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NO: IT-328R3

DATE: FEBRUARY 21, 1994

SUBJECT: INCOME TAX ACT
LOSSES ON SHARES ON WHICH DIVIDENDS HAVE BEEN RECEIVED

REFERENCE: SUBSECTIONS 112(3), (3.1), (3.2), (4), (4.1), (4.2), (4.3) AND (7) (ALSO SECTIONS 9, 113, 115, SUBSECTIONS 10(1), 40(1), 104(19) AND (20), 112(1), 131(1), 138(6) AND 248(6), AND PART IV AND PART VII)



APPLICATION

This bulletin cancels and replaces Interpretation Bulletin IT-328R2, dated May 27, 1985 and Special Release IT-328R2, dated August 19, 1988.

SUMMARY

The purpose of this bulletin is to explain the "stop-loss" rules in section 112 which may apply to reduce a taxpayer's loss on the sale of a share by the amount of certain dividends received on the share. The bulletin discusses the rules that apply to losses resulting from transactions in shares that are capital property and transactions in shares that are not capital property. It also discusses an adjustment to the value of a share held in inventory that may apply where certain dividends have been received on the share.

DISCUSSION AND INTERPRETATION

SHARES THAT ARE CAPITAL PROPERTY

1. Under subsection 112(3), where a corporation owns a share that is capital property and receives dividends described in 3 below on the share, it must reduce any loss arising from a transaction in respect of that share by the amount of those dividends, unless

(a) the corporation owned the share for at least 365 days before sustaining the loss; and

(b) the corporation, alone or with persons not dealing at arm's length with it, did not own more than 5% of the issued shares of any class of the capital stock of the payer corporation at the time the dividend was received.

2. Subsections 112(3.1) and (3.2) provide rules similar to those in 1 above where a share is owned as capital property by a partnership of which a corporation is a partner or by a trust of which a corporation is a beneficiary. Where such a partnership owns the share, thecorporate partner's share of any partnership loss on a transactioninvolving the share is reduced by that corporation's share of dividendsdescribed in 3 below. Where a trust holds the share, the trust's losson a transaction involving the share is reduced by the amount ofdividends described in 3 below that have been designated, by the trust,as dividends deemed to be received by the corporate beneficiary undersubsection 104(19), or for which the trust has made a designation undersubsection 104(20) in respect of the corporate beneficiary.

3. The dividends which are taken into account in determining a corporation's loss under subsection 112(3) or a corporation's share of a partnership loss under subsection 112(3.1) on a share transaction are:

(a) taxable dividends on the share which were

(i) deductible under section 112 or subsection 138(6) in computing the corporation's taxable income, and

(ii) not subject to tax under Part VII of the Act as it read on March 31, 1977;

(b) capital dividends on the share; or

(c) life insurance capital dividends on the share.

The dividends taken into account in determining the loss of a trust under subsection 112(3.2) are the same as above, except that the requirements in (a)(i) and (ii) do not apply and (a) would refer only to "taxable dividends on the share".

4. Subsection 112(7) provides special rules for applying the provisions of subsections 112(3), (3.1) and (3.2) to losses on a new share that had previously been acquired for an old share in an exchange transaction under section 51, 85.1, 86 or 87. Certain dividends (see 3 above) received or designated on the new share, plus such dividends received or designated on the old share, reduce any loss arising from a transaction involving the new share. If the number of old and new shares exchanged was not equal, the reduction in respect of dividends received or designated on the old share(s), as they apply to a new share, will be calculated as follows:

A X B ÷C = D

where:

A = dividends received or designated on all the old exchanged shares

B = adjusted cost base of a new share immediately after the exchange

C = adjusted cost base of all new shares immediately after the exchange

D = reduction in the loss on a new share

NOTE: If the draft legislation released by the Minister of Finance on August 30, 1993 is enacted into law as currently proposed, paragraph 112(7)(b) will be amended so that the amount of dividends on an old exchanged share that can be applied to reduce a loss realized on the disposition of a new share will be limited to the lesser of

a) the dividends (described in 3 above) received or designated on the old exchanged share, and

b) the adjusted cost base of the old exchanged share immediately before the exchange.

