31 October 1990 Income Tax Severed Letter 3M05110 - APFF octobre 1990 - Questions et réponses

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 Department.

15th
CONFERENCE

ASSOCIATION DE PLANIFICATION FISCALE ET
FINANCIERE

1990 CONFERENCE

REVENUE CANADA ROUND TABLE

1990 CONFERENCE

PRACTIONNERS: SEAN FINN, Attorney
Lavery O'Brien

GHISLAIN BROSSARD, C.A., Attorney
Mackenzie Gervais

PIERRE BRUNET, C.A.
Samson Bélair / Deloitte & Touche

REVENUE CANADA CAROLE GOUIN-TOUSSAINT, C.G.A.,
REPRESENTATIVES: Head of Working Group
on Internal Communications
Revenue Canada - Taxation

ANDRE THIBAULT, C.G.A.
Interim Director,
Bilingual Services and Resources
Industries Division
Revenue Canada - Taxation

MARC CUERRIER, Senior Counsel
Tax Counsel Division
Department of Finance Canada

ROBERT DUBRULE, Officer
Tax Policy and Legislation Branch,
Legislation Division,
Business, Property and Personal Section,
Department of Finance Canada
TABLE OF CONTENTS

I. - INCLUSION IN COMPUTATION OF INCOME .................. 1

Question 1 - Bond issue premium (Revenue Canada) # 41 - Marc Séguin ................................. 1

Question 2 - Reasonable allowance (Finance) ................... 2

Question 3 - Stock options (Finance) .......................... 3

II. - CAPITAL GAINS EXEMPTION ............................. 4

Question 4 - 24-month holding period (Revenue Canada) # 19 - M. Ton-That .................................. 4

Question 5 - Qualified shares (Revenue Canada) # 30 - A. LeBlanc ................................... 6

Question 6 - Capital gains exemption and death (Finance) ...... 7

Question 7 - Definition of "Investment income" (Finance) ...... 8

III. - DEDUCTIONS IN COMPUTATION OF INCOME ................... 9

Question 8 - Use of recreational facilities and sub-paragraph 18(1)(l)(i) of the Act (Revenue Canada) # 5 - A. Simard ...................................... 9

Question 9 - Food and beverage deduction (Finance) ........... 10

Question 10 - Deductibility of legal expenses (Revenue Canada) # 32 - V. Plant ..................................... 11

Question 11 - Capital loss (Revenue Canada) # 33 - V. Plant ..................................... 12

Question 12 - Deduction of insurance premiums (Revenue Canada/Finance) # 34 - G. Pelletier ................................. 13 Question 13 - Child Care Expenses - Section 63 (Finance) ..... 14

Question 14 - Inventory valuation (Finance) .................. 15

IV. - CORPORATIONS AND THEIR SHAREHOLDERS .................... 16

Question 15 - Benefit to shareholder (Revenue Canada) # 1 - G. Martineau ................................. 16

Question 16 - Debtor's gain on settlement of debt Section 80, IT-293R (Revenue Canada) # 3 - A. Simard .................................... 17

Question 17 - Group of persons (Revenue Canada) # 49 - A. Godin .................................... 18

Question 18 - Part III Tax (Finance) ......................... 19

Question 19 - Definition of "dividend" (Finance) ............. 20

Question 20 - Rollover and benefit conferred (Finance) ....... 21

V. - NON-RESIDENTS ........................................... 22

Question 21 - Certificate of disposition (Revenue Canada) # 31 - B. Barsalo .................................. 22

Question 22 - Interest payable to a non-resident (Revenue Canada) # 36 - B. Barsalo .................................. 23

VI. - CIVIL LAW CONCEPTS ..................................... 24

Questions 23 and 24 - Definition of trust (Finance) .......... 24

Question 25 - Partition of property (Finance) ................ 25

VII. - GENERAL ANTI-AVOIDANCE PROVISIONS ..................... 26

Question 26 - Capital gains exemption (Revenue Canada) # 27 - G. Martineau ................................ 26

Question 27 - Part IV Tax (Revenue Canada) # 16 - C. Thériault ................................ 27

VIII. - CAPITAL GAINS......................................... 28

Question 28 - Replacement property (Finance) ................. 28

Question 29 - Stock options (Finance) ........................ 29

IX. - FILING OF PRESCRIBED FORMS ............................. 30

Questions 30 and 31 - Filing deadlines (Revenue Canada) # 6 and 7 - R. Gagnon A. Simard .................................... 30

X. - COMPUTATION OF INCOME EARNED POST-1971 .................. 32

Question 32 - Impact of a change of control on computation of "safe income" (Revenue Canada) # 13 - A. Godin ...................................... 32

XI. - MISCELLANEOUS .......................................... 33

Question 33 - Rollover at death (Finance) .................... 33

Question 34 - Restrictions on interest (Revenue Canada) ...... 34

Question 35 - Scientific Research (Revenue Canada) # 4 - G. Pelletier ................................. 35

Question 36 - Associated corporations and control in fact (Revenue Canada) # 22 - M. Ton-That ................................. 37

Question 37 - Winding-up (Revenue Canada) # 43 - G. Martineau ................................ 39

Question 38 - Treatment of free rent (Revenue Canada) # 42 - C. Thériault ................................ 40

Question 39 - 55(2) - Safe income (Revenue Canada) # 23 - C. Thériault ................................ 41

Question 40 - Impact of S.R.T.C.s on the computation of "earned income" (Revenue Canada) # 14 - G. Pelletier .................................. 42

Question 41 - Winding-up of a corporation (Finance) .......... 43

Question 42 - C.N.I.L.s (Finance) ............................ 44

Question 43 - Non-resident (Finance).......................... 45

Question 44 - Gift of cultural property (Finance) ............ 46

Question 45 - Definition of automobile (Finance) ............. 47

Question 46 - Value of employee benefit (Revenue Canada) # 35 - M. Séguin .................................... 48

Question 47 - Benefit to shareholder (Revenue Canada) # 51 - G. Pelletier ................................. 49

Question 48 - Loan to shareholder (Revenue Canada) # 47 - R. Gagnon .................................... 50

Question 49 - Capital gains exemption (Revenue Canada) # 30 - M. Lambert ................................... 51

Question 50 - Superficial losses (Revenue Canada) # 29 - R. Gagnon .................................... 52

Question 51 - Paid-up capital (Revenue Canada) # 51 - R. Gagnon .................................... 53

Question 52 - Term "series of transactions" - paragraph 245(3)(b) (Revenue Canada) # 8 - A. Godin ...................................... 54 Question 53 - Associated corporations (Revenue Canada) # 46 - M. Ton-That ................................. 56

Question 54 - Investment expenses (Revenue Canada) # 37 - V. Plant .................................... 57

Question 55 - Listed personal property (Revenue Canada) # 2 - B. Mandeville ................................. 59

Question 56 - Allowance for use of an automobile - para. 18(1)(r) (Revenue Canada) # 9 - A. LeBlanc .................................... 60

Question 57 - Deduction of management fees (Revenue Canada) # 17 - V. Plant ..................................... 61

Question 58 - Business investment loss para. 39(1)(c) (Revenue Canada) # 20 - V. Plant ..................................... 62

Question 59 - Replacement property (Revenue Canada) # 25 - G. Pelletier ................................. 63

Question 60 - Cost determination (Revenue Canada) # 21 - P. Bourgeois ................................. 65 Question 61 - Replacement property (Revenue Canada) # 26 - V. Plant ..................................... 66

Question 62 - Interest for purposes of Part XIII (Revenue Canada) # 40 - B. Barsalo ................................... 67

Question 63 - Prescribed shares (Revenue Canada) # 48 - J.P. Simard .................................. 68

Question 64 - Cost of acquisition and paid-up capital (Revenue Canada) # 50 - P. Bourgeois ................................. 69

Question 65 - Acquisition of control (Revenue Canada) # 12 - M. Séguin .................................... 70

Question 66 - Rollover of property on death of spouse (Revenue Canada) # 15 - B. Mandeville ................................ 71

Question 67 - Compensatory benefit (Revenue Canada) # 24 - B. Mandeville ................................. 72

I. - INCLUSION IN COMPUTATION OF INCOME

QUESTION 1 Revenue Canada

BOND ISSUE PREMIUM

Interpretation Bulletin IT-114 specifies that the amount of a bond issue premium is to be included when computing the issuer's income if the latter is carrying on a lending business. Generally accepted accounting principles may require that a premium received for a bond be included progressively in income over the life of the bond. Does the Department of National Revenue consider that a financial institution which issues a bond and which receives a premium can recognize the income represented by the premium, or must it declare the premium as income in the year in which it was received?

ANSWER 1

BOND ISSUE PREMIUM

The Department is of the view that the premium must be included in income in the year in which it was received.

While it is true that generally accepted accounting principles apply when determining profits for tax purposes, the specific provisions of the Income Tax Act (Canada) (the "Act") and established legal principles regarding the notion of income must also be taken into account. Depending on whether the amount at issue was an expense or income item, the courts have ruled somewhat differently regarding the application of generally accepted accounting principles. In this case, given that the issuer holds an absolute right to the amount received, and that there is no restriction as to its use, the sum received has all the characteristics of income. In accordance with the principles established in Kenneth B.S. Robertson Ltd [[1944] C.T.C. 75] (1944) (2) D.T.C. 655, the full amount of the premium must be included in income by virtue of section 9 of the Act.

QUESTION 2 Finance

REASONABLE ALLOWANCE

For what reason are allowances of less than a reasonable amount excluded from the application of sub-paragraphs 6(1)(b)(vii) and (vii.1) of the Act by the Draft Amendments to the Income Tax Act and Related Statutes ("Technical Bill")?

ANSWER 2

REASONABLE ALLOWANCE

Sub-paragraphs 6(1)(b)(vii) and (vii.1) of the Act, as proposed in
the Thecnical Bill provide that only reasonable allowances are to
be excluded when computing income. Thus, allowances that are less
than a reasonable amount will, like all allowances in excess of
reasonable amounts, be included when computing employee income.
This will have the effect of permitting the deduction of expenses
referred to in paragraph 8(1)(b) of the Act (travelling expenses)
and in new paragraph 8(1)h.1) of the Act (motor vehicle expenses)
if all the conditions are met. At the present time, only employees
receiving allowances in excess of a reasonable amount may deduct
their expense commission may already deduct their expenses when
they receive allowances of less than a reasonable amount.
QUESTION 3 Finance

STOCK OPTIONS

New paragraph 7(1)(e) of the Act as proposed in the Thecnical Bill stipulates that, at the death of an employee, there is a taxable benefit to the employee equal to the difference between the fair market value of the option immediately after death and the price paid to acquire the option. However, the Technical Notes refer to the difference between the fair market value of the option immediately before death and the price paid to acquire the option.

Since the fair market value of an option immediately before death may differ from its fair market value immediately after death (following receipt of a life insurance policy, for example), can the Department of Finance confirm whether the value of options immediately before or immediately after death should be used in determining the taxable benefit?

ANSWER 3
STOCK OPTIONS

The value of the option immediately after death should be used. Therefore, as the amendment itself is correct, the Technical Notes will be revised accordingly.

II. CAPITAL GAINS EXEMPTION

QUESTION 4 Revenue Canada

• 24- MONTH HOLDING PERIOD

For a share to qualify at determination time as a "Qualified Small Business Corporation share" for purposes of subsection 110.6(1) of the Act, the share may not have been owned by anyone other than the individual or a person or partnership related to that individual throughout the 24-month period preceding the determination time.

Spouses are related persons pursuant to paragraph 251(2)(a) of the Act. The death of one of the spouses ends the marriage and after that time they can no longer be considered related persons.

As a deceased spouce is not a related person with respect to the surviving spouse, will the surviving spouse, who inherits shares from his/her deceased spouse, have to keep the shares for 24 months in order for the shares to be considered "Qualified Small Business Corporation shares"?

Alternatively, can the view be taken that subsection 70(6) of the Act deems that the surviving spouse acquired the shares immediatly prior to the death of his or her spouse, and that consequently, the period during which the deceased spouse owned the shares will be considered in determining whether the 24 month holding period test is met when the surviving spouse disposes of the inherited shares?

ANSWER 4

• 24- MONTH HOLDING PERIOD

It is our view that subsection 70(6) of the Act does not have the effect of deeming the surviving spouse to have acquired the shares immediately prior to the death of his or her spouse.

The definition in subsection 110.6(1) of the Act refers to ownership. To determine ownership, one must refer to either common law or civil law principiles. Paragraph b) of the definition of "Qualified Small Business share" in subsection 110.6(1) of the Act requires that throughout the 24-months preceding the time of the disposition, the shares were not owned by anyone other than the taxpayer or a person or partnership related to the taxpayer who disposed of the share.

Paragraph b) of the definition first requires determination of the legal owners (the "former owners") of the shares during the 24- month period preceding the "determination time", that is, the time of disposition of the shares. Next, it must be determined whether the former owners were related to the disposing taxpayer. In order to make this determination one must determine at what moment in time the disposing taxpayer must be related to the former owners.

During the October, 1990 Round Table, we indicated that the disposing taxpayer had to be related to each of the former owners only during the part of the 24-month period preceding the determination time during which the former owner was the owner of the shares. This would permit a capital gains deduction for the surviving spouse.

However, it was subsequently established that there are other possible interpretations which might lead to a different result. We are therefore unable to confirm that the above interpretation is definitive.

