2020-0839991C6 STEP 2020 - Q6 - Eligible offset

Principal Issues: Where the conditions in subsection 107(2) are met the provision will apply to a distribution of property by a personal trust, in satisfaction of a beneficiary's capital interest in the trust. Consider a situation in which at the time of the distribution, a liability exists in respect of the property. Where the beneficiary assumes a debt or other obligation in respect of the distributed property (and the transfer is conditional on such assumption of debt) this will result in an “eligible offset” as defined in subsection 108(1). What is the impact of the eligible offset?

Position: Pursuant to paragraph 107(2)(c), the eligible offset reduces the proceeds of disposition of the beneficiary’s capital interest. Depending on the circumstances, the eligible offset may not have any impact, or the beneficiary may recognize a capital loss in respect of the disposition of their capital interest.

Reasons: See examples.

Author: Dannehl, Dawn
Section: 107(1), 107(2), 108(1), 248(1) cost amount

2020 STEP CRA Roundtable – November 26, 2020

Question 6:  Impact of an Eligible Offset on a Disposition of a Capital Interest in a Personal Trust

Where a personal trust distributes property to a Canadian resident beneficiary in satisfaction of the beneficiary’s capital interest in the trust, the capital beneficiary is considered to have disposed of their capital interest and subsections 107(1) and 107(2) will generally apply. Consider a situation in which, as a condition of the distribution, the beneficiary assumes a debt of the trust which is applicable to the property being distributed. If the debt assumed by the beneficiary meets the definition of “eligible offset” (footnote 1) in subsection 108(1), will it create either a capital gain or capital loss for the beneficiary in respect of the disposition of their capital interest in the trust?

CRA Response

Although the question focuses on the disposition of the beneficiary’s capital interest, it is useful to consider the treatment of the distributed property as it provides context for the disposition of the beneficiary’s capital interest.

Generally speaking, when subsection 107(2) of the Income Tax Act (“the Act”) applies to a distribution of property by a trust (footnote 2):

*    The trust is deemed under paragraph 107(2)(a) to have disposed of the property for proceeds of disposition (POD) equal to the property's “cost amount” (footnote 3) immediately before the disposition.

*    Pursuant to paragraph 107(2)(b), the beneficiary is deemed to have acquired the property for an amount equal to the total of the amount described in paragraph 107(2)(a) plus, in certain circumstances, an adjustment (footnote 4).  

In respect of the disposition of the beneficiary’s capital interest, in general, the proceeds of disposition are deemed by paragraph 107(2)(c) to be the amount determined in paragraph 107(2)(b) (footnote 5) less any “eligible offset” in respect of the capital interest.    

To determine the beneficiary’s adjusted cost base (ACB) of their capital interest we must consider subsection 107(1) of the Act. Pursuant to paragraph 107(1)(a), the ACB to the taxpayer of their capital interest, for the purpose of computing a capital gain (if any) in paragraph 40(1)(a), is generally equal to the greater of:

*    the ACB otherwise determined immediately before the disposition and

*    the “cost amount” (footnote 6) of the interest immediately before the disposition.

Example 1

Consider an example in which a personal trust resident in Canada (footnote 7) (“Trust”) owns all of the issued and outstanding common shares of the capital stock of a corporation (“the Shares”) which have an ACB of $100,000.  The Trust also has a $20,000 liability in respect of the Shares, which satisfies the definition of “eligible offset” in subsection 108(1).  The Trust beneficiary (“the Beneficiary”) is an individual resident in Canada who did not pay for their capital interest under the Trust and holds the interest as capital property.  The Trust has not previously distributed any of its property to the Beneficiary.  The Trust distributes all of the Shares to the Beneficiary in satisfaction of the Beneficiary’s capital interest in the Trust.  The Shares are capital property (footnote 8) and subsection 107(2.1) does not apply to the distribution.

