Translation disclaimer
This translation was prepared by Tax Interpretations Inc. The CRA did not issue this document in the language in which it now appears, and is not responsible for any errors in its translation that might impact a reader’s understanding of it or the position(s) taken therein. See also the general Disclaimer below.
Principal Issues: Three professionals have been carrying on business through a partnership for many years. The partnership owns all the issued and outstanding shares of a corporation ("Serviceco") that renders services to the partners and their clients. The partnership would dispose of the shares of Serviceco in favour of a corporation ("Opco") owned by one of the partners. Serviceco would then be wound-up into Opco. Opco would then effectively pay the purchase price of the Serviceco shares. Whether section 84.1 or 245 would apply in the given fact situation.
Position: General comments provided. Section 84.1 would apply if it is established that the vendor(s) and Opco do not deal with each other at arm's length with respect to the disposition of the Serviceco shares. The situation where one party to a transaction is merely accommodating the other party in an attempt to obtain a certain tax result may be a situation where the parties are not dealing at arm's length because they do not have separate economic interests which reflect ordinary commercial dealings between parties acting in their own separate interest. This could be the case in the given situation if, among other things, it is established that a significant portion of Serviceco's assets consists of cash or near-cash. Subsection 84(2) or 245(2) may also be applicable if the given fact situation involves surplus stripping.
Reasons: Wording of the Act and previous positions.
2004-010306
XXXXXXXXXX S. Prud'Homme
(613) 957-8975
December 7, 2004
Dear Sir,
Subject: Request for technical interpretation - Sections 84.1 and 245(2)
This is in response to your fax of November 15, 2004, in which you requested our opinion regarding the potential application of sections 84.1 and 245 of the Income Tax Act (the "Act") in a particular situation.
Unless otherwise indicated, all statutory references herein are to provisions of the Act.
It appears to us that the situation described in your letter and summarized below may be an actual situation involving taxpayers. As explained in Information Circular 70-6R5, it is not the practice of this Directorate to provide comments on proposed transactions involving specific taxpayers otherwise than in the form of an advance income tax ruling. If your situation involved specific taxpayers and one or more completed transactions, you should submit all relevant facts and documentation to the appropriate Tax Services Office for its opinion. However, we are able to offer the following general comments that may be helpful. It should be noted that the application of one or more provisions of the Act generally requires an analysis of all the facts relating to a particular situation. Accordingly, and given that your letter only briefly describes a hypothetical situation, the comments we provide below may not be fully applicable in a particular situation.
1) Particular Situation
You have presented us with the situation described below (the "Particular Situation") as part of your request for a technical interpretation.
(a) Three chartered accountants had been practising in a partnership ("SENC") for more than 20 years. None of the three partners held an interest in SENC representing 50% or more of the total interest in SENC.
(b) SENC held all of the issued and outstanding shares of the capital stock of a private corporation ("Serviceco"). Serviceco provided services to SENC, as well as to SENC's clients. The fair market value ("FMV") of the shares of the capital stock of Serviceco held by SENC was approximately $600,000.
(c) Since chartered accountants are now permitted to incorporate their practice, the usefulness of Serviceco as a tax planning tool was no longer required. Accordingly, the following transactions were considered to terminate Serviceco.
(d) SENC would sell the shares in the capital stock of Serviceco to an existing corporation ("Opco") held by one of SENC's partners for a sale price of approximately $600,000.
Opco would own and actively carry on the business.
(e) As a result of the disposition of the shares of the capital stock of Serviceco described above, SENC would realize a capital gain of approximately $600,000, which would be allocated among the partners of SENC in accordance with the terms of the partnership agreement.
(f) Serviceco would then be wound up into Opco. Following this winding-up, Opco would ultimately pay the $600,000 sale price owed to SENC.
We have assumed that SENC would not be deemed to not deal at arm's length with Opco pursuant to paragraph 84.1(2)(b). We have also assumed that the partners of SENC are not related to each other within the meaning of subsection 251(2). Finally, we have assumed that all parties involved in the Particular Situation are resident in Canada.
2) Your Question regarding the Particular Situation
You wish to know whether section 84.1 or subsection 245(2) applies in the context of the Particular Situation.