Revenue Canada, Taxation in conjunction with the Department of Finance is studying this matter. Once we have reached definitive conclusions, these will be communicated to you.

QUESTION 5 Revenue Canada

QUALIFIED SHARES
A corporation which is a member of a purchasing group or a
franchise may be required, by virtue of the membership contract or
the franchise agreement. These shares could be of a public
corporation, to acquire shares of the supplier, or the franchisor.

A corporation which is a member of a purchasing group or belongs to a group of merchants which share a corporate banner may be required, by virtue of the membership contract to acquire some shares of the supplier which is a plubic corporation. In these circumstances wath is Revenue Canada's opinion as to wheter the shares of the supplier corporation are assets used in a business carried on by the corporation for the purposes of the definition of Qualified Small Business Corporation Shares in subsection 110.6(1) of the Act? To the extent that the shares of the supplier corporation are acquired in the ordinary course of its activities will this result in the shares of the franchisor or supplier being considered to be assets used in a business carried on by the corporation?

ANSWER 5

QUALIFIED SHARES
It is a question of fact whether a particular asset is used in a
business carried on by a corporation for the purpose of determining
whether the corporation is a "Small Business Corporation" as
defined in subsection 248(1) of the Act. Generally speaking,
Revenue Canada, Taxation, will consider that an asset is used in a
business carried on by it if it is principally used in that
business and at risk with respect to that business. This implies
that the risk must be more than a remote risk and that the use of
the asset must go beyond simply using it for business purposes.

It would seem to us that shares in a public corporation held by the
member corporation in the corporate group could be considered to be
used in the business it operates provided that the subscription to
such shares is a condition for membership in the public corporate
group. However our interpretation would differ in circumstances
where the shares of the supplier are acquired by a member of a
group or association whithout them being obliged to acquired them.
QUESTION 6 Finance

CAPITAL GAINS EXEMPTION AND DEATH

The proposed amendment to subsection 110.6(14) of the Act is of a relieving nature in that it provides for a greater flexibility as to the access to the capital gains exemption with respect to shares held by a taxpayer at death.

It is proposed that at the time of a taxpayer's death, he/she will be entitled to a capital gains exemption if the shares held at the time of death were SBC shares at a particular time in the 12 months prior to death. At present, shares could be disqualified if they were not SBC shares at the time of death. Since the determination is made immediately prior to death, the taxpayer's estate cannot purify the corporation.

Would it not be preferable to allow purification during the 12 months after death in order to put the deceased taxpayer on the same footing as a taxpayer who sells his/her shares during his/her lifetime?

ANSWER 6

CAPITAL GAINS EXEMPTION AND DEATH

Paragraph 110.6(14)g) of the Act was included in the Thecnical Bill due to criticism of the strictness of the Qualified Small Business Corporation Shares with respect to test a taxpayer who dies during a taxation year. Your suggestion of a post mortem purification would seem to risk being a very imperfect and uncertain tool in controlling access to the exemption. What should be done when the purified corporation becomes recontaminated? How long must the corporation remain pure, etc.? It would appear more natural to base the qualification on a well-established situation of fact occurring in the past, through a broadened retrospective test which would apply to the 12 months prior to death. Finally, we should note that for taxpayers who are concerned with the possibility of dying at time when their shares are not qualified, rollovers to the spouse or children, depending on the case, might permit purification prior to an eventual sale by the spouse or children. Hence, new paragraph 110.6(14)g) of the Act does not apply when there are other means for purifying a corporation even after the death.

QUESTION 7 Finance

DEFINITION OF "INVESTMENT INCOME"

In C.N.I.L. (Cumulative Net Investment Loss) calculations, account is taken of the inclusion required under subsection 15(2) of the Act ("shareholder loans") and of the deductions provided in paragraph 20(1)(j) of the Act.

There is a proposal to amend the definition of C.N.I.L. to exclude these provisions in calculating C.N.I.L. retroactively to 1988, which means that a number of taxpayers will be affected within respect to the 1989 and 1990 taxation years.

What is the justification for such a change? Should it not apply only for the years 1991 onward?

ANSWER 7

DEFINITION OF "INVESTMENT INCOME"

This amendment was proposed at the request of taxpayers who repay, during the course of a year, a sum which had previously been considered as income by virtue of subsection 15(2) of the Act and included for purposes of calculating C.N.I.L. It is possible, however, that retroactive exclusion of the amounts included under this subsection in calculating investment income, as well as that of the amounts included under paragraph 20(1)(j) in calculating investment expenses, will result in considerable practical difficulties and in preferred treatment for taxpayers who may already have benefitted from the exemption as a result of the former C.N.I.L. calculation. In light of this problem, we recommended to the Minister of Finance a change which would provide for exclusion from the C.N.I.L. calculation of amounts included in subsection 15(2) of the Act from 1990 onward, and for the exclusion from this same calculation of amounts included in paragraph 20(1)(j) from 1988 onward, but only with respect to amounts included by virtue of subsection 15(2) of the Act since 1988.

III. DEDUCTIONS IN COMPUTATION OF INCOME

QUESTION 8 Revenue Canada

USE OF RECREATIONAL FACILITIES AND
SUB-PARAGRAPH 18(1)(l)(i) OF THE ACT
a) In The Queen v. Sie-Mac Pipeline Contractors Ltd. [[1990]
2 C.T.C. 8] 90 D.T.C. 6344, the Federal Court, Trial
Division ruled that expenses incurred by a taxpayer in
order to entertain clients at a lodge are not restricted
by of sub-paragraph 18(l)(i) of the Act. What is the
position of the Department of National Revenue with
respect to this decision?

• b) The term "chalet" used in the French version in sub- paragraph 18(1)(l)(i) of the Act was changed to "chalet- hôtel" in 1985. What is the scope of this change especially with respect to the french version paragraph 3 of Interpretation Bulletin IT-148R2?

ANSWER 8

USE OF RECREATIONAL FACILITIES AND
SUB-PARAGRAPH 18(1)(l)(i) OF THE ACT

• a) The Department of National Revenue disagrees with the interpretation given by the Court to the term "use" in this case. The Court ruled that since the taxpayer had neither rented nor had exclusive use of the lodge, he was not subject to the restrictions of sub-paragraph 18(1)(l)(i) of the Act. This decision is contrary to the Federal Court of Appeal decision in The Queen v. Jaddco Anderson Limited, [[1984] C.T.C. 137] 84 D.T.C. 6135. The Department of National Revenue has therefore decided to appeal the decision in this case.
• b) The term "chalet" used in sub-paragraph 18(1)(l)(i) of the Act was replaced by the term "chalet-hôtel" in order to reconcile the French version with the English version (which uses the term "lodge") of the Act. Paragraph 3 of IT-148R2 has not yet been changed to reflect this change: the word "chalet" in the (French version) of this paragraph should be replaced by the term "chalet-hôtel" (lodge).

QUESTION 9 Finance

FOOD AND BEVERAGE DEDUCTION

Does the amendment proposed by the Thecnical Bill to paragraph 67.1(2)(e) of the Act mean that food, beverages or entertainment must be offered on the business premises of the employer in order to avoid the restriction provided in subsection 67.1(2) of the Act?

ANSWER 9

FOOD AND BEVERAGE DEDUCTION

No. In fact, one of the intentions of the proposed amendment is to clarify this point. Food, beverages or entertainment may be consumed by employees working on the business premises of the person who incurred the expenses related thereto. It should be noted that although the French version of this paragraph uses the expression "consumed by employees", it will be considered that the exception also applies when the food, beverages or entertainment are consumed by a spouse or children of an employee, provided that the same conditions are met, that is, that they are offered to all spouses and children.

QUESTION 10 Revenue Canada

DEDUCTIBILITY OF LEGAL EXPENSES

Could you confirm the position of the Department of National Revenue as to the deductibility, when calculating a taxpayer's income for a taxation year, of sums paid during the year by the taxpayer as fees or expenses incurred in order to prepare, institute or prosecute an objection, or to prepare, institute or prosecute an appeal in relation to:

• i) an assessment under a provincial law imposing a tax such as Quebec's Loi concernant l'impôt sur la vente en détail (trans.: Retail Sales Tax Act) L.R.Q., c.l-1;
• ii) an assessment of tax, interest or penalties under the Excise Tax Act, R.S.C., ch. E-13 and Bill C-62 (Goods and Services Tax).

ANSWER 10

DEDUCTIBILITY OF LEGAL EXPENSES

The general rule, as outlined in paragraph 1 of Interpretation Bulletin IT-99R3, is that legal and accounting expenses are deductible if:

• a) they are incurred with a view to gaining income from a property or business; and
• b) they are not capital expenditures.

If these conditions are met, the expenses described in your example
would be deductible when computing business or property income. In
a case in which a taxpayer does not earn business or property
income, objection or appeal expenses are not deductible except in
cases there they constitute fees or expenses allowable under
paragraph 60(o) of the Act. Paragraph 60(o) of the Act includes
representation expenses incurred with respect to the Act or the
Quebec Income Tax Act and the Unemployment Insurance Act.
QUESTION 11 Revenue Canada
CAPITAL LOSS

In the case of Scott v. M.N.R. [[1989] 1 C.T.C. 2305] 89 D.T.C. 281 ("Scott"), the Tax Court of Canada ruled that interest paid on sums borrowed to make interest-free loans to a corporation owned by the borrower is not deductible by virtue of paragraph 20(1)(c) of the Act because it was not borrowed for the purpose of gaining or producing income from a business or property.

Sub-paragraph 40(2)(g)(ii) of the Act provides that, in general, a capital loss resulting from the disposition of a debt is nil unless the debt was acquired for the purpose of gaining or producing income from a business or property.

What is the position of the Department of National Revenue with respect to the Scott decision? Does the Department intend to refuse the capital loss deduction resulting from the disposition of an interest-free debt? If not, under what circumstances does it intend to accept such a deduction?

ANSWER 11
CAPITAL LOSS

The Scott decision with respect to sums borrowed and interest paid takes into account the specific context of this case. The Department of National Revenue continues to apply the position described in Interpretation Bulletins IT-445 and IT-239R2, and applies the principles established in the Ways and Means Notice of Motion tabled on November 26, 1989 by the Minister of Finance with respect to pre-1991 borrowings.

Only a shareholder who meets the four following conditions can claim a capital loss upon disposition of a debt which does not bear reasonable interest rate.

• a) the corporation to whom the loan was made used the borrowed funds in order to produce income from business or property, or used the borrowed funds to lend money at less than a reasonable rate of interest to its Canadian subsidiary which in turn is to be used to produce income from business or property;
• b) the corporation has made every effort to borrow the necessary funds through the usual commercial money markets but cannot obtain financing;
• c) the corporation has ceased permanently to carry on its business; and

d) the loan from the shareholder to the corporation at less
than a reasonable rate of interest does not result in any
undue tax advantage being conferred to either the
shareholder or the corporation.QUESTION 12 Revenue Canada/Finance

DEDUCTION OF INSURANCE PREMIUMS

In the case of The Queen v. Antoine Guertin Ltd. [[1988] 1 C.T.C. 117], [[1988] 1 C.T.C. 360] D.T.C. 6126 ("Guertin"), the Federal Court of Appeal ruled that the premiums paid on a "whole life" insurance policy did not constitute an expense incurred "in the course of borrowing" under paragraph 20(1)(e) of the Act.

Does the Department of National Revenue intend to modify or refine Interpretation Bulletin IT-309R in light of the Guertin case as it applied for the pre-1990 period, that is, the date set for entry into effect of the new paragraph 20(1)(e.2) of the Act proposed in the Technical Bill? More specifically, is it the view of the Department of National Revenue that a portion of whole or term life insurance premiums paid should be deductible in certain circumstances for this period?

As regards the new paragraph 20(1)(e.2) of the Act proposed in the Technical Bill and applicable to premiums payable after 1989, why, in the opinion of the Department of Finance, has its application been limited to cases in which the lender is a corporation?

ANSWER 12 Finance

DEDUCTION OF INSURANCE PREMIUMS

New paragraph 20(1)(e.2) of the Act provides for a limited deduction for life insurance premiums when the insurance is required in order to obtain a loan. Such a requirement is usual only when the lender considers that the death of the insured person would compromise repayment of the loan. As a result, the proposed amendment requires that the lender require that the policy to be assigned. Furthermore, in order to ensure that the deduction applies in situations in which it is normal business practice to provide for such an assignment, the proposed amendment applies to loans granted by an institution, generally a corporation, whose principal business is the lending of money.

ANSWER 12 Revenue Canada

DEDUCTION OF INSURANCE PREMIUMS

The Department of National Revenue's position is that the
conditions described in Interpretation Bulletin IT-309R concerning
the deductibility of life insurance premiums payable pre-1990 as
financing costs remain in effect.
QUESTION 13 Finance

CHILD CARE EXPENSES - SECTION 63

According to section 63 of the Act, child care expenses may be deducted only by the spouse with the lesser income. In the case of Fiset v. M.N.R. [[1988] 1 C.T.C. 2335] (88) D.T.C. 1226 ("Fiset"), the Tax Court of Canada ruled that if a spouse had no income, he/she could not be deemed to have the lesser income. What is the position of the Department of Finance with respect to the Fiset decision?

