ACB of the Class C shares was $XXXXXXXXXX pursuant to paragraph 51(1)(d). It is assumed that none of paragraphs 51(1)(d.1) to (e) has application and that the shares are taxable Canadian property.
Also on XXXXXXXXXX, but subsequent to the conversion, the paid up capital of the Class C shares was increased, creating a deemed dividend of $XXXXXXXXXX in respect of which the private corporation made an election under subsection 83(1) to deem the dividend to be a capital dividend. As a result, the application of subsection 84(1) increased the adjusted cost base of the Class C shares to $XXXXXXXXXX. Also on XXXXXXXXXX, but subsequent to the increase in the paid up capital of the Class C shares, the XXXXXXXXXX Class C shares held by the estate were redeemed, resulting in a deemed dividend of $XXXXXXXXXX and proceeds of disposition of $XXXXXXXXXX. Since the ACB of the Class C shares was $XXXXXXXXXX at that time, the trust has a capital loss before the application of 112(3.2) of $XXXXXXXXXX (resulting from the increase in the PUC that created the deemed dividend payable out of the CDA account)
As a result of the conversion of the Class A and Class E shares into Class B and Class C shares, the capital dividend realized as a result of the increase in the paid up capital and redemption of the Class C shares, the deceased's legal representative made an election under subsection 164(6) to carry the capital loss back to the final return of the deceased, subject to any reduction in the amount of the capital loss under subsection 112(3.2). You have confirmed that subsection 112(7) has no application in this case because no dividends were received by the estate on the Class A or Class E shares and you have done the calculations in paragraph 112(7)(b) and that calculation did not result in any change in the amount of the loss reduction.
Your question concerns the amount of the deceased's capital gain that is used in the calculation of the amount determined under clause 112(3.2)(a)(iii)(B). The legal representative has computed the amount determined under clause 112(3.2)(a)(iii)(B) on an aggregate basis; that is, he used the full amount of the capital gain realized by the deceased on all the shares that were subsequently converted as a result of the reorganization, whereas it is your view that the amount determined under clause 112(3.2)(a)(iii)(B) should be limited to the capital gain realized on the shares that were converted into the shares that gave rise to the capital loss.
We agree with your view.
You allocated the capital gain realized on the Class A shares between the Class B and Class C shares based on relative adjusted cost base of the Class B shares and Class C shares received in exchange for the Class A shares immediately after the conversion. As a result, you determined that XXXXXXXXXX% of the capital gain realized on Class A shares is attributable to the XXXXXXXXXX Class B shares and XXXXXXXXXX% of the capital gain realized on Class A shares is attributable to the XXXXXXXXXX Class C shares. This approach is consistent with approach taken in paragraph 4 of IT-328R3, Losses on Shares on Which Dividends Have Been Received, in determining what portion of any dividends received on the old exchanged shares should be allocated to the various classes of new shares received in exchange for the old shares. The legal representative has not offered any different method of allocating the capital gain realized on the Class A shares between the Class B and Class C shares received in exchange for the Class A shares. Accordingly, we have no objection to your proposed reassessment.
For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency'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. Requests for this latter version should be made by you to Mrs. Jackie Page at (819) 994-2898. A copy will be sent to you for delivery to the client.
T. Murphy
Section Manager
for Division Director
International & Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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