26 June 1998 External T.I. 9727085 - CAPITAL GAINS EXEMPTION

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 Department.

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

Principal Issues:

Whether an ABIL, which is now a net capital loss, affects the capital gains exemption in the year an individual disposes of qualified small business corporation shares?

Position: No.

Reasons:

The annual gains limit is only affected by an individual's allowable business investment losses for the year.

972708
XXXXXXXXXX A. Seidel
(613) 957-8974

Attention: XXXXXXXXXX

June 26 1998

Dear Sirs:

Re: Capital Gains Exemption

This is in reply to your letter dated October 1, 1997 with respect to the interaction of an allowable business investment loss (“ABIL”), as defined in paragraph 39(1)(c) of the Income Tax Act (the “Act”), and paragraph (b) of the definition “cumulative gains limit’ in subsection 110.6(1) of the Act.

The situation described in your letter appears to relate to specific taxpayers and an actual fact situation. To the extent that you require assistance in determining the current tax status of the taxpayers involved, you should contact your local Taxation Services Office. If you require confirmation of the tax consequences of proposed transactions, we bring to your attention Information Circular 70-6R3 ("IC 70-6R3") dated December 30, 1996. Confirmation with respect to proposed transactions involving specific taxpayers should be the subject of a request for an advance income tax ruling. If you wish to obtain an advance income tax ruling for particular taxpayers with respect to specific contemplated transactions, a written request for an advance income tax ruling should be submitted in accordance with the Information Circular. Nevertheless, we can provide you with the following general comments with respect to the interaction of an ABIL and the cumulative gains limit for the capital gains exemption in section 110.6 of the Act.

You have described the situation where a taxpayer: incurred an ABIL; there was insufficient income in the year the ABIL was incurred such that a non-capital loss was created; and the taxpayer was unable to apply the non-capital loss against other income within the seven year carryforward provided by paragraph 111(1)(a) of the Act such that the non-capital loss became a net capital loss pursuant to paragraph (a) of the calculation of C in the formula in the definition of “net capital loss” in subsection 111(8) of the Act. In a subsequent year, the taxpayer incurred a taxable capital gain on the disposition of “qualified small business corporation shares” (the “QSBC Shares”), as defined in subsection 110.6(1) of the Act, all of which would qualify for the section 110.6 capital gains exemption. In the example in your letter, you indicate that the annual gains limit is reduced by allowable business investment losses of a prior year with the result that pursuant to (b) of the definition of cumulative gains limit in subsection 110.6(1) of the Act a portion of the taxable capital gain realized on the disposition of the QSBC Shares will be taxable.

Paragraph (b) of the definition of “cumulative gains limit” provides that “all amounts determined in respect of the individual for the year, or preceding taxation years that end after 1984 for B in the definition of “annual gains limit”” reduce the cumulative gains limit. Pursuant to B in the definition of “annual gains limit” in subsection 110.6(1) of the Act, an individual’s “annual gains limit” is reduced by:

“... the total of

(a) the amount, if any, by which

(i) the individual’s net capital losses for other taxation years deducted (emphasis added) under paragraph 111(1)(b) in computing the individual’s taxable income for the year
exceeds

(ii) the amount, if any, ...for the year, and

(b) all of the individual’s allowable business investment losses for the year; (emphasis added)”.

The effect of (b) in B above is that allowable business investment losses for the year (that is, ABIL’s incurred in that year) are deducted before the capital gains exemption is deducted in computing the income of an individual for the taxation year.

The annual gains limit is not reduced for an ABIL incurred in a prior taxation year. Any amount in respect of an ABIL in excess of an individual’s income for a particular taxation year becomes a non-capital loss and the amount is no longer treated as an ABIL for tax purposes. An individual’s annual gains limit is not affected by any non-capital loss carryforward. Furthermore, any unclaimed ABIL which transmogrified into a non-capital loss and subsequently becomes a net capital loss may reduce an individual’s annual gains limit, but only where it has actually been “deducted (emphasis added) under paragraph 111(1)(b) in computing the individual’s taxable income for the year”. This effectively gives an individual the choice of using the capital gains exemption or any net capital loss carryforward to offset a taxable capital gain incurred on the disposition of QSBC Shares in the year, or a subsequent year, after an ABIL has become a net capital loss.

These comments are provided in accordance with the guidelines set out in paragraph 22 of IC 70-6R3 and are therefore not binding on Revenue Canada.

Yours truly,

Director
Resources, Partnerships and
Trusts Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch