Stop-Loss Rules
NOTE: The material in this course reflects legislation
as of May 31, 2023.
Table of Contents
Stop-Loss eLearning Modules 1 and 2: Superficial Loss Rules and Suspended Loss Rules
1
Introduction
1
Course overview
1
Module 1: Superficial Loss Rules
2
Introduction
2
Superficial loss rules
2
ITA Section 54
3
Identical properties
4
Identical property for superficial loss rules
4
Affiliated persons
5
Other affiliated person rules
9
Knowledge check: Affiliated persons
9
Knowledge check: Affiliated persons
10
Knowledge check: Affiliated persons
10
Tax implications
11
Exceptions
12
How to identify if a superficial loss exists
12
Application scenario: Windy Inc.
13
Summary
17
Module 2: Suspended Loss Rules
18
Introduction
18
Suspended losses
18
Suspended losses in the ITA
19
Knowledge check: ITA subsection 40(3.3)
19
Identical property
20
Tax implications
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21
Triggering events
21
Example
23
Non-depreciable capital property: Exceptions
23
Application scenario: BobCo and Windy Inc.
24
Depreciable capital property tax losses
26
Depreciable capital property tax loss exceptions
28
Triggering events
29
Application scenario: BobCo
30
Application scenario: Depreciable property losses — ss.13(21.2)
31
How to identify if a suspended loss exists
33
Superficial vs. suspended losses
33
Summary
34
Stop-Loss eLearning Modules 3 and 4: Inadequate Consideration
and Non-arm’s Length Transactions
36
Introduction
36
Course overview
36
Module 3: Inadequate Consideration and Non-Arm’s Length Transfers
37
Introduction
37
Arm’s length vs. non-arm’s length transactions
38
Section 69: Inadequate consideration
39
Non-arm’s length proceeds
40
Summary of Non-Arm’s Length Transactions — ss.69(1)
42
Deemed proceeds of disposition — ss.69(11)
42
Knowledge check: Inadequate consideration
43
Knowledge check: Inadequate consideration
43
Knowledge check: Inadequate consideration
44
Knowledge check: Inadequate consideration
44
Knowledge check: Inadequate consideration
44
Application scenario: Tax implications
45
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Exceptions to section 69
47
Attribution refresher
48
Application scenario: Lily’s transfer to her spouse
49
Summary
50
Module 4: Case Study
52
The Prosper Family
52
Summary
56
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STOP-LOSS RULES
Stop-Loss eLearning Modules 1 and 2: Superficial Loss Rules
and Suspended Loss Rules
Introduction
The basic ordering rules of the Income Tax Act (ITA)1 permit taxpayers to use losses from
business or property to offset income from all sources, and allowable capital losses to offset
taxable capital gains. This ability to reduce income and taxes by using losses creates an incentive
for taxpayers to acquire someone else’s losses, accelerate the recognition of losses, or enter into
artificial transactions to create losses. The ITA contains numerous rules that deny or restrict the
availability of losses in certain circumstances. These rules are referred to as “stop-loss” rules.
In this course you will gain a comprehensive understanding of the ITA’s common stop-loss rules as
well as their implications and exceptions. Additionally, you will learn about inadequate consideration,
non-arm’s length transfers and the interaction between attribution rules and stop-loss rules.
By the end of this course, you will be able to assess when superficial and suspended losses exist,
apply rules related to non-arm’s length transfers and inadequate consideration, and recognize and
determine the tax implications for any exceptions.
Course overview
This course has four main modules* that will introduce important concepts related to the stop-loss rules.
Module 1: Superficial Loss Rules
In this module, you will walk through the fundamentals of a superficial loss, and determine how
these rules apply, what they apply to, and what the tax implications are.
Module 2: Suspended Loss Rules
In this module, you will walk through the fundamentals of a suspended loss, and determine how
these rules apply, and what they apply to, and what the tax implications are.
Module 3: Inadequate consideration and non-arm’s length transfers
This module is an overview of the tax implications of arm’s length and non-arm’s length
transactions, as well as transactions with inadequate consideration.
Module 4: Case study: The Prosper Family
Using a real life scenario, you will apply the teachings covered in Modules 1 – 3 to work through
this case study.
1
Income Tax Act, RSC 1985, c. 1 (5th Supp.), as amended (herein referred to as ITA or the Act). Unless otherwise noted, statutory
references in this course are to the ITA.
*
Modules 1 and 2 will be presented together in this eLearning. Modules 3 and 4 will be presented in a separate eLearning.
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STOP-LOSS RULES
Module 1: Superficial Loss Rules
Introduction
Select the buttons to review the learning objectives and required materials.
Learning Objectives
After working through this module, you will be able to:
•
Identify common superficial stop-loss rules in the ITA, and determine their tax
implications
•
Define identical properties
•
Find, identify, and apply the affiliated persons definitions in the ITA to directed fact
scenarios to determine where they apply
•
Determine the tax implications resulting from common superficial stop-loss rules
•
Identify the common exceptions to the superficial loss rules
•
Assess when a superficial loss exists, using a non-directed fact scenario
REQUIRED MATERIALS
To complete this course, you will need a copy of the ITA – paper or electronic.
Superficial loss rules
Select the tabs to learn more.
Why do these rules exist?
The superficial loss rules exist to deny capital losses that would otherwise be realized where the
asset continues to be owned by the taxpayer or an affiliated person. These rules prevent the
realization of losses perceived to be artificially created.
For example, consider a taxpayer who owns shares with an accrued capital loss. They want to
realize the loss to offset a realized capital gain but also want to retain ownership of the shares. The
taxpayer sells the shares, realizes the capital loss and immediately repurchases the same shares.
The superficial loss rules are in place to prohibit taxpayers from undertaking such artificial
transactions to realize losses on assets when they continue to own them after they have realized
the capital loss.
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STOP-LOSS RULES
When do these rules apply?
As provided in s.54, for a superficial loss to exist, a taxpayer must realize a loss from the disposition
of property where:
1.
During the period that begins 30 days before and ends 30 days after the disposition, the taxpayer
or an affiliated person acquires the same or identical property (“substituted property”), and
2.
At the end of that period, the taxpayer or an affiliated person still owns, or has a right to
acquire, the substituted property.
ITA Section 54
Subsection 40(1) contains the general rules for calculating capital gains and losses. These rules
are subject to a number of limitations that are contained in ss.40(2). In particular, sp.40(2)(g)(i)
prohibits the recognition of a loss considered to be a “superficial loss.”
Recall the important information from the sections of the ITA.
Select the buttons to learn more.
Who
With certain exceptions, s.54 defines “superficial loss” to mean
“the taxpayer’s loss from the disposition of a particular property where
(a) during the period that begins 30 days before and ends 30 days after the disposition, the
taxpayer or a person affiliated with the taxpayer acquires a property (in this definition
referred to as the “substituted property”) that is, or is identical to, the particular property,
and
(b) at the end of that period, the taxpayer or a person affiliated with the taxpayer owns or
had a right to acquire the substituted property…”
When
With certain exceptions, s.54 defines “superficial loss” to mean
“the taxpayer’s loss from the disposition of a particular property where
(a) during the period that begins 30 days before and ends 30 days after the disposition,
the taxpayer or a person affiliated with the taxpayer acquires a property (in this definition
referred to as the “substituted property”) that is, or is identical to, the particular property,
and
(b) at the end of that period, the taxpayer or a person affiliated with the taxpayer owns or
had a right to acquire the substituted property…”
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STOP-LOSS RULES
What
With certain exceptions, s.54 defines “superficial loss” to mean
“the taxpayer’s loss from the disposition of a particular property where
(a) during the period that begins 30 days before and ends 30 days after the disposition, the
taxpayer or a person affiliated with the taxpayer acquires a property (in this definition referred
to as the “substituted property”) that is, or is identical to, the particular property,
and
(b) at the end of that period, the taxpayer or a person affiliated with the taxpayer owns or
had a right to acquire the substituted property…”
Identical properties
The term “identical properties” is defined in ss.248(12):
“For the purposes of this Act, one bond, debenture, bill, note, or similar obligation issued by a
debtor is identical to another such obligation issued by that debtor if both are identical in respect
of all rights (in equity or otherwise, either immediately or in the future, and either absolutely or
contingently) attaching to them, except with respect to the principal amount thereof.”
Whether two items are identical properties is a question of fact. However, the ITA provides additional
guidance about items that are considered to be identical properties.
Identical property for superficial loss rules
Paragraph (i) of the definition of “superficial loss” in s.54 specifies that for purposes of the
superficial loss rules:
“a right to acquire a property (other than a right as security only, derived from a mortgage,
hypothec, agreement for sale, or similar obligation) is deemed to be a property that is
identical to the property…”
The CRA’s general view is that properties are identical if they are the same in all material respects
and a prospective buyer would not prefer one property to the other. (Interpretation Bulletin
IT387R2 (Consolidated) ARCHIVED – “Meaning of Identical Properties”)
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STOP-LOSS RULES
Affiliated persons
What does “affiliated persons” mean?
For a superficial loss to exist, there must be an acquisition of an identical property by the original
taxpayer, or a person affiliated with the taxpayer.
In theory, affiliated persons represent a “united economic unit”. Transfers within this united
economic unit are not considered to represent a substantive change in economic interests. As a
result, losses realized when property is sold or transferred from one affiliated person to another
may be considered superficial losses.
The definition of the term “affiliated persons” is found in ss.251.1(1) and includes the following:
Select the tabs to learn more.
1.
An individual and a spouse or common-law partner
2.
A corporation and each of the following:
3.
—
A person who has de facto control of the corporation
—
Each member of an affiliated group that has de facto control of the corporation
—
A spouse or common-law partner of any person described above
Two corporations are affiliated if one of the following applies:
—
Persons who have de facto control of each corporation are affiliated
—
A person who has de facto control of one corporation is affiliated with each member of a
group who has de facto control of the other corporation
—
Each corporation is de facto controlled by a group and each member of each group is
affiliated with at least one member of the other group
What types of relationships qualify as affiliated persons?
Select the tabs to learn more.
Paragraph 251.1(1)(a)
An individual and their spouse or common-law partner.
Mr. A
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Mrs. A
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STOP-LOSS RULES
Subparagraph 251.1(1)(b)(i)
A corporation and a person by whom the corporation is controlled.
Mr. A
100% common
X CO
Subparagraph 251.1(1)(b)(ii)
A corporation and each member of an affiliated group of persons by which the corporation is
controlled.
Mr. A
Mrs. A
50%
50%
X CO
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STOP-LOSS RULES
Subparagraph 251.1(1)(b)(iii)
A corporation and the spouse or common-law partner of any person described in
subparagraphs 251.1(b)(i) or (ii).
