2018-0744151C6 STEP 2018 - Q15 - 164(6) and 112(3.2)(b)

Principal Issues: Whether paragraph 112(3.2)(b) is applicable in respect of taxable dividends received on the share by a trust that designates the dividends under subsection 104(19) in respect of a beneficiary trust that in turn designates the dividends under subsection 104(19) in respect of an individual beneficiary.

Position: No.

Reasons: The exception in subsection 112(3.32) should be applicable to exclude from the calculation in paragraph 112(3.2)(b) any qualified dividends that are ultimately paid in the year to a beneficiary that is an individual (other than a trust).

Author: Panourgias, Marina
Section: 164(6); 112(3.2); 112(3.32)

2018 STEP CRA Roundtable – May 29, 2018

QUESTION 15.  Subsection 164(6) and the application of paragraph 112(3.2)(b)

This question deals with capital loss of an estate on a redemption of shares and the carryback election under subsection 164(6).

In particular, the question relates to the stop-loss rule in subsection 112(3.2) which may be applicable to reduce the capital loss otherwise realized by the estate upon the disposition of a share of the capital stock of a corporation.  There are two components to subsection 112(3.2).  The first component, outlined in paragraph 112(3.2)(a), generally provides for a reduction of the capital loss where non-taxable capital dividends were received by the estate on the share, subject to certain limitations.  The second component, in paragraph (b), provides for a further reduction of the loss where taxable dividends or life insurance capital dividends are received on the share and designated by the trust under subsection 104(19) or 104(20) in respect of a beneficiary that was a corporation, partnership or trust.

Assume that the estate provides that the beneficiary is a spousal trust.  The will of the deceased creates an estate, and under that estate, amounts are to be paid to the spousal trust.  That trust may, in turn, pay amounts to beneficiaries.  In this circumstance, suppose that a taxable dividend is created on a redemption of shares.  The graduated rate estate (“GRE”) receives the taxable dividend.  If this taxable dividend is designated to an individual, then paragraph 112(3.2)(b) would not apply.  However, if the GRE designates the amount to the spousal trust, which then designates the amount to a beneficiary who is an individual, it seems that paragraph (b) could apply to reduce the capital loss.  How does CRA administer this as a question of practice?

CRA Response

Generally, paragraph 112(3.2)(b) provides for a reduction in the capital loss realized by a trust (other than a mutual fund trust) on the disposition of a share in an amount equal to the amount of taxable dividends and life insurance capital dividends received on those shares by the trust and designated by the trust under subsection 104(19) or 104(20) in respect of a beneficiary that is a corporation, partnership or trust.

Subsection 112(3.32) provides an exception to the application of paragraph 112(3.2)(b).  The exception applies in respect of taxable dividends that are “qualified dividends” received on the share by the trust and that are designated by the trust under subsection 104(19) in respect of a beneficiary that is a corporation, partnership or trust, where the trust establishes that:

1)    the dividends were received by a beneficiary that was an individual (other than a trust), or

2)    the dividends were received on a share that was owned by the trust throughout the 365-day period that ended immediately before its disposition and received when the trust (and the beneficiary as well as persons who did not deal at arm's length with the beneficiary) did not own in total more than 5% of the issued shares of any class of the capital stock of the dividend-paying corporation.

Accordingly, where the trust establishes that the taxable dividends paid to a beneficiary that is a corporation, partnership or trust are ultimately received by an individual (other than a trust), the exception in subsection 112(3.32) should be applicable provided that the taxable dividends are qualified dividends.  In our opinion, this exception could apply if the individual is: (a) a shareholder of a corporation that is a beneficiary of the trust; (b) a partner of a partnership that is a beneficiary of the trust; or (c) a beneficiary of another trust that was a beneficiary of the initial trust.

The term “qualified dividend” is defined in subsection 112(6.1) to include: (a) dividends other than those deemed to be received pursuant to subsection 84(3) in respect of a redemption, acquisition or cancellation of shares; and (b) certain dividends deemed to be received pursuant to subsection 84(3).  Where the dividend is deemed to be received pursuant to subsection 84(3) and the share is held by a trust, the dividend would be a qualified dividend pursuant to subparagraph 112(6.1)(b)(iii), if:

1)    the dividend is received by the trust and taxed at the trust level;

2)    the dividend is received on the share and designated under subsection 104(19) by the trust in respect of the following beneficiaries:

(a)   an individual other than a trust,

(b)   a corporation that is a private corporation when the dividend is received by it, where the dividend was paid by another private corporation,

(c)   another trust that does not designate the dividend under subsection 104(19), or

(d)   a partnership all of the members of which are, when the dividend is received, persons described by any of (a), (b) or (c) above; or

3)    the dividend is received on the share and designated by the trust under subsection 104(19) in respect of a beneficiary that is another trust or a partnership, where the trust establishes that the dividend was received on the share by a person described by any of (a), (b) or (c) above.

In the scenario described, a GRE is deemed to receive a dividend (pursuant to subsection 84(3)) which is treated as a taxable dividend.  In the event that the dividend is designated under subsection 104(19) by the GRE in respect of a beneficiary that is a spousal trust and in turn the dividend is designated under subsection 104(19) by the spousal trust in respect of a beneficiary that is an individual, the exception in subsection 112(3.32) should be applicable such that the taxable dividend received by the GRE and ultimately paid to the individual beneficiary of the spousal trust should not be considered in the application of paragraph 112(3.2)(b).

Note that in order for a dividend to be designated under subsection 104(19) by a trust in respect of a beneficiary the provision requires, inter alia, that the amount may be reasonably considered to be included in the beneficiary’s income because of the application of paragraph 104(13)(a), subsection 104(14) or section 105.  For paragraph 104(13)(a) to apply, the amount must have become payable to the beneficiary in the particular year.  Subsection 104(24) provides that for certain purposes of the Act, including subsection 104(13), an amount is deemed not to have become payable to a beneficiary in the year unless the amount was actually paid to the beneficiary in the year, or the beneficiary was entitled in the year to enforce payment of it.

Marina Panourgias
2018-074415

All rights reserved. Permission is granted to electronically copy and to print in hard copy for internal use only. No part of this information may be reproduced, modified, transmitted or redistributed in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, or stored in a retrieval system for any purpose other than noted above (including sales), without the prior written permission of Canada Revenue Agency, Ottawa, Ontario K1A 0L5.

© Her Majesty the Queen in Right of Canada, 2018

Tous droits réservés. Il est permis de copier sous forme électronique ou d'imprimer pour un usage interne seulement. Toutefois, il est interdit de reproduire, de modifier, de transmettre ou de redistribuer de l'information, sous quelque forme ou par quelque moyen que ce soit, de façon électronique, mécanique, photocopies ou autre, ou par stockage dans des systèmes d'extraction ou pour tout usage autre que ceux susmentionnés (incluant pour fin commerciale), sans l'autorisation écrite préalable de l'Agence du revenu du Canada, Ottawa, Ontario K1A 0L5.

© Sa Majesté la Reine du Chef du Canada, 2018