The rules in paragraphs 107(2)(a) to (c) respectively will result in the following:

*    The Trust will be deemed to dispose of the Shares for POD equal to their “cost amount” immediately before the disposition.  The deemed POD of the Shares are therefore $100,000;

*    The Beneficiary will be deemed to acquire the Shares at a cost equal to the total of their “cost amount” to the Trust immediately before the distribution ($100,000) and the amount, if any, by which the ACB to the Beneficiary of the capital interest (nil) exceeds the “cost amount” ($100,000) to the Beneficiary of the capital interest. The Beneficiary is therefore deemed to have acquired the Shares at a cost equal to $100,000;

*    The Beneficiary’s POD of their capital interest are deemed to be equal to the amount, if any, by which the cost at which the Beneficiary is deemed to have acquired the Shares ($100,000) exceeds the total of all eligible offsets ($20,000) of the Beneficiary in respect of the capital interest or part of it. Thus, the Beneficiary’s POD of their capital interest in the Trust are deemed to be $80,000.

For the purpose of computing the Beneficiary’s capital gain, if any, paragraph 107(1)(a) determines the ACB of the Beneficiary’s capital interest to be the greater of its ACB otherwise determined (nil) and the Beneficiary’s cost amount ($100,000).  Therefore, the ACB of the Beneficiary’s capital interest would be $100,000 for the purpose of calculating a capital gain on the disposition thereof.  The application of paragraph 107(1)(a) to the computation of the capital gain in paragraph 40(1)(a) results in a negative amount (deemed POD of $80,000 pursuant to 107(2) less the deemed ACB of $100,000); accordingly, the capital gain is nil.  

It is important to note that the deemed ACB resulting from paragraph 107(1)(a) is only relevant for determining a capital gain – it is not used to determine whether or not a capital loss (footnote 9) results.

The capital loss will be calculated pursuant to paragraph 40(1)(b).  Thus, the loss will be the amount, if any, by which the ACB of the Beneficiary’s capital interest immediately before the disposition (nil) plus any outlays and expenses relating to the disposition (nil) exceeds the Beneficiary’s POD as determined by paragraph 107(2)(c) ($80,000).  Since the result is negative, the capital loss is nil.

Example 2

If we change our facts such that the Beneficiary paid $100,000 for their capital interest in the Trust, certain of the above outcomes are impacted.  Notably though, the results with respect to subsection 107(2) and paragraph 107(1)(a) remain unchanged:

*    The Trust will be deemed to dispose of the Shares for POD equal to $100,000;

*    The Beneficiary will be deemed to acquire the Shares at a cost equal to $100,000 (footnote 10);

*    The Beneficiary’s POD of their capital interest are still deemed to be equal to $80,000;  

*    For the purpose of determining the Beneficiary’s capital gain on the disposition of their capital interest, paragraph 107(1)(a) will deem the beneficiary’s ACB to be $100,000 (footnote 11); and

*    The computation of the capital gain under paragraph 40(1)(a) results in a negative amount (deemed POD of $80,000 pursuant to 107(2) less the deemed ACB of $100,000); accordingly, the capital gain, if any, is still nil.  

However, the computation of the capital loss pursuant to paragraph 40(1)(b) yields a different outcome.  The capital loss is the amount, if any, by which the ACB of the Beneficiary’s capital interest immediately before the disposition plus any outlays and expenses relating to the disposition (now $100,000 plus nil) exceeds the Beneficiary’s proceeds of disposition as determined by paragraph 107(2)(c) ($80,000).  Since the result is positive $20,000, the capital loss, if any, is $20,000.

It is important to note the determination of the ACB of the beneficiary’s capital interest in paragraph 107(1)(a) as described above, does not apply if any part of the interest was acquired for consideration and the trust is non-resident at the time of the disposition. 

Finally, we note that where, as in Example 2, a loss results on the disposition of a capital interest in a personal trust, paragraph 107(1)(c) must be considered. Paragraph 107(1)(c) is a "stop-loss" rule which reduces a beneficiary's loss from the disposition of an interest in a trust in certain situations. The loss restriction provisions in paragraph 107(1)(c) are dependent on whether the beneficiary is a corporation, another trust, or a natural person.  If the beneficiary is a partnership, the stop loss rules contained in paragraph 107(1)(d) may have application.

