Principal Issues: Whether subsection 112(7) applies to a share-for-share exchange subject to subsection 85(1).
Position: Technically no. Subsection 85(1) is not listed as one of the relevant provisions for purposes of subsection 112(7). However, the CRA may consider the application of the general anti-avoidance provision if there is an avoidance transaction.
Reasons: Wording of the Act and previous positions.
FEDERAL TAX ROUNDTABLE 7 OCTOBER 2011
APFF CONFERENCE 2011
Question 17
Application of stop-loss rules
Consider the following facts:
1) On January 1, 1995, Holdco Inc. ("Holdco") subscribed for 100 common shares of Opco Inc. ("Opco") for $100,000.
2) Over the course of the years 1998 to 2000, dividends totaling $500,000 were declared and paid on the common shares of Opco. Holdco deducted those dividends in computing its taxable income pursuant to subsection 112(1).
3) On January 1, 2003, as part of a rollover pursuant to subsection 85(1), Holdco transferred the 100 common shares to Opco and received 100 new common shares of the capital stock of Opco. The agreed amount was set at $100,000. The paid-up capital and the adjusted cost base of those new shares were $100,000 and their fair market value was equal to the fair market value of the old shares.
4) Holdco has not received any dividends on the 100 common shares of Opco since they were acquired on the January 1, 2003 transfer.
5) On August 1, 2007, while Holdco continued to hold the 100 common shares of Opco, Opco ceased operations due to its insolvency. Opco had always been a small business corporation ("SBC") within the meaning of subsection 248(1) and article 1 of the Taxation Act (Quebec) (“QTA") until the date of cessation of operations on August 1, 2007.
6) Holdco made an election to be deemed to dispose of the Opco shares on December 31, 2007 by virtue of subparagraph 50(1)(b)(iii) for nil proceeds of disposition. The capital loss of $100,000 realized by Holdco thereby qualified as a business investment loss. That amount was entirely attributable to the common shares held by Holdco in Opco.
By virtue of the stop-loss rule in subsection 112(3), in the case of a corporation, the corporation's loss on a share is reduced by the total of the following amounts received by the corporation on that share:
- A taxable dividend whose amount is deductible by virtue of sections 112 and 115 or subsection 138(6) in computing taxable income;
- A capital dividend under subsection 83(2); and
- A life insurance capital dividend.
Pursuant to subsection 112(7), there are continuity rules under which dividends paid on a share are taken into account, in order to reduce losses, regardless of whether the shares giving rise to the dividends had been acquired in exchange for other shares in certain tax-free rollovers provided for in sections 51, 85.1, 86 or 87.
Question to the CRA
Since no dividends were received on the common shares that were acquired in the subsection 85(1) rollover, can the CRA confirm that the stop-loss rules provided for in subsection 112(3) will not apply to those shares given that there is no deemed continuity in the case of subsection 85(1) rollovers?
CRA Response
The application of subsection 85(1) requires, among other things, a disposition of eligible property to a taxable Canadian corporation.
In the past, the CRA has considered that a transaction in a particular share of the capital stock of a corporation does not necessarily constitute a disposition of the share, where after the transaction the taxpayer holds a share of the capital stock of the corporation with identical rights and restrictions to the rights and restrictions attached to the particular share. Consequently, depending on the facts and circumstances surrounding the transaction described in paragraph 3 of this question, that transaction may not have resulted in a disposition for tax purposes of the common shares of the capital stock of Opco issued in 1995. In such a case, subsection 85(1) would never have applied to the transaction. In our view, subsection 112(3) would then apply to reduce the loss sustained by Holdco in 2007 on the shares held in the capital stock of Opco by the amount of dividends paid by Opco on those shares during the years 1998 to 2000.
That said, the rules in subsection 112(7) ensure continuity in the shares received by the taxpayer in the context of certain corporate reorganizations described in section 51, 85.1, 86 or 87. Indeed, and as a general matter, for the purposes of subsections 112(3) to (3.32), the shares received in any of the transactions described in subsection 112(7) are deemed to be the same shares as the old shares and dividends received on the old shares are deemed to have been received on the new shares.
It is also interesting to note that in a share rollover described in subsection 85(1), the unrealized capital loss on the disposed share will generally be realized since by virtue of paragraph 85(1)(c), the agreed amount cannot be greater than the fair market value of the exchanged share. The capital loss thus realized will be subject, where applicable, to the stop-loss rules in subsections 112(3) et seq. In comparison, in the case of the rollovers described in sections 51, 85.1, 86 or 87, the adjusted cost base of the old shares generally becomes the cost of the new shares. As a result, no unrealized capital loss (if any) is realized in these rollover transactions.
Given that section 85 is not referred to in subsection 112(7), a share (a "new share") that is acquired in exchange for another share (an "old share") in a transaction to which section 85 applied would not be deemed, on its disposition, to be the same share as the old share for the purposes of any of subsections 112(3) to (3.2). Thus, an unrealized loss on the new share that would have been generated after the rollover transaction by virtue of section 85 and that would be sustained or realized by a corporation upon the disposition of such new share would not technically be reduced by virtue of subsection 112(3) by the amount of dividends received on the old share.
However, a rollover of shares under subsection 85(1) effected to circumvent section 112(7) could constitute an avoidance transaction, which would lead the CRA to consider the potential application of the general anti-avoidance rule. However, in the absence of an analysis of all the facts and circumstances pertaining to a particular situation, it is not possible for us to comment more specifically on the potential application of subsection 245(2).
Urszula Chalupa
(613) 957-2124
October 7, 2011
2011-041217