Deemed Disposition at Death of Capital Property at Fair Market Value
Paragraph 70(5)(a) of the Income Tax Act (Canada)1 (the "Act") deems a taxpayer to have, immediately before the taxpayer's death, disposed of each capital property of the taxpayer and received proceeds of disposition equal to the fair market value ("FMV") of the capital property immediately before the taxpayer's death. As a result, the taxpayer's estate will realize accrued capital gains under paragraph 39(1) (a) and accrued capital losses under paragraph 39(1)(b) in respect of the taxpayer's capital property (and recapture under subsection 13(1) in respect of the taxpayer's depreciable capital property), and notwithstanding that there is no actual disposition for consideration of the taxpayer's capital property at death. One-half of any such capital gains (each a taxable capital gain under paragraph 38(1)(a)) must be netted against one-half of any such capital losses (each an allowable capital loss under paragraph 38(1)(b)) in excess of the taxpayer's allowable business investment losses for the year, and included in the taxpayer's last taxation year income under paragraph 3(b). Generally, to the extent that a taxpayer's allowable capital losses in a year (in excess of the taxpayer's allowable business investment losses for the year) exceed the taxpayer's taxable capital gains for the year, the taxpayer may under paragraph 111(1)(b) and subparagraph 111(1.1)(a)(i) carry forward such net capital losses2 and apply them against taxable capital gains (net of allowable capital losses) in all future years, and carryback such net capital losses and apply them against taxable capital gains (net of allowable capital losses) in the 3 prior years. Subsection 111(2) modifies the otherwise optional 3-year carryback and indefinite period carry-forward of net capital losses under paragraph 111(1)(b) for a taxpayer's year of death. Subsection 111(2) permits all unused net capital losses arising in years up to and including the year of a taxpayer's death to be used to the extent needed to fully offset any taxable capital gains arising in the year of the taxpayer's death and in the immediately preceding taxation year. The historic income inclusion rate for capital gains is preserved for this purpose under subsection 111(1.1). To the extent that any such net capital losses exceed taxable capital gains in the year of the taxpayer's death and in the immediately preceding taxation year and the full amount of all section 110.6 capital gains deductions claimed by the taxpayer for any taxation year, such excess may be deducted in full against any business, employment or other income of the taxpayer in the year of the taxpayer's death and in the immediately preceding taxation year.3
Subsection 159(5) provides that, where a taxpayer's estate duly elects and provides the required security, the taxpayer's estate may pay the tax in respect of the net taxable capital gains arising as a result of the deemed disposition of a taxpayer's capital property under paragraph 70(5)(a) in up to 10 annual installments, and beginning on the day on which the estate would have otherwise been required to pay the tax had the election not been made, with interest at the prescribed rate4 on the balance outstanding.
Paragraph 70(5)(b) deems any person who as a consequence of the taxpayer's death acquires any capital property which is deemed to be disposed of by the taxpayer under paragraph 70(5)(a) to have acquired the property at the time of the death at a cost equal to the FMV of the property immediately before the death.
Subsection 70(6) provides a deferral from the tax which would otherwise arise as a result of the deemed disposition under paragraph 70(5)(a) of a Canadian resident taxpayer's capital property at death where the deceased taxpayer's capital property is transferred as a consequence of the taxpayer's death to the deceased taxpayer's spouse or common-law partner who is a resident of Canada immediately before the taxpayer's death, or to a resident Canadian qualifying spouse or common-law partner trust. In such case, paragraph 70(6)(d) deems the deceased taxpayer, immediately before the taxpayer's death, to have disposed of each capital property owned by the taxpayer immediately before death for proceeds of disposition equal to, (i) in the case of depreciable capital property, the lesser of the deceased taxpayer's capital cost and cost amount of the depreciable capital property immediately before the death, and (ii) in any other case, the deceased taxpayer's adjusted cost base ("ACB") of the capital property immediately before the death, and the surviving spouse or common-law partner or qualifying spouse or common-law partner trust is deemed to have acquired the property for such proceeds. The taxpayer's legal representative may elect under subsection 70(6.2) not to have the subsection 70(6) rollover apply, in which event the general rule in subsection 70(5) will apply.