If the number of old and new shares exchanged was not equal, the reduction which relates to the old exchanged share(s) will be calculated as follows:

A X B ÷C = D

where:

A = total of all amounts, each of which is the lesser of a) and b) above for each old exchange share

B = adjusted cost base of a new share immediately after the exchange

C = adjusted cost base of all new shares immediately after the exchange

D = reduction in the loss on a new share

This proposed amendment will apply to losses arising in the 1992 and subsequent taxation years.

SHARES THAT ARE NOT CAPITAL PROPERTY

5. Subsections 112(4), (4.2) and (4.3), which apply to any taxpayer, operate in a manner similar to subsections 112(3), (3.1) and (3.2) except that they reduce the loss on disposition of a share that is not a capital property.

A loss arising in respect of a share transaction subject to the rules in subsection 112(4) (the share is owned by a taxpayer) or (4.2) (the share is owned by a partnership of which the taxpayer is a member) will be reduced as follows:

(a) if the taxpayer is an individual, the loss will be reduced by dividends (excluding capital gains dividends received from a mutual fund corporation) received on the share if the corporation that issued the share is a taxable Canadian corporation; and

(b) if the taxpayer is a corporation, the loss will be reduced by taxable dividends deductible under section 112, subsection 115(1) or subsection 138(6) in calculating the corporation's taxable income or taxable income earned in Canada, and any dividend other than a taxable dividend.

The loss reductions described above do not apply to any dividends which were subject to tax under Part VII of the Act as it read on March 31, 1977. These rules apply for taxation years after 1989. However, they also apply for the 1985 to 1989 taxation years if the taxpayer elected to have them apply by notifying the Minister in writing before December 11, 1993. Before 1990 (or before 1985 if the election has been made) a taxpayer's loss or a taxpayer's share of a partnership loss would have to be reduced by any dividends received on the share, excluding any capital gains dividends received from a mutual fund corporation and any portion of taxable dividends on which the taxpayer was required to pay tax under Part VII of the Act as it read on March 31, 1977.

Subsection 112(4.3) applies if the taxpayer is the beneficiary of a trust (other than a prescribed trust) that owns a share that is not capital property and the taxpayer receives a dividend in respect of the share pursuant to a designation under subsection 104(19) or the trust has made a designation under subsection 104(20) in respect of the taxpayer for a dividend on the share. Subsection 112(4.3) requires that any loss of the trust arising from a transaction in respect of the share must be reduced by any dividends (other than a capital gains dividend received from a mutual fund corporation) designated under subsection 104(19) or (20).

NOTE: If the draft legislation released by the Minister of Finance on August 30, 1993 is enacted into law as currently proposed, subparagraphs 112(4)(d)(ii) and 112(4.2)(d)(ii) will be amended so that they also exclude a capital gains dividend received from a mutual fund corporation. As a result, (b) above would be revised to:

(b) if the taxpayer is a corporation, the loss will be reduced by taxable dividends deductible under section 112, subsection 115(1) or subsection 138(6) in calculating the corporation's taxable income or taxable income earned in Canada, and any dividend other than a capital gains dividend received from a mutual fund corporation or a taxable dividend.

This proposed amendment will apply to losses arising in the 1990 and subsequent taxation years; however, it will also apply to the 1985 to 1989 taxation years if the above-noted election has been made.

6. The stop-loss rules in 5 above do not apply if:

(a) the taxpayer, partnership or trust, as the case may be, owned the share 365 days or longer before the loss was sustained; and

(b) alone or with persons the taxpayer did not deal with at arm's length, the

(i) taxpayer,

(ii) partnership and the taxpayer (partner), or

(iii) trust and the taxpayer (beneficiary),

as the case may be, did not own more than 5% of the issued shares of any class of the capital stock of the payer corporation at the time the dividend was received.

7. The inventory value of a share which is not a capital property of a taxpayer (other than a prescribed trust) or a partnership which holds it is determined under subsection 112(4.1). This subsection provides that the fair market value of the share will be deemed to be its fair market value otherwise determined at the time the inventory is being valued plus:

(a) if the shareholder is an individual and the corporation paying the dividend is a taxable Canadian corporation, the total of all dividends (except a capital gains dividend received from a mutual fund corporation) received before that time on the share, or that would have been received if the Act were read without reference to subsection 104(19);

(b) if the shareholder is a corporation, any taxable dividend received on the share before that time that was deductible under section 112 or 113 or subsection 115(1) or 138(6) in calculating the corporation's taxable income or taxable income earned in Canada and any dividend other than a taxable dividend received on the share before that time; and

(c) if the shareholder is a partnership, the total of any dividends (other than a capital gains dividend received from a mutual fund corporation) received on the share before that time.

