8 January 2002 Internal T.I. 2001-0097357 - Cost of property acquired from a NAL person

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 CCRA.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.

Principal Issues: Computation of cost and ACB of certain shares acquired in a non-arm's length transaction where a promissory note issued as full consideration had a fair market value less than its principal amount.

Position: Cost is based on the amount paid by the taxpayer to acquire the shares. In this case it is the fair market value of the promissory note.

Reasons: The law.

January 8, 2002

	Elizabeth Bernard	HEADQUARTERS
	Technical Advisor	Reorganizations and
	Ottawa Tax Services Office	  Resources Division
		Michael Cooke
(613) 957-2126

		2001-009735

Cost of Property Acquired From a Non-Arm's Length Person

We are replying to your memorandum of August 17, 2001, in which you requested our views concerning the cost or adjusted cost base ("ACB") of certain shares of the capital stock of a corporation under the Income Tax Act (the "Act") that are acquired in a transaction involving non-arm's-length persons.

In your memorandum, you indicate that an individual resident in Canada ("Mr. A") owned all the issued and outstanding common shares of the capital stock of a corporation ("Opco"). On XXXXXXXXXX, and pursuant to signed purchase and sale agreements, Mr. A sold XXXXXXXXXX % of his Opco shares to his adult son ("S") and XXXXXXXXXX% of his Opco shares to his daughter-in-law ("D"). Mr. A accepted a promissory note from each of S and D as sole consideration for the respective Opco shares sold to S and D. Each promissory note had a principal amount that was equal to the fair market value of the aggregate number of the Opco shares acquired by S and D, respectively. The promissory notes are also non-interest-bearing and are repayable in XXXXXXXXXX annual instalments of $XXXXXXXXXX each, with any remaining principal amount owing due on XXXXXXXXXX. The promissory notes are not repayable on demand.

Based on the CCRA's valuation report, the fair market value of the promissory notes is substantially less than the fair market value of the number of Opco shares for which each note was issued as consideration. We understand that the fair market value of the Opco common shares is not in dispute. Based on the terms of the purchase and sale agreements entered into by each of the parties, as described above, it appears that the parties intended for the transactions to take place on a fair market value basis.

The taxpayer's representative maintains that since S and D are each required to pay Mr. A the full principal amount of their respective promissory notes, the aggregate cost (and ACB) of the Opco shares acquired by each of S and D, respectively, should be equal to that amount. The taxpayer's representative also points out that if Mr. A had simply gifted his Opco shares to S and D, the shares would be deemed to have a cost equal to their respective fair market value pursuant to paragraph 69(1)(c). He questions why his clients should be worse off because they attempted to transact on a fair market basis.

It is your position that the aggregate cost, and consequently the aggregate ACB, of the Opco shares acquired by each of S and D in this situation should be equal to the fair market value of the respective promissory note which was issued as consideration for those shares. You ask whether we concur with your views.

Our Comments

The ACB of a capital property is equal to its "cost" to the taxpayer plus or minus the adjustments described in subsections 53(1) and (2) of the Act. Since "cost" is not a defined term in the Act, reference must be made to its ordinary meaning and to related jurisprudence. The courts have accepted that cost means the amount, expressed in terms of money, that a person paid or gave up in order to acquire the property¹ absent some specific overriding provision of the Act, such as subsection 69(1).

Consequently, the cost of the Opco shares acquired by S and D would be equal to the fair market value of their respective promissory note issued by such person as consideration since this is the value of what each of S and D gave up in order to acquire their respective Opco shares. Moreover, while the taxpayer's advisor is correct in stating that if Mr. A had simply gifted these shares to S and D the cost of those shares to S and D would have been determined under paragraph 69(1)(c), this is not what the parties actually did. Absent situations involving a sham or the application of some specific overriding provision in the Act, the income tax consequences that arise from legally binding transactions entered into by a taxpayer cannot be simply be ignored because other transactions may have yielded a more favourable income tax result.

XXXXXXXXXX

Should you wish to discuss any issues raised in this memorandum, please contact Michael Cooke at 957-2126.

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 Department's mainframe computer. A severed copy will also be distributed to the commercial tax publishers for inclusion in their database. 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. You should make request for this latter version to Jackie Page at (819) 994-2898. The severed copy will be sent to you for delivery to the client.

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

ENDNOTES

¹ See D'Auteuil Lumber Company Limited v. The MNR, 70 DTC 6090 and Geoffrey Stirling v. The Queen, 85 DTC 5199 (FCA).

¹ In various "butterfly" rulings (see paragraph 55(3)(b)) we generally accept, as a statement of fact from the particular taxpayer, that a non-interest bearing note that is payable on demand and issued as consideration for certain property acquired by the taxpayer may have a fair market value equal to its stated principal amount. However, the determination of this issue remains a question of fact that can only be determined on a case-by-case basis.

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