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.
Principal Issues: Application of section 84.1 before May 23, 1985 to a particular fact situation.
Position: General comments only.
Reasons: We do not provide confirmation of tax calculations.
October 25, 2005
Re: Non-arm's length sale of shares
This is in reply to your letter of August 4, 2005, wherein you requested our views on the computation of an individual's capital gain under the Income Tax Act (the "Act") in the following situation.
Briefly, in your letter you indicate that an individual resident in Canada ("Mr. X") subscribed for common shares of a taxable Canadian corporation ("Opco") in 1967. In 1983, Mr. X transferred his common shares of Opco to another taxable Canadian corporation ("Holdco") in exchange for preferred shares of Holdco having a fair market value equal to the common shares of Opco so transferred to Holdco at that time. Mr. X and Holdco did not deal with each other on an arm's length basis. Mr. X and Holdco filed a joint election under subsection 85(1) to defer any capital gain that would have otherwise been realized on the disposition of Mr. X's common shares of Opco (i.e. the agreed amount in the section 85 election was equal to the V-Day value of such shares). However, you also indicate that the preferred shares issued by Holdco as consideration had a paid-up capital equal to their fair market value.
You indicate that Mr. X wants to cause Holdco to redeem the preferred shares that were issued to him by Holdco in 1983. You indicate that unless there was a reduction in the paid-up capital of Mr. X's preferred shares of Holdco under subsection 85(2.1), Mr. X would realize a capital gain on the redemption of the preferred shares of Holdco to the extent that the amount paid by Holdco exceeds the adjusted cost base of such shares as determined under the rules in section 85. You have asked us to confirm that your calculation of Mr. X's capital gain is correct.
The situation outlined in your letter is a factual one, involving specific taxpayers. As explained in Information Circular 70-6R5 ("IC 70-6R5"), it is not this Directorate's practice to comment on proposed transactions involving specific taxpayers, other than in the form of an Advance Income Tax Ruling, nor is it our Directorate's practice to provide confirmation of income tax calculations. Confirmation of the income tax calculations involving specific taxpayers should be directed to the appropriate Tax Services Office. However, notwithstanding the above, we are prepared to offer the following general comments, which may be of some assistance.
The former version of section 84.1 could apply to deem an immediate capital gain and/or a reduction in the adjusted cost base of a share (or debt) of the purchaser corporation where the particular share transfer described in that section took place prior to May 23, 1985. For example, under the former version of paragraph 84.1(1)(a), where the consideration paid by the purchaser corporation included only shares of the purchaser corporation and cash, an immediate capital gain could arise on the disposition of the shares of the subject corporation. In very general terms, the amount of such capital gain would be the amount by which the lesser of (i) the adjusted cost base of the subject corporation's shares immediately before the disposition; and (ii) the amount of cash consideration; exceeded the paid-up capital of the subject corporation's shares immediately before the disposition.
Similarly, for example, under the former version of paragraph 84.1(1)(b), where the consideration paid by the purchaser corporation included only shares of the purchaser corporation, a reduction in the adjusted cost base of a purchaser corporation's shares could arise. Again, in very general terms, the amount of such reduction would be the amount by which the lesser of (i) the adjusted cost base of the subject corporation's shares; and (ii) the increase in the paid-up capital of the purchaser corporation's shares; exceeded the paid-up capital of the subject corporation's shares.
For your information we have provided a copy (attached) of section 84.1 as it applied to certain share dispositions that took place prior to May 23, 1985.
We trust that our comments will be of assistance to you. However, as stated in paragraph 22 of IC 70-6R5, the opinion expressed in this letter is not a ruling and consequently is not binding on the CRA.
David Palamar, Manager
Corporate Reorganizations Section
Reorganizations and Resources Division
Income Tax Rulings Directorate
Policy and Planning Branch
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