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 Can an amount received as proceeds on the redemption of shares be retroactively converted to a retiring allowance?
Position: No.
Reasons: To qualify as a retiring allowance, the amount paid on or after the employee's retirement has to be paid in recognition of long service and not for the redemption of the shares of the employer held by the employee.
April 10, 2001
XXXXXXXXXX TAX CENTRE HEADQUARTERS
XXXXXXXXXX M.P. Sarazin, CA
Office Examination (613) 824-5441
2001-007245
XXXXXXXXXX (the "Taxpayer") (XXXXXXXXXX)
We are writing to you in response to your memorandum of February 26, 2001, requesting our views regarding the taxation of amounts paid by XXXXXXXXXX ("Holdco") to the Taxpayer in XXXXXXXXXX.
Our understanding of the facts is as follows:
1. The Taxpayer worked for XXXXXXXXXX years for XXXXXXXXXX (the "Employer") and retired from his employment with the Employer in XXXXXXXXXX. Employer is a subsidiary wholly-owned corporation of Holdco.
2. While employed with the Employer, the Taxpayer acquired XXXXXXXXXX common shares of Holdco from other employees of the Employer. The Taxpayer dealt at arm's length with these other employees of the Employer. The common shares were acquired as follows:
XXXXXXXXXX.
3. On XXXXXXXXXX, the Taxpayer filed a T664 election to report a capital gain on the common shares of Holdco owned at the end of February 22, 1994. The fair market value of the common shares of Holdco on February 22, 1994 was reported as $XXXXXXXXXX.
4. Prior to retiring, the Taxpayer tried to sell his shares of Holdco to other employees of the Employer. None of the other employees were interested in acquiring the shares of Holdco from the Taxpayer at that time. Consequently, in XXXXXXXXXX, Holdco redeemed the shares held by the Taxpayer for $XXXXXXXXXX.
5. In XXXXXXXXXX, Holdco reported the deemed dividend, under subsection 84(3) of the Act, of $XXXXXXXXXX. On receiving his T5 for the deemed dividend, the Taxpayer realized that he would not get the benefit of the capital gains treatment on the disposition of his shares. Consequently, the Taxpayer asked the Employer to change the treatment of the payment from redemption proceeds to a retiring allowance. Holdco filed an amended T5 for the Taxpayer canceling the original amount reported as a dividend and the Employer issued an amended T4A to the Taxpayer for XXXXXXXXXX reporting the payment of a retiring allowance in XXXXXXXXXX of $XXXXXXXXXX. On XXXXXXXXXX, the Taxpayer entered into an agreement with each of Holdco and the Employer whereunder the Employer agreed to treat the payment made in XXXXXXXXXX to the Taxpayer as a retiring allowance of $XXXXXXXXXX and Holdco agreed to account for the redemption of its shares held by the Taxpayer for an amount equal to its paid-up capital of $XXXXXXXXXX. We note that the agreements are dated several months after the payment was made by Holdco, the retiring allowance reported on the T4A did not agree to the amount of the retiring allowance referred to in the agreement between the Employer and the Taxpayer, and the Employer did not withhold any withholding taxes on the payment of the retiring allowance to the Taxpayer.
6. The Taxpayer contributed $XXXXXXXXXX to his registered retirement savings plan ("RRSP") in the first 60 days of XXXXXXXXXX and claimed the deduction for the contribution under paragraph 60(j.1) of the Act in his XXXXXXXXXX Personal Income Tax Return (the "Return").
7. On XXXXXXXXXX, the Taxpayer, through a representative, requested that the Taxpayer's Return be amended to reflect the business investment loss of $XXXXXXXXXX realized on the redemption of the common shares by Holdco.
8. In XXXXXXXXXX, a Business Equities Valuation Report was issued by the Valuations Section of the XXXXXXXXXX Tax Services Office. The valuator concluded that the fair market values of $XXXXXXXXXX on February 22, 1994 and $XXXXXXXXXX on XXXXXXXXXX for the XXXXXXXXXX common shares of Holdco were reasonable. The valuator noted that it was the Employer's intention to pay $XXXXXXXXXX for the acquisition of the XXXXXXXXXX common shares of Holdco until the Taxpayer requested that the payment be categorized as a retiring allowance.
9. On XXXXXXXXXX, you wrote to the Taxpayer advising that his Return would not be amended to reflect the requested business investment loss of $XXXXXXXXXX. In fact, the Return was reassessed on the basis that the amount of the retiring allowance reported on the T4A ($XXXXXXXXXX) represented proceeds of disposition and not a retiring allowance. The reassessment resulted in a capital gain of $XXXXXXXXXX being added to the Taxpayer's Return for the disposition of the XXXXXXXXXX common shares of Holdco.
10. On XXXXXXXXXX, the Taxpayer, through his representative, responded to your letter by stating that the reassessment was incorrect because subsection 84(3) of the Act would have applied to the redemption of shares by Holdco. In addition, the representative advised you that the proposed reassessment will result in the payment from Holdco being included in the Taxpayer's Return twice, once as proceeds of disposition in computing the capital gain described in the reassessment and as a retiring allowance originally reported in the Return.
A retiring allowance is defined in subsection 248(1) of the Act to mean an amount received
(a) on or after retirement of a taxpayer from an office or employment in recognition of the taxpayer's long service, or
(b) in respect of a loss of office or employment of a taxpayer, whether or not received as, on account or in lieu of payment of, damages or pursuant to an order or judgment of a competent tribunal, by the taxpayer or, after the taxpayer's death, by a dependent or a relation of the taxpayer or by the legal representative of the taxpayer.
