3 November 1989 Ruling 58843 F - Capital Gains Exemption

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.

November 3, 1989

Dear Sirs:

Re:  Subsection 85(1) of the Income Tax Act (Canada) (the "Act")

We are writing in response to your letter dated October 10, 1989 in which you requested our opinion regarding the application of subsection 85(1) of the Income Tax Act (the "Act") in the hypothetical situation outlined hereunder.

Facts

1.     Mr. A is the sole shareholder of Aco, a taxable Canadian corporation.

2.     All of the common shares of Aco are qualified small business corporation shares of Mr. A within the meaning of subsection 110.6(1) of the Act.  We have assumed that the common shares have a fair market value of $500,000 and the adjusted cost base to Mr. A is Nil.  We have also assumed that the common shares of Aco are capital property of Mr. A within the meaning of paragraph 54(c) of the Act.

3.     Mr. A transfers all of his common shares of Aco to Aco and, in consideration therefore, Aco issues to Mr. A special shares of Aco that are redeemable, retractable and non-voting.  The special shares will have an aggregate paid-up capital equal to the paid-up capital of all the common shares immediately before the transfer and a fair market value of $500,000 immediately after the transfer.

4.     The share attributes of the special shares are not identical to the share attributes of the common shares.

5.     Pursuant to subsection 85(1) of the Act, Aco and Mr. A jointly elect, in prescribed form and in accordance with subsection 85(6) of the Act, in respect of the disposition of the common shares to Aco so that the amount agreed upon in their election in respect of the common shares is $500,000.

Our Comments

It is our view that the provisions of subsection 85(1) of the Act would be applicable to the above summarized transaction.  It is also our view that Mr. A would be eligible to claim a deduction pursuant to subsection 110.6(2.1) of the Act concerning the capital gain realized by him on the disposition of his common shares to Aco.

Factors considered in formulating our views concerning the above summarized transaction included the following.

     Pursuant to paragraph 85(1)(a) of the Act, Mr. A would be deemed to have received proceeds of disposition in an amount equal to $500,000 and hence, Mr. A would realize a capital gain of $500,000 on the disposition of the common shares to Aco.  Pursuant to subsection 110.6(2.1) of the Act, Mr. A would be eligible to claim a deduction in respect of such capital gain in computing his taxable income for the taxation year in which the disposition takes place provided, of course, that all of the requirements of that subsection are otherwise met.  Notwithstanding that paragraph 85(1)(a) of the Act would deem Mr. A to have received proceeds of disposition in an amount equal to $500,000, the amount paid by Aco by issuing special shares to Mr. A for the purposes of paragraph 84(3)(a) of the Act would be, pursuant to paragraph 84(5)(d) of the Act, equal to the amount by which the paid-up capital in respect of the class of special shares has increased by virtue of the issue of special shares to Mr. A.  Because the amount so paid by Aco to Mr. A would be equal to the paid-up capital in respect of the common shares being redeemed, acquired or cancelled by Aco, subsection 84(3) of the Act would not deem Aco to have paid a dividend Co Mr. A.  Subsection 84.1 of the Act would not apply to the disposition of the common shares to Aco because the common shares of Aco would not be disposed of to another corporation, that is, a corporation other than Aco.  Pursuant to subsection 86(3) of the Act, subsection 86(1) of the Act would not apply to the disposition of the common shares because subsection 85(1) of the Act would be applicable to the disposition.

In your earlier referenced letter you also enquired as to how our opinion might differ if in the above summarized transaction Mr. A sold Class A special shares of Aco in exchange for identical Class A special shares or in the alternative, Class B special shares with rights that are identical to Class A special shares.  It is our view that where Class A special shares are exchanged for other Class A special shares, there will not be a disposition of the Class A special shares.  As a consequence, subsection 85(1) of the Act would not be applicable.

It is a question of fact whether a disposition occurs where Class A special shares are exchanged for Class B special shares.  However, where the share attributes of both the Class A and Class B special shares are identical it is our view that a persuasive argument could be made to the effect that a disposition has not occurred on the transfer of such shares.

The foregoing comments represent our general views with respect to the subject matter of your letter.  The facts of a particular situation may lead to a different conclusion.  The foregoing opinions are not rulings and, in accordance with the guidelines set out in Information Circular 70-6R dated December 18, 1978, are not binding on the Department.

Yours truly,

T. Harrisfor DirectorReorganizations and Non-Resident DivisionSpecialty Rulings DirectorateLegislative and IntergovernmentalAffairs Branch