Principal Issues: Each of four individuals (the "Individuals") dealing at arm's length owns 25% of the issued and outstanding shares of an operating corporation ("Opco"). Opco is a small business corporation. The adjusted cost base to each of the Individuals of the Opco shares exceeds their fair market value. Each of the Individuals would dispose of his or her Opco shares in favour of another corporation newly incorporated ("Newco"). Whether the loss sustained by each of the Individuals would be a "superficial loss" and would be nil by virtue of subparagraph 40(2)(g)(i) of the Act. Whether these losses would be available to the Individuals, even if the economic reality remains unchanged after the transfer of shares.
Position: Assuming that each of the Individuals does not have de facto control over Newco, the loss sustained by each of the Individuals would not be a "superficial loss." Consequently, subparagraph 40(2)(g)(i) would not apply. The transfer of Opco shares from each of the Individuals to Newco would be subject to the scrutiny of subparagraph 40(2)(g)(i) and the notion of "superficial loss" in section 54 of the Act, but would be outside their stated ambit. Consequently and assuming that no transaction would be carried out in order to circumvent these specific provisions, the transaction should not result directly or indirectly in a misuse of the provisions of the Act or an abuse having regard to the provisions of the Act, even if the transfer of the Opco shares in favour of Newco could constitute an "avoidance transaction."
In order to qualify as a business investment loss, the taxpayer's capital loss must result from a disposition of a share of the capital stock of a small business corporation to a person with whom the taxpayer was dealing at arm's length. Pursuant to paragraph 251(1)(c), it is a question of fact whether, at a particular time, unrelated persons deal with each other at arm's length. Mention is made in paragraph 26 of Interpretation Bulletin IT 419R2 that the situation where one party to a transaction is merely accommodating the other party in an attempt to obtain a certain tax result may be a situation where the parties are not dealing at arm's length because they do not have separate economic interests which reflect the ordinary commercial dealings between parties acting in their own separate interests. In the given situation, it is possible that each of the Individuals and Newco would not deal with each other at arm's length. In such a case, the capital loss sustained by each of the Individuals would not qualify as a business investment loss.
Reasons: Wording of the Act and previous positions.
2005-013463 XXXXXXXXXX S. Prud'Homme (613) 957-8975 September 12, 2005
Dear Sir,
Subject: Request for a technical interpretation of subparagraph 40(2)(g)(i) and section 251.1 of the Income Tax Act
This is in response to your fax of June 3, 2005, in which you requested our opinion regarding the potential application of subparagraph 40(2)(g)(i) of the Income Tax Act (the "Act") in a particular situation.
Unless otherwise indicated, any statutory reference herein is to a provision of the Act.
It appears to us that the situation described in your letter and summarized below may be an actual situation involving taxpayers. As explained in Information Circular 70-6R5, it is not the practice of this Directorate to provide comments on proposed transactions involving specific taxpayers otherwise than in the form of an advance income tax ruling. If your situation involved specific taxpayers and one or more completed transactions, you should submit all relevant facts and documentation to the appropriate Tax Services Office for their opinion. However, we are able to offer the following general comments that may be helpful. It should be noted that the application of one or more provisions of the Act generally requires an analysis of all the facts relating to a particular situation. Accordingly, and in light of the fact that your letter only very briefly describes a hypothetical particular situation, our comments below may not be fully applicable in a particular situation.
(1) Particular Situation
You have presented us with the situation described below (the "Particular Situation") as part of your request for a technical interpretation.
Four individuals (the "Individuals") deal with each other at arm's length. Each of the Individuals owns 25% of the issued and outstanding shares of the capital stock of a particular corporation ("Opco"). Opco is a "small business corporation" as defined in subsection 248(1).
The adjusted cost base to each of the Individuals of the shares of the capital stock of Opco is substantially greater than their fair market value.
In a purely commercial transaction, each of the Individuals will transfer their shares of the capital stock of Opco to a newly formed corporation ("Newco").
Each of the Individuals and Newco are not affiliated with each other.
