12 April 1989 Income Tax Severed Letter 5-7045 - General anti-avoidance rule—sales vs redemptions

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.

Dear Sirs:

This is in reply to your letter dated November 14, 1988, whereby you request Revenue Canada's position with respect to the application of subsection 245(2) of the Income Tax Act (the "Act") where a shareholder arranges the disposition of his shares in a corporation so as to realize a capital gain rather than a deemed dividend in the following hypothetical fact situation.

An individual, Mr. X, owns 10% of the shares of a private corporation ("Opco"), the other 90, of which are owned by an unrelated individual, Mr. Y. The shares of Opco owned by Mr. X constitute "qualified small business corporation shares" to him within the meaning assigned under the definition thereof in subsection 110.6(1) of the Act. An agreement could be entered into by Opco and Mr. X pursuant to which Opco would repurchase his shares. If the adjusted cost base and paid-up capital of such shares to Mr. X were $1,000 and the proceeds of disposition were $100,000, then pursuant to paragraph 84(3)(b) of the Act, Mr. X would be deemed to have received a dividend of $99,000 as a result of the repurchase. If, on the other hand, Mr. Y incorporated another corporation ("Holdco"), it could borrow $100,000 to purchase the shares of Opco owned by Mr. X. Therefore , the disposition of the Opco shares by Mr. X to Holdco would result in a capital gain to Mr X. Opco could then purchase for cancellation the shares of Opco owned by Holdco for $100,000, which would result in Holdco realizing a tax-free deemed dividend. The proceeds would then be used by Holdco to repay the borrowing.

You are of the opinion that subsection 245(2) of the Act should not be applied to the transactions outlined in this hypothetical situation, since in your view, they do not result, directly or indirectly in a misuse of the provisions of the Act or an abuse having regard to the provisions of the Act, read as a whole.

Our Comments

The situation which you set out is quite specific and it appears that it relates to a particular contemplated transaction. Assurance as to the tax consequence of contemplated transactions can only be given in response to a request for an advance income tax ruling. The procedure for requesting an advance income tax ruling is outlined in information Circular 70-6R, published by Revenue Canada, Taxation on December 18, 1978 ("Information Circular 70-6R"). If you wish to obtain any binding commitment with respect to actual cases with facts similar to your example, an advance income tax ruling application should be submitted. Although we are unable to provide any binding assurance here with respect to the queries you have raised, we have stated our general observations below. These observations apply only for the purposes of subsection 245(2) of the Act.

In the series of transactions described above, the tax benefit referred to in subsection 245(1) of the Act arises from the ability of Mr. X to claim a deduction under subsection 110.6(2.1) of the Act. The series of transactions could reasonably be considered to be undertaken primarily to obtain such a tax benefit, and would therefore be an avoidance transaction, within the meaning of subsection 245(3) of the Act. However, in a series of transactions of an arm's length nature, such as is described above, the Department would generally be of the opinion that they would not result directly or indirectly in a misuse of section 110.6 of the Act or an abuse having regard to the provisions of the Act read as a whole, within the meaning of subsection 245(4) of the Act.

In accordance with paragraph 24 of Information Circular 70-6R dated December 18, 1978, these comments do not constitute an income tax ruling and are therefore not binding on the Department.