15 August 1990 Internal T.I. 901639 F - Husband and Wife Related to Each Other Until Divorce Proceedings Finalized

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.

August 15, 1990

Dear Sirs:

Re:  Paragraph 55(3)(a) of the Income Tax Act (Canada) (the "Act")

We are writing in response to your letter dated July 17, 1990 in which you requested our views regarding the application of the above referenced provision of the Act to the hypothetical situation outlined hereunder.

Facts:

1.     Propco, a taxable Canadian corporation as defined in paragraph 89(1)(i) of the Act, has issued certain common shares which are held as the 50% by husband ("H") and 50% by wife ("W") and had also issued certain redeemable preferred shares which are all held by H.  H acquired his Propco preferred shares in exchange for common shares of Propco in a transaction to which subsection 86(1) of the Act applied

2.     Wco, an inactive taxable Canadian corporation, is wholly-owned by W.

3.     H and W are husband and wife, resident in Canada, and are presently living separate and apart by reason of marriage difficulties which have now culminated in divorce proceedings.  As part of a negotiated property settlement it has been agreed that, by way of a series of transaction W's shares in Propco be acquired by H for cash consideration prior to a final divorce judgement.

4.     The shares in Propco and Wco held by each of K and in are capital, property as defined in paragraph 54(b) of the Act.

Contemplated transactions - Option 1

5.     It is contemplated that H will transfer all his preferred shares in Propco to Wco and will take back, as sole consideration, redeemable preferred shares with a redemption value equal to the fair market value of the Propco preferred shares and a paid-up capital as defined in paragraph 89(1)(c) of the Act equal to the paid-up capital of the Propco preferred shares.

6.     Propco and H will jointly elect pursuant to subsection 85(1) of the Act with respect to the transfer of the preferred shares.  The agreed amount, for purposes of subsection 85(1), will be equal to the adjusted cost base of the Propco preferred shares.  The expression "adjusted cost base" ("ACB") as referred to here and subsequently has the meaning assigned by paragraph 54(a) of the Act.

7.     H will then transfer to in the preferred shares of Wco, which were acquired as described in paragraph 5 above, for deemed proceeds equal to the ACB of the shares to H pursuant  to subsection 73(1) of the Act.

8.     W will then transfer to H the common shares in Propco, as described in paragraph 1 above, for deemed proceeds equal to the ACB of the shares to in pursuant to subsection 73(1) of  the Act.

9.     Propco will then redeem the preferred shares held by Wco for  cash proceeds.  Propco will be deemed to have paid a taxable dividend pursuant to subsection 84(3) of the Act.

Contemplated transactions Option-2

10.     As an alternative to the transactions described above, it is contemplated that in will transfer all her shares in Wco, as described in paragraph 2 above, to H for deemed proceeds equal to the ACB of the shares to in pursuant to subsection  73(1) of the Act.

11.     H will then transfer all his preferred shares in Propco to Wco as described in paragraph 5 above.

12.     Propco will then redeem the preferred shares held by Wco for cash proceeds.  Propco will be deemed to have paid a taxable  dividend pursuant to subsection 84(3) of the Act.

13.     H will then transfer to in all the issued and outstanding shares in Wco for deemed proceeds equal to the ACB of the shares to H pursuant to subsection 73(1) of the Act.

14.     W will then transfer to H all her common shares in Propco for deemed proceeds equal to the ACB of the shares to in pursuant to subsection 73(1) of the Act.

Comments

The situation outlined in your letter appears to involve actual contemplated transactions.  Assurance as to the tax consequences of contemplated transactions can only be obtained in the context of an advance income tax ruling.  The procedures for requesting an advance income tax ruling are outlined in Information Circular 70-6R dated December 18, 1978 issued by Revenue Canada, Taxation and the related Special Release thereto.  Nevertheless, we can offer the following general comments.

In both situations outlined in your letter H and in are related to each other until such time as their divorce proceedings are finalized.  Furthermore, Propco and Wco will be related to each other and both H and in will be related to Propco and Wco at the time the dividends will have been deemed to have been paid pursuant to subsection 84(3) of the Act by each of Propco and Wco as described in paragraph 9 above with regards to Option-1 and in paragraph 12 above with regards to Option-2.

It is our view, however, that the deemed dividends will be received by Wco as part of the series of transactions or events that includes the divorce of H and W.  As a result of the divorce, H and W will no longer be related to each other and it will be a question of fact whether they will be dealing with each other at arm's length at a particular time. In the event that they deal with each other at arm's length, it is our view that the deemed dividends will be received by Wco as part of a series of transactions or events that results in

i)     a disposition of any property to H with whom Wco will be dealing at arm's length, or

ii)     a significant increase in the interest in Propco of H with whom Wco will be dealing at arm's length,

with the result that the exception found in paragraph 55(3)(a) will not apply to the dividends to be received by Wco.

Your letter suggests that as an alternative to the above, Wco would designate, pursuant to paragraph 55(5)(f) of the Act, a portion of the dividend received from Propco as being a separate taxable dividend with the intent that such dividend will be paid out of the "safe income" attributable to the preferred shares computed in accordance with paragraphs 55(5)(b), (c) and (d) of the Act. However, you are concerned, that the preferred shares of Propco, transferred to Wco on a tax deferred basis, will not retain their aggregate share of safe income that could have been paid as a safe dividend immediately before the transfer.

It is the Department's view, as indicated in Mr. J.R. Robertson's address to the 1981 Conference of the Canadian Tax Foundation (page 85), that;

     "When a corporation acquires a share as the result of a section 85 rollover such a transferred share will retain its share of safe income that could have been paid as a safe dividend immediately before the transfer.  In effect the transferee's holding period in respect of such a transferred share includes the transferor's holding period.  This is reasonable, because the transferor's potential gain on those shares becomes the transferee's potential gain".

As such, provided that the preferred shares of Propco are acquired by Wco on a rollover basis such that its adjusted cost base will be equal to that of H immediately before the transfer, it is our view that the portion of safe income of Propco to which the preferred shares held by H would have been entitled immediately before the rollover, will flow through as safe income of the preferred shares now held by Wco.

We trust the above will be of assistance.

Yours truly,

for DirectorReorganizations and Non-Resident DivisionRulings DirectorateLegislative and Intergovernmental Affairs Branch