Regarding the potential application of subsection 112(3), none of the Individuals received any dividends on the shares of the capital stock of Opco.
2) Your Comments on the Particular Situation
You are of the view that on the disposition of the shares of the capital stock of Opco, each of the Individuals would have a loss that would not be deemed to be nil pursuant to subparagraph 40(2)(g)(i). Furthermore, you are of the view that subsection 245(2) would not apply in this case to change this result. Finally, you are of the view that this capital loss could qualify as a "business investment loss" within the meaning of paragraph 39(1)(c) (a "BIL").
Your view that subparagraph 40(2)(g)(i) does not apply is based on the fact that each of the Individuals and Newco are not affiliated with each other. Consequently, the conditions in paragraphs (a) and (b) of the definition of "superficial loss" in section 54 are not satisfied.
In your view, the economic reality under the Particular Situation remains unchanged despite the transfer of the shares of the capital stock of Opco to Newco. In these circumstances, you asked whether each of the Individuals can claim a loss regarding the disposition of the shares of the capital stock of Opco.
3) Our Comments on this Case
First, we have assumed for the purposes hereof that none of the Individuals would have any direct or indirect influence that would result in control in fact of Newco. In that regard, we refer you to subsection 251.1(1), the definition of "controlled" in subsection 251.1(3), as well as subsection 256(5.1).
On the basis of the foregoing, it is our view that the loss to each of the Individuals resulting from the disposition of the shares of the capital stock of Opco to Newco would not be a "superficial loss" within the meaning of the definition in section 54. Consequently, that loss to each of the Individuals would not be nil pursuant to the application of subparagraph 40(2)(g)(i).
Furthermore, the practice of the Income Tax Rulings Directorate is generally to rule on the application of subsection 245(2) only after considering all the facts and circumstances of a particular situation in the context of an advance ruling request. In the circumstances, however, we can make the following general comments.
The disposition by each of the Individuals of shares of the capital stock of Opco to Newco (the "Transaction") would be subject to examination under subparagraph 40(2)(g)(i) and the "superficial loss" concept in section 54. This Transaction would, however, fall outside the stipulated ambit of those specific statutory provisions, which are designed to limit the use of losses in certain situations. In these circumstances, and to the extent that there are no transactions carried out in the context of the Particular Situation with a view to circumventing those specific legislative provisions, it would probably be reasonable to consider that the Transaction would not directly or indirectly result in an abuse of the application of the provisions of the Act read as a whole, even though such Transaction may constitute an "avoidance transaction" within the meaning of subsection 245(3).
In closing, you indicated that the capital loss sustained by each of the Individuals in the Particular Situation could qualify as a BIL. Pursuant to subparagraph 39(1)(c)(ii), a BIL sustained by a taxpayer for a taxation year must result from a disposition of shares of the capital stock of a small business corporation to a person with whom the taxpayer was dealing at arm's length. Under paragraph 251(1)(c), whether or not unrelated persons are not dealing at arm's length at a particular time is a question of fact. Paragraph 26 of Interpretation Bulletin IT-419R2 indicates, inter alia, that the situation where one party to a transaction is merely accommodating the other party in an attempt to obtain a certain tax result may be a situation where the parties are not dealing at arm's length because they do not have separate economic interests which reflect ordinary commercial dealings between parties acting in their own separate interests. In the Particular Situation, we are of the view that it is quite possible that each of the Individuals and Newco were not dealing at arm's length. If this is the case, the capital loss sustained by each of the Individuals would not qualify as a BIL.
Please note that this opinion is not an advance ruling and, as stated in paragraph 22 of Information Circular 70-6R5 dated May 17, 2002, it is not binding on the Canada Revenue Agency in respect of any particular factual situation.
We hope that our comments are of assistance.
Best regards,
Stéphane Prud'Homme, Notary, M. Fisc.
for the Director
Corporate Reorganizations and Resource Industries Division
Income Tax Rulings Directorate
Directorate General for Policy and Planning