8 December 2015 External T.I. 2015-0613401E5 F - Attribution Rules -- translation

Principal Issues: Will subsection 74.4(2) apply in the scenarios described?

Position: No in the first scenario. Probably in the second scenario. No in the third scenario but no comments on subsection 245(2).

Reasons: See below.

XXXXXXXXXX 2015-061340
M. Séguin

December 8, 2015

Dear Sir,

Subject: Paragraph 74.4(2)

This is in response to your inquiry dated September 1, 2015 in which you requested our view regarding the application of subsection 74.4(2) of the Income Tax Act (hereinafter the "Act") to three hypothetical situations.

Unless otherwise stated, all statutory references herein are references to provisions of the Act.

This technical interpretation provides general comments about the provisions of the Income Tax Act (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.

Situation 1

1. Mr. X holds all the shares in the capital stock of Opco.

2. Mrs. X, the spouse of Mr. X, holds all the shares in the capital stock of Holdco.

3. Opco holds an amount of cash generated from carrying on its business.

4. Opco decides to subscribe for preferred shares in the capital stock of Holdco for an amount equivalent to the cash balance it holds.

5. Holdco has never been a small business corporation (hereinafter "SBC").

Your question

You wish to receive the comments of the Canada Revenue Agency (the "CRA") regarding the potential application of subsection 74.4(2) in the first hypothetical situation.

Our Comments

Generally, subsection 74.4(2) can apply where an individual has transferred or lent property, either directly or indirectly, by means of a trust or by any other means whatever, to a corporation other than an SBC, where one of the main purposes of the transfer or loan may reasonably be considered to be to reduce the income of the individual and to benefit, either directly or indirectly, by means of a trust or by any other means whatever, a person who is a designated person in respect of the individual. The question whether it is reasonable to consider that one of the main purposes of the transfer of property is to reduce the individual's income and to benefit directly or indirectly a designated person is a question of fact to be resolved only after consideration of all relevant facts and circumstances of each case.

Therefore, subsection 74.4(2) generally should not be applied where it is a corporation rather than an individual who transfers or loans property to another corporation. This provision could, however, apply if it can be demonstrated that an individual indirectly through a trust or otherwise, transferred or loaned property to the corporation so that subsection 74.5(6) applies.

According to our understanding of the situation, the consideration paid by Opco to Holdco for the acquisition of preferred shares in the capital stock of Holdco never belonged personally to Mr. X. Therefore, Mr. X would not be considered, for the purposes of subsection 74.4(2), to have transferred, directly or indirectly, property to Holdco. This provision therefore does not apply in the circumstances of the first hypothetical situation. We refer you in this respect to Technical Interpretation 2002-0147325.

Situation 2

1. Mr. X holds all the shares in the capital stock of Opco.

2. Mrs. X, the spouse of Mr. X, holds all the shares in the capital stock of Holdco.

3. Opco holds an amount of cash generated in carrying on its business.

4. Opco declares and pays a stock dividend on the common shares held by Mr. X by issuing preferred shares in its capital stock. The redemption value of the preferred shares in the capital stock of Opco would be equivalent to the amount of cash that Opco holds and such shares would have a nominal paid-up capital.

5. Mr. X transfers, under subsection 85(1), the preferred shares in the capital stock of Opco to Holdco. In return, Holdco issues to Mr. X preferred shares in its capital stock.

6. Opco then proceeds to the redemption of preferred shares in its capital stock held by Holdco for an amount equal to the redemption amount of those shares, which is paid with the cash held by Opco.

7. Holdco has never been an SBC.

Your question

You wish to receive the comments of the CRA regarding the application of subsection 74.4(2) in this second hypothetical situation.

Our Comments

According to the facts of this second hypothetical situation, the transfer by Mr. X of preferred shares in the capital stock of Opco to Holdco represents, for the purposes of the potential application of subsection 74.4(2), a transfer by an individual of property to a corporation other than an SBC. In addition, Mrs. X would, under the definition in subsection 74.5(5), be a designated person in respect of Mr. X. Consequently, the provisions of subsection 74.4(2) could apply respecting the transfer, to the extent that other conditions of its application were satisfied.

Situation 3

1. Mr. X holds all the shares in the capital stock of Opco.

2. Opco is not an SBC.

3. The fair market value of shares in the capital stock of Opco held by Mr. X is $1 million.

4. Opco declares and pays a stock dividend on the shares in its capital stock held by Mr. X by issuing preferred shares with a redemption value of $1 million and a nominal paid-up capital.

5. Following the above transaction, the spouse of Mr. X subscribes to common shares in the capital stock of Opco.

Your question

You wish to receive the comments of the CRA regarding the application of subsection 245(2) in the third hypothetical situation.

Our Comments

As stated in response to questions 19(c) at the CRA Federal income Tax Roundtable at the 2014 APFF Conference, the position of the CRA is that, technically, subsection 74.4(2) does not apply to the issuance of shares as stock dividends.

Furthermore, the CRA will usually not address the application of section 245 in connection with a request for technical interpretation because all the relevant facts cannot be known. Therefore, we will not comment on the potential application of section 245 in the context of the situation described above. Where taxpayers are planning to carry out transactions to which section 245 could apply, obtaining an advance income tax ruling prior to such operations is recommended.

In closing, this letter is limited to the analysis of the application of subsection 74.4(2) to the three hypothetical situations, and nothing herein should be construed as agreement, on the part of the CRA, that another provision of the Act does not apply to your particular hypothetical situations. The application of a provision or provisions of the Act generally requires the analysis of all the facts and circumstances relating to a given particular situation.

We trust that these comments will be of assistance.

Stéphane Charette, CPA, CMA, MBA
for the Director
Reorganizations Division
Income Tax Rulings Directorate
Legislative Policy
and Regulatory Affairs Branch