2 May 2016 External T.I. 2016-0633351E5 F - Descarries Case and Document no. 2015-0610711C6 -- translation

Principal Issues: Whether we would take a different position from the one taken in document no. 2015-0610711C6 with respect to the application of GAAR in a situation involving an intergenerational family business transfer similar to the proposed transactions in document no. 2005-0134731R3.

Position: No.

Reasons: In accordance with the jurisprudence.

XXXXXXXXXX 2016-063335

J. Lafrenière

(613) 670-9013

May 2, 2016

Subject: Request for technical interpretation - and Descarries Ruling Document number 2015-0610711C6

Dear Sir,

This is in response to your email of February 22, 2016 in which you requested clarification with regard to the position taken in the document number 2015-0610711C6 (hereinafter the "Document").

Unless otherwise stated, all statutory references to a statutory section or included provision in this letter are to a section of the Income Tax Act (hereinafter the "Act"), or to one of its included provisions.

This technical interpretation provides general comments on the provisions of the Act. It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination. The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R7, Advance Income Tax Rulings and Technical Interpretations.

A. Your comments

You stated, on the one hand, that the Document has to some extent reversed the earlier advance ruling 2005-0134731R3 of October 26, 2006 (hereinafter the "Ruling"). Specifically, we stated in the Document that we would recommend that the General Anti-Avoidance Rule Committee confirm that the provisions of subsection 245(2) apply in respect of a series of transactions similar to those contemplated in the Ruling. According to your interpretation, the Ruling followed the spirit of the Act because the transfer to be carried out as part of the proposed transactions was a business succession and could have been carried out by persons dealing at arm's length.

On the other hand, you stated that in the decision in Descarries et al. v. The Queen (footnote 1), the business and assets of the corporation in question had been distributed primarily through a sale of the assets of the real estate company and the orderly or indirect winding-up of the corporation.

In this sense, the finding of the Tax Court of Canada (hereinafter the "Court") on the application of subsection 245(2) makes sense to you in this case because, according to you, section 84.1 was specifically introduced to ensure that persons who do not deal at arm's length cannot agree on transctions that allow them to monetize their section 110.6 capital gains deduction (hereinafter the "CGD") or the fair market value on Valuation Day, or otherwise to strip a corporation of its surplus by transactions or events which people dealing at arm's length would have difficulty agreeing to.

In this regard, you advanced the proposition that by virtue of Swiss Bank Corp. et al. v. M.N.R., (footnote 2), the concept of arm's length dealing is to be interpreted with respect to the objective of the provision in question in order to determine whether the relationship between the parties gives reasonable assurance that the transactions in question are those which could take place between arm's length parties in a commercial context. Accordingly, you analyze the purpose of section 84.1 as being to prevent persons from monetizing their lifetime CGD outside the context of an actual sales transaction occurring on a market basis.

Given the fact that the Document involved a taxpayer who, with a view to retiring, embarked on a process of business succession with a family member similar to one that could be undertaken with an arm's length third party, you are of the view that the purpose of section 84.1 was not circumvented.

B. Your question

You ask us whether we are prepared to reconsider our position taken in the Document and thus not apply subsection 245(2) in respect of a series of transactions similar to those proposed in the Ruling.

C. Our comments

First, we remind you that the Ruling was given based on the facts of that case and is binding on the Canada Revenue Agency except for the taxpayers concerned based on the particular facts. Moreover, a decision to apply section 84.1 or subsection 245(2) requires the analysis of all the facts and circumstances of a particular situation. In a similar context to the Ruling, it is always recommended to obtain an advance income tax ruling before proceeding with such transactions rather than relying on advance rulings issued in respect of other taxpayers or other situations.

In the Descarries decision, the Court outlined the conditions for the applicatin of section 84.1 as follows:

(a) A taxpayer resident in Canada (the transferor), other than a corporation, disposes of shares (the subject shares);

(b) The shares are shares of a corporation resident in Canada (the subject corporation);

(c) The subject shares are capital assets;

(d) The taxpayer transfers the subject shares to a corporation (purchaser corporation) with which the taxpayer does not deal at arm's length;

(e) The subject corporation is connected to the purchaser corporation. (Footnote 3)

[Our emphasis]

Subsequently, after having analyzed the adjusted cost base rules under the planned paragraphs 84.1 (2)(a) and (a.1) and subsection 84.1(2.01), the Court described the object and spirit of section 84.1 as follows:

In summary, the specific rules show that the object, spirit or purpose of section 84.1 of the Act is to prevent taxpayers from performing transactions whose goal is to strip a corporation of its surpluses tax-free through the use of a tax-free zone or the capital gains exemption. (Footnote 4)

Likewise, the explanatory notes of the Ministry of Finance under section 84.1 are to the same effect:

Section 84.1 is an anti-avoidance rule designed to prevent the removal of taxable corporate surplus as a tax-free return of capital through a non-arm’s length transfer of shares by an individual resident in Canada to a corporation.

We note at this point that your description of the object and spirit of section 84.1, namely to prevent to prevent persons from monetizing their lifetime CGD outside the context of an actual sales transaction occurring on a market basis, is too limited, given the analysis of the Court in the Descarries and the jurisprudence in general.

Furthermore, after analyzing the factual context at issue in the Descarries decision, so as to determine whether the avoidance transactions allowing circumvention of section 84.1 thwarted the object and spirit of this provision, the Court found that there had been abuse of this provision:

The result of all three transactions described above is that the tax-free zone made it possible for part of Oka's surplus to be distributed to the appellants tax-free in a manner contrary to the object, spirit or purpose of section 84.1 of the Act. For these reasons, I find that there was an abuse in the application of this provision. (Footnote 5)

Given the current state of the jurisprudence, in the case of a series of transactions, similar to those proposed in the Ruling, that was submitted to us in the context of an advance ruling request, we would reiterate our position to the effect that the Directorate would recommend that the General Anti-Avoidance Rule Committee confirm the application of the provisions of subsection 245(2) in respect of such transactions.

Having said that, we understand your concerns about the application of section 84.1 in the context of an intergenerational transfer of a family business between a parent and children. Nevertheless, the mandate of the Canada Revenue Agency is to administer the Act as drafted while the responsibility for developing tax policy and amendments to the Act resides with the Minister of Finance. If you wish to make representations regarding amendments to the Act, you can send your comments to the Department of Finance, Tax Policy Branch, Tax Legislation Division, 90 Elgin Street, Ottawa, Ontario, K1A 0G5.

We hope that these comments will be of assistance.

Stéphane Charette, CPA, CMA, MBA.
Manager
Reorganizations Division
Income Tax Rulings Directorate
Legislative Policy
and Regulatory Affairs Branch

FOOTNOTES

Note to reader: Because of our system requirements, the footnotes contained in the original document are shown below instead:

1 2014 TCC 75 (hereinafter "Descarries").
2 [1974] S.C.R. 1144 (S.C.C.).
3 Supra note 1, at paragraph 50.
4 Idem, at paragraph 53.
5 Idem, at paragraph 59.