The additions to the value of shares held in inventory described above do not apply to any dividends which were subject to tax under Part VII of the Act as it read on March 31, 1977. These rules apply for taxation years after 1989. However, they also apply for the 1985 to 1989 taxation years if the taxpayer elected to have them apply by notifying the Minister in writing before December 11, 1993. Before 1990 (or before 1985 if the election has been made) the fair market value otherwise determined of the shares, held by any holder referred to above, would have to be increased by any dividends received in respect of the shares (determined without reference to subsection 104(19)), excluding any capital gains dividends from a mutual fund corporation.

Subsection 112(4.1) does not apply if the shareholder held the share for at least 365 days before the time of inventory valuation and the shareholder, alone or together with any non-arm's length person, did not hold more than 5% of the issued shares of any class of the payer corporation at the time the dividend was received.

Note: If the draft legislation released by the Minister of Finance on August 30, 1993 is enacted into law as currently proposed, subparagraph 112(4.1)(d)(ii) will be amended so that it also excludes a capital gains dividend received from a mutual fund corporation. As a result, (b) above would be revised to:

(b) if the shareholder is a corporation, any taxable dividend received on the share before that time that was deductible under section 112 or 113 or subsection 115(1) or 138(6) in calculating the corporation's taxable income or taxable income earned in Canada and any dividend received on the share before that time, other than a capital gains dividend received from a mutual fund corporation or a taxable dividend; and.

This proposed amendment will apply to the 1990 and subsequent taxation years; however, it will also apply to the 1985 to 1989 taxation years if the above-noted election has been made.

GENERAL COMMENTS

8. The loss referred to in subsections 112(3), (3.1) and (3.2) is a capital loss within the meaning of paragraph 39(1)(b) and calculated under paragraph 40(1)(b). The amount of the loss referred to in subsections 112(4), (4.2) and (4.3) is an amount calculated by reference to the aggregate of the costs of acquiring the share and other related costs used in determining income. Adjustments under subsections 112(4), (4.1), (4.2) and (4.3) are determinants of income or loss from a business or property within section 9.

9. The inclusion of the amount of a dividend in calculating the fair market value of a share under subsection 112(4.1) does not prevent the inclusion of all or any part of that dividend in the calculation of a loss pursuant to subsection 112(4), (4.2) or (4.3) at any subsequent time. The example in the Appendix illustrates this principle.

10. Part IV tax on a dividend received is applicable even though the dividend, or a part thereof, was applied to reduce a loss for purposes of subsection 112(3), (3.1), (3.2), (4), (4.2) or (4.3), or to increase the fair market value of a share under subsection 112(4.1).

11. For purposes of subsections 112(3) to 112(4.3), any reference to "5% of the issued shares of any class of the capital stock" should be interpreted as "5% of the issued shares of any series of a class of shares" when there is more than one series of the same class of shares.

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If you have any comments regarding the matters discussed in this bulletin, please send them to:

Director, Technical Publications Division
Legislative and Intergovernmental Affairs Branch
Revenue Canada - Customs, Excise and Taxation
875 Heron Road
Ottawa, Ontario
K1A 0L8

APPENDIX

EXAMPLE

ASSUMPTIONS

1. Cost to Corporation A of share of Corporation B acquired on June 28, 1991 as trading property

   

      $80

2. Taxable dividend received from Corporation B on August 15, 1991 and deducted under subsection 112(1) by Corporation A

      $ 4

3. Fair market value of share at 1991 fiscal year end November 30

      $78    

4. Proceeds of disposition of share, March 5, 1992

      $75

5. Corporation A held more than 5% of the issued shares of Corporation B at all relevant times

APPLICATION OF SUBSECTION 112(4.1)

Cost of share

      $80

 

      ======

Deemed fair market value of share determined under subsection 112(4.1):

 

Fair market value otherwise determined

$78     

Taxable dividend received

$ 4            $82
-----          ========

Lower of cost and fair market value at November 30, 1991

      $80

 

      ========

Loss from inventory adjustments

      NIL

 

      =======

APPLICATION OF SUBSECTION 112(4)

