Principal Issues: An individual ("A") owns all of the issued and outstanding shares of the capital stock of a holding corporation ("Holdco"). More specifically, A owns Holdco common shares having a fair market value ("FMV") of $0,5 million, a nominal adjusted cost base ("ACB") and a nominal paid-up capital ("PUC"). A also owns Holdco preferred shares having a FMV and an ACB of $0,5 million, and a nominal PUC. The high ACB would be the result of a previous crystallization of the capital gains deduction by A. Holdco owns all of the issued and outstanding shares of the capital stock of an operating corporation ("Opco"). More specifically, Holdco owns Opco common shares having nominal FMV, ACB and PUC. Holdco also owns Opco preferred shares having a FMV and ACB of $1 million, and nominal PUC. A would first dispose of his or her Holdco common shares in favour of his or her children for FMV consideration. The children would then dispose of the Holdco common shares in favour of another corporation ("Newco") in consideration for a promissory note. The children would be the only shareholders of Newco. Holdco would then redeem its preferred shares owned by A. Opco would redeem its preferred shares owned by Holdco, in order to allow Holdco to repay the note issued to A. Holdco would pay dividends to Newco in order to allow Newco to repay the notes issued to the children. Whether section 84.1 or 245 would apply in the given fact situation.
Position: General comments provided. Section 84.1 would apply if, for legal purposes, it is established that A disposed of his or her Holdco common shares directly to Newco. Based on the proposed transactions, the children should be able to establish a "nil" amount, pursuant to subparagraph 84.1(2)(a.1)(ii) of the Act, as being the amount in respect of which a deduction under section 110.6 was claimed. It is the CRA's practice to comment on the application of subsection 245(2) of the Act only after reviewing all the facts and circumstances of a transaction in the context of an advance tax ruling. However, it is noted that the loss realized by A on the redemption of the Holdco preferred shares is the result of the crystallization of A's capital gains deduction. This capital loss could be applied to offset the capital gain apparently realized by A on the disposition of the Holdco common shares. These elements should be considered in examining the purpose of section 84.1. This provision is designed to prevent the removal of corporate surpluses as a tax-free return of capital through a non arm's length transfer of shares and the utilization of the capital gains deduction. Furthermore, transactions or series of transactions similar to those described in this letter could, depending on the facts and circumstances surrounding a particular situation, involve surplus stripping. The loss sustained by A on the redemption of the Holdco preferred shares would be denied under subsection 40(3.6) of the Act if, immediately after the redemption of such shares, it is established that A controlled, directly or indirectly in any manner whatever, Holdco.
Reasons: Wording of the Act and previous positions.