Make Sure Clients Report Gains

Advisor's Edge

2013-05-15



When it comes to equities, advisors who pick stocks must also stay abreast of corporate actions that could have tax repercussions, like reorganizations and spin-offs.

A recent Tax Court of Canada decision (Estate of the Late Catherine M. Roud v The Queen, 2013 TCC 36) shows what happens when an uninformed client is caught off guard by corporate actions.

The taxpayer was the late Catherine Roud, who passed away in August 2007. Her cousin, Ms. Murphy, was her estate’s executor and held a power of attorney over Roud's financial affairs prior to her death. In 2006, Roud owned about 4,000 common shares of Aliant Inc., a public telephone company and successor to NewTel, which she acquired during her 50 years as an employee of Newfoundland Telephone until her retirement in the late 1980s.

In July 2006, Aliant Inc. converted to an income trust. As part of the reorganization, each of Roud’s Aliant Inc. shares became one unit of a commercial trust called The Bell Aliant Regional Communications Income Fund.

At the time of conversion, each share (and, consequently, each unit) of the income fund was worth about $33. That meant Roud’s 4,000 units were valued at around $133,000. Roud’s adjusted cost base of her Aliant shares was estimated by CRA to be about $62,000. Murphy’s position was that no capital gain should have been realized and taxed in 2006 since the Aliant corporate shares were not actually sold for cash; they were converted to trust units. Murphy also argued that even if a capital gain should have been reported, it was too late to reassess Roud’s 2006 return as it was now statute-barred.

Conversion to income trust
The Income Tax Act permits a share-for-share exchange on a tax-deferred basis, as was the case when Roud’s NewTel shares were exchanged for Aliant Inc. shares. But an income trust conversion does not qualify for tax-deferred corporate rollover treatment. So, the judge ruled Roud disposed of her Aliant Inc. shares for tax purposes and received, in return, proceeds equal to the fair market value at the time of conversion — albeit in the form of Bell Aliant Trust units. The fact she didn’t receive cash was irrelevant.

Was her 2006 return statute-barred?
Roud’s 2006 tax return didn’t include the capital gain resulting from Aliant converting to an income trust. Murphy signed that 2006 return as the representative under Roud’s power of attorney. CRA reassessed her 2006 return to include the capital gain, but Murphy argued the three-year reassessment period had already passed.

The judge concluded Roud should have known about the tax implications of the conversion transaction since they had been communicated to common shareholders of Aliant Inc. prior to the conversion. Since the Aliant Inc. shares were one of Roud’s significant assets, and she regularly received dividends from them, ignorance was no excuse.

While the judge said there was “absolutely no suggestion that either Ms. Roud or Ms. Murphy intended to do anything wrong,” nonetheless, “the failure to include the capital gain in Ms. Roud's 2006 tax return resulted in a misrepresentation in that return attributable to neglect or carelessness.” Consequently, the judge ruled the normal three-year reassessment period did not apply and the 2006 tax year was found not to be statute-barred with respect to the capital gain on the conversion.

Finally, the judge recommended the CRA consider waiving, under the fairness rules, some of the arrears interest charged on the tax owing.

A small consolation to the estate, but an important lesson for advisors and our clients.