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:
Whether 74.4(2) applies when the regular attribution rules in 74.1(2) already apply.
Position:
Question of fact whether one of the main purpose test is met.
Reasons:
The reduction of capital gains tax on a disposition may constitute a reduction of income for the purposes of the main purpose test in subsection 74.4(2) of the Act
2000-005229
XXXXXXXXXX Karen Power, C.A.
(613) 957-8953
June 29, 2001
Dear XXXXXXXXXX:
Re: Subsection 74.4(2) of the Income Tax Act
We are writing in reply to your letter of October 17, 2000 wherein you requested our opinion regarding the application of subsection 74.4(2) of the Income Tax Act (the "Act") in the following fact situation.
1. A parent ("Parent") owns all the shares of a corporation which is a small business corporation ("Opco").
2. Parent wants to freeze his interest in Opco.
3. Parent has two children under the age of 18.
4. Parent exchanges all of his common shares for redeemable, retractable, preferred shares having a redemption amount equal to the fair market value of the exchanged common shares.
5. Parent then subscribes for 10 new fully participating common shares for a nominal amount. (The rights and restrictions attached to these shares prohibit paying dividends on them if doing so would reduce Opco's net assets to less than the redemption amount of the preferred shares.)
6. Parent settles the new common shares on a discretionary family trust, the beneficiaries of which are his two minor children.
7. Parent is neither a trustee nor a beneficiary (contingent or otherwise) of the trust.
Specifically you have asked whether the Canada Customs and Revenue Agency would apply subsection 74.4(2) to tax Parent on a benefit under that section.
In your letter, you have outlined what appears to be an actual fact situation related to transactions and events which have taken place. The review of such situations is generally the responsibility of the local taxation services offices and, as outlined in paragraph 22 of Information Circular 70-6R4, it is not our practice to provide specific opinions on factual situations otherwise than in the context of an advance income tax ruling. In any event, a request for an advance income tax ruling cannot be considered where the transactions are completed or where the issues involved are primarily questions of fact. Nevertheless, we are prepared to provide the following comments which we hope will be of assistance to you.
As you have indicated, subsection 74.4(2) of the Act applies to attribute a notional amount of interest income to an individual who has transferred or lent property directly or indirectly to a corporation where one of the main purposes of the transfer or loan is to reduce the income of the individual and benefit either directly, or indirectly, a designated person. The purpose of section 74.4 is to prevent a taxpayer from splitting income among designated persons by transferring property to a corporation in which such persons are specified shareholders for the purpose of paragraph 74.4(2)(a).
Whether or not the purpose test is met in any particular situation is a question of fact that can only be determined after a review of all of the relevant details of the particular situation. We concur with your view that the reduction of capital gains tax on a future disposition may constitute a reduction of income for the purposes of the corporate attribution rules in subsection 74.4(2) of the Act.
Thus, in our view, subsection 74.4(2) of the Act could apply to the above noted transactions, even though subsection 74.1(2) would apply to any dividends paid on the common shares and there is no provision under the Act to attribute a capital gain realized by a minor on property transferred directly to the child by his or her parent.
You have also expressed some concern, that with the introduction of the section 120.4 Tax on Split Income ("Kiddie Tax"), the corporate attribution rules as they apply to minors are unnecessary. Furthermore, it is your understanding that subsection 74.4(2) could tax a parent on a deemed interest benefit, even though the dividends were taxed in the hands of a child at a tax rate which would be at least equal to the parent's tax rate.
Section 120.4 of the Act imposes a special tax at the highest marginal rate on individuals under the age of 18 years in respect of an individual's split income for the year. Split income is defined in subsection 120.4(1) to include, among other things, taxable dividends and other benefits on unlisted shares of Canadian and foreign companies (received directly or through a trust). This "Kiddie Tax" takes precedence over most of the attribution rules which are contained in the Act. Subsection 56(5) provides that subsections 56(2), 56(4) and 56(4.1) do not apply to any amount that is included in computing a specified individual's split income. Subsection 74.5(13) provides that subsections 74.1(1), 74.1(2), 74.3(1) and 75(2) do not apply in respect of amounts included in any taxpayer's split income. Although we understand that representations have been made to the Department of Finance on this issue, no such exclusion has been added for the corporate attribution rules as they relate to minors; however, paragraph 74.4(2)(g) of the Act has been added to reduce the amount of any deemed interest benefit by 5/4ths of any dividends received by a minor which are subject to "Kiddie Tax".
We trust our comments will be of assistance to you. However, as noted in Information Circular 70-6R4 issued on January 29, 2001, the above comments are not binding on the Canada Customs and Revenue Agency.
Yours truly,
for Director
Reorganizations and Resources Division
Income Tax Rulings Directorate
Policy and Legislation Branch
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