Mr. A
Mrs. A
100% common
X CO
What types of relationships qualify as affiliated persons?
Select the tabs to learn more.
Subparagraph 251.1(1)(c)(i)
Two corporations, if persons who have control of each corporation are affiliated.
Mr. A
100% common
X CO
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Mrs. A
100% common
Y CO
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STOP-LOSS RULES
Subparagraph 251.1(1)(c)(ii)
Two corporations, if the person who has control of one corporation is affiliated with each member
of a group who has control of the other corporation.
Mrs. A
Mr. A
100% common
Mr. A
50%
X CO
50%
X CO
Subparagraph 251.1(1)(c)(iii)
Two corporations, if each corporation is controlled by a group and each member of each group is
affiliated with at least one member of the other group.
Mr. A
Mr. B
50%
50%
X CO
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Mrs. A
Mrs. B
50%
50%
Y CO
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STOP-LOSS RULES
Other affiliated person rules
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Other points to note on affiliated persons
•
Subsection 251.1(3) provides that the term “controlled directly or indirectly in any manner”
referenced in the definition of affiliated persons is de facto control (which is a broader
definition than de jure control)
•
Paragraph 251.1(4)(a) confirms that persons (including partnerships) are affiliated with
themselves
Affiliated persons rules for partnerships and trusts
•
Paragraph 251.1(1)(d) describes when a corporation is affiliated with a partnership
•
Paragraph 251.1(1)(e) describes when a partnership is affiliated with a particular partner: must
be a majority interest partner
•
Paragraph 251.1(1)(f) describes when two partnerships are affiliated
•
Paragraph 251.1(1)(g) – A trust is affiliated with:
(i) a majority interest beneficiary (MIB)
(ii) persons affiliated with an MIB
•
Paragraph 251.1(1)(h) – Two trusts are affiliated if:
(i) MIB of Trust #1 is affiliated with MIB of Trust #2
(ii) MIB of Trust #1 is affiliated with each member of a majority interest group of beneficiaries
(iii) each member of a majority interest group of beneficiaries of each of the trusts is affiliated
with at least one member of a majority interest group of beneficiaries of the other trust
Knowledge check: Affiliated persons
Which ITA reference affiliates a corporation and each member of an affiliated group of persons by
which the corporation is controlled?
Select the best response.
£
Paragraph 251.1(1)(a)
£
Subparagraph 251.1(1)(b)(ii)
£
Subparagraph 251.1(1)(c)(ii)
£
Subparagraph 251.1(1)(c)(iii)
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STOP-LOSS RULES
Feedback
Subparagraph 251.1(1)(b)(ii) is correct. The others do not apply:
•
Subparagraph 251.1(1)(c)(ii) deals with two corporations where a person who controls one
of the corporations is affiliated with each member of a group who controls the other
•
Paragraph 251.1(1)(a) deals with individuals and their spouse
•
Subparagraph 251.1(1)(c)(iii) – two corporations are affiliated if each is controlled by a group
and each member of each group is affiliated with at least one member of the group.
Knowledge check: Affiliated persons
Dan sells land (held as capital property), which has an adjusted cost base (ACB) of $250,000,
to his son, Sam, for $150,000 (the land’s fair market value [FMV] at the time of sale).
Which of the following statements is true?
Select the best response.
£
Dan will have a superficial loss
£
Sam will have a superficial loss
£
Dan can recognize the capital loss
£
Dan is deemed to have disposed of the land at FMV
Feedback
Dan can recognize the capital loss.
According to s.54, a superficial loss arises when an individual realizes a loss on the disposition of
a property to an affiliated person. Since Dan and Sam are father and son, they are not affiliated.
Pursuant to p.251.1(1)(a), the only individuals that are affiliated with each other are spouses and
common-law partners. Therefore, the superficial loss rules do not apply in this situation.
Knowledge check: Affiliated persons
Dan owns land (held as capital property), which has an ACB of $250,000 and a FMV $150,000.
Instead of selling to his son, Sam, he plans to sell the land to SamCo, a company wholly owned
by Sam. Dan does not have de facto control over SamCo.
Which of the following statements is true?
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STOP-LOSS RULES
Select the best response.
£
Dan will have a superficial loss
£
Sam will have a superficial loss
£
Dan can recognize the capital loss
£
Dan is deemed to have disposed of the land at FMV
Feedback
Dan can recognize the capital loss.
Dan is not affiliated with SamCo because he is not affiliated with any of SamCo’s shareholders.
Conceptually, this makes sense. The general premise of the superficial loss rules is that they
should prevent losses from being realized when property is transferred within the same economic
unit. If a transfer between Dan and his son does not constitute such a transfer (as in the previous
question), then a transfer between Dan and his son’s wholly owned corporation should not, either.
Tax implications
When a loss is determined to be a superficial loss, the tax implications are determined by
paragraphs 40(2)(g) and 53(1)(f).
Subparagraph 40(2)(g)(i) deems the loss to be NIL to prohibit its recognition, and p.53(1)(f) adds
the superficial loss to the cost base of the substituted property.
In general, a taxpayer’s loss after disposing of capital property is NIL to the extent that it is a
superficial loss. Paragraph (h) of the s.54 definition of superficial loss provides an exclusion for
dispositions to which ss.40(3.4) applies. Those dispositions are ones made by corporations, trusts
or partnerships. Thus, the superficial loss rules only apply to transfers made by individuals.
Select the buttons to learn more.
Allocation of disallowed loss
Paragraph 53(1)(f) requires that the amount of the capital loss denied under the superficial loss
rules is added to the ACB of the substituted property. Consequently, the denied loss remains with
the identical substituted property acquired by the affiliated person. If the property is disposed of
in future, the denied loss can be recognized to increase the capital loss or reduce the capital gain
which results at that future time.
Under sp.53(1)(f)(ii), if the capital loss denied under the superficial loss rules relates to the disposition
of shares, and capital dividends were received on those shares, the amount of the superficial loss
added to the ACB of the substituted shares may be reduced further. Different rules apply depending
on whether the person disposing of the shares is a corporation or an individual. However, the details
of these rules is beyond the scope of this course.
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STOP-LOSS RULES
Pro rata denial of loss
When an individual disposes of several identical properties at a particular time, and during the
period beginning 30 days before and ending 30 days after the disposition, the individual or an
affiliated person acquires or retains fewer identical properties, the CRA’s view (2001-0088155 and
2004-0073011E5) is that the superficial loss should be prorated on the basis of the number of items
sold at the particular time and the number of items acquired and retained in the 61-day period.
Exceptions
Paragraphs (c) to (h) of the s.54 definition of superficial loss contain a number of exceptions to the
superficial loss rules. For example, the rules do not apply to the majority of dispositions deemed
by the ITA to take place, even if they are followed by deemed acquisitions.
Some common exceptions are as follows.
Select the tabs to learn more.
The superficial loss rules exclude the following deemed dispositions:
•
Paragraph (c):
—
on a change in use of a property by a taxpayer [ss.45(1)]
—
of a bad debt or a share of a bankrupt corporation [ss.50(1)]
—
on the death of an individual [ss.70(5)]
—
by a trust [ss.104(4)]
—
where an individual becomes or ceases to be resident in Canada [s.128.1]
—
where a corporation becomes or ceases to be exempt from Part I tax [ss.149(10)]
The superficial loss rules also exclude dispositions:
•
Paragraph (d): resulting from the expiration of an option [deemed disposition pursuant
to the definition of a “disposition” under ss.248(1)]
•
Paragraph (e): of a debt obligation where the loss is denied [p.40(2)(e.1)]
•
Paragraph (f): by a taxpayer who is subject to a “loss restriction event” within 30 days after
the disposition
•
Paragraph (g): by a person that becomes or ceases to be exempt from tax under Part I
of the Act within 30 days after the disposition.
•
Paragraph (h): to which subsection 40(3.4) or 69(5) applies
How to identify if a superficial loss exists
In a situation in which a taxpayer disposes of property resulting in a capital loss, determine if a
superficial loss exists by first assessing the situation as follows:
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STOP-LOSS RULES
Select the tabs to learn more.
Establish the facts
a)
Draw a diagram of the before and after
i.
Identify the relationships between the taxpayers
ii.
Does anyone own identical property?
b) Draw a timeline
i.
When did the disposition(s) occur?
ii.
Was there an acquisition?
Identify the tax issues
a)
Which taxpayers (individuals, corporations, etc.) are affiliated?
b) Do the stop-loss rules apply? If so, what are the tax implications?
Develop a research plan
a)
Affiliated persons [ss.251.1(2)]
b) Definition of superficial loss (s.54)
c)
Tax implications [p.40(2)(g); p.53(1)(f)]
After assessing the situation, analyze the issues, conclude, and advise.
Application scenario: Windy Inc.
Consider the facts about Windy Inc. to complete the questions that follow:
Date
Transaction
January 1, 2021
Bob bought 200 shares of Windy Inc. for $20,000
December 21, 2021
Bob sold 100 shares of Windy Inc. to an unaffiliated party for $5,000
January 5, 2022
Bob acquired 100 shares of Windy Inc. for $7,500
December 30, 2022
Bob sold 150 shares of Windy Inc. to an unaffiliated party for $6,000
January 15, 2023
Susan (Bob’s wife) bought 60 Windy Inc. shares for $6,000 and retained
them for more than 30 days
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STOP-LOSS RULES
Select the START button to start the activity.
Loss in 2021
Assuming Bob had substantial capital gains from other dispositions during 2021, what is the total
capital loss from the sale of the Windy Inc. shares that he can claim on his 2021 personal income
tax return?
Enter your response in the field provided.
$
Feedback
Bob will be unable to claim a capital loss in 2021 because he reacquired the shares within
30 days of the disposition and continues to own the shares at the end of that period.
Bob’s ACB in 2021
What was Bob’s ACB of the Windy Inc. shares on December 31, 2021?
Enter your response in the field provided.
$
Feedback
Bob incurred a superficial loss because he acquired an identical property within 30 days after he
disposed of the Windy Inc. shares on December 21, 2021. Since the number of shares outstanding
30 days after the disposal equals the number of shares outstanding just before the disposal,
the full loss amount of $5,000 was a superficial loss as defined in s.54. Thus, the loss was $NIL
pursuant to p.40(2)(g). The superficial loss would have been added to the ACB of the identical or
substituted property pursuant to p.53(1)(f). The superficial loss is not added to the ACB until the
time that Bob acquires the identical or substituted property; therefore, the $5,000 superficial loss
would not be added to the ACB of the shares until January 5, 2022.
