3 March 1989 Income Tax Severed Letter 5-7341 - [Subsection 245(2)]

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.

J.D. Brooks Tel. (613) 957-2111

MAR - 3 1989

Dear Sirs:

Re: Subsection 245(2) of the Income Tax Act (the "Act")

This is in reply to your letter of December 28, 1988 in which you requested our view concerning the application of subsection 245(2) of the Act to a hypothetical situation. The situation you described is as follows:

An individual ("Mr. A") owns all the shares of X Corporation ("X Co.") and Y Corporation ("Y Co."). X Co. is a small business corporation which carries on an active business in Canada. Small business corporation has the meaning assigned by subsection 248(1) of the Act. Y Co. owns land on which X Co. carries on its active business and consequently Y Co. also qualifies as a small business corporation. Mr. A is approached by an arm's length party to sell the land owned by Y Co. at an amount which is substantially in excess of both Y Co.'s adjusted cost base of the land and Mr. A's adjusted cost base of his shares of Y Co. Mr. A proposes to sell the shares of Y Co. and claim the capital gains exemption for qualified small business corporation shares pursuant to subsection 110.6(2.1) of the Act. Mr. A will incorporate a new corporation ("Z Co.") which will acquire land elsewhere to which X Co. will move its business and continue operations. You queried whether subsection 245(2) of the Act would be applied to deny Mr. A's claim under subsection 110.6(2.1) of the Act.

You also presented a variation of this hypothetical situation, wherein the land is presently held by X Co. and used by it in its active business carried on in Canada. Mr. A would incorporate Y Co. and transfer the land from X Co. to Y Co. Such transfer would be made with Mr. A having no expectation of a subsequent sale of the land or the shares of Y Co. in the foreseable future. Presumably, the land would be transferred to Y Co. at an agreed amount in accordance with the provisions of subsection 85(1) of the Act.

Our Comments

The examples which you set out are quite specific and it appears that they may relate to particular contemplated transactions. Assurance as to the tax consequences 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 examples, 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 observations below.

Presuming that there are no transactions, other than those described, that would form part of this series of transactions, it is our view that subsection 245(2) of the Act generally would not apply to deny Mr. A's deduction under subsection 110.6(2.1) which he may otherwise be entitled to claim. This deduction will only be available, however, if the specific requirements of the relevant definitions in subsection 110.6(1) and subsection 248(1) of the Act are satisfied. In particular, please note that the date on which the land owned by Y Co. ceases to be used in X Co.'s business would be relevant in reaching a conclusion as to the satisfaction of the requirements of paragraph (a) of the definition of small business corporation in subsection 248(1) of the Act, and paragraphs (a) and (c) of the definition of qualified small business corporation share in subsection 110.6(1) of the Act. In our opinion, these requirements would not be satisfied if, prior to the share sale, there was a cessation of use by X Co. of the land for a period longer than the minimum necessary to provide the purchaser of the Y Co. shares with vacant possession of its real property.

The variation of the hypothetical situation as set out above would not be sufficient to cause us to alter our view concerning the application of subsection 245(2) of the Act. Other provisions of the Act could apply, however, depending on the facts of a particular situation. For instance, paragraph 85(l)(e.2) would apply if X Co. receives consideration from Y Co. having a fair market value less than the fair market value of the land. Subsection 55(2) could apply to any deemed dividend arising on the redemption or cancellation of shares ("Consideration Shares") issued by Y Co. to X Co. as consideration for the land transfer, if it was concluded that the transfer to Y Co. was part of a series of transactions or events referred to in paragraph 55(3) (a) of the Act which also included a subsequent disposition of the shares of Y Co. to a taxpayer dealing at arm's length with X Co. Depending on the consideration received by X Co. from Y Co., subsection 85(2.1) could apply to reduce the paid-up of the Consideration Shares and thereby augment the effect of any application of subsection 55(2) on a subsequent redemption or cancellation of those shares. Whether or not the land transfer would be part of a series referred to in paragraph 55(3)(a) of the Act would be a question of fact which could only be determined with reference to a specific situation. The extended meaning of a series of transactions or events defined in subsection 248(10) of the Act would be considered in reaching a conclusion on this question. If the land transfer were structured so that paragraph 55(3)(b) would provide relief from the application of subsection 55(2) of the Act, an individual realizing a capital gain as part of the series of transactions or events which also included the land transfer would be precluded by paragraph 110.6(7)(a) of the Act from claiming an exemption with respect to that capital gain.

These comments represent an expression of an opinion and are provided pursuant to the practice referred to in paragraph 24 of Information Circular 70-6R.

Yours truly,

for Director Reorganization & Non-Resident Division Specialty Rulings Directorate Legislative and Intergovernmental Affairs Branch