18 September 2003 External T.I. 2003-0035135 - Stop - Loss Rules

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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CCRA.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.

Principal Issues: Addition to the adjusted cost base of remaining shares owned by an individual where paragraph 40(3.6)(a) applies to deny the loss on a redemption of such shares and the deemed dividend under 84(3) was subject to a subsection 83(2) election.

Position: No addition to the adjusted cost base under paragraph 40(3.6)(b) in this situation because the loss, as otherwise determined is deemed by subsection 112(3) to be nil as well. This result is based on the assumption that no taxable dividends have been received by the individual on the shares.

Reasons: The law.

2003-003513
XXXXXXXXXX Michael Cooke
(613) 957-2126
September 18, 2003

Dear XXXXXXXXXX:

Re: Subsection 40(3.6) and 112(3)

This is in reply to your letter dated August 21, 2003 wherein you requested our comments with respect to the above provisions of the Income Tax Act (the "Act") as they apply to the fact situation described in your letter.

The facts in your letter are briefly restated as follows:

Mr. X owns 1,000 preferred shares of a taxable Canadian corporation ("Opco") that have a fair market value, adjusted cost base and paid-up capital of $1,000, $700 and $1 per share, respectively. Mr. X is affiliated with Opco under section 251.1 at all times for the purposes of this letter. Opco intends to redeem 200 of its preferred shares held by Mr. X. Accordingly, Opco would be deemed to have paid and Mr. X would be deemed to have a received a dividend in the amount of $199,800 pursuant to subsection 84(3),. You indicate that Opco also intends to make an election under subsection 83(2) to have the full amount of the deemed dividend treated as a capital dividend. As a result of the redemption of the 200 preferred shares, Mr. X will realize a capital loss of $139,800 on the disposition but such loss will be denied under paragraph 40(3.6)(a).

It is your view that Mr. X is entitled to add the full amount of the denied loss (i.e. the $139,800) to the adjusted cost base of the remaining preferred shares of Opco under paragraph 40(3.6)(b) and that subsection 112(3) should not apply.

Our comments:

We are unable to confirm your views. Even though the $139,800 capital loss realized by Mr. X would be denied by paragraph 40(3.6)(a), the key issue is whether the amount of this denied loss would be added to the adjusted cost base of any remaining shares of Opco owned by Mr. X by virtue of paragraphs 40(3.6)(b) and 53(1)(f.2).

Paragraph 40(3.6)(b) states that:

(b) in computing the adjusted cost base to the taxpayer after that time of a share of a class of the capital stock of the corporation owned by the taxpayer immediately after the disposition, there shall be added the proportion of the amount of the taxpayer's loss from the disposition (determined without reference to paragraph (2)(g) and this subsection) that

(i) the fair market value, immediately after the disposition of the share

is of

(ii) the fair market value, immediately after the disposition, of all shares of the capital stock of the corporation owned by the taxpayer.

Based on the above, for the purposes of determining the amount of Mr X's denied loss to add to the adjusted cost base of his remaining shares of Opco under paragraph 40(3.6)(b), the amount of the capital loss, as determined without reference to paragraphs 40(2)(g) and 40(3.6)(a), would be deemed to be nil by virtue of the application of subsection 112(3) (assuming no taxable dividends have been received by Mr. X on the preferred shares before that time).

Accordingly, in the above described situation no amount of the denied loss can be added to the adjusted cost base of Mr. X's remaining preferred shares under paragraphs 40(3.6)(b) and 53(1)(f.2).¹

In our view, the above interpretation is consistent with our understanding of tax policy. For example, if Mr. X was not affiliated with Opco immediately after the time the 200 preferred shares of Opco were redeemed by Opco, the amount of the denied loss under subsection 112(3) (again assuming no taxable dividends have been received by Mr. X on the preferred shares before that time) would not be added to the adjusted cost base of any remaining shares of Opco owned by Mr. X at that time.

We trust that our comments will be of assistance to you. However, as stated in paragraph 22 of Information Circular 70-6R5, the opinion expressed in this letter is not a ruling and consequently is not binding on the CCRA.

Yours truly,

for Director
Reorganizations and Resources Division
Income Tax Rulings Directorate
Policy and Legislation Branch

ENDNOTES

¹ See paragraphs 8 and 11 of IT456R for an analogous discussion of the former loss denial rules under subsection 85(4).