The new ACB is calculated as follows:
Opening ACB
Less: ACB of shares sold (100 @ $100 / share)
ACB on December 31, 2021
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Total
Per Share
$ 20,000
$ 100.00
($ 10,000)
$ 10,000
# of Shares
200
(100)
$ 100.00
100
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STOP-LOSS RULES
Loss in 2022
Assuming Bob also had substantial capital gains on other dispositions, during 2022, what is the
total amount of capital loss in respect of the Windy Inc. shares, that he could have claimed on his
2022 personal income tax return?
Enter your response in the field provided.
$
Feedback
Bob would have incurred a superficial loss because a person affiliated with him (his wife) acquired
an identical property within 30 days after he disposed of the shares on December 30, 2022.
Per the CRA’s technical interpretation 2005-0150811E5, the superficial loss can be prorated
because Susan acquired fewer identical properties than Bob disposed of.
The total superficial loss is calculated using the formula: (Least of S, P and B) / S × L, where:
S – number of items disposed of at the time
= 150
P – number of items acquired in the 61-day period
= 60
B – number of items left at the end of that period
= 110 (Bob = 50 + Susan = 60)
L – the loss on the disposition as otherwise
determined
$10,000 (100 shares remaining from 2021 purchase)
+ $5,000 (superficial loss from 2021)
+ $7,500 (100 shares purchased in 2022)
= $22,500 ÷ 200 shares × 150 shares sold
= $16,875 ACB
$6,000 proceeds of disposition less $16,875 ACB
= $10,875 loss
Therefore, total superficial loss: 60 / 150 × $10,875 = $4,350
Resulting capital loss to be claimed on T1: $10,875 less $4,350 = $6,525
Bob’s ACB in 2023
What is Bob’s adjusted cost base of the Windy Inc. shares on January 15, 2023?
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STOP-LOSS RULES
Enter your response in the field provided.
$
Feedback
The new ACB is:
Bob:
Total
ACB on December 31, 2021
$ 10,000
Addition of superficial loss – January 5,
2022 [paragraph 53(1)(f)]
$ 5,000
Acquisition on January 5, 2022
$
Subtotal: ACB on January 5, 2022
$ 22,500
Less: ACB of shares sold (150 @ $112.50/share)
Per share
100
7,500
100
$ 112.50
($ 16,875)
Total: ACB on January 15, 2023
$
5,625
# of shares
200
(150)
$ 112.50
50
The superficial loss is not included in Bob’s ACB, but is included in Susan’s ACB.
Susan’s ACB in 2023
What is Susan’s adjusted cost base on January 15, 2023?
Enter your response in the field provided.
$
Feedback
Total
Susan’s acquisition on January 15, 2023
$ 6,000
Bob’s superficial loss on December 30, 2022
[paragraph 53(1)(f)]
$
Total: ACB on January 15, 2023
$ 10,350
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Per Share
# of Shares
60
4,350
$ 172.50
60
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STOP-LOSS RULES
Summary
Congratulations! You have completed this module. You should now be able to:
•
Identify common superficial stop-loss rules in the ITA
•
Define identical properties with regard to superficial loss
•
Find, identify, and apply the affiliated persons definitions in the ITA to directed fact scenarios
to determine where they apply
•
Determine the tax implications resulting from common superficial stop-loss rules
•
Identify the common exceptions to the superficial loss rules
•
Assess when a superficial loss exists, using a non-directed fact scenario
Select the button to learn more.
KEY POINTS
Recall the following key points related to superficial loss rules:
•
The superficial loss rules aim to prevent taxpayers from realizing losses if there is no real intent
to dispose of the property in question.
•
The superficial loss rules generally do not apply to transfers made by corporations, trusts or
partnerships. They normally apply only to transfers made by individuals.
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STOP-LOSS RULES
Module 2: Suspended Loss Rules
Introduction
Select the buttons to review the learning objectives and required materials.
Learning Objectives
After working through this module, you will be able to:
•
Identify common suspended stop-loss rules in the ITA
•
Define identical properties with regard to superficial and suspended losses
•
Determine the tax implications resulting from common suspended stop-loss rules
•
Identify the common exceptions to the suspended loss rules
•
Assess when a suspended loss exists, using a non-directed fact scenario
•
Differentiate between the tax implications of the superficial and suspended loss rules
REQUIRED MATERIALS
To complete this course, you will need a copy of the ITA – paper or electronic.
Suspended losses
Select the tabs to learn more.
Why do these rules exist?
Like the superficial loss rules, the suspended loss rules are in place to restrict the realization of
capital losses on assets transferred between affiliated persons that do not represent a substantive
change in economic interests. However, due to the wording in p.40(3.3)(a), the suspended loss rules
in subsections 40(3.3) and (3.4) only apply to corporations, trusts and partnerships. These losses are
perceived to be artificially created; thus, they are prevented from being realized.
When do these rules apply (conditions)?
For these rules to apply, there must be a disposition of capital property by a corporation, trust
or partnership that gives rise to a capital loss. In addition, during the period that begins 30 days
before and ends 30 days after the disposition, the disposing taxpayer or an affiliated person
acquires the same or identical property and, at the end of that period, that taxpayer or affiliated
person still owns, or has a right to acquire, the same or identical property.
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Suspended losses in the ITA
Suspended losses can arise in a number of situations covered by the ITA. For example:
•
Depreciable property is addressed in ss.13(21.2)
•
Property that is inventory of an adventure or concern in the nature of trade is addressed
in ss.18(14) and ss.18(15)
and
•
Non-depreciable property is addressed in subsections 40(3.3) to 40(3.5)
We will examine the suspended loss rules related to non-depreciable property found in
subsections 40(3.3) to 40(3.5), followed by those applicable to depreciable property found
in ss.13(21.2).
Select the button to learn more.
What is a suspended loss?
Subsection 40(3.3) sets out the rules that cause ss.40(3.4) to defer losses on certain dispositions
of non-depreciable capital property. These rules will apply when:
“(a) a corporation, trust or partnership (in this subsection and subsection (3.4) referred
to as the “transferor”) disposes of a particular capital property – other than depreciable
property of a prescribed class… – otherwise than in a disposition described in any
of paragraphs (c) to (g) of the definition “superficial loss” in section 54;
(b) during the period that begins 30 days before and ends 30 days after the disposition,
the transferor or a person affiliated with the transferor acquires a property (referred to as
the “substituted property”) that is, or is identical to, the particular property;
and
(c) at the end of the period, the transferor or a person affiliated with the transferor owns
the substituted property.”
Subsection 40(3.4) refers to a loss that arises in these circumstances as a “suspended loss”,
and prohibits this type of loss from being realized.
Knowledge check: ITA subsection 40(3.3)
Identify the correct information below for ss.40(3.3). You can refer to your copy of the ITA or
review the previous slides to refresh your memory.
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Enter your responses in the fields provided.
Question
Legislation: Your Response
Who
What
When
Feedback
Question
Legislation
Who
a corporation, trust, or partnership
What
disposes of a particular capital property – other than depreciable property
When
during the period that begins 30 days before and ends 30 days after the disposition,
the transferor or affiliated person acquires the substituted property and at the end
of the period, the transferor or affiliated person owns the substituted property
Identical property
The meaning of “identical properties” discussed in Module 1 in the context of superficial losses
applies for all purposes of the ITA including the suspended loss rules. However, ss.40(3.5)
deems certain properties to be identical for purposes of applying the suspended loss rules in
subsections 40(3.3) and (3.4) as follows:
•
A right to acquire a property is identical to the property
•
A share acquired in exchange for another share where section 51, 85.1, 86 or s.87 applies is
deemed to be identical to the other share
•
When a share of a corporation is sold and the corporation is merged, then the merged entity
or parent is deemed to own the disposed share while it is affiliated with the transferor
•
When a share of a corporation is sold and the share is redeemed, acquired or cancelled, the
share is deemed to be held by the transferor while the corporation is affiliated
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Select the button to learn more.
Subsection 248(12)
Subsection 248(12) provides that, for the purposes of the ITA, a bond, debenture, bill, note or
similar obligation issued by a debtor is identical to another such obligation issued by that debtor
if both are identical in respect of all rights (in equity or otherwise, either immediately or in the
future, and either absolutely or contingently) attaching to them, except with respect to the
principal amount of the obligation.
Tax implications
What are the tax implications of a suspended loss?
When the suspended loss rules in ss.40(3.3) apply, ss.40(3.4) specifies the tax implications:
“(a) the transferor’s loss, if any, from the disposition is deemed to be nil, and
(b) the amount of the transferor’s loss, if any, from the disposition (determined without
reference to paragraph (2)(g) and this subsection) is deemed to be a loss of the
transferor from a disposition of the particular property at the time that is…”
Subsection 40(3.4) deems the transferor’s loss from the disposition of property to be NIL. Unlike
a superficial loss, the denied capital loss is not added to the ACB of the transferred property and
it does not become a loss to the transferee on the ultimate disposition. Instead, the amount of the
denied loss is suspended and becomes a capital loss to the transferor immediately before the first
of certain triggering events occur after the disposition.
Triggering events
Where the conditions outlined in ss.40(3.3) are met, ss.40(3.4) provides that no loss may be
recognized on the transfer. Instead, any loss is deferred until the earliest of the following events
referred to as “triggering events” in p.40(3.4)(b):
“(b) the amount of the transferor’s loss, if any, from the disposition…is deemed to be a loss
of the transferor from a disposition of the particular property at the time that is
immediately before the first time, after the disposition,
Select the tabs to learn more.
Subparagraph 40(3.4)(b)(i)
at which a 30-day period begins throughout which neither the transferor nor a person affiliated
with the transferor owns
(A) the substituted property, or
(B) a property that is identical to the substituted property and that was acquired after the
day that is 31 days before the period begins,
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Subparagraph 40(3.4)(b)(ii)
at which the property would, if it were owned by the transferor, be deemed by section 128.1 or
subsection 149(10) to have been disposed of by the transferor,
Subparagraph 40(3.4)(b)(iii)
that is immediately before the transferor is subject to a loss restriction event,
Subparagraph 40(3.4)(b)(iv)
at which the transferor or a person affiliated with the transferor is deemed by section 50 to have
disposed of the property, where the substituted property is a debt or a share of the capital stock
of a corporation, or
Subparagraph 40(3.4)(b)(v)
if the transferor is a corporation,
(A) for the purposes of computing the transferor’s foreign accrual property income, exempt surplus
or exempt deficit, hybrid surplus or hybrid deficit, and taxable surplus or taxable deficit… and
(B) for any other purposes, at which the winding-up (other than a winding-up to which
subsection 88(1) applies) of the transferor begins,”
Simply stated, p.40(3.4)(b) includes the following events permitting the release of a suspended loss:
•
A subsequent disposition of the property to a person that is neither the transferor nor a
person affiliated with the transferor (provided that for 30 days after that later disposition
neither the transferor nor an affiliated person owns either the substituted property or an
identical property acquired after the beginning of the 61-day period)
•
A deemed disposition of the property under s.128.1 of the ITA (emigration) or ss.149(10)
(change of taxable status)
•
In the case of a corporation, a loss restriction event of the transferor corporation
•
Where the substituted property is a debt or a share, a deemed disposition under s.50
•
Where the transferor is a corporation, a winding-up of the transferor [other than a winding-up
under ss.88(1)]
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Example
H
33%
D
33%
L
J
34%
33%
A CO
F
33%
M
34%
B CO
Facts:
•
H, D and L are three unaffiliated individuals that control A Co as a group
•
J, F and M are the spouses of H, D and L respectively, and they control B Co as a group.
