Principal Issues: Whether the concept of “substituted shares” used in subsection 93(2.01) may be interpreted in such a way as to refer to shares owned by a taxpayer in respect of which the taxpayer made a capital contribution consisting of shares of another foreign affiliate?
Position: Yes.
Reasons: See below.
2016 International Fiscal Association Conference
CRA Roundtable
Question 7 – Subsection 93(2.01) substituted property rule and capital contributions
Assume the following hypothetical facts:
a) Canco owns all of the shares of each of FA1 and FA2.
b) Canco capitalizes FA1 with $1,000 of equity.
c) FA1 loans $1,000 to FA2 for use in its active business.
d) A few years later, after having paid dividends of $50 to Canco, FA1 becomes a wholly-owned subsidiary of FA2 as a result of a contribution of capital by Canco of the shares of FA1 to FA2. No additional shares are issued by FA2 on the transfer.
e) Some time passes and then Canco sells the shares of FA2 to an arm’s length party, incurring a capital loss of $70. No dividends are ever paid on the shares of FA2.
Does the CRA consider that the shares of FA2 held by Canco are substituted for the shares of FA1 that are acquired by FA2 on the capital contribution such that subsection 93(2.01) would grind the loss down to $20?
CRA Response
Subsection 93(2.01) is a rule that is aimed at reducing the loss from a disposition of shares of a foreign affiliate where prior dividends were paid on those shares or on shares for which those shares were substituted. The reduction applies to the extent the prior dividends are “exempt dividends”, within the meaning of subsection 93(3). There is no purpose test in this rule, i.e. it does not matter whether the purpose of the dividend payment was to create such a loss.
In our view, the “substituted share” rule included in subsection 93(2.01) is to be interpreted based on its ordinary meaning as the interpretive rules in subsection 248(5) do not provide an all-encompassing definition thereof. On this basis, we are of the general view that shares owned by a shareholder in a corporation can be considered to be property substituted for property contributed by the shareholder to the corporation by way of a capital contribution. As such, we are of the view that the loss would be ground down to $20 in the example set out above, on the assumption that the $50 of dividends were “exempt dividends”.
Consistent with past practices, the CRA may be prepared to develop administrative solutions to the extent this approach results in the same dividends being applied to reduce more than one loss.
Yannick Roulier
Dave Beaulne
2016-064212
May 26, 2016