Ms. A and her spouse, Mr. B, each held 50% of the common shares of Opco, with Ms. A also holding Opco preferred shares with a paid-up capital ("PUC") of $200, a redemption value and fair market value (“FMV”) of $2,000,000, and an adjusted cost base ("ACB") of $1,000,000. Ms. A transferred to Mr. B, for no consideration, ½ of her preferred shares, thereby realizing under s. 73(1) proceeds of disposition deemed to be equal to the ACB of those shares of $500,000. Five years later, Opco redeemed those preferred shares for their FMV of $1,000,000.
Would Mr. B's capital loss on the redemption be attributed to Ms. A under s. 74.2(1)(b) or would it instead be added to the ACB of Mr. B’s Opco common shares pursuant to s. 40(3.6)(b). CRA responded:
[T]he loss of $499,900 ("Denied Loss") sustained by Mr. B … would be deemed to be nil by virtue of paragraph 40(3.6)(a). Consequently, no amount of the Denied Loss could be attributed to Ms. A under subsection 74.2(1) … .
By virtue of paragraph 40(3.6)(b), the amount of the Denied Loss … could, however, be added to … the ACB, to Mr. B, of each of the common shares of … Opco that is owned by him immediately following the disposition of such preferred shares of the capital stock of Opco. In this regard, we have assumed that subsection 112(3) would not apply in the particular situation.