25 July 2000 External T.I. 2000-0031395 - Capital Gains Exemption

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: Designation of shares for purposes of the capital gains deduction and subparagraph 84.1(2)(a.1)(ii).

Position: We agree that Mr. A can designate the shares that he purchases from Mr. B as being the shares sold to C, and that, as a consequence, the shares purchased from Holdco B would be the shares sold to Holdco A.

Reasons: Since there is no clear prohibition against selecting the shares in respect of which the deduction was claimed and no obvious reason that such selection ought not to be available, it is our view that a taxpayer may identify the shares represented by the deduction claimed. If the taxpayer includes a designation in his return that specifies the shares in respect of which the exemption is claimed, the Agency will consider this designation binding in respect of the future application of subparagraph 84.1(2)(a.1)(ii).

		2000-003139
XXXXXXXXXX 	T. Lanzer
(613) 957-2129
Attention:  XXXXXXXXXX 

July 25, 2000

Dear Sirs:

Re: Section 84.1 of the Income Tax Act

We are writing in response to your letter of June 7, 2000 wherein you requested our comments on the following hypothetical fact situation.

1. Mr. A owns 100% of Holdco A, and Mr. B owns 100% of Holdco B. Mr. A and Mr. B are brothers.

2. Holdco A owns 50% of Opco, Mr. B owns 25% of Opco, and Holdco B owns 25% of Opco.

3. Mr. A purchases Mr. B's and Holdco B's interest in Opco. Mr. B claims his capital gain exemption for the full amount of his gain. Since Mr. B's cost base was nominal, the gain is equal to the full amount of the proceeds.

4. Following these purchases, Mr. A sells 25% of Opco to C, who is an unrelated third party.

5. Mr. A then transfers his remaining 25% of Opco to Holdco A in exchange for a promissory note equal to the fair market value of the Opco shares.

6. The end result is that C owns 25% of Opco and Holdco A owns 75% of Opco.

Your analysis of this fact situation has raised two possible outcomes.

1. If Mr. A sells the Opco shares that he acquired from Mr. B to Holdco A, section 84.1 of the Income Tax Act will apply and the promissory note received on the sale will result in a deemed dividend to Mr. A.

2. If Mr. A sells the Opco shares that he acquired from Holdco B to Holdco A, section 84.1 will apply, but since the adjusted cost base of those shares will be equal to the promissory note, no deemed dividend will result.

The issue to be determined is which shares are sold to C and which shares are sold to Holdco A.

Our Comments

In your letter, you have outlined what appears to be an actual fact situation related to a particular taxpayer. The review of such situations is the responsibility of the Taxation Services Offices and it is the practice of the Canada Customs and Revenue Agency not to comment on such transactions when the identities of the taxpayers are not known. We can, however, provide you with the following general comments which we hope will be of assistance.

Subparagraph 84.1(2)(a.1)(ii) provides, in part, that in computing a taxpayer's adjusted cost base (for purposes of section 84.1) of a share acquired by him after 1971 from a person with whom he was not dealing at arm's length, the adjusted cost base otherwise determined is to be reduced by the amount of post-1984 capital gains in respect of prior dispositions of the share or a share for which the share was substituted (or such lesser amount as is established by the taxpayer to be the amount in respect of which a deduction under section 110.6 was claimed) by the taxpayer or an individual with whom the taxpayer did not deal at arm's length.

While the onus of establishing the "lesser amount . . . in respect of which a deduction under section 110.6 was claimed" is on the taxpayer, where the taxpayer holds shares that are identical properties, there is no procedure in the Act for determining the particular shares in respect of which the deduction under any of subsections 110.6(2), (2.1) or (3) was claimed. Given that there is no clear prohibition against selecting the shares in respect of which the deduction was claimed and no obvious reason that such selection ought not to be available, it is our view that a taxpayer may identify the shares represented by the deduction claimed.

If the taxpayer includes a designation in his return that specifies the shares in respect of which the exemption is claimed, the Agency will consider this designation binding in respect of the future application of subparagraph 84.1(2)(a.1)(ii). The designation could be made by means of a written statement included with the return. However, such a designation, once made, could not be altered.

In accordance with paragraph 22 of Information Circular 70-6R3, the opinions expressed in this letter are not income tax rulings and are, therefore, not binding on the Canada Customs and Revenue Agency.

Yours truly,

for Director
Reorganizations and International Division
Income Tax Rulings Directorate
Policy and Legislation Branch