CRA confirms that the claiming of a capital gains reserve on a s. 84.1 transfer can result in a s 84.1 deemed dividend on a subsequent transfer
On the non-arm’s length transfer of shares by an individual to a corporation, s. 84.1 prevents the use by the transferor of adjusted cost base in the transferred shares that reflects the previous claiming of the capital gains exemption (“CGE”). However, s. 84.1(2.1) indicates that for purposes of the ACB reduction under s. 84.1(2)(a.1)(ii)) respecting the non-arm’s length transfer, where a capital gains reserve is claimed under s. 40(1)(a)(iii) by the transferor or a non-arm’s length individual and it is possible for the transferor to claim the CGE, the CGE is deemed to have been claimed in the maximum amount irrespective of whether it is in fact claimed and whether in fact there is no intention to claim it.
For example, Father transfers shares of Opco (a small business corporation whose shares are eligible for the CGE) to his children in consideration for a note that is payable over 10 years, claims the capital gains reserve, but does not claim the CGE. The children transfer the Opco shares to a new Holdco in consideration for a note of Holdco, with a view to Opco dividends funding note repayments.
CRA confirmed that this is how s. 84.1(2.1) operates, so that in this example, the children are deemed to receive a dividend on their receipt of the Holdco note. It is irrelevant that the transferor may have CGE room that he wishes to retain for future use - all the available room effectively is deemed to be used.