•
A Co transfers land to B Co with an FMV that is less than its ACB
•
Because of sp.251.1(1)(c)(iii), A Co and B Co are affiliated persons, and so ss.40(3.3) applies
to suspend the inherent loss on the transferred asset. The loss remains with A Co and is only
realized upon a triggering event.
Select the button to learn more.
Pro rata denial of loss
The administrative position of the CRA regarding the pro rata denial of superficial losses is extended
to suspended losses if a transferor disposes of several identical properties at the same time and,
during the period beginning 30 days before and ending 30 days after the disposition, the transferor
(or an affiliated person) acquires or retains fewer identical properties. The CRA’s view is that the
suspended loss should be prorated based on the number of items sold at the same time and the
number of items acquired and retained in the 61-day period. (2001-0088155 and 2004-0073011E5)
Non-depreciable capital property: Exceptions
Exceptions to the suspended loss rules are set out in p.40(3.3)(a), with reference to paragraphs (c)
to (g) in the definition of “superficial loss” in section 54. As with the superficial loss rules, the
suspended loss rules do not apply to most dispositions deemed by the ITA to take place, even if they
are followed by deemed acquisitions.
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Some common exceptions to the suspended loss rules are as follows.
Select the tabs to learn more.
The suspended loss rules exclude deemed dispositions:
•
Paragraph (c):
—
on a change in use of a property by a taxpayer [ss.45(1)]
—
of a bad debt or share of a bankrupt corporation [ss.50(1)]
—
where a corporation or trust becomes or ceases to be resident in Canada (s.128.1)
—
by a trust [ss.104(4)]
—
when a person dies [ss.70(5)]
—
where a corporation becomes or ceases to be exempt from Part I tax [ss.149(10)]
The suspended loss rules also exclude dispositions:
•
Paragraph (d): resulting from the expiration of an option [deemed disposition pursuant
to the definition of a “disposition” under ss.248(1)]
•
Paragraph (e): of a debt obligation where the loss is denied [p.40(2)(e.1)]
•
Paragraph (f): by a taxpayer that is subject to a “loss restriction event” within 30 days after
the disposition
•
Paragraph (g): by a person that becomes or ceases to be exempt from Part I tax within
30 days after the disposition
•
Paragraph 40(3.3)(a): dispositions of “excluded property” by a foreign affiliate
Application scenario: BobCo and Windy Inc.
Bob owns 100% of the shares of BobCo.
BobCo owns shares in Windy Inc.
BobCo has a December 31 year end. Assume BobCo’s ACB of the Windy Inc. shares is $40,000 and
BobCo sells all of its Windy Inc. shares to Bob on January 1, 2022 at their FMV of $20,000. Bob holds
the shares of Windy Inc. until November, 2023 and then sells them to an arm’s length party for $60,000.
Select the START button to start the activity.
Suspended loss on shares
What amount of capital loss can BobCo report in 2022 on the sale of the Windy Inc. shares to Bob?
Enter your response in the field provided.
$
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Feedback
Since Bob is the controlling shareholder of BobCo, the capital loss of $20,000 expected to be
realized by BobCo on the sale of the Windy Inc. shares is deemed by ss.40(3.4) to be NIL and
suspended until Bob sells the shares in 2023, to an arm’s length party.
Suspended loss on shares
What is BobCo’s capital gain / loss in 2023?
Select the best response.
£
$ 20,000 capital loss
£
$ NIL
£
$ 10,000 capital gain
£
$ 20,000 capital gain
Feedback
Bob’s sale of the Windy Inc. shares to an arm’s length party in November, 2023 is a triggering
event which will permit BobCo’s suspended capital loss from 2022, to be realized in 2023. The
amount of the capital loss = proceeds of disposition of $20,000 less ACB of $40,000 = $20,000.
Suspended loss on shares
What if, instead of BobCo owning the shares, Bob himself owned them? Bob is the sole
shareholder of BobCo. Assume that on January 1, 2022, Bob sold his shares of Windy Inc.
to BobCo for $20,000, which was the FMV of the Windy Inc. shares at the time. Bob’s ACB of
the Windy Inc. shares immediately before the disposition was $40,000, and BobCo retained the
shares for more than 30 days after the sale.
What is Bob’s suspended loss under subsection 40(3.4) on the sale of the Windy Inc. shares to BobCo?
Enter your response in the field provided.
$
Feedback
Per ss.40(3.3), ss.40(3.4) only applies to a corporation, trust or partnership – not an individual.
Thus, Bob could not have a suspended loss result from ss.40(3.4). Instead, a superficial loss arose
due to p.40(2)(g) and the definition of “superficial loss” in s.54, and this caused the capital loss
he expected to be $20,000 on his Windy Inc. shares to be deemed to be $NIL. In accordance
with p.53(1)(f), the superficial loss of $20,000 is added to the cost base of the Windy Inc. shares
now held by the affiliated party, BobCo.
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Depreciable capital property tax losses
Although capital losses do not arise on the disposition of depreciable capital property, terminal
losses may arise. A terminal loss can also be suspended when there is a disposition of depreciable
capital property to an affiliated person.
Subsection 13(21.2) applies to suspend a terminal loss on the disposition of depreciable property
in the following circumstances:
“(a) a person or partnership (the “transferor”) disposes at a particular time (otherwise than
in a disposition described in any of paragraphs (c) to (g) of the definition “superficial loss”
in section 54) of a depreciable property…of a particular prescribed class of the transferor,
(b) the lesser of
(i) the capital cost to the transferor of the transferred property, and
(ii) the proportion of the undepreciated capital cost to the transferor of all property
of the particular class immediately before that time that
(A) the fair market value of the transferred property at that time is of
(B) the fair market value of all property of the particular class immediately before that
time exceeds the amount that would otherwise be the transferor’s proceeds of
disposition of the transferred property at the particular time, and
(c) on the 30th day after the particular time, a person or partnership (in this subsection
referred to as the “subsequent owner”) who is the transferor or a person affiliated with
the transferor owns or has a right to acquire the transferred property (other than a
right, as security only, derived from a mortgage, hypothec, agreement for sale or similar
obligation), the following rules apply: ….
(d) for the purposes of applying this section and section 20 and any regulations made for
the purpose of paragraph 20(1)(a) to the transferor for taxation years that end after the
particular time,
(i) the transferor is deemed to have disposed of the transferred property for proceeds
equal to the lesser of the amounts determined under subparagraphs (b)(i) and (ii)
with respect to the transferred property,
(ii) where two or more properties of a prescribed class of the transferor are disposed of at
the same time, subparagraph (i) applies as if each property so disposed of had been
separately disposed of in the order designated by the transferor or, if the transferor does
not designate an order, in the order designated by the Minister,
(iii) the transferor is deemed to own a property that was acquired before the beginning of
the taxation year that includes the particular time at a capital cost equal to the amount
of the excess described in paragraph (b), and that is property of the particular class, until
the time that is immediately before the first time, after the particular time…”
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To summarize, ss.13(21.2) applies when:
1.
A person or partnership (the transferor) disposes of a depreciable property,
2.
The transferor’s proceeds of disposition are less than the lesser of the property’s capital cost
or proportionate undepreciated capital cost (UCC), and
3.
30 days after the disposition, the transferor or a person affiliated with the transferor owns or
has a right to acquire the property.
When these conditions are met, the loss is disallowed but remains with the transferor either until
the transferee then disposes of the property to a non-affiliated person, or until a triggering event
occurs.
The loss that becomes suspended in this situation is not a capital loss, but a terminal loss. Unlike
the suspended loss rule for non-depreciable property, this particular suspended loss rule applies
to all taxpayers including individuals and partnerships.
Transferor – adjusted proceeds of disposition
Subparagraph 13(21.2)(e)(i) effectively denies any loss on the transferred property by deeming
the transferor’s proceeds of disposition to be the lesser of either the property’s capital cost or its
proportionate UCC.
When the property is the last one in the asset class, the adjustment to the proceeds of disposition
ensures no terminal loss arises when it is disposed of.
When there is other property in the asset class, the proportionate UCC is calculated as:
Total UCC of the property’s class ×
Value of the particular property
Value of all properties in class
As such, the suspended loss rules apply regardless of whether the property disposed of is the last
asset in the class (i.e., the suspended loss rules can apply to a disposition that would not otherwise
produce a terminal loss).
If the transferor disposes of more than one depreciable property of the same class at the same time,
each property is deemed to be disposed of separately in the order designated by the transferor or,
if no order is so designated, by the Minister.
Transferor – notional property
Subparagraph 13(21.2)(e)(iii) deems the transferor to continue to own a notional property with
a capital cost equal to the denied loss.
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The transferor adds the cost of the notional property to its UCC class and continues to claim
capital cost allowance (CCA) on the property until a triggering event occurs. Such an event
triggers a disposition of the notional property for NIL proceeds, and when the notional property
is the only property in its class at the time of the triggering event, the transferor may claim
a terminal loss on the remaining UCC balance.
Under sp.13(21.2)(e)(iii), the notional property is deemed to have been acquired before the
beginning of the taxation year in which the disposition occurred, thus the half-year rule in
Income Tax Regulation (Regulation) 1100(2) does not apply. Furthermore, the notional property
is considered available for use when the transferred property becomes available for use by the
transferee [sp.13(21.2)(e)(iv)].
Transferee
Paragraph 13(21.2)(g) deems the transferee’s capital cost and UCC to be the same as the
transferor’s capital cost and UCC at the time of the transfer. The transferee is deemed to have
deducted the excess of the property’s capital cost over its FMV as CCA in prior taxation years,
such that the transferee will be taxed on any potential recapture that arises when the property is
disposed of in the future.
