In today’s environment, the transfer of a stock portfolio as part of a corporate reorganization or an attempt to realize losses must be handled carefully to ensure that accrued capital losses don’t vanish.
There are a number of situations in which a taxpayer may wish to make a transfer of a stock portfolio. For example, a substantial investment by an individual in U.S. stocks may be subject to estate tax. One way to sidestep this problem would be to transfer the portfolio to a Canadian holding company. In the course of a “purification” of a small business corporation for purposes of accessing the capital gains exemption, a stock portfolio may have to be transferred from an operating company to a holding company. Finally, an individual may wish to crystallize accrued losses while retaining the stock in order to shelter capital gains in the year, or the three prior years.
If a stock portfolio is to be transferred to a related party, knowledge of the “stop loss” rules contained in the Income Tax Act (“the Act”) is essential. There are a number of such rules that will affect losses in different ways, depending on the transaction.
Transfer by an Individual to a Corporation
The “superficial loss” rules generally deny capital losses where a taxpayer disposes of capital property and, within 30 days, an affiliated person has acquired the property. An individual is affiliated with a corporation when he or his spouse controls the corporation. The corporation must add the denied loss to the adjusted cost base (“ACB”) of the property it receives. Thus, a transfer of a stock portfolio with both gains and losses may be performed through the use of the rollover provisions in section 85 of the Act. The elected amount for the shares with accrued gains would be their ACB. For the shares with accrued losses, the elected amount cannot exceed the fair market value of the shares. The loss on the transfer will be added to the corporation’s ACB of the shares, and the rollover will effectively be completed.
Transfer by a Corporation
The superficial loss rules discussed above will not apply where the transferor is a corporation. Rather, if a corporation transfers loss property to an affiliated person, losses are “suspended” in the transferor’s hands. Corporations are affiliated where they are controlled by the same person, or affiliated persons. When the property is subsequently sold by the transferee to an arm’s length party, the loss is realized, and may only be used by the original owner. A capital loss may be of little use unless the original corporation incurs capital gains from other sources in the future.
Depending on the nature and reasons for the reorganization, there may be a number of solutions to the above problem. The transferor could retain a sufficient portion of the portfolio to ensure that future gains will be realized to offset the losses. Another answer might be to retain the stock portfolio, and transfer other assets into a new corporation.
Transfer Between Individuals
A transfer between affiliated individuals is subject to the superficial loss rules discussed earlier. The definition of affiliated individuals is restricted to persons who are spouses. Thus, a parent, for example, could transfer stock with accrued losses to a child, and realize the losses for tax purposes.
A planning opportunity exists if one spouse has accrued gains that need to be sheltered. The spouse with losses could transfer assets such that the superficial loss rules apply (care must be taken to avoid certain attribution rules). The accrued losses are effectively transferred from one spouse to the other.
Transfer to an RRSP
Specific rules deny losses where an individual transfers capital property to his RRSP. In effect, the loss is lost forever, since the RRSP is tax exempt. It may be possible to circumvent this rule by selling stock on the open market and repurchasing it immediately within the RRSP. The superficial loss rules will not apply. The CRA may apply the General Anti-Avoidance Rule in such a case. On the other hand, a delay of 30 days to circumvent the superficial loss rules does not seem to be offensive to the CRA.