Stop Loss Rules

The Income Tax Act contains several sections to disallow tax losses on transfers to affiliated persons. The meaning of Affiliated can be found HERE, the meaning of Person can be found HERE and the meaning of Transfer can be found HERE. 

The Superficial Loss Rules are part of the Stop Loss Rules and can be found HERE. The purpose of these rules are to prevent taxpayers from realizing deductible losses without any real intention to dispose of the property in question. However, taxpayers are motivated to obtain some tax benefit from their poor performing assets without permanently disposing of them. 

There are exceptions to the Stop Loss Rules and the Superficial Loss Rules as follows:

1. a deemed disposition of a loan or deposit ceasing to be an eligible loan of an international banking centre business (paragraph 33.1(11)(a))

2. a deemed disposition where a taxpayer acquires property for some purpose and later uses it for the purpose of gaining or producing income, or vice versa (subsection 45(1))

3. a deemed disposition of a bad debt or a share, under the provisions of section 50

4. a deemed disposition on the death of the taxpayer (section 70)

5. a deemed disposition when a taxpayer becomes, or ceases to be, resident in Canada

6. a disposition under the mutual fund reorganization rules of paragraph 132.2(1)(f)

7. a deemed disposition where a life insurer changes the use of the property (subsection 138(11.3)

8. certain dispositions under the mark-to-market rules applicable to financial institutions under subsection 142.5(2) and paragraph 142.6(1)(b)

9. a deemed disposition of assets by an employee profit sharing plan under subsection 144(4.1) or 144(4.2)

10. a deemed disposition where a corporation ceases to be exempt from Part 1 tax (subsection 149(10))

11. the expiration of an option

12. a disposition of a debt obligation where the loss was denied under paragraph 40(2)(e.1)

13. a disposition by a corporation the control of which is acquired within 30 days after the disposition

14. a disposition by a person that becomes or ceases to be exempt from tax under Part 1 within 30 days after the disposition

There are some tax planning ideas to avoid Stop Loss problems HERE.

The Stop Loss Rules In Detail

Non-Depreciable Capital Property in Section 40(3.3)(a) of the Income Tax Act

Non-Depreciable Capital Property is defined HERE.

In general, capital losses on dispositions to affiliated persons are denied until there is a final arm's length disposition. The denied loss stays with the transferor. It requires that the Transferor keep track of when the Transferee sells the property to an unaffiliated person, and then the Transferor can claim the loss at that time.

Where the losses are disallowed on dispositions of non-depreciable capital property from a corporation, partnership, or trust (the "Transferor") where the Superficial Loss Rules would not otherwise apply and, during a period that begins 30 days before and ends 30 days after the disposition, the transferor or a person affiliated with the transferor acquires the same or an identical property and the transferor or affiliated person owns such property at the end of that period. In this case, the denied capital loss is preserved and allowed at a later point in time to the transferor when the property is no longer owned by the transferor or an affiliated person. Unlike the Superficial Loss Rules, the denied loss is not added to the transferee's adjusted cost base of the property substituted nor is the loss added to the transferor's cost base in any shares it owns in the transferee. 

Shares in Section 40(3.6) and 112(3) to 112(4.1) of the Income Tax Act

There is another specific stop loss rule where a taxpayer, including an individual, disposes of a share in the capital stock of a corporation to that corporation, and the taxpayer is affiliated with the corporation immediately after the disposition. The provision may apply, for example, to a redemption, acquisition or purchase for cancellation of the taxpayer's share by the corporation. It does not apply to a disposition of a distress preferred share. The taxpayer's capital loss, if any, is deemed to be nil. The amount of the denied loss is added to the cost base of the shares in the corporation owned by the taxpayer immediately after the disposition. However in the case of corporations disposing of shares in other corporations, the loss is reduced by certain dividends received on those shares unless the shares have been owned for one year or more at the time of the transaction and the holding was not more than 5% of the issued shares of any class at the date the dividend was received. If the taxpayer owns no shares in the corporation immediately after the disposition but is nonetheless affiliated with the corporation, it appears that the loss is denied with no relief in the form of an increased cost base. 

