1 November 2002 External T.I. 2002-0146775 - Share Sale by Employees Yields Cap. Gain

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: (1) Whether 84.1 or 84(3) would apply to arm's length employees who sell their shares to a purchaser corporation incorporated for the purpose of the purchase? (2) Would such employees be denied the capital gain exemption in respect of the sale of their shares? (3) Would the GAAR apply?

Position: (1) No (2) No (3) No

Reasons: Provided that the purchaser corporation is not acting as an agent for the corporation whose shares are the shares being sold and provided the employee deals at arm's length with the corporations, the employee should be entitled to a capital gain on the sale of the shares to the purchaser corporation.

XXXXXXXXXX 2002-014677

November 1, 2002

Dear XXXXXXXXXX:

Re: Sale of Shares by Employees

We are writing in reply to your letter of June 12, 2002 wherein you requested our opinion regarding the application of subsections 84(3), 84.1(1) and 110.6(2.1) of the Income Tax Act (Canada) (all further statutory references in this letter are to the Act unless otherwise stated) in a situation where employees of a corporation sell their shares in the capital of that corporation to a purchaser corporation that is incorporated for the purpose of making the purchase.

The situation in your letter may be briefly described as follows:

1. "Opco" is a "Canadian-controlled private corporation".

2. Employees of Opco deal at arm's length with Opco and, as a group, own up to 14% of its issued common shares (the "Common Shares").

3. Pursuant to the terms of a shareholders' agreement to which each of the employees and other Opco shareholders will be a party, an employee will be required, upon the occurrence of certain specified events related principally to the employee's cessation of employment or insolvency, to sell his/her Opco Common Shares to a new corporation (herein called "Newco") for a cash purchase price equal to the then fair market value of such Common Shares.

4. Newco will be a "Canadian-controlled private corporation" that is incorporated for the purpose of acquiring Opco Common Shares from the employees. Newco will not be a subsidiary corporation of Opco nor its parent corporation. As well, Newco will not be controlled by any person or group of persons that control Opco.

5. At such time as Newco is required to purchase Opco Common Shares from an employee, Newco will obtain a non-interest bearing loan from Opco in an amount equal to the purchase price of the Opco Common Shares to be purchased.

6. Shortly after the purchase of Opco Common Shares from an employee, Newco will transfer such Common Shares to Opco for fair market value consideration.

Your question is whether either of subsections 84(3) or 84.1(1) will apply to the sale by an employee of Opco Common Shares to Newco to treat all or any part of the sale proceeds as a dividend. You have also asked whether the arrangement described herein would deny a deduction under subsection 110.6(2.1) to an employee who realizes a capital gain in respect of the sale of his/her Opco Common Shares to Newco. Lastly, you have asked whether subsection 245(2) would be applied to the arrangement described herein.

Your requests appear to relate to proposed transactions or completed transactions. Confirmation of the income tax consequences of proposed transactions involving specific taxpayers will only be provided in response to a request for an advance income tax ruling. To make such a request the advance income tax ruling must be submitted in accordance with the guidelines set out in Information Circular 70-6R5 ("IC-70-6R5") dated May 17, 2002. However, if the situation relates to a completed transaction a request for the Canada Customs and Revenue Agency's views must be made to your local Tax Services Office. We can, however, provide the following general comments.

A substantially similar arrangement was considered in our files 2000-0024635 (September 29, 2000) and E59476 (April 20, 1990), except that in those arrangements the corporation established to purchase shares from the employees was a subsidiary corporation of Opco. The views expressed in respect of those arrangements apply similarly to the arrangement you have described and, for your convenience, are repeated here with appropriate modifications to describe your arrangement:

1. In situations where a new corporation has been established (in the example you have given, "Newco") to facilitate the repurchase of Opco shares held by employees, our general position is that section 84.1 of the Act does not apply as long as the employees and the corporations are dealing with each other at arm's length and Newco is not purchasing the Opco shares as agent for Opco. Based on the same provisos, subsection 84(3) does not apply to the purchase by Newco of Opco shares held by the employees.

2. To the extent that all of the other criteria in section 110.6 of the Act are met, an arrangement such as the one described above would not, in and of itself, preclude a taxpayer from claiming a deduction under subsection 110.6(2.1) of the Act.

3. We would generally not apply subsection 245(2) of the Act to this type of arrangement.

Our comments are provided in accordance with the practice outlined in paragraph 22 of IC-70-6R5.

Yours truly,

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