Is it the opinion of the Department of Finance that the amendments to section 3 of the Act as proposed in the Technical Bill are consistent with the Fiset decision?

ANSWER 13

CHILD CARE EXPENSES - SECTION 63

The proposed amendment is intended to specify that the income of a taxpayer for purposes of Part I of the Act is equal to zero if in a given taxation year the taxpayer has no income or suffers a net loss. In the Fiset case, the court concluded that it was impossible to determine which of the two spouses had the higher income when one of the two had no income. The proposed amendment is intended to confirm the generally accepted interpretation that when spouse "A" has no income, and spouse "B" does have income, it is spouse "B" who has the higher income.

QUESTION 14 Finance

INVENTORY VALUATION

Subsection 10(2.1), as proposed in the Technical Bill, will be added to the Act in order to provide that the inventory of a taxpayer at the end of a taxation year shall be computed in the same manner as for the preceding taxation year unless the taxpayer obtains the concurrence of tax authorities to change this method. This amendment is intended to insert in the Act the accounting principle that financial statements are to be prepared using consistent principles from one year to the next.

Was this amendment necessary in light of the Federal Court of Appeal decision in The Queen v. Cyprus Anvil Mining Corporation, [[1990] 1 C.T.C. 153] 90 D.T.C. 6063? This decision upheld the position of tax officials who applied the principle of consistency in calculating inventory for tax purposes.

ANSWER 14

INVENTORY VALUATION

Although this decision upheld our position, we felt that it would be timely to legislate in this matter. Indeed, we believe that it is important for the Act to require a consistent method for inventory valuation rather than a simple stipulation that properties making up the inventory at the beginning of the year be valued the same as they were valued at the preceding year-end.

Sub-question: What are the criteria for changing methods?

Answer: These will be established by the Department of
National Revenue.
IV. CORPORATIONS AND THEIR SHAREHOLDERS

QUESTION 15 Revenue Canada

BENEFIT TO SHAREHOLDER

THE FACTS:

- Mr. A is the sole shareholder of Opco 1
- Mr. A and Mr. B (unrelated to Mr. A) each hold 50% of the
issued shares of Opco 2's capital stock.
- Opco 1 and Opco 2 carry on businesses of the same type.
- Mr. A, Mr. B and Opco 1 have all guaranteed Opco 2's
borrowings.
- Opco 2 declares bankruptcy and Opco 1 repays Opco 2's
creditors without demanding any amount from either Mr. A
or Mr. B.

QUESTIONS:

• a) Assuming that Mr. A, Mr. B and Opco 1 are not jointly and severally responsible for the guarantee given to Opco 2's creditors, does subsection 15(1) of the Act apply with respect to Mr. A?

If so, what percentage of the amounts paid by Opco 1 will
be attributable to him?

• b) If Mr. A, Mr. B and Opco 1 were jointly and severally responsible for the guarantee given, would your answer be different?

ANSWER 15

BENEFIT TO SHAREHOLDER

In the case of the above example, we are of the view that Opco 1
confers a benefit on Mr. A for purposes of subsection 15(1) of the
Act whether or not the guarantees are joint and several. The
amount of the benefit to be included in computing Mr. A's income
will be equal to the latter's share in the sums paid to creditors
by Opco 1 that this latter can demand from him. In the event that
Opco 1's guarantee was intended only to protect its shareholder's
(Mr. A's) investment in Opco 2, we are of the opinion that any sum
paid by Opco 1 to Opco 2's creditors would constitute a benefit
conferred on Mr. A. However, the provisions of subsection 15(1) of
the Act would not apply to the portion of the sums recovered from
Mr. A and Mr. B after Opco 1 had exercised its recourse against
them.
QUESTION 16 Revenue Canada

DEBTOR'S GAIN ON SETTLEMENT OF DEBT
SECTION 80, IT-293R

Paragraph 11 of Interpretation Bulletin IT-293R establishes that section 80 of the Act is applicable in situations where a debtor corporation issues shares of its share capital to a creditor in settlement of a debt where the fair market value of the shares thus issued is less than the principal amount of the unpaid debt. Paragraph 11 continues by noting that when an amount due to a shareholder by a corporation is extinguished by a capital contribution of the shareholder to the corporation, section 80 of the Act applies to the total amount of the extinguished debt.

It would appear that the tax treatment accorded to the debtor corporation is higher when the creditor is a shareholder of the corporation.

Could you confirm our understanding of paragraph 11 of Interpretation Bulletin IT-293R? What are the grounds and reasons for such a position? What meaning is given by the Department of National Revenue to the expression "in the form of a contribution"?

ANSWER 16

DEBTOR'S GAIN ON SETTLEMENT OF DEBT
SECTION 80, IT-293R

The term "contribution" is not defined in the Act. In the opinion of the Department of National Revenue, this term signifies a contribution of capital, and any transaction which would increase the capital of a corporation without the latter offering consideration for this increase (that is, for which no share is issued) would give rise to a capital contribution. We refer you to paragraph 2 of Interpretation Bulletin IT-456R.

The issue of shares by a corporation in settlement of a debt constitutes a consideration paid in order to increase its capital. Whether or not the debt was contracted with a shareholder, if the fair market value of the shares issued in payment of the debt is less than the unpaid principal, section 80 of the Act applies. However, as indicated in paragraph 11 of Interpretation Bulletin IT-293R, section 80 of the Act does not apply if the fair market value of the shares at the date of the settlement is not less than the principal amount of the debt, whether or not the creditor is a shareholder.

QUESTION 17 Revenue Canada

GROUP OF PERSONS

Paragraph 84.1(2)(b) of the Act provides for an extended meaning of the term "not to deal at arm's length" for purposes of subsection 84.1(1) of the Act.

Sub-paragraphs 84.1(2)(b)(i) and (ii) of the Act use the term "group of less than six persons". Does the Department of National Revenue intend to apply paragraph 84.1(2)(b) when a single person holds the control of a corporation before and after disposition? If so, why does the Department of National Revenue not apply the decision in Southside Car Market Ltd et al v. the Queen, [[1982] C.T.C. 214] 82 D.T.C. 6179? In this decision, the Federal Court, Trial Division established that a corporation cannot be controlled by a group of persons if a single person controls it.

ANSWER 17

GROUP OF PERSONS

No. The Department of National Revenue does not intend to apply paragraph 84.1(2)(b) of the Act when a single person holds control of a corporation, whether he/she is the "purchaser corporation" or the "subject corporation" within the meaning of subsection 84.1(1) of the Act. It should be noted however, that in many situations a person will be considered to be related with the purchaser corporation without having to consider the extended meaning that is given to this concept by virtue of paragraph 84.1(2)(b) of the Act.

QUESTION 18 Finance

PART III TAX

Subsection 184(3) of the Act provides that when Part III tax under the Act applies to a dividend that is in excess of the capital dividend account of a corporation, an election may be made for part of the dividend to be deemed a taxable dividend.

Subsection 184(4) of the Act provides the conditions which must be met by this election. New paragraph 184(4) of the Act, as proposed in the Technical Bill, introduces a maximum period of delay of thirty (30) months within which an election provided in subsection 184(3) of the Act may be made without the concurrence of all of the shareholders with a right to receive part of the dividend. What is the reason for such a deadline?

ANSWER 18
PART III TAX

The election to deem that part of a dividend already paid out in the form of a capital dividend as a separate dividend which may therefore receive exemption from the special tax on excess elections must in the future not only fulfil the conditions described in subsection 184(3) of the Act, but must also be made within 30 months following payment of the dividend unless all shareholders with a right thereto (and not only those with a known address) concur with the election. Note that this concurrence results in the periods of presumption in subsections 152(4) to (5) being effectively renounced. The 30-month period thus corresponds to the maximum period which can be accorded to a corporation by the Department of National Revenue to finalize an election, given that reassessments of individual shareholders' tax returns are limited to 36 months after mailing of the initial notice of assessment.

QUESTION 19 Finance

DEFINITION OF "DIVIDEND"

Why does the Technical Bill exclude certain share dividends from the definition of "dividend" in subsection 248(1) of the Act? Why are only those dividends received by corporations included in this exclusion?

ANSWER 19

DEFINITION OF "DIVIDEND"

Since May 23, 1985, the tax treatment of stock dividends has changed, principally to ensure that these dividends give rise to a dividend for purposes of the Act equal to the payer corporation's increase in paid-up capital as a result of payment of the share dividend. This measure was principally intended to counter possible abuse of the capital gains exemption provision. However, this measure also applies to stock dividends paid to Canadian corporations by foreign corporations, even though the capital gains exemption was not at all in question and that the foreign corporation's paid-up capital has nothing to do with computing the Canadian corporation's capital gains. In the future, these stock dividends will be excluded from the definition of "dividend" for purposes of the Act.

QUESTION 20 Finance

ROLLOVER AND BENEFIT CONFERRED

The amendment to paragraph 85(1)(e.2) of the Act as proposed in the Technical Bill is intended to make the rule concerning the benefit conferred in the case of a transfer to a wholly owned corporation less stringent. Thus, a shareholder may transfer property to a corporation controlled by him/her in exchange for shares without fear of creating a taxable benefit.

Why has this rule not been extended to transfers between related corporations? For example, Mr. A owns 100% of subsidiary "A" and subsidiary "B". Subsidiary "A" transfers an asset to subsidiary "B" under section 85 of the Act; could paragraph 85(1)(e.2) of the Act apply?

ANSWER 20

ROLLOVER AND BENEFIT CONFERRED

As indicated in your question, the amendment to paragraph 85(1)(e.2) of the Act is specifically intended to exclude wholly owned subsidiaries of a group of related individuals upon whom a benefit might have been conferred in the case of a transfer for consideration of less than the fair market value of the property transferred. Related corporations do not benefit from the same treatment because there are possibilities for abuse such as:

Example: Benefit to a related corporation - paragraph 85(1)(e.2) of the Act

• 1. A invests $2 M in X Co. and X Co. uses this sum to acquire two similar properties at $1 M each.
• 2. Several years later, each property is worth $2 M and A wishes to sell one of them without paying tax.
• 3. A incorporates Y Co. and, in accordance with section 85 of the Act, X Co. transfers Property 1 to Y Co. in consideration for a share with a paid-up capital of $1. The agreed-upon sum is $1 M. Assume that, paragraph 85(1)(e.2) does not apply.
• 4. X Co. buys back the share for $1.
• 5. A sells X Co. for $2 M, which corresponds to the ACB of X Co. shares. No tax would be payable on the dismisal.

V. NON-RESIDENTS

QUESTION 21 Revenue Canada

CERTIFICATE OF DISPOSITION

Mrs. A., a resident of Canada, owns a building located in Canada. Mrs. A dies leaving her building to her five heirs in equal shares. Of these five, one is a non-resident of Canada. Mrs. A's executors, all of whom are Canadian residents, wish to have the estate dispose of the building and split the proceeds from the disposition among the five heirs. Must the estate obtain a certificate under section 116 of the Act in order to dispose of the building?

ANSWER 21

CERTIFICATE OF DISPOSITION

Only a non-resident person is subject to the rules contained in section 116 of the Act when disposing of a building situated in Canada. The position of the Department of National Revenue concerning the determination of the residence of an estate is described in Interpretation Bulletin IT-447. In our view, the estate of Mrs. A is a person resident in Canada because all of the executors reside in Canada. In the above example, Mrs. A's executors will have the authority to sell the building, and the estate is a person resident in Canada; thus, we are of the opinion that the estate does not need to obtain a clearence certificate as provided in section 116 of the Act in order to dispose of the building.

QUESTION 22 Revenue Canada

INTEREST PAYABLE TO A NON-RESIDENT

Paragraph 8 of Interpretation Bulletin IT-361R states that, in certain cases, the fact that a borrower is required to make deposits in excess of 25 per cent of the total principal amount of a loan within 5 years to a sinking fund controlled by the borrower, does not cause the interest paid to lose the benefit of the exemption provided in sub-paragraph 212(b)(vii) of the Act. This same paragraph states that the exemption may be lost if more than 25% of the principal amount of the loan is deposited with an independent trustee or third party.

Under what circumstances does the Department of National Revenue consider that depositing sums with a trustee or third party leads to loss of the benefit of the exemption provided in subparagraph 212(1)(b)(vii) of the Act? What is the Department of National Revenue's definition of the term "sinking fund controlled by the borrower"? Must the borrower have absolute control over it? What are the reasons for the distinction between the two types of guarantees?

ANSWER 22

INTEREST PAYABLE TO A NON-RESIDENT

The Department's concern with respect to sinking funds is with situations where liquid assets are invested in a fund in a systematic manner in order to give the lender access to financial resources sufficient to reimburse the capital lent. Normally a sinking fund will be segregated from the general fund of the deposit taking institution or constitute a fund under the control of either a trustee or an independent third party.

It is our view that the borrower must have absolute control over disbursements from the fund and must, generally speaking, be its beneficiary with respect to capital, income,as well as gains or losses realized by the sinking fund.

VI. CIVIL LAW CONCEPTS

QUESTIONS 23 AND 24 Finance

DEFINITION OF TRUST

New subsection 248(3) of the Act as proposed in the Technical Bill introduces certain presumptions applicable to the concepts of Quebec civil law. Paragraph 248(3)(c) of the Act introduces a presumption with respect to arrangements similar to a trust:

• 1. How does the Department of Finance interpret the phrase: "rights and obligations that are substantially similar to the rights and obligations under a trust" which appears in sub-paragraph 248(3)(c)(iii) of the Act? What are these rights and obligations?
• 2. The introductory section of paragraph 248(3)(c) of the Act stipulates "other than a trust". How can an arrangement create rights and obligations that are substantially similar to those under a trust without constituting a trust?

