22 May 1990 Ruling 900281 F - Corporate Reorganizations Course Material on Surplus Strips

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.

SUBJECT:  Review of Corporate Reorganizations Course Material Lesson 5 Surplus Strips

This memorandum is in response to yours dated April 3, 1990 wherein you requested our technical review of the Instructors Lesson Plan and the Participants Package of the Corporate Reorganizations Course Material.  This memorandum offers our comments on the course material with respect to Lesson 5.

Our comments are as follows:

Participants Package

1.     With respect to the fifth condition under paragraph 2.2(a) on page HO/4, we are unaware of any provision which requires that the purchaser corporation be a resident of Canada.

2.     With respect to the third situation found on page H0/5, the reference to 10% of ownership of votes and fair market value should be a reference to "more than 10%".

3.(a)     In Example V under the title "Paid-up Capital Reduction" found on page HO/9.1 of 2, the figures "1,100" and "4,00" in items 2 and 3 should be "1,000" and "4,000", respectively.

   (b)     In Example II under the title "Immediate Deemed Dividend" found on page HO/9.2, the figure "1,100" in item 5 should be "1,000".

4.     On page HO/II.3, second paragraph, line 4, we suggest that it would be better to say that the Opco shares were "qualified small business corporation shares" within the meaning assigned by subsection 110.6(1) than to say that Opco qualified as a small business corporation.

5.     In the bottom half of page HO/11.6, the figure "250,00" found inside the rectangular box should be "250,000".

6.     In the example at the bottom of page HO/14.1, the PUC and ACB of the shares redeemed should be $2,000 (i.e. 20% of $10,000) and the deemed dividend should be $98,000.

7.     In the example on page HO/14.2, the PUC of shares redeemed should be $2,000, the deemed dividend should be $98,000, the ACB of the shares redeemed should be $20,000 and the loss on disposal should be $18,000.

8.     In fact (2) on pages EX/17 and Ex/22, it may add clarity to the question if the words "for cash of $115,000" is added to the end of the following sentence

     "Under the first arrangement he can sell the shares directly to Bill and Bill will immediately sell the shares to his wholly owned holding company, Billco Ltd."

9.     The last sentence on page 18.2 states that "The maximum deduction available to Joe for 1986 is "$85,000".  It appears that the year "1986" should be replaced by "1990" since the sale takes place on June 30, 1990.

10.     On page HO/12.2, we do not think it is correct to say that "the present paragraph 84.1(2)(a) deals with the ACB of shares acquired pre V-day from a non-arm's length party" as paragraph 84.1(2)(a) as it currently reads does not mention anything about non-arm's length parties.

11.     The example on pages HO/19.3 and HO/19.4 is quite confusing.  At the bottom of page HO/19.3 it is suggested that a subsection 85(1) election is made at an agreed amount of $100,000; however, the calculation of the section 40 capital gain described on page 19.4 is computed as if no election was made. In our view, other than the fact that the "Total amount subject to tax" at the bottom of page HO/19.4 should be $379,000 (not $279,000), this example is correct if a subsection 85(1) election is not made.  However, if an election is made pursuant to subsection 85(1), the agreed amount cannot be less than the fair market value of the non-share consideration pursuant to paragraph 85(1)(b).  If the agreed amount is $289,000 which is equal to the "Hard Boot" Cash, then an immediate capital gain of $189,000 will be realized by the transferor in addition to the immediate capital gain of $90,000 resulting from the application of subsection 84.1(1).

     The same problem also appears in the example on pages HO/19.6, HO/19.7 and HO/19.8 if an election pursuant to subsection 85(1) is made.  In such case, the agreed amount will be deemed to be $300,000 under paragraph 85(1)(b). Consequently, an immediate capital gain of $50,000 under subsection 40(1) will arise in addition to the immediate capital gain of $75,000 under paragraph 84.1(1)(a).  Moreover, the reduction in ACB of $75,000 will all be allocated to the debt pursuant to paragraph 84.1(1)(b).  As the ACB of the new shares is nil as computed under paragraph 85(1)(g) or (h), there will not be any reduction of their ACB under 84.1(1)(b).

     If no subsection 85(1) election is made, the numerator in the equation to compute the portion of the reduction allocated to "debt" found at the bottom of page HO/19.7 should be $125,000, not $250,000.  If an election pursuant to subsection 85(1) is made, the amount of the reduction in the ACB of the debt should be $75,000 as mentioned above.

12.(a)     The answer to option 1 of the exercise found on page EX/20 appears to be missing.

    (b)     The answer to option 3 of the same exercise has not included a situation wherein Mr. Jones and Joco Ltd. jointly file an election under subsection 85(1) to have the shares of Jones Ltd. transferred at an agreed amount of $30,000.  In such case, the immediate capital gain under subsection 40(1) will be $9,000 in addition to the immediate capital gain under paragraph 84.1(1)(a) of $9,000. Also, the ACS reduction of the note receivable will be $11,000.  There will not be any reduction in the ACB of the new shares as their ACB is already nil.

13.     With respect to the Final Exercise found on page EX 30, we suggest that the fact that both Mr. Jones and Jones Ltd. are residents of Canada be included in the facts.

14.     The amount of the deemed dividend found at the bottom of page AN/31.1 of 4 should be $54,000, not $554,000.

Instructors Lesson Plan

15.     With respect to the reference to 10% of ownership of votes and fair market value found on page 17, see comment 2 above.

16.     On page 18, we do not agree with the statement "For that reason, it was felt that for purposes of 84.1 and 212.1, subsection 186(2) could only apply where 1) purchaser corp. controls subject Corp. or 2) purchaser corp. together with non-arm's length persons controls subject corp." In a situation where the shares of subject corp. acquired by purchaser corp. are non-voting shares, then neither 1) nor 2) in the above-noted statement would apply.  However, pursuant to subsections 186(2) and (4), subject corp. can still be considered connected with purchaser corp. if persons who do not deal at arm's length  with purchaser corp. control subject corp.  Accordingly, you may wish to reconsider not including this criterion in the Participants Package at B 2.2(b).

17.     The expression "A = L. Cap. all classes $1,000,000" found in the middle of page 25 under the title "Common Shares" should be "A = L. Cap. all classes $1,200,000".

18.     On page 52 under the list of the similarities and differences between sections 84.1 and 212.1, we know of no requirement that the "Purchaser Corp." must be a Canadian resident for the purposes of section 84.1.  Also, for the purposes of section 212.1, both the "Subject Corp." and the "Purchaser Corp." must be a Canadian Corporation, which by the definition assigned by subsection 248(1) and paragraph 89(1)(a), must be a resident of Canada.

We have not been provided with the overheads and other teaching aids mentioned in the Lesson Plan and, therefore, offer no comments on these items.

for DirectorReorganizations and Non-Resident DivisionSpecialty Rulings DirectorateLegislative and Intergovernmental Affairs Branch