14 February 2003 External T.I. 2002-0168815 - Deemed Capital Gain on Puc Reduction

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: Does a payment in reduction of paid-up capital that results in a negative adjusted cost base give rise to a capital gain?

Position: Yes

Reasons: The law

XXXXXXXXXX 2002-016881
Marc Edelson
February 14, 2003

Dear XXXXXXXXXX:

Re: Technical Interpretation Request: Negative Adjusted Cost Base on Paid-Up Capital Reduction

We are writing in reply to your letter of October 16, 2002 wherein you requested our opinion as to whether a capital gain may be deemed to be realized in connection with a reduction in the paid-up capital of shares. In this letter, all statutory references are to the Income Tax Act (Canada) unless otherwise stated.

In your letter you describe a situation that we have summarized as follows:

1. An individual resident in Canada acquired all of the shares of a Canadian-controlled private corporation in an arm's length transaction. The amount paid for the shares and the adjusted cost base ("ACB") of the shares to the individual is the nominal amount of $1.

2. The amount of the paid-up capital ("PUC"), as that term is defined in subsection 89(1), of the shares acquired by the individual is significant, say $10,000.

3. The shares represent capital property to the individual.

4. The corporation will take the necessary steps to reduce its PUC to $1 and will pay the individual the amount of the reduction, being $9,999.

Your request appears 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.

It is our view that, in the example given above, where the shares owned by the individual represent capital property to the individual:

(a) as the payment made on the reduction in the PUC of the shares does not exceed the amount of such PUC, no dividend will be deemed to have been paid to the individual as a result of the reduction in such PUC;

(b) as the amount received by the individual in respect on the reduction of the PUC of his shares is not deemed to be a dividend pursuant to subsection 84(4), the amount of such payment will be deducted in the calculation of the ACB to the individual of his shares pursuant to subparagraph 53(2)(a)(ii);

(c) as the amount to be deducted in computing the ACB to the individual of his shares ($9,999) will exceed the ACB to the individual of his shares immediately before that reduction ($1), pursuant to subsection 40(3) the excess ($9,998) will be deemed to be a gain of the individual from a disposition of his shares at that time;

(d) as the gain, in our example, is not otherwise included in the individual's income, paragraph 39(1)(a) will characterize the gain referred to in paragraph (c) above as a capital gain; and

(e) the amount of the gain referred to in paragraph (c) above ($9,998) will be added to the cost of the shares to the individual pursuant to paragraph 53(1)(a), effectively reinstating the ACB to the individual of the shares to a nil amount, while the PUC of the shares will be $1.

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

Yours truly,

for Director
International and Trust Division
Income Tax Rulings Directorate
Policy and Legislation Branch