Partnerships
Under p.13(21.2)(f), when a partnership is subject to the suspended loss rules after disposing of a
depreciable property, and the partnership ceases before one of the triggering events occurs, the
suspended loss does not simply expire. Instead, the partnership is deemed to continue to exist, and its
partners are deemed to remain members of the partnership, until a triggering event occurs. At that point,
the previously denied terminal loss is allowed to the partnership and, in turn, allocated to the partners.
Tax-deferred rollovers
Pursuant to p.13(21.2)(d), when ss.13(21.2) applies to a disposition, the tax-deferred rollover
provisions for transfers of property to corporations (s.85) and partnerships (s.97) do not apply.
Depreciable capital property tax loss exceptions
The suspended loss rules do not apply to certain dispositions of depreciable property identified
in p.13(21.2)(a):
•
Dispositions described in paragraphs (c) to (g) of the definition of superficial loss in s.54
(these were described in detail in the section addressing common exceptions to the suspended
loss rules relating to non-depreciable capital property as well as the superficial loss rules)
•
Dispositions of “excluded property” by a foreign affiliate (or a partnership of which the foreign
affiliate was a member) for the purposes of computing the foreign affiliate’s exempt surplus
or deficit and taxable surplus or deficit in respect of the taxpayer (this type of disposition is
beyond the scope of this course)
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Triggering events
Paragraph 13(21.2)(e) sets out the “triggering events” that allow a suspended terminal loss to be
claimed as follows:
“…for the purposes of applying this section…to the transferor for taxation years that end
after the particular time…
…until the time that is immediately before the first time, after the particular time,
Select the tabs to learn more.
Clause 13(21.2)(e)(iii)(A)
at which a 30-day period begins throughout which neither the transferor nor a person affiliated
with the transferor owns or has a right to acquire the transferred property (other than a right, as
security only, derived from a mortgage, hypothec, agreement for sale or similar obligation),
Clause 13(21.2)(e)(iii)(B)
at which the transferred property is not used by the transferor or a person affiliated with the
transferor for the purpose of earning income and is used for another purpose,
Clause 13(21.2)(e)(iii)(C)
at which the transferred property would, if it were owned by the transferor, be deemed by
section 128.1 or subsection 149(10) to have been disposed of by the transferor,
Clause 13(21.2)(e)(iii)(D)
that is immediately before the transferor is subject to a loss restriction event, or
Clause 13(21.2)(e)(iii)(E)
if the transferor is a corporation…and…
…(II) for any other purposes, at which the winding-up (other than a winding-up to which
subsection 88(1) applies) of the transferor begins, and…”
Triggering events in p.13(21.2)(e) are similar to the triggering events outlined for the release
of suspended losses under ss.40(3.4):
•
A subsequent disposition of the property to a person that is neither the transferor nor a
person affiliated with the transferor (provided that for 30 days after that later disposition
neither the transferor nor an affiliated person owns the substituted property)
•
A deemed disposition of the property under s.128.1 of the ITA (emigration) or ss.149(10)
of the ITA (change of taxable status)
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•
In the case of a corporation, a loss restriction event of the transferor corporation
•
Where the substituted property is a debt or a share, a deemed disposition under s.50 of the ITA
•
Where the transferor is a corporation, a winding-up of the transferor [other than a winding-up
under ss.88(1)] and
•
Where the property ceases to be used for the purpose of earning income [c.13(21.2)(e)(iii)(B)]
Application scenario: BobCo
Bob is the sole shareholder of BobCo.
On February 1, 2022, Bob sold computer equipment to BobCo for $20,000 (the FMV at the time).
His ACB of the equipment was $40,000. The UCC of the equipment to Bob at the time of the
transfer was $25,000 (Class 50). The computer equipment is the only equipment in the class.
BobCo retained the equipment for more than 30 days after the sale.
Select the START button to start the activity.
Suspended loss on disposition
What is Bob’s suspended loss on the disposition of the computer equipment to BobCo?
Enter your response in the field provided.
$
Feedback
The suspended loss rule in ss.13(21.2) relating to depreciable capital property applies to individuals.
Had Bob sold the equipment to an unaffiliated person, ss.13(21.2) would not apply, and Bob would
have realized a terminal loss of $5,000 from the disposition of all equipment in the class. Since
BobCo and Bob are affiliated [sp.251.1(1)(b)(i)], the terminal loss is denied, and Bob is deemed
by sp.13(21.2)(e)(iii) to own a notional property of the same class. The notional property’s cost is
deemed to be the amount by which the deemed proceeds exceed the actual disposition proceeds.
Bob’s deemed proceeds are determined by p.13(21.2)(e) [which refers to p.13(21.2)(b)] to be the
UCC of the class – i.e., $25,000. Before the beginning of the taxation year that includes the date
of disposition, Bob is deemed by sp.13(21.2)(e)(iii) to acquire a notional asset of the same class
(50 in this case), with a capital cost equal to the excess of the deemed proceeds of $25,000 over
the actual proceeds of $20,000 – i.e., $5,000.
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Half-year rule
True or False: The half-year rule applies to the notional property that Bob is deemed to have
acquired when he disposed of the computer equipment.
Select the best response.
£
True
£
False
Feedback
Subparagraph 13(21.2)(e)(iii) deems Bob to have acquired the notional property before the beginning
of the taxation year in which he disposed of the property. Therefore, Bob was deemed to have
acquired the property in 2021. Accordingly, the half-year rule does not apply in 2022.
Class 50 UCC
What amount is added to BobCo’s Class 50 UCC?
Enter your response in the field provided.
$
Feedback
Paragraph 13(21.2)(g) deems BobCo to have acquired the property at the transferor’s capital
cost ($40,000). BobCo also is deemed to have claimed the excess of the transferor’s deemed
cost ($40,000) over the FMV ($20,000), i.e., $20,000 as CCA of the class in prior taxation years.
Therefore, the UCC of the class is reduced by the $20,000 CCA, and BobCo’s UCC is deemed
equal to $20,000 (deemed capital cost of $40,000 less deemed CCA of $20,000).
As a result, assuming it remains the only asset in the class, BobCo could be subject to recaptured
CCA in the future if the computer equipment is disposed of at a time when it is worth more than
the UCC of the class.
Application scenario: Depreciable property losses — ss.13(21.2)
•
A Co and C Co have taxation years ending on December 31
•
Both A Co and C Co are controlled by Dad
•
Dad would like to reduce A Co’s 2021 taxable income of $100,000 to $NIL
•
A Co has one piece of heavy equipment:
—
Capital cost = $300,000
—
FMV = $150,000
—
UCC = $250,000
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•
Dad plans to sell A Co’s heavy equipment to C Co in December in order to realize the accrued
terminal loss of $100,000 in 2021 and reduce A Co’s taxable income to $NIL
•
C Co can then sell the heavy equipment to a non-affiliated person in 2022
—
an unrelated purchaser has indicated his interest in acquiring the heavy equipment in
March 2022 and, if that does not work out, Dad has no doubt he will be able to sell the
equipment to another party before the end of 2022
—
no CCA was claimed on the equipment in 2021, and none will be claimed in 2022
Select the START button to start the activity.
Depreciable property losses ss.13(21.2)
True or False: This plan would reduce A Co’s 2021 taxable income to $NIL.
Select the best response.
£
True
£
False
Feedback
•
Dad, A Co, and C Co are all affiliated persons based on the definition in ss.251.1(1)
•
Since the sale of the equipment is to an affiliated person, and the equipment is in a terminal
loss position, ss.13(21.2) must be consulted to determine whether the suspended loss rules will
apply to the proposal
•
ss.13(21.2) applies where:
(a) a person (A Co) disposes at a particular time (December 2021 – exact date not specified)
of depreciable property of a prescribed class (heavy equipment) of the transferor (A Co)
(b) the lesser of (i) capital cost to A Co ($300,000) and (ii) the UCC of the class applicable
to the heavy equipment ($250,000) exceeds the amount that would be the proceeds
of disposition ($150,000) ¨ $100,000 and
(c) on the 30th day after the particular time (December 2021 – exact date not specified), a person
affiliated (C Co) with the transferor (A Co) owns the transferred property (heavy equipment)
•
Since the criteria for ss.13(21.2) noted in a) and b) above are met, and since C Co will continue
to own the heavy equipment until at least March 2022, the criterion in paragraph c) is also met,
therefore, ss.13(21.2) will apply to suspend the terminal loss that A Co is attempting to realize.
•
Subsection 13(21.2) will suspend the terminal loss until the heavy equipment is no longer
owned by an affiliated person for at least 30 days.
•
Therefore, Dad’s plan to reduce A Co’s taxable income will not work.
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How to identify if a suspended loss exists
In a situation in which a taxpayer disposes of property resulting in a capital loss, determine
if a suspended loss exists by first assessing the situation as follows:
Select the tabs to learn more.
Establish the facts
a)
Draw a diagram of the before and after
i.
Identify the relationships between the taxpayers
ii.
Does anyone own identical property?
b) Draw a timeline
i.
When did the disposition(s) occur?
ii.
Was there an acquisition?
Identify the tax issues
a)
Which taxpayers (individuals, corporations, etc.) are affiliated?
b) Do the stop-loss rules apply? If so, what are the tax implications?
Prepare a research plan
•
Affiliated persons [ss.251.1(2)]
—
—
if dealing with a capital loss
•
Definition of suspended loss [ss.40(3.3)]
•
Tax implications of suspended losses [p.40(3.4)(a)]
•
Triggering events [p.40(3.4)(b)]
if dealing with a terminal loss
•
Definition of suspended loss [ss.13(21.2)]
•
Tax implications of terminal losses [ss.13(21.2)(d) to (g)]
•
Triggering events [p.13(21.2)(e)]
After assessing the situation, analyze the issues, conclude, and advise.
Superficial vs. suspended losses
The superficial and suspended loss rules are quite similar. Both sets of rules restrict the realization
of losses on assets transferred between affiliated persons that do not represent a substantive
change in economic interests.
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While both the superficial and suspended loss rules rely on the concept of affiliated persons,
the superficial loss rules apply to capital losses when an individual disposes of property, and
the suspended loss rules related to non-depreciable property apply when a corporation, trust or
partnership disposes of property. The suspended loss rules in respect of depreciable property,
however, apply to all taxpayers including individuals.
Select the button to learn more.
