Principal Issues:
Whether a capital loss is deemed to be nil under 40(3.4)(a) in the following situation:
1. A public corporation ("Parentco") owns XXXXXXXXXX % of the issued and outstanding shares of another public corporation ("Subco").
2. The remaining XXXXXXXXXX % of the issued and outstanding shares of Subco are held by the public.
3. The fair market value of the Subco shares held by Parentco is less than is adjusted cost base.
4. The following series of transactions were undertaken in order to make Subco become "private":
a. Step 1: Parentco incorporated a new corporation ("Newco").
b. Step 2: Parentco transferred its Subco shares to Newco at FMV and realized a $XXXXXXXXXX capital loss. Newco issued preferred shares to Parentco as sole consideration for this transfer.
c. Step 3: Within 30 days of the disposition of the Subco shares by Parentco, Subco and Newco merged ("Mergerco"). On the merger, shares of its capital stock were issued by Parentco to the public (Triangular amalgamation under subsection 87(9)).
Position: Parentco's capital loss is denied by subsection 40(3.4) of the act.
Reasons: The Subco shares (i.e., the "substituted property") were still own by a person affiliated with Parentco at the end of the period referred to in paragraph 40(3.3)(c) since paragraph 40(3.5)(c) applies to deem Mergerco to own the Subco shares (until such time that Parentco and Mergerco cease to be affiliated). In the context of 40(3.3), (3.4) and (3.5), the term "apply to" under 40(3.5)(c) means "relate to", its synonym. The context being that:
a) 40(3.3)(a) refers only to the disposition "of a particular capital property".
b) In order to apply 40(3.3) when the particular capital property disposed of is a share of the capital stock of a corporation one has to take into account the deeming rule provided under 40(3.5)(c). The preamble of 40(3.5) sets out clearly this requirement.
c) It is not the word "apply" in itself or the expression "where subsections (3.3) and (3.4) apply" that must be construed in 40(3.5)(c) but the broader expression "For the purpose of subsection (3.3) and (3.4) ... where subsection (3.3) and (3.4) apply to the disposition ... of a share ...". From this perspective, whenever the capital property disposed of is a share, the deeming rule of 40(3.5)(c) must be taken into consideration.
d) In contrast, the position put forward by the taxpayer proposes that in order that 40(3.5)(c) applies, a share disposed of must first meet the three conditions under 40(3.3) qua capital property disposed of and for a period of 30 days after the disposition, before the deeming rule provided under 40(3.5)(c) can be taken into consideration. In our view, this interpretation is not logical in the context of 40(3.3), (3.4) and (3.5) and does not make sense.
XXXXXXXXXX
Subsections 40(3.3), (3.4) et (3.5)
This is in response to your memorandum of January 13, 2003, in which you requested our opinion as to whether subsection 40(3.4) applies to deem nil a capital loss of $XXXXXXXXXX incurred by the above-noted taxpayer on the disposition of an investment to a XXXXXXXXXX% owned subsidiary.
For the purposes of our opinion, we have reviewed the following documents provided by you:
- Your worksheets F-1 to F-5.
- Memorandum dated June 19, 2001 from XXXXXXXXXX summarizing the steps to be taken to realize the loss on the XXXXXXXXXX shares.
- Memorandum from XXXXXXXXXX dated January 23, 2002 regarding the application of paragraph 40(3.5)(c) to XXXXXXXXXX.
- Copy of Mr. Marc Ton-That's article "Navigating the stop-loss rules", Corporate Structures and Groups, Volume VI, No. 3, Federated Press 2000, pp. 324-328.
- Pages 1 to 24 of the Information Circular explaining the merger and its consequences.
- List of documents relating to the series of transactions (List of documents pp. 3 to 19).
- Copy of the share sale agreement entered into on XXXXXXXXXX.
In addition, unless otherwise indicated, all legislative references herein are to the provisions of the Income Tax Act (the "Act").
