2019-0793481I7 Application of Paragraph 40(3.4)(b)

Principal Issues: Whether the transactions noted would result in a previously suspended capital loss becoming available.

Position: Yes.

Reasons: Application of paragraph 40(3.4)(b).

Author: Patel, Komal
Section: 40(3.4), 40(3.5)

                                                                                       April 30, 2019

XXXXXXXXXX                                                               HEADQUARTERS
International Large Business Case Manager                 Income Tax Rulings
XXXXXXXXXX                                                                Directorate
                                                                                        K. Patel
                                                                                        (416) 973-2418

                                                                                        2019-079348

XXXXXXXXXX (“ACo”)
Application of paragraph 40(3.4)(b) to the suspended capital loss realized on the internal reorganization of equity interests in a foreign affiliate

We are writing in response to the January 23, 2019 letter requesting the Income Tax Rulings Directorate’s (ITRD’s) opinion on the application of paragraph 40(3.4)(b) of the Income Tax Act (the “Act”) to the transaction steps described herein. Please note that this letter is a continuation of our previous letter, our document number 2017-0735771I7 and that the entities described herein are the same and are referred to in the same way as in document 2017-0735771I7.

FACTS & ASSUMPTIONS

1.    ACo is a public corporation, the shares of which are traded on the XXXXXXXXXX Stock Exchange. ACo is a taxable Canadian corporation and a resident of Canada for purposes of the Act.

2.    BCo is a corporation formed under the laws of XXXXXXXXXX and is a resident of XXXXXXXXXX. ACo owns XXXXXXXXXX% of the common shares of BCo.

3.    FCo is a corporation formed under the laws of XXXXXXXXXX and is a resident of XXXXXXXXXX. FCo is a holding company with subsidiaries that operate XXXXXXXXXX. The shares of FCo were excluded property (footnote 1) at the time of the transactions described in points 10 and 11 below. FCo has Class A and B common shares outstanding.

4.    DCo is a XXXXXXXXXX formed under the laws of XXXXXXXXXX and a XXXXXXXXXX for XXXXXXXXXX tax purposes. DCo is a wholly-owned subsidiary of ACo.

5.    ECo is a XXXXXXXXXX formed under the laws of XXXXXXXXXX and a XXXXXXXXXX for XXXXXXXXXX tax purposes. ECo is a wholly-owned subsidiary of DCo.

6.    BCo, DCo and ECo are controlled foreign affiliates (“CFAs”) (footnote 2) of ACo.

7.    On XXXXXXXXXX, ECo transferred all of its Class B shares of FCo to BCo in exchange for XXXXXXXXXX Class B common shares of BCo that track to ECo’s indirect interest in FCo.  The FMV of the shares of FCo that were transferred by ECo was equal to the FMV of the shares of BCo received by ECo as consideration.

8.    On XXXXXXXXXX, ACo had incurred a loss in the amount of $XXXXXXXXXX on the disposition of shares of CCo (a former CFA of ACo) to BCo (the “Suspended Loss”).  As pointed out in document 2017-0735771I7, the Suspended Loss was deemed to be nil pursuant to subsection 40(3.4) since BCo was affiliated with ACo.

9.    XXXXXXXXXX, CCo was liquidated into BCo and such liquidation constituted a designated liquidation and dissolution (“DLAD”). (footnote 3) In document 2017-0735771I7, we concluded that the tax deferred liquidation of CCo into BCo would not result in the Suspended Loss becoming available, as such liquidation would fall within the ambit of “merger” in subparagraph 40(3.5)(c)(i). Accordingly, BCo is deemed to own the shares of CCo as long as BCo and ACo are affiliated and the presumption that the Suspended Loss is deemed to be nil will apply over that period. After the liquidation of CCo, BCo owned XXXXXXXXXX of the issued and outstanding Class B common shares of FCo.

10.   On XXXXXXXXXX, ACo transferred its shares of BCo to DCo for consideration including shares of the capital stock of DCo pursuant to subsection 85.1(3) of the Act.

11.   Between XXXXXXXXXX and XXXXXXXXXX, BCo disposed of XXXXXXXXXX Class B shares of FCo to arm’s length parties through a series of open market trades.

ISSUE

Would a liquidation of BCo into DCo result in the Suspended Loss becoming available to ACo under paragraph 40(3.4)(b) as a result of the liquidation of BCo?

ANALYSIS

All or substantially all the Suspended Loss was attributable to the accrued loss on the Class B common shares of FCo held by CCo.  No Class B common shares of FCo were acquired by ACo or a person affiliated with ACo after the disposition described in point 11 above.  ACo’s capital loss on the disposition of the CCo shares was suspended pursuant to subparagraph 40(3.5)(c)(i) which states:

(c) if subsections (3.3) and (3.4) apply to the disposition by a transferor of a share of the capital stock of a particular corporation and after the disposition

(i) the particular corporation is merged or combined with one or more other corporations, otherwise than in a transaction in respect of which paragraph (b) applies to the share, then the corporation formed on the merger or combination is deemed to own the share while the corporation so formed is affiliated with the transferor,

As concluded in document 2017-0735771I7, BCo is deemed to own the shares of CCo while it is affiliated with ACo (i.e., the transferor).

Upon the completion of the liquidation of BCo, it would no longer be affiliated with ACo.

Paragraph 40(3.4)(b) provides:

(3.4) Loss on certain properties — If this subsection applies because of subsection (3.3) to a disposition of a particular property,

...

(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 immediately before the first time, after the disposition,

(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,

Pursuant to subparagraph 40(3.4)(b)(i), the Suspended Loss will be deemed to be a capital loss of ACo immediately after the completion of the liquidation of BCo.

For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency’s electronic library. A severed copy will also be distributed to the commercial tax publishers, following a 90-day waiting period (unless advised otherwise), for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should the taxpayer request a copy of this memorandum, they may request a severed copy using the Privacy Act criteria, which does not remove taxpayer identity. Requests for this version should be e-mailed to: ITRACCESSG@cra-arc.gc.ca.

We trust our comments will be of assistance, and thank you for your enquiry.

Yours truly,

Yves Moreno
Section Manager
for Director
International Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

FOOTNOTES

Note to reader:  Because of our system requirements, the footnotes contained in the original document are shown below instead:

1  As defined in subsection 95(1).
2  As defined in subsection 95(1).
3  As defined in subsection 95(1).

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