Where a Canadian resident taxpayer at his or her death owns shares of a private corporation which each meet the conditions for being a "qualified small business corporation share" in subsection 110.6(1) at any time during the 12 month period immediately prior to the taxpayer's death5, the taxpayer's estate may claim the capital gains deduction (subject to a lifetime limit (in 2023) of $485,595, or $971,190 of capital gains, and indexed annually) on the taxable capital gain arising on the deemed disposition of the deceased taxpayer's shares under paragraph 70(5)(a), and after adjusting for the taxpayer's cumulative net investment loss, previously claimed allowable business investment losses, and certain capital losses. The "qualified small business corporation share" deduction is shared with a $500,000 deduction (or $1,000,000 of capital gains) for dispositions of a qualified farm property or a qualified fishing property.6
Potential for Double Taxation on the Deemed Disposition of Shares of a Private Corporation
There is a potential for double taxation where shares of a private corporation which have an accrued but untaxed gain associated with them have been deemed pursuant to paragraph 70(5) (a) to be disposed of as a consequence of the death of a taxpayer who owned the shares at the time of his or her death, and for proceeds equal to the FMV of the shares immediately before the taxpayer's death, and where the shares are not bequeathed to the deceased taxpayer's spouse or common-law partner or to a qualifying spouse or common-law partner trust.
In the absence of any planning, the shares will be subsequently distributed by the estate to its Canadian resident beneficiaries at the adjusted cost base to the estate7 of the shares, and unless the estate's legal representative makes an election to distribute the shares at their FMV8. Where the corporation at the time of the taxpayer's death owns assets which have accrued but untaxed gains associated with them - which gains are otherwise reflected in the gain in the value of the shares taxed at the deceased taxpayer's death – the corporation will realize those taxable gains on a subsequent disposition of the assets. The deemed disposition of the deceased taxpayer's shares will not automatically increase the tax cost of the corporation's assets by the amount of the gain inherent in the deceased's shares which is taxed at the deceased's death. If the after-tax proceeds are distributed as dividends by the corporation to the taxpayer's beneficiaries (following the transmission of the shares of the corporation to the taxpayer's beneficiaries), one dividend will constitute a non-taxable capital dividend (to the extent of the corporation's capital dividend account, and to the extent an election is made by the corporation to treat the dividend as a capital dividend) and another dividend will constitute a separate, taxable dividend. Double taxation arises as a result of the taxation of the gain in the shares owned by the deceased taxpayer, the taxation of the gain inherent in the corporation's assets which is reflected in the gain in the deceased's shares, and on the distribution by the corporation to the beneficiary shareholders of the after-tax proceeds of the corporation's assets.
The corporation might instead of paying dividends to the beneficiary shareholders redeem their shares with the after-tax proceeds of the sale of the corporation's assets. A portion of the resulting deemed dividends (in excess of the paid-up capital ("PUC") of the shares) will constitute a capital dividend (to the extent of the corporation's capital dividend account, and to the extent an election is made) and the remaining portion a taxable dividend. The beneficiary shareholders will realize a capital loss to the extent of the excess of the ACB of the shares over their PUC, subject to the stop-loss provisions in subsections 40(3.6) and 112(3) discussed below. The beneficiary shareholders may not though carry back the loss to recover taxes paid by the taxpayer's estate on the capital gain arising on the deceased taxpayer's death, and may only apply the capital loss against capital gains realized by them in the three years prior or in any following year. Double taxation again arises to the extent the beneficiary shareholders do not realize capital gains against which the capital losses can be applied.
The above double tax exposure to the beneficiaries would be avoided if the shares of the corporation, which now have an ACB equal to their FMV at the taxpayer's death, are subsequently sold by the beneficiaries.
1. All statutory references are to the provisions of the Income Tax Act (Canada), unless otherwise stated.
2. "net capital loss" is defined in subsection 111(8).
3. See paragraph 30 of Interpretation Bulletin 232R3 – Losses, Their Deductibility in the Loss Year or in Other Years dated July 4, 1997.
4. The prescribed rate of interest is calculated and published quarterly under section 4301 of the Income Tax Regulations.
5. See paragraph 110.6(14)(g).
6. See subsections 110.6(2), 110.6(2.1), and 110.6(2.2).
7. See subsection 107(2).
8. See subsection 107(2.001).
Originally published September 25, 2023
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