Facts and assumptions relevant to this case
1. XXXXXXXXXX is a Canadian corporation and a public corporation within the meaning of the Act.
2. XXXXXXXXXX held at the end of XXXXXXXXXX XXXXXXXXXX% of the common shares of XXXXXXXXXX.
3. XXXXXXXXXX was a Canadian corporation and a public corporation within the meaning of the Act.
4. The tax attributes of the XXXXXXXXXX shares held by XXXXXXXXXX were as follows:
ACB
$XXXXXXXXXX
FMV
$XXXXXXXXXX
Unrealized loss
$XXXXXXXXXX
5. In XXXXXXXXXX, XXXXXXXXXX submitted a privatization proposal pursuant to which XXXXXXXXXX would acquire all of the common shares of XXXXXXXXXX that it did not already hold.
6. In order to effect this privatization, a series of transactions were initiated by XXXXXXXXXX.
7. The first step in the series of transactions (Step #1) was to incorporate XXXXXXXXXX ("Newco") on XXXXXXXXXX.
8. The second step in the series of transactions (Step #2) took place on XXXXXXXXXX and was the organization of Newco. A single share was issued on XXXXXXXXXX.
9. The third step in the series of transactions (Step #3) took place on XXXXXXXXXX and was the sale by XXXXXXXXXX of all of the shares it held in XXXXXXXXXX to Newco. This sale resulted in a capital loss of $XXXXXXXXXXX.
10. Finally, the last step in the series of transactions (Step #4) took place on XXXXXXXXXX and involved the amalgamation of XXXXXXXXXX and Newco. This was a triangular merger to which subsection 87(9) applied. Upon the amalgamation becoming effective, all of the common shares of XXXXXXXXXX, other than those held by Newco, were exchanged for common shares of XXXXXXXXXX at a predetermined exchange ratio. Following the amalgamation, all of the common shares of the amalgamated corporation (XXXXXXXXXX Mergerco) were held by XXXXXXXXXX.
Questions Asked
1. Does paragraph 40(3.5)(c) apply in conjunction with subsections 40(3.3) and (3.4), as implied by the following preamble to subsection 40(3.5): "For the purposes of subsections 40(3.3) and 40(3.4)".
2. Does paragraph 40(3.5)(c) apply after subsections 40(3.3) and (3.4) as implied by the opening words of that paragraph: "where subsections 40(3.3) and 40(3.4) apply ... "
3. Do subsections 40(3.3) and 40(3.4) apply to the facts presented?
Your Position
In your request, you indicated that you believe that the conditions set out in subsection 40(3.3) are met and that subsection 40(3.4) should therefore apply.
Taxpayer's Position
In a letter dated January 20, 2003, the taxpayer's representatives set out the taxpayer's position. In their view, subsection 40(3.4) does not apply to the sale of shares in Step #3 because the third condition set out in paragraph 40(3.3)(c) has not been met. Neither XXXXXXXXXX nor any person affiliated with XXXXXXXXXX held the shares of XXXXXXXXXX, any property identical to those shares or any property deemed to be identical to those shares.
They indicate that they are of the opinion that the deeming rule in paragraph 40(3.5)(c) is not applicable since one of the conditions precedent to its application, namely the application of subsections 40(3.3) and 40(3.4) to the disposition of the shares, has not been met.
In addition, they consider that subsections 40(3.3) and 40(3.4) are intended to restrict the deductibility of losses in certain specific situations. Extending the restrictions to situations not covered by these rules is, in their view, contrary to Parliament's intent.
Analysis
The issue to be resolved in this case is whether the deemed ownership provided by paragraph 40(3.5)(c) applies only when subsections 40(3.3) and 40(3.4) have already been applied, or whether the deeming rule serves to determine whether those subsections apply.
