Principal Issues: Pre-1972 and post-1971 shares of a foreign affiliate are sold, and a 93(1) election made. The post-1971 shares result in a loss which is denied under 93(2), although there is no loss overall. Is there any relief from this anomaly?
Position: No
Reasons: Wording of the legislation.
XXXXXXXXXX 2003-004237
S. E. Thomson
August 19, 2004
Dear XXXXXXXXXX:
Re: Sale of shares of Foreign Affiliate
This is in reply to your email of September 10, 2003 in which you ask for our views on the following scenario. We apologize for the delay in responding to your query.
A corporation resident in Canada (Canco) disposes of all 100 shares that it owns in a foreign affiliate (FA) for proceeds of disposition (POD) of $24,000, or $240 per share. Eighty-nine of the shares are pre-1972 shares, and 11 of the shares are post-1971 shares. Canco owned 100% of the shares of FA prior to the disposition, and the disposition is at arm's length.
By virtue of subsection 26(8) of the Income Tax Application Rules (ITAR), for purposes of computing the adjusted cost base (ACB) of the shares, the pre-1972 shares are deemed to have been disposed of first. The ACB of the pre-1972 shares is $7,120 or $80 per share, and the ACB of the post-1971 shares is $1,760 or $160 per share. The overall gain on the sale of the 100 shares is therefore $24,000 - (7,120 + 1,760) = $15,120.
Canco has elected under subsection 93(1) of the Income Tax Act (the "Act") in respect of each of the shares. The effect of subsection 93(1) is that a portion of the proceeds of disposition of each share shall be deemed to be a dividend received on the share, and not proceeds of disposition.
The FA's exempt surplus pool immediately before the disposition was $14,000, or $140 per share. Canco designates $140 per share in its election By virtue of the subsection 93(1) election, then, the POD of each share is reduced by $140. The revised POD for the pre-1972 shares is $8,900 or $100 per share. Since the ACB of these shares is $7,120, the result is a gain of $1,780. The revised POD for the post-1971 shares is $1,100 or $100 per share. Since the ACB of these shares is $1,760, the result is a loss of $660. This loss is denied under subsection 93(2) of the Act.
However, on the 100 shares taken as a whole, there is no loss. In total, the revised gain is $24,000 - 14,000 - (7,120 +1,760) = $1,120, and there is no denied loss. In your view, the $660 loss on the disposition of the post-1971 shares is created by a fiction of the Act. That is, since all of the shares are sold at the same time, Canco has not experienced a loss, and should not be disadvantaged.
OUR COMMENTS
Although you have asked for our technical interpretation on a hypothetical situation, it appears that your request involves a transaction or series of transactions contemplated by a specific taxpayer. As such, we are precluded from commenting on your situation except in the context of an advance income tax ruling. However, we are able to offer the following general comments regarding the relevant provisions of the Income Tax Act. Since these comments are general in nature, they may or may not apply in your situation, and accordingly, are not binding on the Canada Revenue Agency.
In our view, subsection 93(1) of the Act applies on a share-by-share basis, and therefore, in the above example, the POD of each share is reduced by $140. Similarly, the capital gain or loss, as computed in subsection 39(1) of the Act, would be computed on each property, and, as defined in subsection 248(1) of the Act, the term "property" includes a share. Therefore the resulting gain or loss, after the application of the subsection 93(1) election, would be computed on a share-by-share basis. As noted above, this would result in a gain on the pre-1972 shares of $1,780, and a loss on the post-1971 shares of $660. Subsection 93(2) also applies on a share-by-share basis; that is, the gains and losses from the disposition of all the shares in total are not netted prior to the application of subsection 93(2). The $660 loss is denied under subsection 93(2) of the Act.
We trust that we have been of some assistance.
Yours truly,
Olli Laurikainen, C.A., Manager
for Director
International & Trusts Division
Income Tax Rulings Directorate