Carried value of inventory December 1, 1991

      $80

Proceeds of disposition, March 5, 1992

      $75

 

      -------

Loss otherwise determined

      $ 5

Less: Taxable dividend received

      $ 4

 

      -------

Loss determined under subsection 112(4)

       $ 1

 

      =======

 

EXPLANATION OF CHANGES FOR INTERPRETATION BULLETIN IT-328R3 LOSSES ON SHARES ON WHICH DIVIDENDS HAVE BEEN RECEIVED

INTRODUCTION

The purpose of the Explanation of Changes is to give the reasons for the revisions to an interpretation bulletin. It outlines revisions that we have made as a result of changes to the law, as well as changes reflecting new or revised departmental interpretations.

OVERVIEW

This bulletin discusses the "stop-loss" rules in section 112 which may apply to reduce a taxpayer's loss on the sale of a share that is capital property, as well as the loss on the sale of a share that is not capital property, by the amount of certain dividends received on the share. It also discusses an adjustment to the fair market value of a share held in inventory that may apply where certain dividends have been received on the share.

We revised the bulletin to reflect changes in the Income Tax Act resulting from Bill C-18, which received Royal Assent on December 17, 1991. In addition, the proposed amendments in the August 30, 1993 draft legislation, which affect the bulletin, have been reflected in italics where applicable. The contents of this bulletin, however, are not affected by the proposed changes in Bill C-136. (Bill C-136 was tabled in the House of Commons in June 1993 and will be reintroduced, along with the August 30, 1993 draft legislation, in bills after Parliament resumes in January 1994, as indicated by the Minister of Finance in a news release dated December 20, 1993.)

LEGISLATIVE AND OTHER CHANGES

Throughout the bulletin, we have made minor changes for clarification or readability purposes.

In new # 3 (former # 4), the dividends which are taken into account in determining the loss of a trust under subsection 112(3.2) have been explained separately, since they differ slightly from those taken into account in determining the loss of a corporation under subsection 112(3), or the loss of a corporate partner under subsection 112(3.1).

The note at the end of new # 4 (former # 5) reflects the proposed amendment to paragraph 112(7)(b) in the August 30, 1993 draft legislation. This amendment sets a limit on the amount of dividends on an old exchanged share that can be applied to reduce a loss realized on the disposition of a new share (acquired for the old share in certain exchange transactions).

New # 5 (first part of former # 6) reflects the amendments in Bill C-18 to subsections 112(4) and (4.2). These amendments relate to the dividends which reduce a loss on the disposition of a share that is not a capital property of a taxpayer (subsection 112(4)), or of a partnership of which the taxpayer is a member (subsection 112(4.2)). Determining the loss reduction will vary depending on whether the taxpayer is an individual or a corporation. Because subsection 112(4.3) was not amended in Bill C-18, we separated the discussion on this subsection from the discussion on subsections 112(4) and (4.2).

The note at the end of new # 5 reflects the proposed amendments to subparagraphs 112(4)(d)(ii) and 112(4.2)(d)(ii) in the August 30, 1993 draft legislation. The amended provisions would exclude from the "stop- loss" rules, therein, certain capital gains dividends.

New # 6 (second part of former # 6) lists the exceptions to the "stop- loss" rules in subsections 112(4), (4.2) and (4.3), with the former paragraph changed for clarification purposes.

New # 7 (former # 7) reflects the Bill C-18 amendments to subsection 112(4.1). These amendments relate to the dividends taken into consideration in determining the inventory value of a share that is not capital property. In addition, where the share is held by an individual, these amendments add a requirement with respect to the corporation paying the dividend.

The note at the end of new # 7 reflects the proposed amendment to subparagraph 112(4.1)(d)(ii) in the August 30, 1993 draft legislation. The amended provision would exclude certain capital gains dividends from the inventory valuation rule where the holder of the share is a corporation.

New # 8 replaces former # 8. The references to subsections 4(1) and 9(2), in the former paragraph, have been revised to section 9. The reference to subsection 4(1) is not required. In addition, subsection 9(2) refers only to losses, whereas the provisions referred to in the last sentence of new # 8 may be adjustments to income.

We have revised the Appendix to indicate that the dividends received were deducted under subsection 112(1), to comply with the requirements of revised subsections 112(4) and (4.1) (as explained in # 5 and 7 of the bulletin). In addition, we have changed the dates of the example to more current dates.

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