In their submissions, the representatives of XXXXXXXXXX urge us to adopt a strict interpretation of the term "apply" in paragraph 40(3.5)(c). Rather, it is our view that in the specific context of the provisions of subsections 40(3.3), (3.4) and (3.5) and the stop-loss rules generally, the term "apply" in paragraph 40(3.5)(c) is synonymous with "visent" [in French] (c.f. Nouveau Dictionnaire des Synonymes, LAROUSSE) (and that in the English version of the Act the term "apply" has the meaning of "relate" (c.f. The New Thesaurus, ROGET'S II). Our position is based on the following observations.
Subsection 40(3.4) is a specific anti-avoidance measure intended to prevent a corporation, trust or partnership ("the transferor") from recognizing an unrealized capital loss on a capital property (other than a depreciable property) as long as the property, or an identical property, is held by the transferor or by a person affiliated with the transferor. This paragraph is part of the "stop loss rules" in the Act. These rules are scattered throughout the Act and are drafted in a similar manner. For example, the following subsections are intended to restrict other types of losses: 13(21.2), terminal losses; 14(12), losses in respect of eligible capital property; 18(15), losses in respect of inventory; 40(3.6), "share redemption" losses; and 40(2)(g)(i), superficial losses.
Subsection 40(3.3) contains the three conditions that must be met to engage the application of subsection 40(3.4). First, the transferor must have disposed of capital property (other than depreciable property). Second, the transferor or an affiliated person must have acquired the same property or an identical property during the period beginning 30 days before the disposition and ending 30 days after the disposition. Finally, the transferor or an affiliated person must own the property (or an identical property) at the end of the period. Please note that paragraph 40(3.3)(a) applies to the disposition of a property that is capital property (other than depreciable property).
Subsection 40(3.5) contains four deeming rules that apply for the purposes of subsections (3.3) and (3.4). The first two deeming rules, contained in paragraphs 40(3.5)(a) and (b), are deeming rules relating to the determination of what is identical property, while the last two deeming rules, contained in paragraphs 40(3.5)(c) and (d), are deeming rules relating to the ownership of a share.
In his book Driedger on the Construction of Statutes, Third edition, Professor E.A. Driedger discusses the importance of the immediate context in determining the meaning of a word or expression:
When judges read words in their immediate context, like any other reader they draw on their competence in language and their general store of knowledge to determine which of the range of possible meanings 'makes sense' in the context. Ambiguity is resolved and vagueness is reduced when the judge is able to rule out inappropriate possibilities on grounds that are judicially noticed and that usually seem too obvious for comment. (page 13)
Professor Pierre-André Côté, in his book Interprétation des lois, refers to the extent to which the context and the intended purpose can vary the meaning of a word: [TaxInterpretations translation]
(...) [W]e must not forget that the interpreter must look for the meaning that a word has in the context of a given statute, and not only for the dictionary meaning. Dictionaries define the meaning of words according to their use in a certain number of recurring and standard contexts. The best dictionaries will also use a sentence to indicate the context in which the word has the defined meaning. The range of meanings defined in the dictionary is necessarily limited and the interpreter must take this into account: it cannot be repeated often enough "how much the context and the intended purpose can vary the meaning of a word". For example, the Court of Appeal ruled that a grader had been "smuggled" into the country even though it had crossed the border in front of a customs office, in broad daylight, at a speed of ten miles per hour. Although dictionaries have defined "smuggling" as "a clandestine or secret introduction", the Court held that, in the context of the Customs Act, the element of clandestineness was not essential. (page 333) (emphasis added)
A little further on, on page 356 of his book, he quotes Professor Guiraud approvingly: [TaxInterpretations translation] "It is the context that specifies the meaning ... every word is linked to its context from which it derives its meaning". He goes on to talk about the objective and subjective intentions of the legislature. The objective intention is the one that emerges from the text of the law itself, as he indicates on page 377 of his book: [TaxInterpretations translation]
The intention of the legislature cannot, like nitrogen, be extracted from the air: it must be deduced from the text considered in its appropriate environment. The courts are therefore right to say that we must look for the intention in the text, provided, however, that this does not mean that we must limit ourselves to a formula dissociated from the context.