Depreciable Property in Section 13(21.2) of the Income Tax Act

Depreciable Property is defined HERE.

There is another stop loss rule which denies the deduction of a terminal loss on the disposition of a depreciable property of a prescribed class by a corporation, trust or partnership (transferor), where either the transferor or a person affiliated with the transferor owns the property or a right to acquire the property 30 days after the disposition.  Any denied terminal loss is in effect “frozen”, and is subsequently allowed to the transferor upon the earliest of certain triggering events, such as where the property is again disposed of and is no longer owned by the transferor or an affiliated person. Until the triggering event occurs, the transferor may claim capital cost allowance (CCA) as if the transferor continued to own the property with a capital cost equal to the amount of the denied terminal loss. If there is no terminal loss on the disposition of the depreciable property, this stop loss rule still applies in the circumstances described above if the amount that would otherwise be the proceeds of disposition of the depreciable property is less than the lesser of the transferor's capital cost of the property, and the proportion of the undepreciated capital cost (UCC) of the class to which the property belongs that the value of the property is of the value of all properties in the class. In such case, the transferor is deemed to have disposed of the property at the lesser of these two amounts (the deemed proceeds), and the amount by which the deemed proceeds exceeds the amount that would otherwise be the proceeds of disposition is added back as a capital cost of a notional depreciable property of the same class owned by the transferor.

Eligible Capital Property in Section 14(12) of the Income Tax Act

Eligible Capital Property is defined HERE.

There is a stop loss rule to prevent the loss on the disposition of eligible capital property. In particular, the provision applies where a corporation, trust or partnership (transferor) disposes of a particular eligible capital property in respect of a business and would otherwise be eligible for the deduction for example if the company ceases to carry on business and during the period that begins 30 days before the disposition and ends 30 days after the disposition, either the transferor or a person affiliated with the transferor acquires the property or an identical property (called the “substituted property”) and such person owns the substituted property at the end of the period. When this happens, the transferor is deemed to continue to own eligible capital property in respect of the business and not to have ceased to carry on the business, until immediately before the earliest of one of the triggering events. Until the triggering event, the transferor can continue to deduct amounts in respect of the taxpayer's cumulative eligible capital pool and the deduction  for the loss on disposition is deferred until the triggering event. For these purposes, where the transferor is a partnership which otherwise ceases to exist after the disposition of the property but before the triggering event, the partnership is deemed to continue to exist, and its members are deemed to remain members, until immediately after the first triggering event. The triggering events are: 

1. a subsequent disposition of the substituted property so that neither the transferor nor an affiliated person owns the property; provided that during the 30-day period afterwards neither the transferor nor an affiliated person owns the substituted property, or another property identical to the substituted property that was acquired within the 30 days before the subsequent disposition of the substituted property;

2. when the substituted property is no longer eligible capital property in respect of a business carried on by the transferor or an affiliated person;

3. when the transferor becomes or ceases to be resident in Canada, if the eligible capital property would have been subject to the deemed disposition rules if it were still owned by the transferor;

4.  if the transferor is a corporation, when it becomes or ceases to be exempt from Part 1 tax;

5. if the transferor is a corporation, an acquisition of control of the corporation by a person or group of persons;

6. if the transferor is a corporation, when a winding-up of the transferor begins, other than a winding-up into a parent corporation subject to the rollover provisions of the Income Tax Act.

Inventory in Section 18(14) and 18(15) of the Income Tax Act

Finally, there is a stop loss rule to deny losses where a person (the Transferor) disposes of inventory of a business that is an adventure or concern in the nature of trade and, during a period that begins 30 days before and ends 30 days after the disposition, the transferor or a person affiliated with the transferor acquires the same or identical property and at the end of the period the transferor or a person affiliated with the transferor owns the same or identical property. The loss is denied and the amount of the loss is deemed to be the loss of the transferor after certain triggering events such as the transferee selling the property. 

There are some tax planning ideas to avoid Stop Loss problems HERE.

Careful planning with a Chartered Accountant is warranted. Contact Keith Anderson CA at (780) 447-5830 if you need advice. 

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