11 December 2015 External T.I. 2015-0601561E5 F - Attribution Rules -- translation

Principal Issues: Will subsection 74.4(2) apply to both scenarios presented?

Position: No in the first scenario. May technically apply in the second scenario depending on the facts and circumstances.

Reasons: See below.

XXXXXXXXXX 2015-060156

Mr. Séguin

December 11, 2015

Dear Sir,

Subject: Subsection 74.4(2)

This is in response to your request dated July 21, 2015 in which you requested our views regarding the application of subsection 74.4(2) of the Income Tax Act (hereinafter the "Act") to two hypothetical situations.

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 if its included provisions.

This technical interpretation provides general comments about 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 70-6R6, Advance Income Tax Rulings and Technical Interpretations.

Situation 1

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

2) Opco is a small business corporation (hereinafter "SBC").

3) Mr. X effected an estate freeze in favour of a discretionary trust ("Trust X").

4) Following the freeze, Trust X holds 100% of the common shares in the capital stock of Opco.

5) Trust X incorporates a new corporation ("Holdco") and subscribes, for a nominal value, for the common shares in the capital stock of Holdco. Holdco is never an SBC.

6) The beneficiaries of Trust X are the adult children of Mr. X, his wife and Holdco.

7) Each year, to ensure that Opco maintains its status as an SBC, Opco pays a dividend on the common shares in its capital stock equal to the surplus funds generated in the carrying on of its business.

8) Trust X distributes this dividend to Holdco. Trust X makes a designation under subsection 104(19) with respect to such dividends and distribute the amounts received as dividends from Opco to Holdco. Dividends paid by Opco on common shares of its capital stock do not have the effect of reducing the FMV of the estate freeze held by Mr. X in the capital stock of Opco.

Your question

You wish to know the Canada Revenue Agency's views regarding the potential application of subsection 74.4(2) in the first situation.

Our Comments

Generally, subsection 74.4(2) can apply to a transfer or loan of property made directly or indirectly, by means of a trust or otherwise, by an individual to a corporation other than an SBC, where it is reasonable to consider that one of the main purposes of the transfer is to reduce the individual's income and to benefit, directly or indirectly through a trust or otherwise, a designated person. The question whether it is reasonable to consider that one of the main purpose 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 in light of all the circumstances and aspects of each case.

Thus, it appears that in the situation described above, the provisions of subsection 74.4(2) would not apply to the transfer of property by Mr. X to Opco in the course of an estate freeze so long as Opco remained an SBC.

Furthermore, although the payment of a dividend by Opco to Holdco equal to the surplus funds generated in carrying on the business of Opco could be considered a transfer of property, subsection 74.4(2) generally would not apply where it is a corporation, rather than an individual, which transfers or lends property to a corporation. This legislative provision could however apply if it is demonstrated that an individual indirectly, by means of a trust or otherwise, transferred or lent property to a corporation or if subsection 74.5(6) applied. In this regard, we refer you to Technical Interpretation 2002-0147325 regarding property generated by the internal operations of a corporation. According to our understanding of the facts of the first situation, Mr. X would not be considered, for purposes of subsection 74.4(2), to have indirectly transferred property to Holdco.

Finally, subsection 104(2) provides that a trust is deemed to be in respect of the trust property an individual. Trust X would be an individual for the purposes of subsection 74.4(2). However, no designated person in respect of Trust X would be involved in the reorganization described in the first situation. Consequently, subsection 74.4(2) does not apply to Trust X.

Situation 2

1) Mr. X transfers his business, by virtue of a rollover under section 85, to a new corporation (hereinafter, "Opco") in exchange for shares of the latter.

2) The other shareholders of Opco are the wife of Mr. X, Mrs. X, a minor child of Mr X and a corporation (Holdco), each of which holds a separate class of participating shares in the capital stock of Opco. The attributes of each class of participating shares in the capital stock of Opco provide for the potential payment of a discretionary dividend.

3) Holdco is never an SBC.

4) Mr. X, Mrs. X and the minor child of Mr. X subscribe for the same number of common shares in the capital stock of Holdco.

Each year, to ensure Opco remains an SBC, Opco pays a dividend on shares of its capital stock held by Holdco equal to the surplus funds generated in carrying on its business.

Your question

You wish to know the Canada Revenue Agency's views regarding the potential application of subsection 74.4(2) to the second situation.

Our Comments

In light of the conditions for the application of subsection 74.4(2), it appears that, for so long as Opco remains an SBC, this provision would not apply to the transfer of property (the business assets) effected by Mr. X to Opco in the course of incorporating his business, nor also to the consideration paid by Mrs. X for the acquisition of shares in the capital of Opco. Furthermore, as stated above, subsection 74.4(2) should generally not apply where it is a corporation, rather than an individual, who has transferred or lent property to a corporation. Applying this position to our understanding of the facts of the second situation, Mr. X would not be considered, for purposes of subsection 74.4(2), to have indirectly transferred property to Holdco.

It should be noted, however, that in the situation described above, the consideration paid by Mr. or Mrs. X for the acquisition of shares in the capital of Holdco, which is not an SBC, would technically constitute a transfer of property by an individual (Mr. or Mrs. X) to a corporation other than an SBC (Holdco). Thus, subsection 74.4(2) could technically apply, depending on the other facts and circumstances, to such transfers.

Our comments are not intended to be exhaustive of all tax consequences which could arise from the two situations briefly described above. They are limited to the analysis of the application of subsection 74.4(2).

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