He adds on page 379: [TaxInterpretations translation]
Words only express intention: they should not be an end in themselves. If, despite material errors, drafting blunders or the inherent weaknesses of language as a tool, the intention is clear, the judge should give it effect.
(...)
Consideration of the context may justify restricting or extending the "literal" meaning of a term, i.e., its meaning apart from the context.
We are of the view that Parliament's objective intention, in light of the context of subsections 40(3.3) to 40(3.5), is that the deemed ownership under paragraphs 40(3.5)(c) and (d) is necessary to determine whether the test of ownership in paragraph 40(3.3)(c) is met in the case where the capital property disposed of by the transferor and described in paragraph 40(3.3)(a) consists of a share of the capital stock of a corporation. The introductory words of subsection 40(3.5), "For the purposes of subsections 40(3.3) and 40(3.4)", also support this conclusion. In this context, the expression "apply to" ("s'appliquent à") must be given the meaning of its synonym "relate to" ("visent à").
Furthermore, it is not only the word "apply" in paragraph 40(3.5)(c) that must be interpreted, nor just the expression "if subsections 40(3.3) and 40(3. 4) apply", but rather the broader expression "[f]or the purposes of subsections 40(3.3) and 40(3.4) ... where subsections 40(3.3) and 40(3.4) apply to the disposition by a transferor of a share of the capital stock of a corporation". In our view, this expression should be interpreted as meaning, "The following deeming rules apply for the purposes of subsections 40(3.3) and 40(3.4); ...where subsections 40(3.3) and 40(3.4) apply to the disposition by a transferor of a share of the capital stock of a corporation... ".
This interpretation seems to us to be more logical in light of the purpose of the stop-loss rules and to be preferable to the interpretation of the term "apply" suggested by the representatives of XXXXXXXXXX. In their view, a share of the capital stock of a corporation that has been disposed of must first be held by an affiliated person at the end of the period ending 30 days after its disposition as non-depreciable capital property before the deemed ownership of a share of the capital stock of a corporation in paragraph 40(3.5)(c) can be considered.
Finally, if Parliament had wanted to exclude amalgamations occurring before the end of the 30-day period from the application of subsection 40(3.4), it would have clearly indicated so. The two conditions for the application of the presumption in paragraph 40(3.5)(c) are that it must be a disposition of shares and that, after the disposition, the corporation must be merged. It is clear that the expression "after the disposition" means any time after the disposition. Parliament could have stated, for example, "30 days after the disposition" if it had intended that the deemed ownership in paragraph 40(3.5)(c) is not to apply to amalgamations occurring before the end of the 30-day period following the disposition. Since this is not the case, we must rely on an interpretation that takes into account the ordinary meaning of the words in their overall and immediate context and that is consistent with the purpose and spirit of the Act and Parliament's objective intention.
Finally, our interpretation seems to us to be consistent with the tax policy underlying subsections 40(3.3) to (3.5) set out by the Department of Finance.
In conclusion, we confirm that we are of the view that subsection 40(3.4) applies to deem the capital loss incurred by XXXXXXXXXX in Step #3 to be nil. We also recommend that you consult your local tax avoidance section to determine whether the general anti-avoidance rule can be invoked as an alternative position in this case.
Access to Information
For your information, unless exempted, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Customs and Revenue Agency's electronic library. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, the electronic library version can be provided. Alternatively, the client may request a severed copy using the Privacy Act criteria, which does not remove client identity. Requests for this latter version should be made by you to Ms. Jackie Page at (819) 994-2898. A copy will be sent to you for delivery to the client.
Maurice Bisson, CGA
for the Director
Corporate Reorganizations and
and Resource Industries Division
Income Tax Rulings Directorate
Policy and Legislation Branch