| 24(1) | 5-9793 |
| M. Symes | |
| (613) 957-2091 | |
| 19(1) |
September 12, 1990
Dear Sirs:
Re: Paragraph 53(1)(f.1) and Subsection 40(2) of the Income Tax Act (Canada) (the "Act")
This is in response to your letter of March 22, 1990 in which you requested our views as to the application of paragraphs 40(2)(e) and (g) and 53(1)(f.1) and subsection 85(4) of the Act to the hypothetical situation described herein.
Assume that a taxable Canadian corporation, A Co, holds a non-interest bearing debt (the "Debt") of another corporation, which debt it acquired for a cost equal to the principal amount thereof. The Debt represents capital property, within the meaning of paragraph 54(b) of the Act, to A Co. A Co transfers the Debt to B Co, a taxable Canadian corporation with which it is related, within the meaning of subsection 251(2) of the Act, for an amount equal to the fair market value of the Debt. Assuming that such value is less than the principal amount thereof, A Co will realize a capital loss as a result of the transfer. You are of the view that paragraphs 40(2)(e) and (g) and 85(4)(a) will apply to deny such loss and that the amount of the denied loss will be added to B Co's cost of the Debt by virtue of paragraph 53(1)(f.1).
On a subsequent disposal of the Debt by B Co to a person with which it deals at arm's length for fair market value proceeds of disposition, you are of the view that the loss realized by B Co would not be denied by virtue of paragraph 40(2)(e). You are also of the view that it would be a question of fact as to whether the loss would be denied by virtue of paragraph 40(2)(g) of the Act.
OPINIONS
We note that the application of paragraph 40(2)(e) and subsection 85(4) in respect of a disposition of property does not depend on whether the transferor and the transferee are related. Paragraph 40(2)(e) may apply where a corporation disposes of property to a person by whom it was controlled, directly or indirectly in any manner whatever or to a corporation that was controlled, directly or indirectly in any manner whatever, by a person described above. Subsection 85(4) may apply to a disposition of property by a taxpayer or partnership to a corporation that, immediately after the disposition, was controlled, directly or indirectly in any manner whatever, by the taxpayer, by the spouse of the taxpayer or by a person or group of persons by whom the taxpayer was controlled, directly or indirectly in any manner whatever.
Assuming that, for example, B Co is controlled by the same person who controls A Co, paragraph 85(4)(a) would apply to deem the loss realized by A Co on the disposition of the Debt to be nil. Subject to the application of paragraph 85(4)(b) of the Act, the amount of the loss denied by paragraph 85(4)(a) would be added to the cost of the Debt to B Co by virtue of paragraph 53(1)(f.1). (If, immediately after the disposition of the Debt, A Co owned any shares of the capital stock of B Co, paragraphs 85(4)(b) and 53(1)(f.2) would add the amount of the denied loss to the adjusted cost base of such shares to Co and no adjustment would be made to the cost of the Debt to B Co under paragraph 53(1)(f.1)). You note that 53(1)(f.1) does not provide for a cost base addition in respect of losses which are deemed to be nil by paragraph 40(2)(g). In our view, this exclusion is deliberate. However, in this case, paragraph 85(4)(a), by virtue of its opening words, takes priority over paragraph 40(2)(g), i.e., the loss to A Co is deemed to be nil by paragraph 85(4)(a) and not paragraph 40(2)(g).
On the subsequent disposition of the Debt by B Co to an arm's- length person, the loss realized thereon will not be denied by paragraph 40(2)(e) or 85(4)(a) of the Act. However, it would appear that the loss would be denied by virtue of paragraph 40(2)(g), specifically subparagraph (ii) thereof. While it would be a question of fact whether the Debt was acquired by B Co for the purpose of producing income, we are unable to envision a situation where the purchase of a non-interest-bearing debt by a person could be for the purpose of gaining or producing income.
The comments contained herein are only expressions of opinion and are not binding on Revenue Canada, Taxation, in accordance with the procedure set out in paragraph 24 of Information Circular 70-6R.
Yours truly,
Mark Symesfor DirectorReorganizations and Non-Resident DivisionRulings DirectorateLegislative and Intergovernmental Affairs Branch