3) Our Comments on the Particular Situation
First, it should be emphasized that your letter only briefly describes a hypothetical situation. Among other things, the information you provided with respect to each partner's interest in SENC is incomplete. In addition, your letter does not provide any information with respect to the shareholders' equity of Serviceco and Opco, the exact nature of the assets owned by Serviceco and Opco, the tax attributes of those assets, and the use that would be made of those assets in connection with and following the transactions described. Your letter also provides no information regarding the consideration paid by Opco to SENC. In particular, there is no statement of the source of the funds or property paid by Opco as consideration in the above transaction.
In the absence of such information, it is therefore impossible for us to give a definitive opinion on the potential application of section 84.1 or subsections 84(2) and 245(2) in the Particular Situation. However, we can make the following general comments.
Under paragraph 251(1)(c), whether or not unrelated persons are not dealing with each other at arm's length at a particular time is a question of fact. Paragraph 26 of Interpretation Bulletin IT-419R2 indicates, inter alia, that a situation where one party to a transaction is merely accommodating the other party in order to achieve a certain tax result may be a situation where those parties are not dealing at arm's length because they do not have separate economic interests which reflect ordinary commercial dealings between parties acting in their separate interests. This could be the case in the Particular Situation, for example, if a significant or material portion of Serviceco's assets were found to be cash or cash equivalents. To the extent that section 84.1 was applicable in the Particular Situation, a dividend would be deemed to be paid by Opco to SENC and received by SENC on the disposition of the shares of the capital stock of Serviceco. The partners of SENC would then be required to include their share of that dividend in their income for the relevant taxation year.
With respect to the potential application of subsection 84(2), it would be necessary to determine whether, in the context of the particular situation, any funds or property of Serviceco would be distributed or otherwise appropriated, in any manner, to SENC or its partners on the winding-up, discontinuance or reorganization of the business of Serviceco. To the extent that subsection 84(2) is applicable in the Particular Situation, a dividend would be deemed to be paid by Serviceco to SENC on the shares of the capital stock of Serviceco. The partners of SENC would then be required to include their share of that dividend in their income for the relevant taxation year.
Furthermore, the practice of the Income Tax Rulings Directorate is generally to rule on the application of subsection 245(2) only after reviewing all the facts and circumstances relating to transactions in the context of an advance ruling request. However, we are of the view that transactions or series of transactions of the type described above could, depending on the facts and circumstances of a particular situation, trigger the application of subsection 245(2). Indeed, certain stratagems could result in situations of surplus stripping from a particular corporation that would be contrary to the scheme of the Act. This scheme of the Act is derived from paragraph 12(1)(j), which refers to subdivision h, which includes subsection 84(2) and section 84.1. According to the jurisprudence, this scheme of the Act requires that a distribution of property from a corporation to its shareholders, regardless of the form of the distribution, be treated as income at the shareholder level, and not as a capital gain. Depending on the facts and circumstances of the Particular Situation, the Canada Revenue Agency would consider the application of subsection 245(2) to redetermine the tax consequences of the transactions described above and to recharacterize the proceeds received by SENC as a dividend.
In conclusion, and due to the fact that your letter does not contain several essential pieces of information, we are unable to comment on other tax implications that may result from the Particular Situation.
We hope that our comments are of assistance and look forward to hearing from you.
Stéphane Prud'Homme, Notary, M. Fisc.
For the Director
Corporate Reorganizations and Resource Industries Division
Income Tax Rulings Directorate
Policy and Planning Branch
All rights reserved. Permission is granted to electronically copy and to print in hard copy for internal use only. No part of this information may be reproduced, modified, transmitted or redistributed in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, or stored in a retrieval system for any purpose other than noted above (including sales), without prior written permission of Canada Revenue Agency, Ottawa, Ontario K1A 0L5
© Her Majesty the Queen in Right of Canada, 2004
Tous droits réservés. Il est permis de copier sous forme électronique ou d'imprimer pour un usage interne seulement. Toutefois, il est interdit de reproduire, de modifier, de transmettre ou de redistributer de l'information, sous quelque forme ou par quelque moyen que ce soit, de facon électronique, méchanique, photocopies ou autre, ou par stockage dans des systèmes d'extraction ou pour tout usage autre que ceux susmentionnés (incluant pour fin commerciale), sans l'autorisation écrite préalable de l'Agence du revenu du Canada, Ottawa, Ontario K1A 0L5.
© Sa Majesté la Reine du Chef du Canada, 2004
Email this Content