29 May 1998 External T.I. 9803695 - ECE GRIND ON ACQUISITION FROM RELATED PARTY

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues: Whether the ECE of a son who acquires eligible capital property from a corporation controlled by his parents would be subject to a reduction under subsection 14(3) of the Act based on an earlier claim for capital gains exemption made by the parents in connection with the disposition the corporation.

Position: Yes.

Reasons: The ECE reduction under ss 14(3) of the Act takes into account capital gains exemption claimed by a person not dealing at arm's length in connection with an earlier disposition by that person to a person not dealing at arm's length.

XXXXXXXXXX 	J. Gibbons
		5-980369
Attention:  XXXXXXXXXX 

May 29, 1998

Dear XXXXXXXXXX:

We are replying to your letter of February 10, 1998, in which you request our comments with respect to transactions involving “eligible capital property.” According to our telephone conversation (Gibbons/XXXXXXXXXX) on May 19, 1998, your main concern is with the “grind-down” of “eligible capital expenditure” (“ECE”) when eligible capital property is acquired by an individual (the “son”) from a corporation controlled by the individual’s parents.

Written confirmation of the tax implications inherent in particular transactions are given by this Directorate only where the transactions are proposed and are the subject matter of an advance ruling request submitted in the manner set out in Information Circular 70-6R3. In addition, where the questions involve completed transactions, including tax-related balances, they should be directed to the taxpayer’s local tax services. The following comments are, therefore, of a general nature only.

When a taxpayer (the “transferee”) acquires ECE from a person (the “transferor”) who does not deal at “arm’s length,” subsection 14(3) of the Income Tax Act (the “Act”) applies to effectively reduce or grind the transferee’s “eligible capital expenditure” by 4/3 of the total of all amounts that may reasonably be considered to have been claimed as a capital gains exemptions, under section 110.6 of the Act, by the transferor or any other person with whom the transferee was not dealing at arm's length in connection with the transferor's disposition of the property to the transferee or in connection with any previous disposition of the same property.

If the eligible capital property is subsequently disposed of by the transferee, subsection 14(3) of the Act provides that the reduction is reversed to the extent that the transferee receives proceeds in excess of the amount of the original ECE. In addition, if the disposition is to a particular person or partnership (the “subsequent transferee”) who does not deal at arm's length, the ECE of the subsequent transferee may be subject to an ECE reduction on the same basis as was the ECE of the original transferee. This is because the ECE reduction under subsection 14(3) of the Act takes into account any capital gains exemption claimed by another person with whom the transferee (in this case, the second transferee) was not dealing at arm's in connection with an earlier disposition of the same eligible capital property.

By virtue of subsection 251(1) of the Act, “related persons” are deemed not to deal with each other at arm’s length. The term “related persons” is defined in subsection 251(2) of the Act and includes, under paragraph (a) thereof, individuals connected by a “blood relationship” and, under subparagraph (b)(iii) thereof, a corporation and a person who is related to a person in a “related group” that controls the corporation. Pursuant to subsection 251(6) of the Act, a child and his parents, as well as married persons, are considered connected by a blood relationship. The term “related group” means a group of persons each member of which is related to every other member. Therefore, a parent and a child, as well as a child and a corporation controlled by the child’s parents, are deemed not to deal with each other at arm’s length.

Accordingly, when an individual acquires eligible capital property from a corporation controlled by his parents, and the parents had previously claimed capital gains exemption in connection with an earlier disposition of the same eligible capital property to the corporation, in accordance with the provisions of subsection 14(3) of the Act, the ECE of the individual will be reduced by the amount of such capital gains exemption.

We trust that these comments will be of assistance.

P. Spice
for Director
Business and Publications Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch

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