Dawn Dannehl / Steve Fron
November 26, 2020
2020-083999

FOOTNOTES

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

1  Subsection 108(1) defines an “eligible offset” of a taxpayer at any time in respect of all or part of the taxpayer’s capital interest in a trust to be the portion of any debt or obligation that is assumed by the taxpayer and that can reasonably be considered to be applicable to the property distributed at that time in satisfaction of the interest or part of the interest, as the case may be, if the distribution is conditional upon the assumption by the taxpayer of the portion of the debt or obligation.  

2  Subsection 107(2) is subject to subsections 107(2.001), (2.002), and (4) to (5).

3  Unless expressly otherwise provided in the Act, paragraph 248(1)(b) defines “cost amount” to a taxpayer of any property at that time which is a capital property (other than depreciable property) of the taxpayer to be its adjusted cost base to the taxpayer at that time. The “cost amount” in subsection 248(1) is distinguishable from the “cost amount” of a beneficiary’s capital interest in a trust, which is defined in subsection 108(1) and is described further below.

4  The adjustment is a bump equal to the “specified percentage” of any excess of the adjusted cost base (ACB) to the beneficiary of the capital interest over the beneficiary’s “cost amount” as defined in subsection 108(1).  For the purposes of this discussion, we do not consider a situation in which a “bump” results.   

5  Subparagraph 107(2)(c)(i) considers what the result in paragraph 107(2)(b) would be if the specified percentage were 100%.  In the Example below, the specified percentage is 100%, accordingly, no other adjustment is necessary to the paragraph 107(2)(b) amount. 

6  The “cost amount” to a taxpayer at any time of a capital interest in a trust (or part of it) is defined in subsection 108(1) as, generally speaking, where any money or other property of the trust has been distributed by the trust to the taxpayer in satisfaction of all or part of the taxpayer’s capital interest as the total of: the money so distributed and all amounts, each of which is the cost amount (generally the ACB) to the trust, immediately before the distribution, of each such property.

The amount in the second bullet, in subparagraph 107(1)(a)(ii), is: the amount, if any, by which the cost amount to the beneficiary immediately before the disposition exceeds the total of all amounts deducted under paragraph 53(2)(g.1) in computing the ACB of the interest to the beneficiary.

7  The analysis for Example 1 would also apply if the trust was factually non-resident.

8  The specified percentage determined in paragraph 107(2)(b.1) is 100%.

9  Note that the Act formerly contained a “greater certainty” provision in 107(1)(b) to be used for computing a possible capital loss. This paragraph was repealed in 2001 and the Department of Finance’s March 2001 Technical Notes state “Paragraph 107(1)(b) is repealed because it is unnecessary. Since paragraph 107(1)(a) applies only for the purposes of computing a taxpayer's capital gain, it is clear without paragraph 107(1)(b) that the ACB calculation in paragraph 107(1)(a) is not relevant for the purposes of computing a taxpayer's allowable capital loss”.

10  This amount is determined as above, as the total of the “cost amount” of the Shares to the Trust immediately before the distribution ($100,000) and the amount, if any, by which the ACB to the Beneficiary of their capital interest (now $100,000) exceeds the “cost amount” ($100,000) to the beneficiary of the capital interest. The beneficiary is deemed to have acquired the Shares at a cost equal to ($100,000);

11  Determined as follows:  the greater of the ACB otherwise determined to the beneficiary immediately before the disposition (now $100,000) and the amount, if any, by which the cost amount to the beneficiary immediately before the disposition ($100,000) exceeds the total of all amounts deducted under paragraph 53(2)(g.1) in computing its ACB to the beneficiary immediately before the disposition (nil).  Therefore, the ACB of the beneficiary’s capital interest is $100,000;

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