Last Minute Attempt to Split Capital Gain with Spouse
Mony v. The King
This is a case that may be relatable to many small business owners. I have simplified the case in my own scenario below. This is for illustrative purposes only.
Husband owned shares in a CCPC. His wife helped him run the Company but never owned any shares.
One day, husband was offered $2m for his 2,000 shares. Realizing that he'd have a capital gain of nearly $2m, which is much higher than the lifetime capital gains exemption (LTCGE), he performed a series of clever transactions to use up some of his wife's LTCGE.
First, he gifted her half of his shares. Under s.73(1) of the Income Tax Act (ITA), assets can be rolled over to your spouse at cost. Downside of this is that under s.74.2(1), any future gain could be attributed back to the husband.
Then, on the same day, he sold his wife the remaining shares for the fair market value of $1m. To do so, he had to elect out of the s.73(1) spousal rollover for this specific sale. As a result, husband had a $1m capital gain. Since his wife did not have $1m, he lent her the $1m with a bona fide loan. Note that the attribution rule does not apply if the shares are sold at FMV to the spouse.
At this point, the wife now owns all 2,000 shares and her cost base is $1m. Half of her shares have a cost base of nearly nil. The other half has a cost base of $1m. If she sold all her shares to the 3rd party for $2m, she would have a capital gain of $1m on the first 1,000 shares that have a cost base of nearly nil. This $1m would be all attributed back to her husband (due to gifting).
However, there's one little section in the ITA, s.47(1), that deems the cost base of identical properties acquired to be averaged. So wife's cost for the first 1,000 shares is $500,000 and second 1,000 is $500,000. The sale to the 3rd party for $2m would produce:
a capital gain on the first 1,000 shares of $500,000, which would be attributed back to the husband (as opposed to the full $1m), and
a capital gain on the second 1,000 shares of $500,000, which she could use her lifetime capital gains exemption.
Although technically possible, the judge found that s.245 General Anti-Avoidance Rule (GAAR) applied. For GAAR to apply, three conditions are necessary:
There must be a tax benefit arising from a transaction or series of transactions of which the transaction forms part (ss. 245(1) and (2));
the transaction must be an avoidance transaction in the sense that it cannot reasonably be said that it is primarily for a bona fide purpose ‑ obtaining a tax benefit not being regarded as a genuine object;
there must have been abusive tax avoidance in the sense that it is not reasonable to conclude that a tax benefit would be consistent with the object or spirit of the provisions invoked by the taxpayer.
Despite the series of clever transactions, all the capital gain was attributed back to the husband due to GAAR.
To read the real case, click here.