Summary table
The following table summarizes superficial and suspended losses:
Transferor is a corporation, trust or partnership
Transferor is an individual
Capital loss on transfer (suspended loss)
Capital loss on transfer (superficial loss)
•
to an affiliated purchaser (s.251.1)
•
to an affiliated purchaser (s.251.1)
•
capital loss is denied [ss.40(3.4)]
•
•
capital loss is kept with the transferor until the
transferee sells the asset to a non-affiliated person
capital loss is denied as a superficial
loss [s.54, p.40(2)(g)]
•
denied loss is added to the cost of the
asset to the transferee
Terminal loss (suspended loss)
Terminal loss (suspended loss)
•
on transfer to an affiliated purchaser (s.251.1)
•
•
terminal loss is denied [ss.13(21.2)]
•
terminal loss is kept with the transferor until the
transferee sells the asset to a non-affiliated person
•
transferee records the asset with a cost to the
transferor and an addition to UCC equal to FMV
[p.13(7)(e)]
same as for corporations, trusts or
partnerships
Summary
Congratulations! You have completed this module. You should now be able to:
•
Identify common suspended stop-loss rules in the ITA
•
Define identical properties with regard to superficial and suspended losses
•
Determine the tax implications resulting from common suspended stop-loss rules
•
Identify the common exceptions to the suspended loss rules
•
Assess when a suspended loss exists, using a non-directed fact scenario
•
Differentiate between the tax implications of the superficial and suspended loss rules
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Select the button to learn more about the key points.
KEY POINTS
Recall some of the key points related to the suspended loss rules:
•
Suspended capital loss rules apply only to corporations, trusts and partnerships
•
Suspended terminal loss rules apply to corporations, trusts and partnerships as well as to individuals
•
When the suspended loss rules apply, the transferor’s loss from the disposition of property is
deemed to be NIL, and the amount of the denied loss is suspended until a triggering event
takes place that allows the loss to be realized
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Stop-Loss eLearning Modules 3 and 4: Inadequate Consideration
and Non-arm’s Length Transactions
Introduction
In this section of the course, you will investigate the income tax implications when there is
inadequate consideration provided in a transaction, learn about non-arm’s length transfers, and
explore the interaction between attribution rules and stop-loss rules.
You will also work on a case study requiring you to apply this foundational knowledge and the
CPA Way research process to address the scenario.
Course overview
This course has four main modules* that will introduce important concepts related to the
stop-loss rules.
Module 1: Superficial Loss Rules
This module explained the fundamentals of a superficial loss, and determine how these rules
apply, what they apply to, and what the tax implications are.
Module 2: Suspended Loss Rules
This module explained the fundamentals of a suspended loss and determine how these rules
apply, and what they apply to, and what the tax implications are.
Module 3: Inadequate consideration and non-arm’s length transfers
This module is an overview of the tax implications of arm’s length and non-arm’s length
transactions, as well as transactions with inadequate consideration.
Module 4: Case study: The Prosper Family
Using a real life scenario, you will apply the teachings covered in Modules 1 – 3 to work through
this case study.
*
Modules 3 and 4 will be presented together in this eLearning. Modules 1 and 2 should already be completed.
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Module 3: Inadequate Consideration and Non-Arm’s
Length Transfers
Introduction
Select the buttons to review the learning objectives and required materials.
Learning Objectives
After working through this module, you will be able to:
•
Apply the Income Tax Act (ITA)2 rules related to non-arm’s length transfers
and inadequate consideration
•
Differentiate between arm’s length and non-arm’s length transactions
•
Identify when the inadequate consideration provision applies to non-arm’s length
transactions
•
Determine the current and future tax implications resulting from inadequate
consideration
•
Recognize the exceptions where taxpayers may transact at amounts other than fair
market value (FMV)
•
Explain the interaction between the attribution rules and the stop-loss rules
REQUIRED MATERIALS
To complete this course, you will need a copy of the ITA - paper or electronic.
2
Income Tax Act, RSC 1985, c. 1 (5th Supp.), as amended (herein referred to as ITA or the Act). Unless otherwise noted, statutory
references in this course are to the ITA.
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Arm’s length vs. non-arm’s length transactions
Select the circles to learn more.
Arm’s length
Although the term “at arm’s length” is used throughout the ITA, the ITA does not contain a precise
definition of the term. Section 251, which is the statutory provision for determining arm’s-length
relationships, refers to three categories of persons who may not deal with each other at arm’s
length:
1.
Related
2.
Unrelated trusts and beneficiaries
3.
Persons not related to each other
The second category refers specifically to certain personal trusts and their beneficiaries.
Subsection 251(1)
Subsection 251(1) defines “arm’s length” for purposes of the ITA as follows:
“(a) related persons are deemed not to deal at arm’s length
(b) a taxpayer and a personal trust are deemed not to deal with each other at arm’s length if
the taxpayer, or any person not dealing at arm’s length with the taxpayer, is beneficially
interested in the trust, and
(c) it is a question of fact whether unrelated persons are at a particular time dealing at arm’s
length”
The term “related persons” is defined in ss.251(2) in significant detail.
What is FMV?
In general, when parties are acting at arm’s length, there is a presumption that they conduct
business and enter into transactions at FMV.
The determination of FMV is a question of fact, not law, and it is generally considered to be
“the highest price an asset might reasonably be expected to be sold by the owner in the normal
method applicable to the asset in question in the ordinary course of business in a market not
exposed to any undue stresses and composed of willing buyers and sellers dealing at arm’s length
and under no collusion to buy or sell”. [Henderson, [1973] C.T.C 636 at 644 (FCTD)]
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Arm’s length transactions
However, as indicated in p.251(1)(c), the determination of whether or not parties to a transaction
are acting at arm’s length is a question of fact, and not always clear-cut. To determine whether
they are dealing at arm’s length, the courts use the following criteria to assess the relationship
of parties to a transaction:
•
Are the parties of a common mind, which directs the bargaining for both parties to the transaction?
•
Are they acting in concert without separate interests?
•
Is there de facto control?
All three criteria need not be satisfied in every case. In any situation, any one or more of the
criteria may be of greater or lesser importance in determining whether the parties are dealing
at arm’s length. Each situation must be examined based on its circumstances.
Price adjustment clauses and agreements of purchase and sale
A price adjustment clause is typically incorporated into an agreement entered into by non-arm’s
length persons to provide for an adjustment to the transaction price if a third-party, such as the
CRA or a court of law, determines that the FMV of the transferred property is greater or less than
the amount the parties have otherwise determined. It is a safeguard that protects the parties to
a transaction from potential adverse tax consequences that could result if the FMV used in the
transaction differs from the CRA’s estimate of FMV. This will change the actual purchase price and
alter that consideration thereto.
Valid price adjustment clause
For a price adjustment clause to be valid, it must meet the following conditions outlined in
paragraph 1.5 of Income Tax Folio S4-F3-C1, “Price Adjustment Clauses” (Folio S4-F3-C1):
1.
The agreement reflects a bona fide intention of the parties to transfer the property at FMV
2.
The FMV for purposes of the price adjustment clause is determined by a fair and reasonable
method and performed in good faith
3.
The parties agree that if the FMV of the transferred property determined by the CRA or a court
of law differs from their valuation, they will use the value determined by the CRA or the court
4.
The excess or shortfall in price is actually refunded or paid, or a legal liability therefor is adjusted
Section 69: Inadequate consideration
Section 69 of the ITA provides rules to adjust the value of consideration when there is inadequate
consideration in transactions involving transfers of property between arm’s length and non-arm’s
length taxpayers.
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When a taxpayer disposes of or acquires a property from a non-arm’s length person for an
amount not equal to its FMV, s.69 governs the transferor’s proceeds as well as the transferee’s
cost. The net result is a potential for double tax.
In contrast, when a taxpayer disposes of property to an arm’s length person for an amount not
equal to its FMV, s.69 governs only the transferor’s proceeds.
Select the button to learn more.
What is inadequate consideration?
The term “inadequate consideration” is generally used to describe consideration that is not equal
to the FMV of the asset or liability being transferred. When consideration in a particular transaction
is either greater than or less than FMV, for income tax purposes it is viewed as inadequate.
Non-arm’s length proceeds
Select the circles to learn more.
Non-arm’s length proceeds > FMV — p.69(1)(a)
When a taxpayer (the transferee) acquires property from a non-arm’s length person (the transferor)
for an amount in excess of its FMV, p.69(1)(a) deems the transferee to have acquired the property
for a cost equal to FMV. However, for purposes of calculating the gain or loss, the transferor must
use the actual proceeds they received.
In this way, the transferor is penalized because they will pay tax on the gain based on the actual proceeds
they received. In addition, this adjustment prevents the transferee from inflating the cost of the property.
Select the button to learn more.
Example
Andrew purchases shares of ACo from his father, Jason, paying $1,250 at a time when the shares
had an FMV of $1,000. Jason’s adjusted cost base (ACB) of the shares is $100.
The following chart compares the implications of transacting as proposed versus transacting at FMV.
Sale from Jason to Andrew
for proceeds > FMV
Deemed proceeds of
disposition = actual $ paid
ACB
Capital gain
Jason
$ 1,250
100
$ 1,150
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Sale from Jason to Andrew
Andrew for proceeds = FMV
– Proceeds of sale
Jason
Andrew
$ 1,000
–
100
$ 1,000
900
–
$1,000 ACB (amount paid)
– Capital gain
$
40
STOP-LOSS RULES
In effect, the $250 that Andrew overpaid for the shares resulted in a capital gain to Jason of $250
more than the gain would have been had they transacted at FMV. In addition, Andrew does not
get the benefit of the full amount paid in his ACB for future capital gain or loss determination
on the eventual sale of the ACo shares. Thus, the result is double tax.
Non-arm’s length proceeds < FMV — p.69(1)(b)
When a taxpayer disposes of property to a non-arm’s length person for an amount less than
its FMV, p.69(1)(b) deems the taxpayer to have received proceeds of disposition equal to FMV.
However, the actual amount paid becomes the transferee’s cost of the property.
In this way, the transferor is penalized because they will pay tax on the gain based on the FMV,
not on the proceeds they received. Unfortunately, this adjustment does not increase the cost of
property for the transferee, so they may have a larger gain on this property if subsequently sold
for amount in excess of their purchase price.
Select the button to learn more.
Example
Ashleigh purchases shares of ZCo from her mother, Andrea, paying $800 at a time when the
shares had an FMV of $1,000. Andrea’s ACB of the shares is $100.
The following chart compares the implications of transacting as proposed versus transacting at FMV.
