27 August 1985 Income Tax Severed Letter 5-7703 - Subsections 85.1(3), 85.1(4) and paragraph 95(6) (b) of the Income Tax Act

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.

We are writing in response to your letter of May 27, 1983 in which you requested our comments concerning the application of the above-mentioned provisions of the Income Tax Act ("the Act").

The concerns raised in your letter can be illustrated through the use of the following example:

A Canadian company ("Canco") is a 100% owned subsidiary of a foreign corporation ("F Co."). Canco on 100% of a foreign affiliated ("FA Co.") which is incorporated and resident in the same jurisdiction as F Co. For valid business reasons, Canco transfers its shares of FA Co. (which represent capital property) to a subsidiary of F Co. that is incorporated and resident in the same jurisdiction as F Co. Canco receives retractable preference shares having reasonable dividend entitlement and representing all the shares of a separate class of stock of the foreign transferee corporation. The value of these shares received by Canco, and the amount at which they are retractable, equals the fair market value of the shares of FA Co. at the time of their transfer. For purposes of this example, we can assume that this transfer is not part of a series of transactions or events designed to dispose of the shares of FA Co. to a person who deals at arm's length with Canco.

You have requested our views with respect to the application of subsections 85.1(3) and (4) and paragraph 95(6)(b) of the Act in this type of example. In our view, it appears that 85.1(3) would apply and 85.1(4) would not apply to the transfer described in this example. Whether or not the provisions of paragraph 95(6)(b) will apply to a situation where subsection 85.1(3) is otherwise applicable is a question of fact which must be determined in each particular case. In the example outlined above, it has been indicated that there are valid business reasons for the transactions. We would not generally consider that issuance of shares by the transferee in order to comply with the requirements of 85.1(3) would cause 95(6)(b) to apply. However, if one of the main reasons for the transactions is to reduce or postpone taxes that would otherwise apply if the transfer had not been done, then 95(6)(b) could apply.

Although you have not requested our comments thereon, some of the provisions of subsections 15(1), 56(2) and 245(2) may apply as a result of this type of transaction if the value of the shares received as consideration by Canco does not equal the value of the shares transferred. In addition, this value would have to be maintained in Canco in order for these provisions not to apply. For example, where there are no restrictions with respect to the impairment of the transferee's ability to redeem in full the retractable preferred shares, such shares may not have a fair market value equal to their reduction amount even at the time they are issued.

We hope this information will be of assistance to you.