ANSWERS 23 AND 24

DEFINITION OF TRUST

New subsection 248(3) of the Act provides presumptions about trusts in Quebec in order to enable Quebec taxpayers to benefit from the same tax instruments generally available in the other provinces when trusts are created under sections 104 to 108 of the Act.

A deemed trust, in the case of contractual arrangements similar to those of a trust, is only one of the types of deemed trusts which will in future be similar to actual trusts for purposes of the Act. Thus contractual arrangements entered into in Quebec which, through legal relationships of the type principal/agent or lender/borrower, or which, through various contracts of a trust or management contract type, attempt to fulfil the requirements attached to the definitions of "unitary interest" or "mutual fund trust" or "mortgage RRSP" are validated from the tax point of view while awaiting regularization of their status in civil law through provincial legislation. The other types of deemed trusts are those which arise out of the creation of a usufruct, a right to use and habitation, or substitution created by a will or by an act between living persons. These operations will henceforward be treated as transfers in a trust. This presumption will permit settlement of the tax uncertainties attaching to the use of these civil law contracts. They will also permit avoidance of the problems related to break- ups and to the evaluation of these persons' rights. Finally, this technique will permit deductions for capital cost allowance of the properties subject to these trusts, and will also offer the possibility of income splitting available when property is held in trust (subsection 104(13.1) of the Act).

QUESTION 25 Finance

PARTITION OF PROPERTY

New subsection 248(20) of the Act as proposed by the Technical Bill establishes rules governing the partition of joint or undivided interests property.

What are the reasons for introducing this new subsection into the Act?

Why are rights in fungible tangible property described in a person's inventory excluded from application of subsection 248(20) of the Act?

ANSWER 25

PARTITION OF PROPERTY

New subsection 248(20) of the Act outlines the tax consequences of a partition which ends joint ownership of one or more properties. There is then disposition and acquisition by each person with an ownership interest of an undivided interest in the partitioned properties. This rule will put an end to the principle of the retroactive or declaratory effect of partition. It is presumed that in the future each person disposes of something and acquires something through partition. The rule applies under both civil and common law. An example of what is intended follows.

Example: Partition of property - subsection 248(20) of the Act

Assuming that partition is not disposition, an exchange is made with only 50% of the profit realized; the gain could be reduced even further by transferring only a nominal percentage interest (1%).

More aggressive transactions would also permit avoidance of the attribution rules and contravention of measures such as those provided in subsection 98(3) of the Act when a partnership is dissolved.

Finally, the exclusion of partition of fungible tangible property described in an inventory is directed against, for example, oil stocks from oil fields. Application of the deemed disposition rule to these properties at the time of partition, that is upon extraction, could lead to serious disturbances of the allocation of revenues among the provinces as prescribed under the regulations.

Other exceptions to this rule, provided in subsections 248(21) and (22) of the Act, include partition of property subject to a marriage contract, including possible rollovers between spouses and the necessity for harmonizing these dispositions with the Quebec Income Tax Act.

Finally, please note that another exception to this rule is under review for partitions leading to the distribution of a property such as partition of land among joint owners, and that a modification of the entry into effect of this measure is also under review in order to accommodate certain partitions in progress at the time of announcement of the new rule.

VII. GENERAL ANTI-AVOIDANCE PROVISIONS

QUESTION 26 Revenue Canada

CAPITAL GAINS EXEMPTION

Mr. A, Mr. B, Mr. C and Mr. D are brothers each of whom holds 25% of Opco's shares. These shares have a low adjusted cost base and paid-up capital, but a high fair market value. One child of each of the existing Opco shareholders has created a holding company. Opco's existing shareholders sell their Opco shares to the holding company created by the child of one of the other Opco shareholders for cash, and benefit from the capital gains exemption available for Qualified Small Business Corporation Shares (section 110.6 of the Act). Is the Department of National Revenue of the opinion that section 84.1 of the Act applies to such a transaction? If not, does the Department of National Revenue consider that this transaction is an avoidance transaction for purposes of section 245 of the Act? If so, does the Department of National Revenue consider that the transaction or series of transactions constitutes directly or indirectly in a misuse of the provisions of the Act or an abuse having regard to the provisions of the Act.

ANSWER 26

CAPITAL GAINS EXEMPTION

We are of the view that the provisions of section 84.1 of the Act apply when the seller of Opco shares has a non-arm's-length relationship within the meaning of paragraph 251(1)(b) of the Act with the corporation controlled by his nephew or niece, whichever may be the case, which purchases his shares. As stipulated in paragraph 251(1)(b) of the Act, the determination as to whether or not related persons had such a relationship at a given point in time is a question of fact. This determination should be examined taking into account the general guidelines set forth in paragraphs 11 to 14 of Interpretation Bulletin IT-419. If it is established that the seller and purchaser of Opco shares are dealing at arm's length, the provisions of section 84.1 of the Act will not apply.

Avoidance of application of section 84.1 of the Act and use by the seller of the capital gains exemption provided in section 110.6 of the Act constitute tax benefits under subsection 245(1) of the Act. In our opinion, sale by an Opco shareholder of Opco shares to a corporation controlled by a nephew or niece constitutes a subsection 245(3) avoidance transaction carried out to circumvent application of section 84.1 of the Act.

As mentioned in paragraph 25 of Information Circular 88-2, a transaction carried out to circumvent application of section 84.1 of the Act is not a transaction to which subsection 245(4) of the Act applies because it constitutes an abuse in the application of the overall provisions of the Act.

In our opinion, the provisions of subsection 245(2) of the Act would apply to the transaction described above.

QUESTION 27 Revenue Canada

PART IV TAX

Three individuals wish to each acquire 5% of the voting and participating shares in the capital stock of Opco, a Canadian- controlled private corporation.

The three individuals form Holdco, in which they each hold 1/3 of the shares issued. Holdco acquires 15% of Opco's capital stock.

Does the Department of National Revenue consider that this constitutes an avoidance transaction to which subsection 245(2) of the Act would apply? If so, can the taxpayers benefit from the exception provided in subsection 245(4) of the Act?

Would the answers to these questions be different if the three individuals had initially acquired Opco shares, and then transferred these shares to Holdco?

ANSWER 27

PART IV TAX

The purchase of 15% of Opco shares by three individuals through Holdco could be considered an avoidance transaction if the purchase by a single management company was intended to obtain a tax benefit, such as avoiding application of paragraph 186(1)(a) of the Act. However, we are of the opinion that this type of transaction would not constitute a misuse in the application of the provisions of the Act or an abuse of the Act as a whole, and that subsection 245(2) of the Act would not apply. Our position would be the same if the three individuals had each acquired 5% of Opco shares and subsequently transferred them to Holdco.

VIII. CAPITAL GAINS

QUESTION 28 Finance

REPLACEMENT PROPERTY

The Technical Notes regarding new paragraph 44(5)(b) of the Act indicate that the definition of "replacement property" is to be extended. However, this definition would appear to be more restrictive in the following situation:

X Inc. leases a property to its subsidiary Y Inc. which uses the property in an active business. X Inc. earns property income from the property it leased to Y Inc., which uses the property in an active business. The property in question is accidentally destroyed, and a new property is acquired by X Inc. However, subsequent to the destruction, X Inc. leases the new property to an arm's length corporation.

In this situation, it would appear that X Inc. will not be
able to benefit from the rollover provided in section 44
of the Act, whereas it could have done so under former
subsection 44(5) of the Act. Does the Department of
Finance share this view?

ANSWER 28

REPLACEMENT PROPERTY

It is true that the amendment proposed in paragraph 44(5)(b) of the
Act could have the effect of forcing any related corporation which
was using the former property for the purpose of gaining or
producing income to use the replacement property in the same or a
similar business. This results in a tightening of the former rule
in circumstances in which the taxpayer was not personally using the
former property in a business, and would have had a right to the
rollover following a forced disposition due to the simple fact that
he has acquired a replacement property which he leased out.
However, this change is a response to repeated requests for
recognition of the real-world business situation which occasionally
involves withdrawal of some assets from the operations of an active
business. Moreover, recognition of the use to which a property may
be put by a related individual leads to the necessity for this
related individual to continue this use for any replacement
property. Finally, it would appear that this problem could be
avoided fairly simply by ensuring that the related individual uses
the replacement property in his business. If this situation
results in major problems, the Act might require revision.
QUESTION 29 Finance

STOCK OPTIONS

When computing the adjusted cost base of a share, the value of a benefit included in income by virtue of section 7 of the Act must be added to the cost of acquiring the shares in accordance with paragraph 53(1)(j) of the Act. Paragraph 49(3)(b) of the Act also provides that the cost of the option must be added to the adjusted cost base of an acquired share unless an amount was added under paragraph 53(1)(j) of the Act was added to the adjusted cost base of the shares. These two provisions mean that the price paid to acquire an option is not taken into account in the adjusted cost base of a share, thus creating a larger taxable gain than economic gain.

Does the Department of Finance plan to correct this anomaly?

ANSWER 29

STOCK OPTIONS

Yes. Paragraph 49(3)(b) of the Act will be amended to include the cost of the option in the increase of the adjusted cost base of the share. IX. FILING PRESCRIBED FORMS

QUESTIONS 30 AND 31 Revenue Canada

FILING DEADLINES

• a) Section 22 of the Act requires that a prescribed form (T2022) be filed in order to benefit from the rules provided in this section. Section 22 of the Act does not specify any date or deadline for filing a T2022 form. Paragraph 4 of Interpretation Bulletin 188R stipulates that the T2022 must be filed by the seller and purchaser with their income tax return for the year of sale. What is the basis in law for paragraph 4 of Interpretation Bulletin IT-188R?
• b) Subsection 80(3) of the Act deals with the deemed settlement of debts at winding-up, to which the rules in subsection 88(1) of the Act apply. Under subsection 80(3) of the Act, the parent corporation must make an election in accordance with the prescribed form (T-2027) no later than the date by which its income tax return must be filed in compliance with Section 150 of the Act in order for the debt to be deemed to be extinguished in an amount equal to the cost to it of the debt. However, the Act does not appear to contain provisions concerning the possibility of late-filing this election. Is the Department of National Revenue prepared to accept a late-filed election and if so, in what specific cases and under what conditions?
• c) In order to benefit from the rollover provided in Section 44 of the Act, a taxpayer must make an election on his income tax return for the year in which he acquired the replacement property. There is no form provided for making such an election.

Paragraph 7 of Interpretation Bulletin IT-259R requires
that a letter accompany the taxpayer's income tax return
so that he can benefit from the rollover (unless the
replacement property was acquired in the same year as the
replaced property was disposed of). What is the basis in
law for paragraph 4 of Interpretation Bulletin IT-259R?
Would not an implicit election through the computations
contained in the income tax return suffice?

ANSWERS 30 AND 31

FILING DEADLINES

• a) Section 22

The election provided in Section 22 of the Act is not
valid unless a T2022 form is filed. It is preferable for
taxpayers to file the T2022 form with their tax return in
order to facilitate processing of their return. Without
it, the Department of National Revenue may adjust the
taxpayer's computation without applying Section 22 of the
Act. If a taxpayer does not file a T2022 form with his
return, his election will be accepted provided that it is
filed by the deadline for filing a notice of objection for
the year in question.

• b) Subsection 80(3)

There is no provision of the Act to permit acceptance of
an election when T2027 forms are filed late after December
31, 1986.

• c) Section 44

In the past, the Department of National Revenue required
a letter; the Draft Legislation resolves the problem by
prescribing a form to be completed for 1990 and
thereafter.

X. COMPUTATION OF INCOME EARNED POST-1971

QUESTION 32 Revenue Canada [overruled by 2000-0029615 F]

IMPACT OF AN ACQUISITION OF CONTROL
ON THE COMPUTATION OF "SAFE INCOME"

Must deemed capital losses realized by virtue of paragraph 111(4)(d) of the Act be included when computing earned income for purposes of subsection 55(2) of the Act?

ANSWER 32

IMPACT OF AN ACQUISITION OF CONTROL
ON THE COMPUTATION OF "SAFE INCOME"

No. Income earned or realized for purposes of subsection 55(2) of the Act is computed for the period ending prior to the start of the series of transactions or events ("the said period"). Any gain computed under paragraph 111(4)(e) of the Act and any deemed loss computed under paragraph 111(4)(d) of the Act is a gain or a loss, whichever is applicable, for the period following the said period.

XI. MISCELLANEOUS

QUESTION 33 Finance

ROLLOVER AT DEATH

Under what circumstances will the new paragraph 70(6)(d.1) of the Act as proposed in the Technical Bill lead to different results from those currently in effect by virtue of sub-paragraph 70(6)(d)(ii) of the Act?

In addition, in what cases will subsection 100(3) of the Act not be applicable at the death of a partner?

