2017-0690651E5 Net Capital Losses - Year of Death

Principal Issues: Whether a taxpayer can use a full deduction of the remaining $100,000 of net capital losses in the year of death to create a non-capital loss in the year of death.

Position: No.

Reasons: Wording of the legislation.

Author: Ng, Tania
Section: 2(2), 3, 111(1)(b), 111(2), 111(8)

XXXXXXXXXX                                                                                                                            2017-069065
                                                                                                                                                    T. Ng
November 21, 2017

Dear XXXXXXXXXX,

Re: Treatment of Net Capital Losses on Year of Death

We are writing in reply to your email correspondence dated February 23, 2017, in which you requested our comments on the interpretation of subsection 111(2) of the Income Tax Act (the “Act”) and the definition of “non-capital loss” found in subsection 111(8) of the Act.

Specifically, you asked whether the definition of “non-capital loss” found in subsection 111(8), read in conjunction with subsection 111(2), would allow a taxpayer to deduct the full amount of unused net capital losses in the year of death, creating a non-capital loss which can be carried back to another taxation year.

Our comments:

This technical interpretation provides general comments about the provisions of the Act and related legislation (where referenced).  It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination.  The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information  Circular IC 70-6R7, Advance Income Tax Rulings and Technical Interpretations.

Under section 3 of the Act, the amount by which a taxpayer’s allowable capital losses exceeds allowable business investment losses for any year is first applied to reduce the taxpayer’s taxable capital gains for that year.  Any remainder that is not deductible is eligible for carryover under paragraph 111(1)(b) by virtue of the descriptions of A and B of the definition of “net capital loss” in subsection 111(8).

Section 111 contains the loss carryover provisions of the Act.  These provisions set out the rules under which a loss sustained in a particular taxation year may be carried backward or forward to another taxation year for the purpose of computing a taxpayer’s taxable income for that other taxation year.

The carryover of non-capital losses are governed by paragraph 111(1)(a).  Paragraph 111(1)(a) permits non-capital losses to be carried back three years and forward twenty years until they are completely absorbed in computing the taxpayer’s income of such other years.

The carryover of net capital losses are governed by paragraph 111(1)(b).  Paragraph 111(1)(b) permits net capital losses to be carried back three years and forward indefinitely until they are completely absorbed in computing the taxpayer’s income of such other years.

There are a couple of limitations to the amount that can be deducted pursuant to paragraph 111(1)(b).  The first is found in subsection 111(1.1).  Subsection 111(1.1) provides that any such amount deducted pursuant to paragraph 111(1)(b) is limited to the amount of the taxpayer’s net capital gain in such other year.  See in particular paragraph 111(1.1)(a) which refers to the amount determined under paragraph (b) of section 3 (note that a reference to paragraph 111(3)(b) would be to “paragraph (3)(b)”)).  In addition, subsection 111(1.1) contains an adjustment provision in respect of the amount of net capital losses which may be deducted under paragraph 111(1)(b).  This adjustment provision is relevant when the inclusion rate for capital losses for the year is different from the inclusion rate for the year in which the net capital loss is used.

The second limitation is found in subsection 111(3).  Paragraph 111(3)(a) reduces the amount in respect of a net capital loss that may be claimed for a taxation year by amounts claimed in respect of that loss in preceding taxation years.  Paragraph 111(3)(b) prescribes the order in which a net capital loss is to be applied to other years (i.e., an ordering rule).

Generally speaking, both non-capital and net capital losses arising in the year of death can be carried back to the three taxation years preceding death in the normal manner, which is described above.  Also, non-capital and net capital losses of prior years carried forward to the year of death can be applied in the year of death on the terminal return in the normal manner. However, if, in the year of death, a taxpayer has a net capital loss or any unused net capital losses carried forward from prior years, the special rules in subsection 111(2) concerning the application of paragraphs 111(1)(b) and 111(1.1)(b), as they are to be read under these circumstances, allow the deduction of such losses (less the amount of any capital gains exemption claimed by the taxpayer under section 110.6) up to the amount of the taxpayer’s available income from all sources for the year of death and the immediately preceding year.

The modification provided in subsection 111(2) in the year of death clearly indicates the parameters within which unused net capital losses can be applied against all sources of income (i.e., Parliament intended for this concession to apply only in the year of death and the immediately preceding year).  Accordingly, if there is a balance of unused net capital losses remaining after applying the unused net capital losses against all sources of income in the year of death and immediately preceding year, it is our view that such unused net capital losses are not transformed into a non-capital loss that can be carried back to another taxation year other than as described above.

We trust that these comments will be of assistance.

Yours truly,

Michael Cooke, CPA, CA
Manager
Corporate Reorganizations Section II
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

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