27 June 1991 Internal T.I. 9103147 F - Transfers and Loans to Corporations

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.

7-910314

SUBJECT:       24(1) Subsection 74.4(2) and paragraph 85(1)(e.2) of the Income Tax Act (the "Act")         

You have asked for our views on the application of subsection 74.4(2) of the Act to the fact situation that you outlined in your memorandum dated January 25, 1991. We are also including a comment on the department's view on the determination of fair market value for purposes of paragraph 85(1)(e.2)

The fact situation you outlined in your memorandum is as follows:

24(1)

24(1)

Our Comments

We agree with the implication in your memorandum that the results of the series are relevant in the determination of whether subsection 74.4(2) should apply to the transfer of shares of the operating company by the individual to the investment company, to the extent that such results assist in the determination of whether one of the main purposes of the transfer may reasonably be considered to be to reduce the income of the individual and to benefit his spouse (the "Main Purpose Test").

The Main Purpose Test is an objective test rather than a subjective one; the application of this attribution provision is based on what "may reasonably be considered to be" the main purposes of the transfer rather than what the taxpayer intended to be the main purposes of the transfer. The following quotes from Clair F.L. Young's article, "The Attribution Rules: Their Uncertain Future in the Light of Current Problems", contained in the March-April 1987 Canadian Tax Journal at pages 309 and 310, may be helpful in understanding the nature of this objective test.

          ... the taxpayer's intention must be determined by reference to both the taxpayer's subjective purpose and what his purpose may reasonably be considered to have been at the time of the transaction on the basis of external factors.

The purpose test ...is not based on the single main purpose of the transaction but on one of the main purposes. The result is that it is not sufficient, for example, for a taxpayer to argue that the main purpose of a transaction is to effect an estate freeze in respect of property transferred to a corporation if at the same time it may reasonably be considered that another main purpose is to split income with a spouse or minor. Furthermore, the purpose test is extremely wide in scope. The test is based on an intention to benefit the spouse or minor, in any manner whatever, and to reduce the income of the individual who transfers or lends property to the corporation.

          ... subsequent events are irrelevant in determining whether the test is met.... For example, even if the transferred property generates no income, the corporation pays no dividends, and the fair market value of the transferred property decreases, there is attribution of an amount if the purpose test applied at the time of the transfer is satisfied and section 74.4 applies.  The reverse is also true.  If income is generated by the property, the corporation pays a dividend, and the fair marker value of the transferred property increases but the required purpose is absent, there is no attribution of an amount.

It is our view that what may reasonably be considered to be one of the main purposes of the transfer is essentially a question of fact, that can best be determined by your office since you have access to the particular facts of the situation. However, you may find the following observations to be of assistance in making that determination:

1.        You have indicated that the results of the transactions include a reduction in the shareholder's income, as evidenced by the deemed dividend on the redemption of the operating company's shares being received by the investment company. In our view, that circumstance does not appear to be evidence that one of the main purposes of the transfer was to reduce the income of the shareholder because no dividend would have been deemed to have been paid were it not for the transfer and redemption of the operating company shares. Perhaps the future reduction in dividend payments to the shareholder is the result that should be considered when using the results of the transfer to assist in the determination of the purpose of the transfer.

     Further, you have indicated that the transfer of the shares resulted in a benefit to the shareholder's spouse because funds were available for the payment of a salary to the spouse of the shareholder from the investment company. In our view, the payment of a salary to the spouse may be a result of the spouse providing managerial services to the investment company and not a result of the transfer of the shares by the shareholder. If this is not the case, (i.e. if the spouse of the shareholder is not providing managerial services of value), then the deductibility of the salary should be questioned under paragraph 18(1)(a) or section 67 of the Act, rather than attacked under section 74.4.

2.     Although the transfer of excess funds from the operating corporation to the investment corporation ("purification") may have been one of the main purposes of the transaction, if it is also reasonable to conclude that another of the main purposes was to split income with the taxpayer's spouse, the Main Purpose Test would be met.

3.     It is our view that the following considerations, which are referred to in your memorandum, would not appear to be relevant to the determination of whether the Main Purpose Test has been met:

    (a)      the use of section 85 by the shareholder;

    (b)       the fact that the shareholder has achieved significant benefits from other tax planning in the years under review; and

    (c)       the fact that the shareholder is willing to take additional steps to ensure that his spouse does not benefit from the growth in the investment corporation.

4.     The following considerations may be relevant to the determination of whether the Main Purpose Test has been met:

     (a)      value of the consideration received by the shareholder on the transfer to the investment corporation;

     (b)  the rights to future income or future growth in respect of the transferred property or property substituted therefor (i.e. whether future income or future growth can reasonably be expected to accrue to someone else as a result of the transfer); and

     (c)      amount of the potential benefit to the spouse of the taxpayer (which assists in the determination of whether it is one of the "main" purposes, or an "incidental" purpose).

Paragraph 85(1)(e.2)

In determining whether the fair market value of the preferred shares of the investment company that were received by the taxpayer as consideration is equal to the fair market value of the shares of the operating company transferred to the investment company, the department normally considers retractable shares with a redemption amount equal to the fair market value of the transferred property to have full fair market value where there can be no erosion of this value (by payment of dividends on other classes of shares, for instance). If the shares taken back by the individual taxpayer did not have these attributes, you may consider the application of paragraph 85(1)(e.2).

Other

In making all of the above comments we have assumed that the investment corporation was not an S.B.C. throughout any taxation year of the shareholder that includes a period after the transfer of the shares of the operating company because if the investment company was an S.B.C. throughout any such period, the provisions of 74.4(2) would not apply to the transfer of property in that taxation year.

Should you have any questions concerning our comments, please do not hesitate to contact the writer.

Yours truly,

DirectorReorganizations and Non-resident DivisionRulings DirectorateLegislative and Intergovernmental Affairs Branch