12 January 1984 Income Tax Severed Letter 5-5649 - [Subparagraph 40(2)(g)(ii)]

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.

G.D. Dixon (613) 995-1178

Jan 12/84

Dear Sirs:

This is in reply to your letter of October 26, 1983 wherein you have requested our views with respect to subparagraph 40(2)(g)(ii). For the purposes of discussion, you have provided the following situation:

Mr. X froze his estate in 1974 by transferring his shares of Opco Limited, a C.C.P.C., to Holdco Limited as part of an estate freeze. The Opco shares had:

A.C.B. at 30 June 1974                            $300,000

F.M.V. at 30 June 1974                            700,000

Mr. X. utilizes Section 85 on the transfer and as consideration received:

Shareholder's loan account, without interest $300,000

Preference shares, without cost base               400,000

Opco has experienced financial difficulties recently. As a result Holdo has sold the Opco shares to third parties, partially due to lender insistence. The shares were sold for $100,000 and the proceeds have been reinvested by Holdco in short term deposit receipts. Foldco does not have any other assets and its present financial position basically looks as follows:

ASSETS

Term deposit                               $100,000

LIABILITIES

Shareholder's loan without interest        $300 000

SHAREHOLDERS' DEFICIENCY

Share Capital

Preference shares (no cost base)            400,000
Coron Shares                                25 000

                                            425,000

Deficit                                    (625 000)

                                           (200 000)

Liabilities and shareholders' deficiency $100,000

It appears practically that the $100,000 term deposit receipt may be used to repay $100,000 of the shareholder's loan. This would result in no assets remaining and the balance of $200,000 of shareholder's loan and the shares would be worthless.

You have asked a number of questions with respect to the above situation as it relates toparagraph 6 of Interpretation Bulletin IT-239R2 and paragraph 5 of the predecessor Bulletin IT-2398 .

You have suggested that conditions (a), (c) and (d) of paragraph 6 of IT-239R2 have been met and condition (b) would have been met if the taxpayer had attempted to borrow the funds from the usual commercial lending sources and if that condition were known at the time the transfer of shares had taken place. You have noted that if IT-239R had not been amended, all of the conditions contained in paragraph 5 thereof would have been satisfied.

Paragraphs 3 through 5 of IT-239R2 provide the Department's general position with respect to the deductibility of capital losses from loaning funds at less than reasonable rates of interest in non-arm's length situations whereas paragraph 6 outlines the exception to the general position. IT-239R2 contemplates the situation where a debtor/creditor relationship exists between a shareholder and a corporation as a result of a borrowing/lending transaction. It does not contemplate a particular circumstance where a non-interest bearing "debt" represents the unpaid balance of a purchase price arising from a disposition of property. The particular right to receive an amount was neither acquired for the purpose of gaining or producing income from a business or property nor as consideration for the disposition of capital property to a person with whom the taxpayer was dealing at arm's length. As a consequence, the exception to the Department's general position as stated in paragraph 6 of IT-239R2 , as well as the previous paragraph 5 of IT-239R , would not be applicable to the above example. It is therefore our view that the taxpayer's loss, if any, would be nil.

Where a loan which was non-interest bearing was replaced with a new interest-bearing obligation prior to the time the obligation was determined to be a bad debt as contemplated by paragraph 50(1)(a) of the Act, it would be a question of fact whether the situation would meet the general position the Department has established. Whether a disposition of a debt obligation and acquisition of a new obligation had taken place, would depend on the terms of the obligations and other relevant factors. Generally, the comments in paragraph 5 of IT-239R2 would be relevant.

In a situation where shares, whether common and/or preferred, and debt constituted the consideration taken back or the original freeze, and an arm's length third party held voting control of the corporation through ownership of preferred shares which were redeemed shortly after the freeze, it is unlikely that the taxpayer could be said to have disposed of property in an arm's length transaction. You may wish to note the comments contained in paragraph 10 through 14 of Interpretation Bulletin IT-419 .

Finally, our answer would not be different if the value of shares which are listed on a prescribedstock exchange is frozen through the use of a holding corporation. If the consideration included a non-interest bearing "debt", subparagraph 40(2)(g)(ii) of the Act would still be relevant.

We trust our comments will be of assistance.

Yours truly,

M. Hiltz

Chief Corporate Reorganizations Section Corporate Rulings Directorate

GDD/lc