ANSWER 33

ROLLOVER AT DEATH

New paragraph 70(6)(d.1), with paragraphs 70(9.2)(c) and 70(9.3)(e) of the Act, are part of a series of measures allowing deferral of realization of a capital gain on an interest in a partnership held by a taxpayer at the time of death and for which the adjusted cost base is negative. At the present time, in spite of the deemed disposition at the adjusted cost base, a subsection 100(2) gain is realized if the adjusted cost base of the interest is negative. The proposed special treatment will apply only to interests which are not already subject to special treatment at death. As a result, interests included in subsections 100(3) and 98.2 of the Act are excluded as they are already subject to special treatment. Therefore, only partnership interests which are transferred to a taxpayer who is already a member of a partnership or who becomes a member thereof following the acquisition of a partnership interest will benefit from the new measure. These assumptions will mean that the beneficiary of the partnership interest will be in the same tax situation as the deceased partner, and that the negative adjusted cost base will not give rise to any immediate gain under subsection 100(2) of the Act at the time of death. This measure is inspired by the similar treatment granted to negative cost base partnerships which were held by a corporation at wind-up or amalgamation (see paragraphs 88(1)(a.2), c) and e.2) as well as paragraph 87(2)e.1) of the Act). This measure does not apply in the case of an intervivos transfer of partnership interest since this would give rise to possible avoidance.

QUESTION 34 Revenue Canada

RESTRICTIONS ON INTEREST

Subsection 18(2) of the Act limits the deduction of amounts paid as interest on a debt with respect to the acquisition of land or of property taxes on land. In the case of a corporation whose principal business is, in general, leasing or sale of real property, the subsection 18(2) restrictions apply only to the excess of the amounts incurred over the base level deduction as established under subsection 18(2.2) of the Act.

In the case of a partnership consisting of corporations whose business consists of selling or leasing real properties, is it the opinion of the Department of National Revenue that the base level deduction is computed at the partnership level or at the corporate partner level?

ANSWER 34

RESTRICTIONS ON INTEREST

In the opinion of the Department of National Revenue, a partnership may not claim the base level deduction even if all the partners are corporations operating a principal business. Unlike paragraph 18(3.4)(b) of the Act, paragraph 18(2)(b) of the Act does not make any reference to a partnership consisting of corporations operating a principal business.

Furthermore, the base level deduction of a corporation which is a member of a partnership of individuals does not permit a corporation to deduct the interest and property taxes incurred by the partnership for land which it owns. Computation of income or losses must be made as provided in subsection 96(1) of the Act at the partnership level. Subsection 18(2) of the Act therefore applies to the partnership with regard to interest incurred by the partnership for the lands which it owns.

A corporation whose interest expenses are subject to subsection 18(2) and subparagraph 18(3)(b)(ii) of the Act could benefit from the base level deduction by virtue of paragraph 18(2)(f) of the Act (even if it does not own land) provided that it meets the criterion of a principal business provided in the aforementioned paragraph and provided that section 245 of the Act is not applicable.

QUESTION 35 Revenue Canada

SCIENTIFIC RESEARCH

A tax credit is granted for scientific research and experimental development ("SR & ED") current expenditures within Canada provided that they meet the conditions established in subsection 37(1) of the Act. Interpretation Bulletin IT-151R3 specifies in paragraph 7 that "Within the overall limitations of subsection 37(1), current expenditures made in Canada on Sr & Ed carried on in Canada may be deducted in computing the income in the year" (our emphasis).

• a) What is the definition of "made in Canada"?
• b) Would current supplies purchased outside Canada for consumption or use in Canada be considered allowable expenditures under subsection 37(1) of the Act, and thus eligible for an investment tax credit?
• c) Would an expenditure for an employee salary or payment to a sub-contractor outside Canada, but made in the context of an SR & ED project carried out in Canada, qualify under subsection 37(1) of the Act if it was made to support the Canadian project directly?
• d) Are sums paid to a related corporation by a taxpayer carrying out SR & ED for which the relable of corporation receives a fixed profit of 15% of expenses, deductible under subsection 37(1) of the Act?

ANSWER 35

SCIENTIFIC RESEARCH

• a) The reference in paragraph 7 of Interpretation Bulletin IT-151R3 to the notion of "made in Canada" is derived from the heading of paragraph 37(1) of the Act as it was at the time of publication of the bulletin.

In 1988, paragraphs 37(1)(a), (b) and (e) of the Act were
amended to eliminate "made in Canada" references.

b) The Department of National Revenue is of the opinion that
current supplies purchased outside Canada for consumption
or use in Canada for SR & ED carried out in Canada will be
considered to be eligible expenses under subsection 37(1)
of the Act in accordance with paragraph 2900(2)(a) of the
Income Tax Regulations.
c) The salary of an employee working in Canada who travels
outside Canada will generally be eligible under subsection
37(1) of the Act if the expenditures are directly
attributable to the SR & ED carried out in Canada.
However, when such expenditures are for SR & ED carried on
outside Canada, they will be eligible under subsection
37(2) of the Act but not under subsection 37(1) of the
Act. When an SR & ED project is carried on partly in and
partly outside Canada, the expenditures relating to the
part of the project carried on outside Canada will be
eligible only under subsection 37(2) of the Act.

Payments to a subcontractor for services rendered outside
Canada, or a salary paid to an employee for work normally
carried on outside Canada, will not be eligible under
subsection 37(1) of the Act because the SR & ED is not
being carried on in Canada.

• d) In accordance with subsection 2900(2) of the Income Tax Regulations, expenditures (other than for materials used in SR & ED and salaries for employees directly connected with the SR & ED) which are directly connected with the research and which would not have been made if this research had not been carried on are considered to be directly attributable to the SR & ED, and are deductible by virtue of subsection 37(1) of the Act provided that they are reasonable in the circumstances.

QUESTION 36 Revenue Canada

ASSOCIATED CORPORATIONS AND DEFACTO CONTROL

Subsection 256(5.1) of the Act introduces the concept of defacto control into the determination of wheter corporations are associated. Are the examples which follow situations in which there would be defacto control?

• 1. A franchiser (the "franchiser") operating outside Quebec wishes to grant a master franchise for development of the Quebec region. For this purpose, he becomes a shareholder holding 49% of a new corporation (Novelco), 51% of whose shares are held by a third person at arm's length from the franchiser. Among the rights maintained under the franchise contract by the franchiser are the following: site approval, approval of franchisees, and the right to purchase real property used by the franchisees at fair market value;
• 2. Instead of a franchise contract, the franchiser concludes a development agreement under which Novelco has the right to purchase or construct real properties for lease to the franchiser. Under the agreement, Novelco has the right to refuse to construct on a particular site. The normal default conditions are included in the agreement, and leases are established in accordance with market conditions. The franchiser is Novelco's only client.
• 3. An aircraft construction company convers the production contract for a specific item to a corporation whose sole client is the aircraft construction company.

What does the expression "business carried on" contained in subsection 256(5.1) of the Act mean? Do restrictions on obtaining financing or the distribution of dividends constitute "business carried on"?

ANSWER 36

ASSOCIATED CORPORATIONS AND DEFACTO CONTROL

• • Certain generally identifiable factors would indicate a defacto control situations:
• • economic dependence;
• • the possibility of terminating the existence of the other party or of affecting its profitability by withdrawing support such as bank guarantees, by interrupting supplies, or by causing insurmountable financial difficulties;
• • the possibility of appropriating the profits or property of the other party;
• • the possibility of changing the other party's board of directors or of reversing its decisions.
• • When influence is derived from a supply franchise, license, lease, management, distribution supply, or other similar contract, it will not be assumed that there is control in fact solely because of the contract when the latter is concluded for business purposes and not for the purpose of controlling the other party.
• • Since each situation must be assessed on its merits, we are not able to describe all the types of influence which might be present in a contract which would not result in a situation of control in fact.
• • The expression "Business carried on" has the usual meaning given to this expression, taking into account the specific nature of each type of business. We are of the opinion that contracts determining the linkages between a franchisee and a franchiser with respect to the way in which the business operated by the franchisee is to be operated could involve restrictions on the financing or payment of dividends provided that these restrictions are intended to protect the franchiser's investment rather than to control the franchisee.

QUESTION 37 Revenue Canada

WINDING-UP

Subsection 88(1) of the Act grants a rollover "where a taxable Canadian corporation(...) has been wound up". Paragraphs 3, 4 and 5 of Interpretation Bulletin IT-125R, dated February 3, 1975, require that a corporation be dissolved, or that such will occur within a short period of time, for there to be a wind-up within the meaning of subsection 88(1) of the Act. The bulletin also indicates that, generally speaking, a resolution by the shareholders authorizing the winding-up of a corporation is evidence of the intention to dissolve.

Does the Department of National Revenue consider that the administrative policy outlined in Interpretation Bulletin IT-126R is applicable to corporations governed by Quebec corporate law? How will the Department of National Revenue apply subsection 88(1) of the Act to a company wound up during one year, but dissolved several years later due to difficulties in transferring certain assets, or due to a delay in obtaining the required authorizations from government officials for transfers of permits or permissions? Is there a case for making a distinction for corporations governed by the Canada Business Corporations Act, R.S.C., (1985) chapter C- 44?

ANSWER 37

WINDING-UP

It is the position of the Department of National Revenue that the remarks contained in paragraphs 3, 4 and 5 of Interpretation Bulletin IT-126R apply to corporations governed by Quebec corporate law. As a result, these corporations will be deemed to be wound-up for purposes of subsection 88(1) of the Act when the criteria in these paragraphs of the Bulletin are met.

The comments in paragraph 5 of Interpretation Bulletin IT-126R concerning deadlines for obtaining formal dissolution are applicable when the corporation has met all the criteria of the relevant federal or provincial legislation, including that of Quebec, and is awaiting confirmation of the dissolution from the appropriate federal or provincial government. These comments do not apply when the corporation governed by a provincial or federal law cannot be dissolved because certain assets could not be transferred or because it has been unable to obtain the required authorization from government officials to transfer permits or permissions.

QUESTION 38 Revenue Canada

TREATMENT OF FREE RENT

Could you confirm the tax treatment for a taxpayer who is the owner of a building and who grants a rent-free period to another person in order to persuade the latter to sign a long-term lease. In paragraph 14 of Interpretation Bulletin IT-359R2, the Department of National Revenue would appear to be indicating that any rebate of rent for a period of the lease represents a reduction in the rental income of the landlord.

ANSWER 38

TREATMENT OF FREE RENT

Interpretation Bulletin IT-359R of December 20, 1983 is presently under review, and a new version will be published in the near future.

It is the position of the Department of National Revenue that the treatment of an incentive in the form of free rent must be dealt with in accordance with business principles established by the Canadian Institute of Public Realtors (CIPREC). When the incentive is provided in order to induce a new tenant to sign a lease. The practice recommended by this body concerning such an incentive is that the landlord must include the value of the rent which would otherwise have been received in computing his income, and the cost assigned to this rent-free period must be deferred and amortized over the period of the lease. However, when a rent-free period is provided in order to induce a tenant to renew his lease, the cost assigned to the rent-free period may be deducted as an expense in the year in which the incentive was provided, or deferred and amortized over the period of the new lease.

QUESTION 39 Revenue Canada

55(2) - SAFE INCOME

Mr. X holds 100% of Opco capital stock. These shares have an ACB of $1.00, a fair market value of $1,000,000, and $500,000 of safe income attributable to them for purposes of subsection 55(2) of the Act. Mr. A sets up Holdco and transfers his Opco shares to Holdco. An election under subsection 85(1) of the Act is made, and the sum agreed to is $500,001. Subsequently, Opco pays a dividend of $500,000 to Holdco, and Holdco sells Opco shares to a third party for $500,000.

Is the dividend paid by Opco to Holdco included under subsection 55(2) of the Act?

ANSWER 39

55(2) - SAFE INCOME

Since the unrealized gain on Opco shares exceeds the income earned
by Opco prior to the beginning of the series of transactions, a
portion of the gain realized by Mr. X at the time of rollover is
attributable to Opco's safe income, and the other portion is
attributable to something other than safe income. Therefore, a
proportional share of safe income is capitalized in the adjusted
cost base of Opco shares held by Holdco (approximately $250,000),
leaving an unrealized gain attributable to safe income of
approximately the same amount. As a result, the payment of a
$500,000 dividend by Opco to Holdco will come under subsection
55(2) of the Act because it will reduce the unrealized gain
attributable to something other than safe income.
QUESTION 40 Revenue Canada

IMPACT OF SRTCs ON THE COMPUTATION OF "SAFE INCOME"

Does the scientific research tax credit provided in section 127.3 of the Act reduce the amount of safe income of a corporation as defined for purposes of subsection 55(2) of the Act? If so, by how much?

ANSWER 40

IMPACT OF SRTCs ON THE COMPUTATION OF "EARNED INCOME"

A corporation which acquires a property described in subparagraphs 127.3(2)(a)(iii) to (v) of the Act, that is, a share, credit or right, is entitled to a SR & ED tax credit of 50% of an amount designated by the issuer.

One of the elements in computing safe income on hand is the amount of tax paid or payable. Thus in situations where the tax payable has been reduced by an SR & ED tax credit claimed during the year, the net tax liability must be taken into account for purposes of computing safe income, that is, net of the tax credit.

Computation of safe income on hand is also affected by capital gains and by the net expenditure of SR & ED not deductible from the calculation of income.

QUESTION 41 Finance
WINDING-UP OF A CORPORATION - 69(5)(e)

Could you give an example of the application of new paragraph 69(5)(e) of the Act as proposed in the Technical Bill?