The determination of whether an amount would constitute a retiring allowance for purposes of the Act depends on the facts of each case. In order to conclude that the amount paid to the Taxpayer constituted a retiring allowance for purposes of the Act, you would have to support a conclusion that the $XXXXXXXXXX was paid by the Employer to the Taxpayer in recognition of the Taxpayer's long service with the Employer. Since the amount was paid by Holdco in XXXXXXXXXX at the time that Holdco redeemed the XXXXXXXXXX common shares of its capital stock held by the Taxpayer and, as confirmed by your office, the Employer does not normally pay significant retiring allowances to its retiring employees, we would find it difficult to support a conclusion that the amount paid in XXXXXXXXXX was a retiring allowance for purposes of the Act. The XXXXXXXXXX agreements should not result in the retroactive conversion of redemption proceeds into a retiring allowance for purposes of the Act. Consequently, we agree with your conclusion that the amount received by the Taxpayer from Holdco represented proceeds on the redemption of the XXXXXXXXXX common shares of Holdco.
The Employer and Holdco agreed to convert a non-deductible capital payment into a deductible retiring allowance payment. The Taxpayer converted a deemed dividend under subsection 84(3) of the Act into a retiring allowance that would be taxed when it is withdrawn from his RRSP. Unfortunately, in computing the taxes owing on the reported deemed dividend, the Employer and the Taxpayer's advisors did not consider the effects of the claim for his allowable business investment loss and the reduction of taxes resulting from the dividend tax credit. The payment would have been subjected to total taxes of less than 15%.
In order to correct all of the reporting errors, you should consider the following reassessments:
(1) The Employer or Holdco would have claimed a deduction for the amount of retiring allowance reported on the amended T4A for XXXXXXXXXX. Since the amount was, in fact, proceeds for the redemption of shares and not a retiring allowance, the amount was not deductible by either the Employer or Holdco under the Act. Consequently, the claim for the deduction for the payment of the retiring allowance (by the Employer or Holdco, whichever has taken the deduction) should be disallowed.
(2) Since the Taxpayer did not receive a retiring allowance, the amount reported on the T4A should not be included in the Taxpayer's XXXXXXXXXX Return. Consequently, the $XXXXXXXXXX retiring allowance reported on the T4A by the Employer should be included in the Taxpayer's Return as a deemed dividend under subsection 84(3) of the Act. Since there was no retiring allowance paid in XXXXXXXXXX, the Taxpayer was not entitled to a deduction under paragraph 60(j.1) of the Act in XXXXXXXXXX. The reversal of the retiring allowance income inclusion will be offset by the disallowance of the deduction for the contribution to the RRSP under paragraph 60(j.1) of the Act.
(3) In order to avoid the double tax that would result when the $XXXXXXXXXX which will be taxed as a deemed dividend, as described in (2) above, and taxed again as RRSP income when it is withdrawn from the RRSP, the Taxpayer may withdraw the undeducted contributions from the RRSP and claim an offsetting deduction under subsection 146(8.2) of the Act. Consequently, the income inclusion resulting from the RRSP withdrawal will be offset by the deduction allowed under subsection 146(8.2) of the Act. We note that, in order to qualify for the deduction under subsection 146(8.2) of the Act, the Taxpayer would have to withdraw the amount from his RRSP in the year in which the Return is reassessed.
(4) The over-contribution to the Taxpayer's RRSP in XXXXXXXXXX would be subjected to tax under Part X.1 of the Act. We note that where the over-contribution resulted as a consequence of a reasonable error and steps are being taken to eliminate the excess (such as, the withdrawal of the excess contribution within the time allowed under subsection 146(8.2) of the Act), the Minister may waive the taxes that may be charged under Part X.1. You will have to make this decision based on your review of the facts in this case.
(5) As noted in 13 of Interpretation Bulletin IT-484R2, the Taxpayer would be entitled to claim the business investment loss resulting on the redemption of the shares by Holdco. As noted in 10 of IT-484R2, the business investment loss would be reduced by 4/3 of the amount deducted, under section 110.6 of the Act, as a capital gain deduction in 1994. Since the Taxpayer acquired the shares from an arm's length person after 1971, the provisions of subparagraph 39(1)(c)(vi) of the Act, as described in 8(b) of IT-484R2, would not apply to reduce the business investment loss.
The suggested amendments would result in the correct taxation of the amount received by the Taxpayer in XXXXXXXXXX. The Taxpayer would have to pay taxes of approximately $XXXXXXXXXX of income taxes on the $XXXXXXXXXX deemed dividend and there will not be any additional amount owed in respect of the RRSP withdrawals. This seems to be a reasonable resolution to this situation.
Since Holdco and the Employer have formatted subsequent share redemptions in this same format, you should review and correct these subsequent share redemptions at the same time.
For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Legislation Access Database (LAD) on the Canada Customs and Revenue Agency's mainframe computer. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, they can be provided with the LAD version, or they may request a copy severed using the Privacy Act criteria, which does not remove client identity. Requests for this latter version should be made by you to Mrs. Jackie Page at (819) 994-2898. A copy will be sent to you for delivery to the client.
Roberta Albert, CA
for Director
Financial Industries Division
Income Tax Rulings Directorate
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