31 March 1993 Income Tax Severed Letter 3M05210-14 - APFF 1992: Question 14—Paid-up capital and deemed divid end

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. Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

                     TRANSLATION FROM FRENCH

ASSOCIATION DE PLANIFICATION FISCALE ET FINANCIFERE

                   REVENUE CANADA ROUND TABLE

1992 CONFERENCEASSOCIATION DE PLANIFICATION FISCALE ET FINANCIFERE
                   REVENUE CANADA ROUND TABLE
                          October 1992

                          QUESTIONS A

                    I. REORGANIZATIONS

Question 14

Paid-up capital and deemed dividend

When a corporation governed by the Canada Business Corporations Act issues shares of its capital stock, it must add the full amount of any consideration it receives for any shares it issues to the appropriate stated capital account. By exception, paragraph 26(3)(a) of that Act allows a lesser amount to be added to the stated capital account when the shares are issued (i) in exchange for property of a person who immediately before the exchange did not deal with the corporation at arm's length within the meaning of that term in the Income Tax Act (the "Act"), or (ii) in exchange for shares of a body corporate that immediately before the exchange or that, because of the exchange, did not deal with the corporation at arm's length within the meaning of that term in the Income Tax Act.

(a) When a shareholder carries out a simplified crystallization for the capital gains exemption, he transfers the corporation's shares for shares of another class. To the extent that the individual has a non-arm's length relationship with the corporation, can the corporation, under subparagraph 26(3)(a)(i) of the Canada Business Corporations Act credit the stated capital account maintained for the shares with an amount that is less than the fair market value of the shares received?

(b) To the extent that the individual is at arm's length from the corporation at the time of the crystallization, can the corporation, pursuant to subparagraph 26(3)(a)(ii) of the Canada Business Corporations Act, credit the relevant stated capital account with an amount less than the fair market value of shares received, on the basis that it is acquiring the shares of a body corporate (i.e. itself) with whom it is not at arm's length immediately before the exchange?

(c) An individual owns the entire outstanding shares of Opco, and their adjusted cost basis is $100,000, the paid-up capital is $500,000 and the fair market value is $600,000. To crystallize a capital gains exemption, the individual sells his common shares to Opco for cancellation and, in consideration, Opco issues him shares of another class of its capital stock whose stated capital for corporate purposes and fair market value are $600,000. The amount agreed on by the individual and Opco in their section 85 election is $500,000.

     (i)  Is the individual deemed to have received a $100,000
          dividend under subsection 84(1) of the Act, since
          subsection 85(2.1) of the Act reduces the paid-up
          capital of shares issued in consideration of a $100,000
          amount?

     (ii) To the extent that subsection 84(1) of the Act does not
          apply to situation (i) above, is the individual deemed
          to have received a $100,000 dividend under subsection
          84(3) of the Act?

Department of National Revenue response

(a) Subject to certain readjustments provided for therein, (b) paragraph 89(1)(c) of the Act provides that the "paid-up capital" in respect of a share of any class of the capital stock of a corporation constitutes "... an amount equal to the paid-up capital in respect of that class of shares at that time, computed without reference to the provisions of this Act..."

The question regarding the amount to be credited to the stated capital account requires an interpretation of the Canada Business Corporations Act by the Department. An interpretation of the Canada Business Corporations Act falls outside the Department's mandate.

To the extent that the Canada Business Corporations Act allows the addition to the stated capital account of a class of shares of an amount less than the fair market value of the shares transferred, as a result of a sale of shares as described above, the point of departure for calculating the paid-up capital with respect to the shares of a corporation's capital stock will be the stated capital established under the Canada Business Corporations Act.

(c) Under subsection 84(1), when a corporation resident in Canada has at any time after 1971 increased the paid-up capital in respect of the shares of any particular class of its capital stock otherwise than by an operation described in subsection 84(1), the corporation is deemed to have paid a dividend on the issued shares of the particular class. It is our opinion that, in the example you submitted to us, subsection 84(1) applies to deem the individual to have received a $100,000 dividend at the time the shares of another class were issued in consideration for the cancelled common shares.

The reduction in paid-up capital under subsection 85(2.1) is made on computing the paid-up capital at a time after the issuance of the new shares in your example. The paid-up capital with respect to the new shares will therefore also be reduced under subsection 85(2.1) by $100,000 and thus will be equal to $500,000. The purchase or subsequent repurchase of these shares may result in a dividend under subsection 84(3) of the Act. Such double taxation may be avoided, in our opinion, by the application of subsection 4(4) of the Act.

We realize that it does not seem appropriate to apply subsection 84(1) to such a situation, and we have accordingly referred the problem to the Department of Finance.