Sale from Andrea to Ashleigh
for proceeds < FMV
Deemed proceeds of
disposition = FMV
ACB
Capital gain
Andrea
$ 1000
100
$ 900
Sale from Andrea to Ashleigh
Ashleigh for proceeds = FMV
– Proceeds of sale
Andrea
Ashleigh
$ 1,000
–
100
$ 1,000
900
–
$ 800 ACB (amount paid)
– Capital gain
$
In effect, the $200 that Ashleigh underpaid for the shares resulted in a capital gain to Andrea
of $200 more than anticipated with the $800 proceeds they used. In addition, Ashleigh does not
get the benefit of the increase to the deemed FMV proceeds in her ACB for future capital gain or
loss determination on the eventual sale of the ZCo shares. Thus, the result is double tax.
Gifts of property for NIL consideration — p.69(1)(c)
When property is gifted for no consideration, the transferor is deemed to receive proceeds of
disposition equal to the property’s FMV at the time, and the recipient is deemed to acquire the
property at that same value [p.69(1)(c)].
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This rule applies to all gifts of capital property, regardless of whether the gift was made to a
non-arm’s length person.
Summary of Non-Arm’s Length Transactions — ss.69(1)
The following chart provides a summary of the implications of transferring property for
inadequate consideration:
Non-arm’s length transactions — ss.69(1)
Deemed proceeds to
Consideration
transferor / seller
ACB to purchaser
Double taxation
FMV
Actual consideration
FMV
No
NIL (gift)
FMV
FMV
No
>FMV
Actual proceeds
FMV
Yes
<FMV
FMV
Actual consideration
Yes
Deemed proceeds of disposition — ss.69(11)
When taxpayers transact with anyone for proceeds less than FMV, ss.69(11) must be considered.
Subsection 69(11) applies if, as part of series of transactions or events, the following three
conditions are met:
1.
A taxpayer disposes of property for proceeds of disposition that are less than FMV,
2.
“One of the main purposes” of the disposition was to benefit from a tax deduction or exemption
when a non-affiliated person disposes of the same property as in point one above, and
3.
The subsequent disposition of the property by the non-affiliated person occurs within three
years of the initial disposition.
If these conditions are met, ss.69(11) applies to the initial disposition and deems the proceeds
of disposition on the property to be equal to FMV.
If the benefit the transferor seeks to obtain is tax-exempt status, the non-affiliated requirement
in ss.69(11) does not apply.
Caution: Subsection 69(12) allows the Minister to assess or reassess as necessary to give effect
to ss.69(11) without regard to assessment limitation periods.
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Select the button to learn more.
Affiliated person
Simplified, the term “affiliated person” describes a relationship where one corporation is
“affiliated” with another corporation or individual only if the same person(s) and/or the spouse(s)
of the person(s) who controls the other corporation also controls the first corporation. Two
individuals are affiliated if they are spouses or common-law partners. For details regarding
affiliated persons, see s.251.1 of the ITA and review Module 1.
Knowledge check: Inadequate consideration
Mark is the sole shareholder of MarkCo. His shares in MarkCo. have an ACB of $175,000 and an
FMV of $145,000. If Mark sells his shares of MarkCo. to his son, London, for $50,000, what is
Mark’s capital loss on the transaction?
Enter your response in the field provided.
$
Feedback
Mark and his son, London, are related. Therefore, they do not deal at arm’s length.
Paragraph 69(1)(b) applies in this situation because a taxpayer has disposed of a property for
inadequate consideration to a non-arm’s length taxpayer for proceeds less than FMV. It deems
Mark to have received proceeds of disposition equal to the FMV at the time ($145,000); thus, the
loss is $145,000 – $175,000 = $30,000.
However, there is no offsetting adjustment to London’s cost, and the ACB of the shares to London
remains at $50,000. As a result, double taxation may apply on $95,000 ($145,000 – $50,000)
when London sells the shares in the future.
Knowledge check: Inadequate consideration
True or False: Related persons are considered to be at arm’s length with each other.
Select the best response.
£
True
£
False
Feedback
They are considered to deal at non-arm’s length with each other. [p.251(1)(a)]
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Knowledge check: Inadequate consideration
Which provision defines related persons to include “individuals connected by blood relationship,
marriage, or common-law partnership, or adoption”?
Select the best response.
£
Subsection 251(1)
£
Subsection 251(2)
£
Subsection 251(3)
£
Subsection 251.1(1)
Feedback
Subsection 251(2) defines related persons to include individuals connected by blood relationship,
marriage, or common-law partnership, or adoption.
Knowledge check: Inadequate consideration
Inadequate consideration in ________________ includes “where a taxpayer has acquired anything
from a person with whom the taxpayer was not dealing at arm’s length at an amount in excess
of the fair market value thereof at the time the taxpayer so acquired it, the taxpayer shall be
deemed to have acquired it at that fair market value.”
Select the best response.
£
Subsection 69(1)
£
Paragraph 69(1)(a)
£
Subparagraph 69(1)(b)(i)
£
Subparagraph 69(1)(b)(ii)
Feedback
Paragraph 69(1)(a) provides the tax implications of acquiring something from a person with whom
the taxpayer was not dealing at arm’s length, for proceeds greater than FMV.
Knowledge check: Inadequate consideration
Which of the following is an example of inadequate consideration?
Select all that apply.
£
Charles acquires shares valued at $1,000 for $50 from his mother
£
Margaret gifts shares of her holding company valued at $5,000 to her favourite employee, Bill
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£
Sally sells her computer to her sister, Cathy, for $300, even though it’s only worth $100
£
Bill sells his car to a neighbour for its current value of $1,500 and allows the neighbour to pay
him in three instalments over the next six months
Feedback
The following are examples of inadequate consideration:
•
Charles acquires shares valued at $1,000 for $50 from his mother
•
Margaret gifts shares of her holding company valued at $5,000 to her favourite employee, Bill
•
Sally sells her computer to her sister, Cathy, for $300, even though it’s only worth $100
Application scenario: Tax implications
Martha owns marketable securities that are currently trading at $15,000, which she originally
purchased for $10,000. Martha has agreed to sell the marketable securities to her daughter,
Diane, for $12,000.
Select the START button to start the activity.
Tax implications
What are the tax consequences to Martha and Diane if they carry out this plan?
Enter your responses in the fields provided.
Sale from Martha to Diane
Martha
Diane
Deemed proceeds of disposition
$
–
ACB
$
$
Capital gain
$
–
Feedback
Sale from Martha to Diane
Martha
Diane
Deemed proceeds of disposition
$ 15,000
–
ACB
$ 10,000
$ 12,000
Capital gain
$ 5,000
–
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Tax implications
If Diane then sells the marketable securities for $15,000, what are the tax consequences?
Enter your responses in the fields provided.
Diane sells at FMV
Diane
Proceeds of disposition
$
ACB
$
Capital gain
$
Feedback
Diane sells at FMV
Diane
Proceeds of disposition
$ 15,000
ACB
$ 12,000
Capital gain
$ 3,000
As a result of their transactions, tax is paid on $8,000 of capital gains ($5,000 for Martha and
$3,000 for Diane).
Tax implications
What if they had transacted at FMV? What would the tax consequence have been?
Enter your responses in the fields provided.
Sale from Martha to Diane
Martha
Proceeds of sale
$
Cost base (amount paid)
$
Capital gain
$
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Diane
–
$
–
46
STOP-LOSS RULES
If Diane later sells at FMV
Diane
Proceeds of sale
$
Cost base (amount paid)
$
Capital gain
$
Feedback
Sale from Martha to Diane
Martha
Diane
Proceeds of sale
$ 15,000
–
Cost base (amount paid)
$ 10,000
$ 15,000
Capital gain
$ 5,000
–
If Diane later sells at FMV
Diane
Proceeds of sale
$ 15,000
Cost base (amount paid)
$ 15,000
Capital gain
$
NIL
Had they transacted at FMV, they would have paid tax on only $5,000 of gain (entirely by Martha).
As a result of transacting at less than FMV, they have subjected themselves to double taxation on
a $3,000 gain.
Exceptions to section 69
Specific exceptions relating to non-arm’s length parties may override the rules for inadequate
consideration. For example,
Select the tabs to learn more.
Rights or things
A transferee who acquires property that is a right or thing to which ss.70(3) applies is exempt
from p.69(1)(c) because of ss.69(1.1). Instead, the transferee is deemed to acquire the property
at a cost equal to the total of:
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•
the portion of the cost to a deceased taxpayer from income for the year of death
•
any expenditure incurred by the taxpayer to acquire the property
Gifts or bequests
Gifts or bequests to a spouse or common-law partner are allowed under ss.73(1), as they
are exempt from ss.69(1) by virtue of the wording “except as expressly otherwise provided”
in the preamble to ss.69(1).
Intergenerational rollovers
Intergenerational rollovers of qualified farm and fishing property are allowed:
•
upon death, under subsections 70(9.01), (9.11), (9.21) and (9.31)
•
while living, under subsections 73(3.1) and (4.1)
Generally, under ss.73(3.1), ss.69(1) does not apply when a taxpayer transfers a qualified farm
property to a child while the taxpayer is still alive and defers the capital gain on the transfer.
However, if the child sells the qualified farm property within the following three years and claims
the capital gain exemption, ss.69(11) could deny the rollover retroactively.
Attribution refresher
The spousal rollover rules in s.73 are an exception to the inadequate consideration rules, since
they require transfers of capital property between spouses to take place at the transferor’s ACB.
Thus, these rules for the transfer of property defer the realization of any accrued gains or losses.
When the transferee spouse subsequently disposes of the property, the resultant gain or
loss at that time is attributed back to the transferor spouse if they are still married or in a
common-law relationship.
Pursuant to subsections 74.1(1) and 74.2(1), income, losses and capital gains realized on
property loaned or transferred to a spouse (including a common-law partner) may be subject
to attribution.
To avoid attribution on transfers of capital property, ss.74.5(1) requires the following:
•
In the case of spousal transfers, that the spouses elect out of the spousal rollover provisions
of ss.73(1) such that the transfer takes place at FMV, not cost.
•
That FMV consideration be received by the transferor.
•
If the consideration includes a loan, that the loan bear interest at a rate that is greater or
equal to the prescribed rate at the time the loan is made, and that interest be paid within
30 days of the end of every year in which the loan debt is outstanding.
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These requirements to avoid attribution are similar to the inadequate consideration rules in s.69,
which seek to eliminate the tax benefits of the transfer for proceed amounts other than FMV.
Use caution when dealing with non-arm’s length transfers, since other provisions may be invoked
[e.g., ss.15(1), ss.56(2), s.74.1-74.4, s.160 and ss.246(1)].
Application scenario: Lily’s transfer to her spouse
Lily transfers marketable securities with an ACB of $4,000 and a FMV of $10,000 to her husband,
Mark, for $4,000.