ANSWER 41

WINDING-UP OF A CORPORATION - 69(5)(e)

Let us consider the following example:

On winding-up, the shares of C are cancelled, and it is assumed
that shareholder B disposes of his shares in C by virtue of
subsection 89(4) of the Act. Since C is a person to whom
subsection 40(2)(e)(i) of the Act, including sub-paragraph
40(2)(e)(ii) - a corporation controlled indirectly by a person who
controlled shareholder B - applies, the restriction provided in
paragraph 40(2)(e) of the Act with respect to losses would apply.
This is an anomaly, given that such a restriction does not apply to
an individual shareholder in the same situation. The proposed
amendment simply confirms that, upon disposition of the shares of
a corporation on winding-up, the paragraph 40(2)(e) restriction on
a corporation's capital losses does not apply.
QUESTION 42 Finance

C.N.I.L.

Why exclude the deductions provided under paragraphs 20(1)(c), (d) and (e) of the Act in sub-paragraph (a)(i) of the new definition of "investment expense" in subsection 110.6(1) of the Technical Bill, when these expenses cannot be deducted from income under subsection 18(11) of the Act?

ANSWER 42

C.N.I.L.

Note that these expenses are limited by subsection 18(11) of the
Act in computing C.N.I.L. only for debts contracted after November
12, 1981. Therefore, interest expenses for debts contracted prior
to November 13, 1981 had to be excluded. Clearly, this type of
interest expense is excluded for purposes of computing C.N.I.L.
because it has nothing to do with investment income or with
investment expenses, but rather is related to pension income. The
reasoning is the same as for the exclusion from the computation of
C.N.I.L.s of income to which subsection 15(2) applies.
QUESTION 43 Finance

NON-RESIDENT

What situations are included by the addition of the words "any interest therein" to subsection 115(3) of the Act as proposed in the Technical Bill?

ANSWER 43

NON-RESIDENT

Use of the words "any interest therein" is intended to make it clear that section 115 of the Act applies not only to disposition of a taxable Canadian property described in sub-paragraphs 115(1)(b)(i) to (ix) of the Act or of an option in respect thereof, but also to the disposition of any other related interest. Thus, for example, a non-resident who disposes of an interest in real property located in Canada would be included.

QUESTION 44 Finance

GIFT OF CULTURAL PROPERTY

Will the fair market value of cultural property donations be subject in all cases to an evaluation under the new subsection 118.1(10) of the Act proposed in the Technical Bill?

ANSWER 44

GIFT OF CULTURAL PROPERTY

The fair market value of all gifts of cultural property made after February 20, 1990 will be determined by the Canadian Cultural Property Export Review Board. However, if a taxpayer does not wish to take advantage of the tax provisions which apply to gifts of cultural property, such as exemption from capital gains which may result from the gift, such a determination will be unnecessary and the gift can be treated as an ordinary charitable donation subject to the provisions which apply thereto.

QUESTION 45 Finance

DEFINITION OF AUTOMOBILE

The new definition of "automobile" proposed in the Technical Bill (248(1)(e)(i) and (ii)) excludes pick-up trucks or light vans when, during the taxation year in which they were acquired, they served either:

• • primarily for the transportation of goods or equipment in the course of gaining or producing income;
• • all or substantially all for the transportation of goods, equipment or passengers in the course of gaining or producing income.

As a result, a taxpayer who did not meet these conditions could circumvent this restriction by arranging to acquire pick-up trucks or vans during the final week of his taxation year. During this week, the motor vehicle would be used only for allowable purposes. During the following taxation year, the percentage use for allowable purposes would not matter; the motor vehicle would not be subject to the restrictions on rental, depreciation and interest expenses.

Does the general anti-avoidance rule apply in this situation?

ANSWER 45

DEFINITION OF AUTOMOBILE

The fact that a taxpayer acquires property at one time or another
during a taxation year does not in itself constitute a form of
avoidance. The taxpayer may have sound business reasons for
waiting until the very end of the year to acquire certain property.
However, if the principal reason for the late acquisition proved to
be an intention to circumvent the use test, and to obtain a tax
benefit, it would likely be considered an avoidance transaction in
which the overall provisions of the Act were abused. The
requirement that a van has only to be used during the year of
acquisition for very specific purposes in order to be eligible for
exclusion from the definition of "automobile" was intended as a
simplification, to save taxpayers from having to take subsequent
changes of use of the property into account. If the strategy
described in the above question were to succeed, action would be
taken to amend the Act.
QUESTION 46 Revenue Canada

VALUE OF EMPLOYEE BENEFIT

Paragraph 6(1)(a) of the Act stipulates that the value of benefits received by an employee in the course of employment is taxable. Does the Department of National Revenue consider that the following situations give rise to a taxable benefit? If so, on what basis should the value of such a benefit be computed?

Parking provided by the employer in a space adjacent to
that in which he carries on his business;

Parking fees paid to a third party by the employer for his
employees' vehicles.

ANSWER 46

VALUE OF EMPLOYEE BENEFIT

The Department of National Revenue commented on this topic at the 1987 A.Q.P.F.S. Conference Round Table (question 34). However, the position given at that time was subsequently refined. In our view, a taxable benefit must be included when computing an employee's income where the benefits from a parking place free of charge, or at a lower cost than the rental value of the parking space, and where the value of this benefit can be quantified. Where the parking space is provided by the employer in a space adjacent to the business, the Department of National Revenue is of the opinion that the value of the benefit must be determined using the fair market value for rental of an equivalent parking space. In a case where an employer pays a sum for his employees' parking to a third party, the Department of National Revenue considers that the taxable amount of the benefit corresponds to the amount of parking fees paid.

QUESTION 47 Revenue Canada

BENEFIT TO SHAREHOLDER

Subsection 15(2) of the Act provides for inclusion in a shareholder's income of a loan from a corporation. Paragraph 20(1)(j) of the Act provides a deduction from the shareholder's income when the loan is paid back. Paragraph 80.4(3)(b) of the Act indicates that no deemed interest is to be included based on subsections 80.4(1) and (2) of the Act when the amount of the loan is included in the shareholder's income.

Mr. X is the sole shareholder of X Inc. X Inc. lends $10,000 interest-free to Mr. X in year 1. This loan is included in Mr. X's income in year 1. Mr. X repays the loan in year 4, and benefits from the deduction provided in paragraph 20(1)(j) of the Act for this year.

In the opinion of the Department of National Revenue, must Mr. X include deemed interest in his income for years 1, 2, 3 and 4?

ANSWER 47

BENEFIT TO SHAREHOLDER

In paragraph 80(4(3)(b) of the Act, it is stated that subsections 80.4(1) and (2) do not apply to a loan or debt included in computing a person's income under Part I of the Act.

Given that subsection 15(2) was applied in this situation (since the amount of $10,000 was included in computing Mr. X's income), it is our view that Mr. X is not required to include a deemed benefit with respect to interest computed at the required rate on the said loan in computing his income for years 1 to 4 under the provisions of subsections 80.4(1) and (2) of the Act.

QUESTION 48 Revenue Canada

LOAN TO SHAREHOLDER

Paragraph 15(2)(a) of the Act provides certain circumstances in which a loan to a shareholder does not have to be included in the shareholder's income.

Does the Department of National Revenue consider that loans benefitting from these exemptions are "assets used in an active business carried on (...) by the corporation" for the purpose of the definition of "Qualified Small Business Corporation Share" in subsection 110.6(1) of the Act? Under what circumstances is this the case?

ANSWER 48

LOAN TO SHAREHOLDER

It is the position of the Department of National Revenue that a loan included under paragraph 15(2)(a) of the Act which does not have to be included in the income of the person or corporation which received it, and which is made by a corporation whose usual activities do not include lending money, is not an asset used primarily in an active business carried on by the corporation for the purpose of the definition of "qualified small business corporation share" in subsection 110.6(1) of the Act.

A loan to which subsection 15(2) of the Act applies, made by a corporation during the normal course of its financial lending business, will qualify as an asset used in an active business carried on by the corporation if it is made under the same terms and conditions as loans made by the corporation during the normal course of business.

The Technical Bill proposes amendments to subsection 15(2) and to the definition of "Qualified Small Business Corporation Share" in subsection 110.6(1) of the Act. The position of the Department of National Revenue would apply to these provisions as amended by the Technical Bill.

QUESTION 49 Revenue Canada

CAPITAL GAINS EXEMPTION

Mr. D holds 100% of the shares of Farmco, a corporation carrying on the business of farming. Mr. D sells his Farmco shares to his children for an amount less than the fair market value of the shares, but nevertheless realizes an exemption on the capital gain on Farmco shares resulting from the disposition. When Mr. D's shares were sold, the rules provided in subsection 73(4) of the Act apply. Subsequently, Mr. D's children sell their Farmco shares to Mr. M and benefit from the capital gains exemption. In the view of the Department of National Revenue, do the above transactions constitute avoidance transactions for purposes of section 245 of the Act? If so, do these transactions constitute abuse of the Act in the opinion of the Department of National Revenue? Why?

ANSWER 49

CAPITAL GAINS EXEMPTION

The tax consequences of the transactions described in this question require determination in light of all the relevant facts.

For example, if the children are in reality the agents of their father, it is the Department of National Revenue's opinion that the gain realized by them upon the sale of shares to Mr. M should be included in computing their father's income. On the other hand, if the shares are not capital property, the gain resulting from the sale of the shares will not be a capital gain and, consequently, no exemption will be allowable by virtue of section 110.6 of the Act.

If Mr. D sells his shares in Farmco to his children with the sole purpose of multiplying the capital gains deduction to be claimed by reason of the transactions already described, it is the view of the Department of National Revenue that this sale constitutes an avoidance transaction within the meaning of subsection 245(3) of the Act.

Only following a detailed examination of all the circumstances surrounding the transactions will the Department of National Revenue be in a position to ascertain whether there was abuse in application of the Act as a whole. Subsection 245(2) of the Act may apply.

Round Table question 43 at the 1989 Conference of the Canadian Tax
Foundation was different from this one as it involved a gift of
shares to children. Our answer made reference to this gift,
indicating clearly that it must be unconditional. Therefore our
answer took for granted that the subsequent sale of shares to third
parties was not contemplated to at the time when the gift was
made.QUESTION 50 Revenue Canada

SUPERFICIAL LOSSES

Mr. A holds a portfolio of securities whose ACB is $100,000 and whose fair market value is $10,000. Mrs. A., Mr. A's wife, holds a portfolio of securities whose ACB is $100,000 and whose fair market value is $190,000. Mr. and Mrs. A wish to dispose of all their securities. To this end, Mr. A sells his portfolio of securities to a third party at arm's length. A few days later, Mrs. A acquires a portfolio of securities identical to those disposed of by Mr. A to a third party. Two months later, Mrs. A sells all the securities held by her to a third party at arm's length. These transactions result in a situation at the time of sale by Mrs. A of the financial assets held by her in which neither a gain nor a loss is realized by her. Does the Department of National Revenue consider that one or more of these transactions constitutes an avoidance transaction within the meaning of section 245 of the Act? Does the Department of National Revenue consider that one or more of these transactions constitutes a misuse or abuse of the Act for purposes of subsection 245(4) of the Act?

ANSWER 50

SUPERFICIAL LOSSES

For purposes of our answer, we assume that the stocks making up Mr. and Mrs. A's portfolios of securities consist of capital property.

According to the facts submitted above, some transactions have the sole purpose of obtaining a tax benefit. Some of the transactions making up the series of transactions would constitute avoidance transactions within the meaning of subsection 245(3) of the Act.

In our opinion, these transactions would constitute an misuse of the Act taken as a whole. The provisions concerning superficial losses are not intended to permit interspousal transfers of capital losses. Furthermore, the attribution rules (section 74.2 of the Act) were intended to prevent interspousal transfers of capital losses.

QUESTION 51 Revenue Canada

PAID-UP CAPITAL

Mr. A holds shares in corporation A which have a fairly low paid-up capital and a high adjusted cost base. Corporation B subscribes a large amount for this same class of corporation A shares.

From the taxation point of view, the paid-up capital of a class of shares is divided equally over the number of shares in this class. (paragraph 89(1)(c) of the Act).

Thus corporation B's share subscription increases the paid-up capital of Mr. A's shares in corporation A. Does Mr. A receive a taxable benefit under subsection 15(1) of the Act due to this subscription? Does he receive a deemed dividend under subsection 84(1) of the Act?

ANSWER 51

PAID-UP CAPITAL

In the Department's opinion, Mr. A does not receive a benefit that must be included in his income by virtue of subsection 15(1) of the Act, nor a deemed dividend by virtue of subsection 84(1) of the Act, provided that the transaction falls within the exceptions provided in paragraph 84(1)(b) (that is, provided that the increase in paid-up capital is equal to or less than the value of the net increase in assets or the net decrease in liabilities).

QUESTION 52 Revenue Canada

THE TERM "SERIES OF TRANSACTIONS" - PARAGRAPH 245(3)(b)

The House of Lords recently analysed the concept of a "series of transactions" in the cases of Craven v. White, IRC v. Bowater Property Developments Limited, and Bayles v. Gregory, (1988) S.T.C.476. The following four criteria were developed at that time to determine whether a transaction was part of a "series of transactions":

• 1) How advanced were negotiations to complete the other transactions at the time of the transaction under review;
• 2) The nature of the transactions;
• 3) The probability that the other transactions would be concluded at the time of the transaction under review;
• 4) To what degree, after the particular transaction, were the transactions completed without real interruption.

