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: Various questions regarding a previous crystallization and proposed sale.
Position: General comments provided.
Reasons: General comments provided.
XXXXXXXXXX 2000-006213
Karen Power, CA
(613) 957-8953
June 12, 2001
Dear XXXXXXXXXX:
Re: Technical Interpretation
We are writing in response to your letter of December 18, 2000 wherein you requested our comments on several issues related to the situation described therein.
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.
Qualified Small Business Corporation Shares
An individual who realizes a gain on the disposition of a qualified small business corporation (QSBC) share, as defined in subsection 110.6(1) of the Income Tax Act (the "Act"), may be entitled to a deduction in calculating his or her taxable income according to subsection 110.6(2.1) of the Act. In order for a share to so qualify, the corporation must be a small business corporation (SBC), as defined in subsection 248(1), and among other requirements the share must not have been owned by anyone other than the individual or a person or partnership related to the individual throughout the 24 months immediately preceding its disposition. According to paragraph 110.6(14)(f) of the Act, newly issued shares of a corporation are deemed to offend this latter requirement subject to certain exceptions contained in that paragraph. Shares issued as consideration for other shares, as part of a transaction or series of transactions in which the person disposed of property to the corporation that consisted of all or substantially all the assets used in an active business carried on by that person, or as payment of a stock dividend will not be subject to the rule contained in paragraph 110.6(14)(f) of the Act. In the situation you describe, the issued shares which are to be sold do not appear to meet any of these exceptions.
Price Adjustment Clause
Information Circular 89-3, Policy Statement on Business Equity Valuations, provides the Agency's general views regarding the valuation of shares of closely-held or private corporations. We would have to consider all of the factors related to the particular Canadian-controlled private corporation in making any determination of the fair market value of its shares. We have not been provided with sufficient information to determine whether a challenge of the original valuation in your situation is warranted.
As set out in paragraph 26 of Information Circular IC 76-19R3, the Agency will accept the operation of a price adjustment clause in the context of a transaction subject to section 85 of the Act where the conditions set out in IT-169 are complied with and where an amended election is filed pursuant to subsection 85(7.1). IT-169 sets out a number of criteria which must be met before the Agency will recognize a price adjustment clause, including the requirement that the method for valuing the property be fair and reasonable and the requirement that the Agency be notified, by way of a letter attached to the tax return of each of the parties to the transaction, of the existence of the price adjustment clause.
Deemed Dividend
As discussed in paragraph 1 of Interpretation Bulletin IT-489R Non-Arm's Length Sale of Shares to a Corporation, section 84.1 of the Act contains rules concerning a non-arm's length disposition of shares to a corporation for consideration which generally includes shares of the corporation. For the section to be applicable, the following conditions must be satisfied:
(a) a taxpayer resident in Canada (other than a corporation) disposes of shares (the "subject shares");
(b) the subject shares are of any class of the capital stock of a corporation resident in Canada (the "subject corporation");
(c) the subject shares are capital property of the taxpayer;
(d) the disposition is to a corporation (the "purchaser corporation") with which the taxpayer does not deal at arm's length; and
(e) immediately after the disposition, the subject corporation is connected with the purchaser corporation.
Where the provisions of subsection 84.1(1) apply, there may be a reduction of the paid-up capital of the shares of the transferee corporation issued as consideration or the transferee corporation may be deemed to have paid a dividend to the transferor taxpayer. While the deemed dividend is taxable immediately to the transferor taxpayer, the reduction in the paid-up capital of the shares of the transferee corporation has the effect of preserving the potential for deemed dividends on the redemption of those shares that was inherent in the shares transferred.
We have not been provided with sufficient information to determine whether all of the above conditions have been satisfied, however it would appear that the provisions of section 84.1 could apply to Mrs. X on the transfer of her Opco common shares to Holdco during the 1999 reorganization. Nonetheless, the effect of the provisions of section 84.1 will not apply where the sum of the non-share consideration and the paid-up capital of the share consideration does not exceed the greater of:
- the paid-up capital of the transferred shares, and
- the transferor's "arm's length adjusted cost base" of the transferred shares.
The provisions of section 84.1 would not apply on a disposition of shares to an arm's length person. Whether subsection 245(2) would apply to a situation to which section 84.1 does not apply, can not be determined without an examination of all the circumstances of the particular situation. Where a transaction or series of transactions is considered to result in the avoidance of the application of subsection 84.1(1), the application of subsection 245(2) of the Act will be considered if the transaction is an avoidance transaction as defined in subsection 245(3) and the transaction or, if the transaction is part of a series of transactions, the series of transactions is carried out to circumvent the purpose of section 84.1 or the provisions of the Act as a whole.
Subsection 55(2)
Subsection 55(2) of the Act applies, inter alia, where as part of a transaction or event or series of transactions or events, one of the purposes of the dividend (or, in the case of a dividend under subsection 84(3) one of the results of which) was to effect a significant reduction in the portion of a capital gain that, but for the dividend, would have been realized on a fair market value disposition of the share immediately before the dividend and that could reasonably be considered to be attributable to anything other than income earned or realized by any corporation after 1971 and before the safe income determination time.
In the situation you have outlined, subsection 55(2) of the Act may apply to the deemed dividend received by Holdco during the 1999 reorganization if the proposed disposition of the shares of Opco to an arm's length person forms part of a series of transactions or events, within the meaning of subsection 248(10), that includes the reorganization of Opco in 1999. However, a review of all the facts surrounding your situation would be required before such a determination could be made.
In addition, the provisions of subsection 55(2) of the Act could apply to the proposed intercorporate dividend paid by Opco to Holdco prior to the purchase of Opco's shares if the amount of the intercorporate dividend exceeds the portion of Opco's safe income attributable to the preferred shares. In calculating the amount of safe income attributable to Opco's preferred shares the following comments should be reviewed.
In situations where a part of the capital gain inherent in the shares of a corporation (Opco) is crystallized on their transfer to another corporation (Holdco) by an individual, not all of the individual's potential gain on the transferred shares of Opco will become a potential gain of Holdco. Consequently, it is our approach to apportion the safe income on hand, to which the entire gain is in part attributable, proportionately to each part of the gain. Therefore, the amount of safe income on hand that would be attributable to the Opco preferred shares immediately following the transfer to Holdco will be determined using the following formula:
A x B/C
where:
A) is the safe income on hand attributable to the shares of Opco held by the individual immediately before the transfer or safe income determination time relating to the series of transactions which included the transfer;
B) is the potential gain on the preferred shares of Opco held by Holdco; and
C) is the potential gain on the shares of Opco immediately before their transfer to Holdco.
Furthermore, subsequent to the exchange of a common share for a preferred share, safe income may accrue to the preferred share only to the extent of the dividend entitlement attached to the share.
Although it is a question of fact whether the provisions of subsection 245(2) of the Act would apply to a specific transaction or series of transactions, it is our general view that subsection 245(2) will not apply to a transaction or series of transactions which is subject to the scrutiny of a specific anti-avoidance provision, such as subsection 55(2), unless such transaction or series of transactions has been structured to circumvent the provisions of the specific provision.
We trust our comments will be of assistance to you. These comments are provided in accordance with the guidelines set out in paragraph 22 of Information Circular 70-6R4 issued on January 17, 2001.
Yours truly,
for Director
Reorganizations and Resources Division
Income Tax Rulings Directorate
Policy and Legislation Branch
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