Understanding Synthetic Dispositions

A “synthetic disposition” refers to financial arrangements which allow taxpayers to defer tax by “economically” disposing of a property while continuing to own it for tax purposes. These transactions were shut down as of Budget Day, March 21, 2013.

In essence, all or most of the risk for loss or gain to the subject property is guaranteed by acquiring another property at approximately the same value as the former property. In these instances the taxpayers will be deemed to have disposed of the property for tax purposes. Where the person does not deal at arm’s length with the taxpayer entering into such an agreement, the measure will not apply if it is reasonable to assume the non-arm’s length person did so without knowledge of the taxpayer’s ownership of the property in question.

While this provision will not apply to ordinary hedging transactions, which typically involve managing the risk of loss only, or ordinary-course securities lending or leasing arrangements, the explanations in the budget go on to clarify that the new measures will apply to the following arrangements:

• A “forward sale” of the property
• A “put-call collar” in respect of an underlying property
• The issuance of certain indebtedness in exchange for the property
• A potential “return-swap”
• A securities borrowing to facilitate a short sale of property that is identical or similar to another property of the taxpayer or a person related to the taxpayer

In the above instances, if the taxpayer is deemed to have disposed of and then reacquired a property after entering into a synthetic disposition transaction, the taxpayer will be deemed not to own the property for the purpose of meeting the holding-period tests in the stop-loss rules in section 112 of the Income Tax Act and the foreign tax credit rules in subsection 126(4.2).

These rules will also affect a financial institution that acquires a foreign stock over a dividend payment date. In this case, the institution would have to hold the stock for longer than one year in order to claim a foreign tax credit in respect of foreign withholding taxes imposed on the dividend.

If the taxpayer later regains the risk of loss or the opportunity for gain or profit, the property would be considered to be owned from that point onward for the purposes of the holding-period tests. 

Examples will follow in this and future issues of Knowledge Bureau Report, excerpted from Knowledge Bureau’s online tax research library, EverGreen Explanatory Notes.

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