Tax Planning

Publish mortem tax planning with loss carryforwards? – VAT

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One of the most important considerations in post-mortem planning is the presumed disposition for death. Section 164 (6) EStG (“ITA“) provides a method of dealing with the presumed disposition. This subsection enables a graduated estate to bear a capital loss from the first year after death through the deceased’s final year. The choice is available to the extent that the capital loss is present exceeds any capital gains accrued on the estate that year, and the capital loss carried back can then help offset the capital gain derived from the presumed disposition of death.

Other sections of the ITA may have interesting and unexpected interactions with Subsection 164 (6). One of these interactions, which emerges from subsections 40 (3.6) and (3.61), was discussed at the STEP CRA 2020 round table. The rating agency’s response is significant in that it indicates a change in position on the views expressed by the rating agency when it was questioned on the same subject in 2012. Sub-section 40 (3.6) is generally used as a background to limit a loss on the sale of shares to one issuer, if the shareholder and the issuer are connected immediately after the sale. The issuer refers to the company that issued the shares. A sale of shares to the issuer is a common method of crystallizing a loss for an election under Section 164 (6), and the estate and the company will often be linked. The motion for 40 (3.6) to limit 164 (6) elections was apparently not intended. Subsection 40 (3.61) was added in 2004 to relieve estates wishing to conduct subsection 164 (6) elections. Subsection 40 (3.61) reads

If the legal representative of the taxpayer decides in the context of the administration of the estate of a deceased taxpayer in accordance with section 164 (6) to deal with all or part of the capital loss of the estate (without reference to section 40 (3.4) and (3.6)) from the sale of a share Paragraphs 40 (3.4) and (3.6) apply to the estate only in relation to the loss to the extent that the amount of the loss exceeds the part of the loss in the share capital of a company as a capital loss of the deceased taxpayer from the sale of the share, to whom the choice applies.

Subsection 40 (3.61) refers to the loss determined without reference to Subsection 40 (3.6). There is no equivalent wording in subsection 164 (6). Practitioners found that this creates an apparent circularity.1 The amount of loss for purposes of Subsection 40 (3.61) would be determined under other provisions of the ITA, but before 40 (3.6). On the other hand, the amount below 164 (6) appears to be calculated after applying 40 (3.6) and 40 (3.61).

The problem is especially relevant if the property has also made a capital gain in the first year. Let’s say the estate had a loss of $ 100 and a separate gain of $ 20, to simplify the example. In accordance with Section 164 (6) (a), only that portion of the loss in excess of profit may be carried back. In the example, only $ 80 could be returned. The excess loss of $ 20 that is not covered by the election is not protected by Subsection 40 (3.61) and will be considered zero if Subsection 40 (3.6) applies. It was feared that the loss available for the election under Section 164 (6) would then be reduced by the part of the loss that is considered zero under Section 40 (3.6). In the example this would mean the loss would only be $ 80 and the eligible amount would still be limited by the profit of $ 20. This could then occur in circles until all of the loss is ground. While this was primarily an issue where the entire loss due to a win was not eligible for election, there could also be cases where the choice was not applicable to the entire loss for another reason.

The rating agency was asked about this circularity in 2012.2 At this point in time, they confirmed that the technical application of the provisions apparently leads to circularity. Indeed, the rating agency had not seen a case of circularity and indicated that it would examine the matter on a case-by-case basis. While this was not a clear indication that the amount of loss in subsection 164 (6) would be mitigated, it appeared that the rating agency was inclined to interpret the provisions in this way.

At the 2020 STEP CRA Roundtable, the CRA was asked to address this issue again. The question and answer itself were previously published in issue 2543 on tax issues. The rating agency has now changed its guidelines. The rating agency’s updated response indicates that reducing the estate loss in any way that circularity allows would be contrary to the purpose of subsection 40 (3.61). The credit rating agency has also set out its current view on how to apply the rules. The rating agency initially applies subsection 164 (6) without referring to subsection 40 (3.4) or (3.6). Then paragraphs 40 (3.4) or (3.6) apply to losses that are not the subject of the option under 164 (6).

The scenario considered in the question and answer included a scenario relating to Mr. X. Mr. X died in possession of all shares in the share capital of a private company (“PrivateCo”) as well as a broader investment portfolio. These assets were subject to the death sentence in accordance with Section 70 (5). The property made additional capital gains from its investment portfolio of $ 30,000 in its first year. In addition, PrivateCo redeemed a portion of the shares held by the estate in the first year after death, resulting in a $ 1 million capital loss on the estate.

The amount eligible for redemption under Subsection 164 (6) is the net loss of $ 970,000 due to Section 164 (6) (a). The rating agency’s response assumes the estate will take back the full $ 970,000. According to the rating agency’s current view, Paragraph 40 (3.6) would only apply to the USD 30,000 that could not be repaid. In this case, Mr. X and then his estate owned all of the shares in PrivateCo. The estate only took back part of the shares. After redemption, the estate would continue to hold the remaining shares, which are all shares outstanding. As such, the estate appears to be controlled by PrivateCo and linked immediately upon disposal as defined in subsection 251.1 (1). Therefore, Subsection 40 (3.6) considers the remaining loss of $ 30,000 to be zero. The profit of $ 30,000 would not be diminished by the loss, and the estate would continue to pay tax on the profit of $ 30,000. Since the rating agency now believes that subsection 164 (6) is determined without reference to subsection 40 (3.6), the application of subsection 40 (3.6) would not affect the choice of subsection 164 (6). As a result, the estate would be able to carry back the net loss of $ 970,000 against the gain on the final period’s return.

This is a welcome clarification that seems to be in line with the intent of Subsection 40 (3.61). However, this result appears to require that the credit rating agency read words in subsection 164 (6) that are actually absent. It would be preferable to amend the law to confirm this interpretation.


1 Nick Moraitis and Manu Kakkar, “Possible circularity problem with loss of estate” (2006) 6: 3 Tax for the owner-manager 6-7.

2 2012-0462941C6 – 2012 Ontario Canadian Tax Foundation Q14 – circularity with 164 (6), 2012-0449801C6 – STEP CRA Roundtable Question 5 – June 2012

Originally published by GSNH February 2021

The content of this article is intended to provide general guidance on the subject. A professional should be obtained about your particular circumstances.


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