25 February 2005 Internal T.I. 2005-0113541I7 - Artificial loss

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: Whether the stop loss rules or GAAR apply to deny the tax benefit resulting from a loss which is created through a series of transactions including the issuance of shares having a high redemption value and a low paid up capital.

Position: We recommend applying GAAR.

Reasons: Previous positions from the GAAR committee.

									February 25, 2005

	Kathie Cameron						HEADQUARTERS
	Tax Avoidance Section Kitchener/				Income Tax Rulings
	Waterloo Tax Services TSO					  Directorate
	166 Frederick Street						Yves Moreno
	Kitchener ON							(613) 952-1764

									2005-011354

This is in response to your fax dated January 27, 2005, concerning transactions whereby a capital loss has been claimed by the taxpayer as a result of a series of transactions designed to eliminate the tax payable on a capital gain realized by the taxpayer.

You ask whether the loss described in your fax can be stopped under one of the provisions of the Act.

The facts which are relevant to that determination can be summarized as follows:

1- In XXXXXXXXXX sold shares and realized a capital gain.

2- On XXXXXXXXXX ("Lossco") is incorporated.

3- On XXXXXXXXXX, the XXXXXXXXXX Trust is settled by XXXXXXXXXX father. The trustees are XXXXXXXXXX. The beneficiaries are XXXXXXXXXX minor children.

4- On XXXXXXXXXX subscribes for common shares of Lossco by using a daylight loan. XXXXXXXXXX will use the proceeds of the daylight loan to purchase shares of Lossco. The stated capital of the shares is then reduced to a nominal amount and the amount of that reduction is added to the contributed surplus of Lossco. The latter then loans money to XXXXXXXXXX who uses it to repay the daylight loan. XXXXXXXXXX subsequently reimburses Lossco by using money received from various sources (his wife, another corporation and a trust settled by his father in XXXXXXXXXX).

5- On XXXXXXXXXX, Lossco declares a stock dividend of preferred shares having a high redemption value and a nominal stated capital on the shares described in point 4.

6- On XXXXXXXXXX sells the common shares of Lossco described in point 4 to the XXXXXXXXXX Trust described in point 3, thereby triggering a capital loss which is intended to offset the capital gain described in point 1. After the sale, XXXXXXXXXX still controls Lossco.

Based on our previous position in respect of the affiliation to a trust, it appears that XXXXXXXXXX is not affiliated to the trustees of the XXXXXXXXXX Trust. Accordingly, he is not affiliated to that trust and the loss is not a superficial loss. XXXXXXXXXX would not be affiliated with the trust under the current proposed measures either, because he is not affiliated with the majority interest beneficiaries of the trust.

However, we recommend applying GAAR to deny the tax benefit that resulted from the loss described in point 6 as a consequence of the stock dividend described in point 5. A file involving the issuance of high/low preferred shares to trigger a capital loss without an economic loss was submitted to the attention of the GAAR committee on February 15, 2005. The submission indicates that the GAAR committee recommended the application of GAAR in similar cases on November 23, 2004, May 5, 2004 and in decisions 98122, 96111 and 95094.

The above comments represent our general views with respect to the subject matter of your letter and are provided in accordance with paragraph 22 of Information Circular 70-6R5.

Yours truly,

T. Murphy
for Director
International & Trusts Division
Income Tax Rulings Directorate
Policy and Planning Branch