Will the Department of National Revenue apply these criteria in interpreting the term "series of transactions" as used in paragraph 245(3)(b) of the Act? What will then be the relevance of subsection 248(10) of the Act? Does the Department of National Revenue have other relevant criteria?

ANSWER 52

THE TERM "SERIES OF TRANSACTIONS" - PARAGRAPH 245(3)(b)

Generally speaking, the Department of National Revenue does not consider that these criteria are adequate for determining whether or not a transaction is part of a series of transactions. Subsection 248(10) of the Act provides that for purposes of the Act, the term "series of transactions or events" is deemed to include any related transactions or events completed in contemplation of the series. As a result, "series of transactions" has a much broader meaning than that which it may be considered to have been given in the case of Craven v. White. On this point, the position of Revenue Canada was described by Mr. Michael Hiltz in the 1988 Conference Report of the Canadian Tax Foundation, "Section 245 of the Income Tax Act", page 7:6: "...the preliminary and subsequent transactions will be part of a series even though at the time of the completion of the preliminary transaction the taxpayer either had not determined all the important elements of the subsequent transactions - including, possibly, the identity of other taxpayers involved - or had lacked the ability to implement the subsequent transactions."

However, when it is necessary to determine, disregarding subsection 248(10) of the Act, whether a given transaction belongs to a series of transactions beginning prior to September 13, 1988 and ending before 1989, the comments made in Craven v. White may be relevant, given that there is no Canadian case law on this subject. Generally speaking, a series of transactions, determined without taking subsection 248(10) of the Act into consideration, would not include a non-arm's length transaction concluded in contemplation of a series unless at the time of the preliminary transaction all the important elements of the subsequent transactions, including the identity of all the persons involved in the transaction and the essential conditions of the agreement(s), were known, and unless the subsequent transactions were eventually completed. The four criteria you mentioned were cited by the British court only as factors which should be taken into account when determining whether a number of transactions should be considered to constitute one and only one compound linear transaction for tax purposes, or whether each transaction should be considered to be independent of the others. Other elements of equal or greater importance may occur in specific cases, as was noted very clearly in the decision of Lord Jauncey of Tullichettle. The Department of National Revenue has not established other criteria, and each case must be dealt with on its own specifics.

QUESTION 53 Revenue Canada

ASSOCIATED CORPORATIONS

Subsection 256(1.1) of the Act sets out the conditions required for a share to of a "specified class" for purposes of establishing whether two corporations are associated.

Paragraph 256(1.1)(e) of the Act requires that the redemption value of a share cannot exceed the aggregate "of an amount equal to the fair market value of the consideration for which the shares were issued and the amount of any unpaid dividends thereon".

In the opinion of the Department of National Revenue, are accumulated, undeclared dividends (cumulative dividends) included in "unpaid dividends" for purposes of paragraph 256(1.1)(e) of the Act?

Should a different meaning be given to the term "accrued and unpaid dividends" used in subsection 191(4) of the Act?

ANSWER 53

ASSOCIATED CORPORATIONS

Unpaid dividends for purposes of paragraph 256(1.1)(e) of the Act are unpaid dividends which would normally be a portion of the redemption amount of the share as determined in accordance with the rights relating to the class of shares to which the share in question belongs. These may include accumulated undeclared dividends, or declared unpaid dividends.

We are of the view that the term "accrued and unpaid dividends" used in subsection 191(4) of the Act would have the same meaning.

QUESTION 54 Revenue Canada

INVESTMENT EXPENSES

• a) Are fees paid to trustees or executors of an estate within the context of their duties deductible under paragraph 20(1)(bb) of the Act as sums paid by a taxpayer during the year to obtain their advice concerning the advisability of selling shares or stocks? If so, under what circumstances is this the case?
• b) Are fees paid to a corporate trustee by a trust or an estate for management or for safeguarding of documents deductible by virtue of paragraph 20(1)(bb) of the Act?
• c) Are professional fees paid to a lawyer or accountant for professional services rendered regarding investment or tax advice also deductible by virtue of paragraph 20(1)(bb) of the Act when the accountant or lawyer is acting as the trustee or executor of an estate?
• d) The English language text of subparagraph 20(1)(bb)(i) of the Act refers to a "share or security of the taxpayer", whereas the French version refers to "actions ou valeurs mobilières" (trans.: "shares or securities" (our italics). In the opinion of the Department of National Revenue, which version better reflects the lawmaker's intention?

ANSWER 54

INVESTMENT EXPENSES

Paragraph 20(1)(bb) of the Act allows a taxpayer to deduct fees other than a commission paid to a person for advice as to the advisability of purchasing or selling a specific share or security, or for the administration or management of his shares or securities. Fees are to be paid to a person whose principal business is advising others as to the advisability of purchasing or selling specific shares or securities, or includes the provision of services in respect of the administration or management of shares or securities. Such fees should be reasonable in the circumstances.

In response to your specific questions, our positions are as follows:

• a) The deductibility of fees for the services of trustees or executors of an estate in the context of their duties is to be determined in relation to the facts of each case, taking into account the nature of the work carried out. Such an expenditure could be deductible if it were made with the intention of gaining or producing income from a business or property. We are of the view that the fees of trustees for settling or transfer of the properties of an estate are costs of a "capital" nature and are not deductible by virtue of paragraph 18(1)(b) of the Act. These expenditures may, however, be deducted when computing the income of a business or property of the trust provided that the conditions of paragraph 20(1)(bb) of the Act are fulfilled.
• b) Services in repsect of administration or management of shares or securities such as:

- the custody of securities;
- the maintenance of accounting records;
- the collection and remittance of income;
- the right to buy or sell on their own judgement on behalf
of some clients without consulting to those clients;

would normally qualify.

The issue of whether fees for management services or for
safeguarding documents are eligible under paragraph
20(1)(bb) of the Act is a question of fact.

For further details, please refer to Interpretation
Bulletin IT-238R2.

• c) In order for fees paid to a lawyer or accountant to be deductible by virtue of paragraph 220(1)(bb) of the Act, they must, among other things, be paid to a person whose principal business consists of giving advice as to the advisability of purchasing or selling a specific share or security or, among other things, for services in respect of the administration or management of shares or securities. This determination is therefore a question of fact.

d) It would seem to us that both versions involve the
purchase and sale of shares or securities by the taxpayer.
QUESTION 55 Revenue Canada

LISTED PERSONAL PROPERTY

Paragraph 54(e) of the Act lists personal property the disposition of which results in the tax consequences provided in Section 41 of the Act ("Listed Personal Property"). Section 41 and clause 3(b)(i)(B) of the Act refer to "net gain" and "taxable net gain" with reference to listed personal property. Taxable net gains receive different tax treatment from taxable capital gains. The capital gains exemption provided in 110.6(1) of the Act makes reference to a "cumulative gains limit" and an "annual gains limit". These two terms, which are defined in subsection 110.6(1) of the Act, are determined using the "capital gains" computed when applying paragraph 3(b) of the Act.

Does the difference between the terminology in subsection 110.6(1) of the Act and that applicable to listed personal property mean that the gains realized on disposition of listed personal property are not eligible for capital gains exemption?

ANSWER 55

LISTED PERSONAL PROPERTY

The definition of "capital gain" in subsection 248(1) of the Act refers to the definitions of this term in section 39 of the Act, which designates the gain determined in accordance with the provisions in subdivision c of Division B, Part I of the Act. This subsection prescribes three computations for gains realized following disposition of a listed personal property: computation of the "capital gain" provided in sections 39 and 40, followed by computation of the "taxable capital gain" which, by virtue of section 38 of the Act, represents 3/4 of the capital gain, and finally computation of the "net taxable gain" as provided in section 41 of the Act. The first two computations prove useless because, under clause 3(b)(i)(A) of the Act, the aggregate of the taxable capital gains of the taxpayer for the year from dispositions of property other than listed personal property must be taken into account. This latter exclusion of clause 3(b)(1)(A) of the Act with respect to taxable capital gains made from the disposition of listed personal property and the inclusion of net taxable gains included in clause 3(b)(i)(B) of the Act confirms, in our opinion, that the gain from a disposition of this type of property is, above all, a capital gain, but one which receives special treatment. In addition, section 41 of the Act is repeated in subdivision c of the Act entitled "Taxable capital gains".

We are therefore of the opinion that the capital gains deduction
provided in section 110.6 of the Act applies to dispositions of
listed personal property.QUESTION 56 Revenue Canada

ALLOWANCE FOR USE OF AN AUTOMOBILE - PARAGRAPH 18(1)(r)

Paragraph 18(1)(r) of the Act restricts the amount deductible for an allowance paid to an employee for the use of an automobile to a prescribed amount. As of September 1, 1989, this prescribed amount was $.31 for the first 5,000 kilometres travelled by an employees, and $.25 per kilometre thereafter.

Does this mean that if an employee had already travelled 5,000 kilometres as of September 1, 1989, only $.25 per kilometre will be deductible?

ANSWER 56

ALLOWANCE FOR USE OF AN AUTOMOBILE - PARAGRAPH 18(1)(r)

It is our view that the number of kilometres corresponds to the
total kilometres travelled during the year, and that the new rates
of $.31 and $.25 apply to kilometres travelled commencing from
September 1, 1989. This means that in a case where an employee had
travelled 5,000 kilometres prior to September 1, 1989, the employer
will be limited to a deduction of $.27 per kilometre for these
5,000 km, that is, to the old rate, and to a deduction of $.25 per
kilometre travelled during the remainder of the taxation year.
QUESTION 57 Revenue Canada

DEDUCTION OF MANAGEMENT FEES

Five employees of Opco form Holdco, in which each holds 1/5 of the shares issued. Holdco borrows the necessary funds and acquires 25% of the share issue of Opco capital stock. The five employees agree with Opco that their wages will be paid in the form of management fees to Holdco.

Paragraph 18(1)(p) of the Act limits the deductibility of personal services business expenses. The interest paid by Holdco on the borrowing to acquire Opco shares creates a loss from property deductible under paragraph 3(d) of the Act.

Can the Department of National Revenue confirm that Holdco's interest expenses can be applied against its management fees? If so, does the Department of National Revenue intend to invoke section 245 of the Act with respect to these transactions? Will the taxpayers involved benefit from the exception provided in subsection 245(4) of the Act?

ANSWER 57

DEDUCTION OF MANAGEMENT FEES

Provided that interest expenses were not incurred in order to gain the income from the personal services business (subject to paragraph 18(1)(p) of the Act), but rather to earn income from property (dividends on Opco shares), interest deductibility will not be limited by the provisions of paragraph 18(1)(p) of the Act.

A corporation may carry out more than one business, as discussed in Interpretation Bulletin IT-206R. As a result, Opco will be able to claim interest incurred in order to gain dividend income from Holdco.

The use of a personal services business results in a tax benefit to the five employees, and the interest deduction also results in a tax benefit. Therefore, these transactions could constitute avoidance transactions within the meaning of subsection 245(3) of the Act.

However, in our opinion subsection 245(2) of the Act will not generally apply to transactions such as those described above, since there is no abuse in the application of the provisions of the Act as a whole within the meaning of subsection 245(4) of the Act.

QUESTION 58 Revenue Canada

BUSINESS INVESTMENT LOSS
PARAGRAPH 39(1)(c)

In May Estate v. M.N.R. [[1988] 1 C.T.C. 2303] 88 D.T.C. 1189 ("May Estate"), the Tax Court of Canada established that in order to benefit from a business investment loss, a trust must establish that it has acquired the shares of a person who was at arm's length and has disposed of them to a person who was at arm's length.

Subparagraph 39(1)(c)(ii) of the Act would appear to require that only the disposition of shares must occur between persons who are at arm's length.

What is the position of the Department of National Revenue with respect to the May Estate decision?

ANSWER 58

BUSINESS INVESTMENT LOSS
PARAGRAPH 39(1)(c)

The May Estate case was decided on the basis of the particular
facts in the case. The judge's decision was based on an
interpretation of paragraph 39(1)(c) as a whole, including
subparagraphs 39(1)(c)(vi) and 39(1)(c)(ii) of the Act. It is our
position that this decision does not have the effect of adding a
condition to subparagraph 39(1)(c)(ii) of the Act that the shares
must have been acquired in an arm's-length transaction. For
purposes of determining whether subparagraph 39(1)(c)(vi) of the
Act applies, with the dividend reducing the loss to nil, the
decision implies that shares issued prior to 1972 were involved.
QUESTION 59 Revenue Canada

REPLACEMENT PROPERTY

Section 44 of the Act provides for a rollover when a taxpayer acquires a replacement property.

• a) Does the Department of National Revenue intend to allow taxpayers to benefit from the rollover provided in section 44 of the Act in the following situation:

Opco holds real property located in municipality X. X
expropriates Opco's property. All of the Opco shares are
subsequently acquired by a third party. After agreeing
with X concerning the commercial development of the
property, Opco reacquires the property from X for the same
amount as that granted by X upon expropriation.

• b) Subsection 44(5) of the Act defines the term "replacement property". Paragraph 44(5)(a) requires that the replacement property be acquired for the same use as the former property. Is this requirement fulfilled when the taxpayer was leasing the replaced property to a tenant and leases the replacement property to another tenant who uses it for a different purpose than that for which the former tenant used the replaced property?