Select the START button to start the activity.
ITA provision
Consider the facts and identify which ITA references would apply.
Select the best response.
£
Subsection 69(1)
£
Subsection 73(1)
£
Subsection 74.1(1)
£
Subsection 74.5(1)
Feedback
Subsection 73(1) will apply since this is a spousal transfer. The other provisions are considerations
when analyzing, but do not apply.
Proceeds of disposition
What will Lily’s proceeds of disposition be when she transfers the marketable securities to Mark
as proposed?
Select the best response.
£
$ NIL
£
$ 4,000
£
$ 10,000
£
any amount selected between $4,000 and $10,000
Feedback
Subsection 73(1) will automatically apply to cause Lily to have proceeds equaling ACB of $4,000,
resulting in no gain or loss to her on the transfer. Mark’s ACB will equal Lily’s proceeds of $4,000.
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STOP-LOSS RULES
The proceeds of disposition to Lily and ACB to Mark are not adjusted by ss.69(1) despite the fact
that the transfer occurs for inadequate consideration. Subsection 69(1) indicates that it applies
“except as expressly otherwise provided in this Act”. Since ss.73(1) permits spousal transfers at
cost, it is one of the exceptions to ss.69(1).
Attribution
True or False: Lily and Mark need not be concerned about the attribution rules applying to the
gift of marketable securities since ss.73(1) permits the transfer at ACB.
Select the best response.
£
True
£
False
Feedback
Even though transfers of assets are permitted by ss.73(1) to take place at ACB, any income
earned by Mark on the marketable securities, will attribute back to Lily.
In order to avoid attribution, they must elect out of the rollover in ss.73(1) and proceeds
of $10,000 (FMV) must be paid by Mark to Lily. In doing so, Lily will have proceeds equaling FMV
of $10,000, resulting in a capital gain of $6,000. Mark’s ACB will equal the proceeds of $10,000
he provides to Lily. Any future gain on sale in this scenario will be included in Mark’s income and
will be subject to tax. Attribution will not apply.
Summary
Congratulations! You have completed this module. You should now be able to:
•
Apply the ITA rules related to non-arm’s length transfers and inadequate consideration
•
Differentiate between arm’s length and non-arm’s length transactions
•
Identify when the inadequate consideration provision applies to non-arm’s length transactions
•
Determine the current and future tax implications resulting from inadequate consideration
•
Recognize the exceptions where taxpayers may transact at amounts other than FMV
•
Explain the interaction between the attribution rules and the stop-loss rules
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STOP-LOSS RULES
Select the button to learn more.
KEY POINTS
Recall some of the key factors related to inadequate consideration and non-arm’s length transfers:
•
Where property is acquired from a non-arm’s length person at an amount in excess of FMV,
p.69(1)(a) deems the acquisition to be at FMV, preventing the inflation of cost in non-arm’s
length transactions
•
Where property is transferred at less than FMV, the transferor is deemed to have received
proceeds equal to the property’s FMV
•
Subsection 69(11) prevents taxpayers from disposing of a property on a tax-deferred basis
while obtaining the benefit of a tax deduction or other entitlement available to non-affiliated
persons on a subsequent disposition of the property that takes place within three years
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STOP-LOSS RULES
Module 4: Case Study
The Prosper Family
The entire Prosper family are residents in Canada. Alysia Prosper, Randy Prosper’s wife of 10 years,
owns a minority interest of 500 shares of Lux Inc., a public company. The shares were purchased
in 2018 and have an ACB of $20,000.
It is now October 31, 2023 and the FMV of the Lux Inc. shares is $5,000. Alysia has suggested
that she sell the shares of Lux Inc. to Randy today for $5,000 cash. When she files her 2023
tax return, Alysia will elect out of the spousal rollover provisions of ss.73(1), such that the sale
will take place at FMV, not cost. Randy intends to hold the shares until December 7, 2023, as
he expects the FMV to increase drastically and would like to use the funds to put towards the
purchase of a new ATV at his cottage.
Select the START button to start the activity.
Attribution
True or False: If Alysia elects out of the spousal rollover provisions of ss.73(1) on the transfer of
the Lux shares to Randy, and Randy pays her $5,000, the attribution rules will not apply.
Select the best response.
£
True
£
False
Feedback
Attribution will not apply if she elects to have the transfer occur at FMV and Randy pays FMV
consideration of $5,000 to her [ss.74.5(1)].
Tax implications of sale
What are the tax implications to Randy and Alysia with respect to the sale of the Lux shares
in 2023?
Select all that apply.
£
Alysia will recognize a capital loss of $15,000
£
Alysia’s capital loss will be a superficial loss
£
Randy’s ACB of the shares will be $20,000
£
Randy’s ACB of the shares will be $5,000
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STOP-LOSS RULES
Feedback
Randy and Alysia are married and therefore are affiliated persons. Since Randy, an affiliated
person, will own the Lux shares on the 30th day following Alysia’s sale, her capital loss will be
considered a superficial loss in accordance with the definition in s.54. The result is that the loss
Alysia realizes on the transfer is deemed to be $NIL and the amount of the loss, $15,000, is
added to Randy’s ACB. Thus, Randy’s ACB of the Lux shares is $20,000.
Transfer of shares to RESP — Affiliation
Instead of selling the shares to Randy, Alysia decides to transfer the shares of Lux Inc. to a Registered
Education Savings Plan (RESP) for the benefit of their 16-year-old son, Nicholas. The transfer will take
place on November 1, 2023.
True or False: Alysia is affiliated with the RESP.
Select the best response.
£
True
£
False
Feedback
The definition of affiliated persons in sp.251.1(g)(ii) would apply. This subparagraph relies
on the definition of “majority-interest beneficiary” in ss.251.1(3): a person whose interest as
a beneficiary has, together with the beneficiary interests of all persons with whom the person is
affiliated, a FMV that is greater than 50% of the FMV of all beneficiary interests in the trust.
Technical Interpretation 2010-0352921E5 – Transfer of securities into an RESP, dated June 15,
2010 provides that “The individual [transferor – Alysia in this scenario] will be affiliated with
the RESP trust if either the individual or the individual’s spouse or common-law partner is a
majority-interest beneficiary of the RESP trust, as defined in subsection 251.1(3) of the Act.
Whether the individual is a majority-interest beneficiary of the RESP trust is a question of fact
that can only be determined after analyzing all the facts and circumstances, including
the arrangement entered into between the individual and the promoter of the RESP. In most
cases, however, we would expect that an RESP trust will be affiliated with the subscriber under
the plan, given the rights that subscribers typically have under RESPs (i.e., the right to receive
a refund of payments and the contingent right to receive an accumulated income payment).”
Given this interpretation, Alysia, should be considered affiliated with the trust.
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STOP-LOSS RULES
Transfer of shares to RESP — Capital loss
Instead of selling the shares to Randy, on November 1, 2023, Alysia transfers the shares of Lux
Inc. to an RESP for the benefit of their 16-year-old son, Nicholas. Alysia is a majority-interest
beneficiary of the RESP under ss.251.1(1).
True or False: Alysia can recognize the capital loss in 2023.
Select the best response.
£
True
£
False
Feedback
Since the RESP, an affiliated person, will own the Lux shares on the 30th day following Alysia’s
sale, her capital loss will be considered a superficial loss in accordance with the definition
in s.54. The result is that the loss Alysia realizes on the transfer will be deemed to be $NIL, and
the amount of the loss, $15,000, will be added to the ACB of the shares held by the RESP; thus,
the RESP’s ACB of the Lux shares will be $20,000.
Gift of shares
Alysia is still thinking about what to do with the Lux shares, but instead of selling them to Randy
or transferring them to an RESP, she is considering gifting them to her 16-year old son Nicholas.
Which provision(s) need to be considered when assessing the implications of this transaction?
Select all that apply.
£
Subsection 69(1)
£
Subsection 69(11)
£
Subsection 74.1(2)
£
Subsection 74.5(1)
Feedback
Subsection 69(1), inadequate consideration, and ss.74.1(2), attribution on transfers and loans
to minors, need to be considered.
Proceeds of disposition of the gift
True or False: Alysia’s proceeds of disposition on the gift of the shares to her son will be NIL.
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STOP-LOSS RULES
Select the best response.
£
True
£
False
Feedback
Subparagraph 69(1)(b)(ii) will apply, and her proceeds of disposition will be deemed to be the
FMV of $5,000.
ACB of gifted shares
What will Nicholas’ ACB of the shares be if Alysia proceeds to gift him the Lux shares?
Select the best response.
£
$ NIL
£
$ 5,000
£
$ 15,000
£
$ 20,000
Feedback
Since Alysia and Nicholas are not affiliated per ss.251.1, the superficial loss rules would not apply.
Since this is a gift, p.69(1)(c) will apply and Nicholas’ ACB will be $5,000.
New facts
Now consider this: The entire Prosper family are residents in Canada. Alysia Prosper and Randy
Prosper have been married for 10 years. Alysia’s wholly owned investment holding company,
ARNCo, owns a few marketable securities that are in loss positions. In particular, ARNCo holds
shares of FCo which has an FMV of $2,000 and an ACB of $5,000. Alysia would like ARNCo
to gift the FCo shares to Randy on November 1, 2023 so that she can realize the loss and allow
Randy the ability to profit from any future gains. If Randy is gifted the shares, he intends to hold
them for at least a year, until their value rebounds and he can generate a gain on sale. ARNCo has
a December 31 year-end.
If this plan is followed, what will ARNCo report as a capital loss from the shares in its 2023 tax return?
Select the best response.
£
$ NIL
£
$ 2,000
£
$ 3,000
£
$ 5,000
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STOP-LOSS RULES
Feedback
Since ARNCo will be giving the shares of FCo to Randy for $NIL proceeds, and Randy is a
non-arm’s length person, sp.69(1)(b)(i) will apply and ARNCo will be deemed to have received
proceeds equal to FMV of $2,000. One would expect a capital loss of $3,000 to result for ARNCo.
However, since Randy is an affiliated person with respect to ARNCo [since he is the controlling
shareholder’s spouse – sp.251.1(1)(b)(iii)], and the criteria in ss.40(3.3) applies, ss.40(3.4) will deny
the loss, deeming it to be $NIL. Subsection 40(3.4) will allow the loss to be recognized when the
shares of FCo are no longer owned by an affiliated person of ARNCo, i.e., when Randy sells them
to an unaffiliated person.
Summary
Congratulations! You have completed this eLearning.
You should now be able to apply what you have learned about the stop loss rules to a case study.
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Chartered Professional Accountants of Canada
CONFIDENTIAL: For training purposes only
56