ANSWER 59

REPLACEMENT PROPERTY

• a) For the purposes of this question, we shall assume that the former property and the replacement property constitute capital properties for the taxpayer.

Where a taxpayer reacquires a former property within the
time period described in paragraph 44(1)(c) of the Act, as
a result of abandonment of the property by the
expropriating authorities, the taxpayer is considered to
have acquired the property as a replacement. (as per
paragraph 12 of Interpretation Bulletin IT-259R2).

In our opinion, the reacquisition of the property of
municipality X by Opco would be considered to be the
acquisition by Opco of a replacement property.

The fact that control of Opco was acquired by another
person following the expropriation and prior to
acquisition of the replacement property is not conclusive
in and of itself as to the application of the provisions
of section 44 of the Act, provided that the series of
transactions does not entail abuse in application of the
Act as a whole.

• b) If the former property were used by the taxpayer for the purpose of gaining or producing business income, the Department of National Revenue would normally consider that the replacement property was acquired "for the same or a similar use" if the property was used for the purpose of gaining or producing income from the same or a similar business, as provided in paragraph 44(5)(b) of the Act. We are of the opinion in this regard that the use of the property by the tenant has no influence on the type of income generated by the owner.

Conversely, if the former property was not used for the
purpose of gaining or producing an income from a business,
the positions described in paragraph 15 of Interpretation
Bulletin IT-259R2 will apply:

"Although the replacement property generally will bear the
same physical description as the former property, e.g.
land replaced by land or a building by a building, there
may be cases where a different type of property provides
the same use or function as the former property."

Given that in the situation with which you have presented
us, the replacement property has the same physical
characteristics and serves to gain the same type of
income, that is, rental income, we are of the opinion that
this property qualifies as a replacement property by
virtue of paragraph 44(5)(a) of the Act.

However, we wish to bring to your attention that in this latter situation the former property does not meet the conditions of paragraph 44(1)(b) of the Act since a rental property does not constitute a former business property according to the definition of this term in subsection 248(1) of the Act. In order for the section 44 provisions to apply, it is essential that the disposition of a former rental property fulfil the criteria of paagraph 44(1)(a), that is that it was taken illegally, destroyed, or expropriated. Your question does not specify wheter these conditions are net.

QUESTION 60 Revenue Canada

COST DETERMINATION

A taxpayer inherits land. He must incur professional fees in order to defend against an action brought by a third party who claims to be the inheritor of the land. Can the taxpayer add these professional fees to the cost of the land? If so, upon what legislative provisions would he base himself?

ANSWER 60

COST DETERMINATION

The terms "cost" and "capital cost" are not defined in the Act. The courts have ruled that the term "cost", for purposes of application of subparagraph 54(a)(i) of the Act, means the price paid to acquire a property. In the above example, the cost of the property would be equal to the deemed cost of acquisition by virtue of paragraph 70(5)(c) of the Act. The courts have also ruled that the term "cost" includes all the expenditures incurred directly in order to acquire a property. However, no expenditure to place oneself in a position to obtain a property would be part of the "cost" of the property.

In our view, the legal expenses incurred in the above example to defend against an action brought by a third party who claims to be the inheritor of the land are intended to establish the respective rights of the co-inheritors, and therefore do not constitute expenses incurred directly in order to acquire the property. These legal expenses would not, therefore, be part of the cost of the property.

QUESTION 61 Revenue Canada

REPLACEMENT PROPERTY

Mr. X owns vacant land which constitutes a capital property for him. The municipality in which the land is located adds water and sewer services on the vacant land held by X. In order to finance the installation of these services, the municipality requires an amount of $10,000 from X. Can the $10,000 paid by X to the municipality be added to the ACB of the land to X? What legislative provisions would allow this?

ANSWER 61

REPLACEMENT PROPERTY

We assume that no depreciable property was acquired by X as a result of the payment to the municipality.

The definition of the adjusted cost base in paragraph 54(a) of the Act for a non-depreciable property is the cost of the property to the taxpayer adjusted, as at that time, in accordance with the provisions of section 53 of the Act.

Amounts which may be added to the adjusted cost base are specified in subsection 53(1) of the Act. In our opinion, the amount in question is not included in any of these provisions, and therefore cannot be added to the adjusted cost base of the vacant land.

It is likely that water and sewer services can be added to the initial cost of the vacant land, since these services added an enduring benefit to the land as discussed in paragraph 4 of Interpretation Bulletin IT-128R.

Utilities service connection expenses are eligible under paragraph 20(1)(ee) of the Act only if there is income from a business and if the conditions described in paragraphs 1 and 2 of Interpretation Bulletin IT-452 are met.

If the taxpayer is carrying on a business but does not meet all the conditions set out in paragraph 20(1)(ee) of the Act, it is also possible that the expense will qualify as an eligible capital expenditure as explained in paragraph 6 of Interpretation Bulletin IT-452.

The amount deductible under paragraph 20(1)(ee) of the Act reduces the adjusted cost base in accordance with paragraph 53(2)(m) of the Act, and does not constitute an eligible capital expenditure under paragraph 14(5)(b)(i) of the Act, as the case may be.

QUESTION 62 Revenue Canada

INTEREST FOR PURPOSES OF PART XIII

Paragraph 214(15)(a) of the Act creates an assumption that sums paid as consideration for a guarantee constitute interest for purposes of Part XIII of the Act. Can such interest receive the exemption provided in subsection 212(1)(b)(vii) of the Act? Does the same apply to deemed interest under paragraph 214(15)(b) of the Act?

ANSWER 62

INTEREST FOR PURPOSES OF PART XIII

Subsection 214(15) of the Act deals with two separate situations. In paragraph 214(15)(a), the beneficiary of "actual" interest on a bond is not the same as the beneficiary of "deemed" interest, unlike the situation for paragraph 214(15)(b) of the Act.

Provided that the beneficiary of "deemed" interest is dealing at arm's length with the borrower, the amounts paid as consideration for a guarantee which are deemed to be a payment of interest on a bond by virtue of paragraph 214(15)(a) of the Act will be eligible for the exemption provided in subparagraph 212(1)(b) provided that the "actual" interest on this bond is also eligible for the exemption. Under paragraph 214(15)(b) of the Act, an amount paid or credited as consideration for an agreement is deemed to be an interest payment only when the "actual" interest on the bond issued by virtue of a lending agreement is not eligible for the exemption provided in subparagraph 212(b)(vii) of the Act. Therefore, in the above case; the amounts paid or credited as consideration for a lending agreement retain their basic characteristics and are not deemed to be interest payments.

QUESTION 63 Revenue Canada

PRESCRIBED SHARES

Section 6205 of the Income Tax Regulations (the "Regulations") defines the meaning of "prescribed share" for purposes of subsection 110.6(8) and (9) of the Act. Mr. A holds all the shares issued from the capital stock of A Inc. A Inc. recognizes its capital stock and Mr. A's shares are converted into preferred shares. New common shares of A Inc. are issued to Mr. A's two adult daughters. Provision 6205(2)(a)(ii)(B) of the regulation requires that the "other shares" be issued to "another shareholder of the corporation". In the opinion of the Department of National Revenue, are Mr. A's adult daughters "other shareholders" for purposes of this provision of the Act? Does the regulation require the other shareholder to have been a shareholder at the time when the corporation was reorganized?

ANSWER 63

PRESCRIBED SHARES

An amendment dated August 28, 1990 applicable to 1985 and subsequent taxation years was made to subsection 6205(2) of the Regulations.

Subparagraph 6205(2)(a)(ii) of the Regulation, as amended, requires that, at the time of the issue of a particular share (in this case, the preferred shares issued to Mr. A) or at the end of the arrangement, that the main purpose of the arrangement was to permit any increase in value of the property of the corporation to accrue to the other shares (in this case the common shares issued to Mr. A's daughters), that the other shares be owned, depending upon the circumstances, by:

(i) the person - called the "original holder" - to whom the
particular share was issued;
(ii) a person who did not deal at arm's length with the
original holder;
(iii) a trust none of the beneficiaries of which were persons
other than the original holder or a person who did not
deal at arm's length with the original holder: or
(iv) any combination of persons described in (i), (ii) or
(iii): or
(v) employees of the corporation or of a corporation
controlled by it.

Therefore, it is not necessary for Mr. A's daughters to have been shareholders at the time of issue of the preferred shares to Mr. A, but it is essential that they were shareholders on one or the other of the two dates mentioned, either the date of issue of the preferred shares to Mr. A, or at the end of the arrangement.

QUESTION 64 Revenue Canada

COST OF ACQUISITION AND PAID-UP CAPITAL

A Inc. transfers an asset worth $1,000 to B Inc. (a wholly owned subsidiary of A Inc.) in consideration for the issue of 100 common shares with a paid-up capital of $100.

What is the cost of acquisition of the asset to B Inc.: $100 or $1,000?

ANSWER 64

COST OF ACQUISITION AND PAID-UP CAPITAL

A transfer such as the one described above could be made through a sale subject to a section 85 rollover, or as a straight sale.

In the first case, provided that the fair market value of the property being transferred is greater than the greater of the fair market value of the common shares received by A Inc. and the amount agreed on by the parties (the "excess"), paragraph 85(1)(e.2) of the Act could have the effect of increasing the agreed amount on by an amount equal to the excess. However, since A Inc. held all of B Inc. shares immediately prior to the transfer, paragraph 85(1)(e.2) of the Act might have no effect on this transaction if the amendments as proposed in subsection 63(2) of the Technical Bill are enacted in their present form. In this case, the cost of acquisition of the property to B Inc. would be $100 if we assume that the agreed amount on was equal to this amount.

If the asset is sold by A Inc. to its subsidiary (B Inc.) without resource to the rollover provisions, subparagraph 69(1)(b)(i) of the Act will apply, and the proceeds of disposition for A Inc. will be deemed to be $1,000, that is, the fair market value of the asset transferred. If the price paid to A Inc. by B Inc. is less than the fair market value of the transferred asset, no adjustment to the cost of acquisition for the acquiring party (B Inc.) is provided by the Income Tax Act.

QUESTION 65 Revenue Canada

ACQUISITION OF CONTROL

Subsection 249(4) of the Act stipulates that a deemed year end occurs when control of a corporation is acquired. Does the Department of National Revenue consider that there is acquisition of control in the following situation?

Mr. A holds 60%, and Mr. B holds 40%, of the shares of A Inc. capital stock. A Inc. redeems the shares held by Mr. A..

ANSWER 65

ACQUISITION OF CONTROL

Yes, we are of the opinion that Mr. B has acquired control of A Inc.

However, if Mr. A and Mr. B were not dealing at arm's length immediately prior to the share redemption by A Inc., there was no acquisition of control provided that the amendments as proposed in paragraph 256(7)(a) of the Technical Bill are enacted in their present form.

QUESTION 66 Revenue Canada

ROLLOVER OF PROPERTY ON DEATH OF SPOUSE

Subsection 70(6) of the Act provides for a rollover for property transferred or allocated to the spouse "on or after the death of the taxpayer". Subsection 248(8) of the Act specifies the meaning of this term.

Since the entry into effect in Quebec of Bill 146 on July 1, 1989, death constitutes a cause for dissolution of marriage which gives rise to distribution of family assets (462.3 C.C.Q.).

Does the Department of National Revenue consider that a transfer of property to a spouse through the estate of the deceased spouse in order to meet the requirements of section 462.3 C.C.Q. will benefit from the rollover provided in subsection 70(6) of the Act?

ANSWER 66

ROLLOVER OF PROPERTY ON DEATH OF SPOUSE

Adoption of the Loi modifiant le Code civil du Québec et d'autres dispositions législatives afin de favoriser l'égalité économique des époux (trans: Act to amend the Quebec Civil Code and other legislative provisions to promote the economic equality of married persons) (L.Q. 1989, ch. 55) by the Quebec National Assembly on June 21, 1989 has resulted in a number of requests for technical interpretations with regard to income taxes. With the assistance of its legal counsel, the Department of National Revenue is currently working on an interpretation of the provisions of the Act with respect to situations which may arise pursuant to passage of the new sections of the Quebec Civil Code, including the potential application of subsection 70(6) of the Act for transfers such as those described in this question.

QUESTION 67 Revenue Canada

COMPENSATORY BENEFIT

Since the passage of Bill 146, a compensatory benefit may be required even where married persons continue to live together (section 462.14 C.C.Q.). If a subsection 73(1) rollover is not used on transfer of property as payment of such a compensatory benefit, how will the attribution rules be applied to income and capital gains generated by the transferred property?

ANSWER 67

COMPENSATORY BENEFIT

Subsections 74.1(1) and 74.2(1) of the Act theoretically cover all transfers of property between spouses. The attribution rules will not apply if one of the exceptions provided in section 74.5 of the Act is met.

In this case, one should question whether the transferring spouse receives, in consideration for the transferred property, one or more properties with a fair market value equal to or greater than the fair market value of the transferred property. At first glance, it is the view of the Department of National Revenue that the transferring taxpayer does not receive anything in consideration for the transfer. Thus the exception provided in subsection 74.5(1) of the Act could not apply.

However, as was mentioned in the reply to question 66, the Department of National Revenue is presently examining, with the advice of legal counsel, the problem raised in this question so as to establish an official position which we hope can be issued soon.