18 November 1991 Internal T.I. 9126817 F - Tax Treatment of Proceeds of Disposition

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 - 912681 19(1)

SUBJECT:            (the "Taxpayers") Tax Treatment of Proceeds of Disposition

We are writing in response to your memorandum of August 29, 1991 which was forwarded to the Rulings Directorate for reply by the Applications Opinions Section, Audit Applications, Head Office.

Our understanding of the facts is as follows:

Facts

1.     

2.     

24(1)

3.     

4.     

24(1)

Taxpayers' Position

1.     

24(1)

2.     

District Office Position

1.     The Taxpayers' first position is not consistent with the Purchase Agreement nor was it consistent with the disposition reported on the Taxpayers' returns.

     Furthermore, the Taxpayers' position was also not consistent with the position of the Purchaser who could argue that the ACB of the shares he bought was 24(1)  pursuant to the Purchase Agreement and not the 24(1) received by the Taxpayers.

2.     With respect to the alternative position suggested by the Taxpayers' representative, you have noted that it was inconclusive as to whether there had in fact been a disposition of the debt since the Company had not filed a financial statement since the disposition.  Furthermore, even if the debt had been disposed of, subparagraph 40(2) (g) (ii) would deem the capital loss to be nil because the debt was not laid out for the purpose of earning income from business or property nor was it part of the consideration in the disposition of property.

District Office Queries

You have asked us to consider the following:

1.     Based on the above Facts, and in particular the Purchase Agreement, can the Department accept the Taxpayers' representatives' first assertion that the proceeds of disposition should be allocated between the shares and the debt?

2.     Does paragraph 53(1) (c) apply to recognize an advance of 24(1) by the Taxpayers to the Company as a contribution of capital and as such an increase in the ACB of their shares in the Company?

3.     If neither of the above alternatives is applicable, is the Department justified in increasing the Taxpayers' capital gain from 24(1) to 24(1) when in fact 24(1)  was the amount eventually left in the Taxpayer's hands

Our Comments

1.     From Fact 2 (a) above, the Purchase Agreement was for the purchase of all the outstanding shares in the capital of the Company.  This was agreed to by both the Vendor , ie ., the Taxpayers, and the Purchaser. From Black's Law Dictionary on page 395 regarding the importance of mutuality of intention with respect to contracts its northeast "there can be no true contract without a mutual undercurrents intention of the parties.  We also note the comments made by Judge Noel in Herb Payne Transport Limited v MNR, 63DTC 1075, at page 1075: "There is also no question that if the purchaser and vendor acting at arm's length, reach a mutual decision as to apportionment of price against various assets which appear to be reasonable under the circumstances, they should be accepted by the taxation authority as accurate and they should be binding on both parties".  Based on these comments, in our view, requests for unilateral allocation where none was originally agreed to should generally not be accepted.

         Accordingly, we agree with your position that the 24(1) represents the gross proceeds of disposition for the shares.The documentation provided does not support the allocation of proceeds between the shares and the debt.  Thus, assuming that the documentation reflects the intent of the parties, the gross proceeds of disposition for the shares should remain at     24(1) and the Purchaser's ACB of the shares should be

2.     Paragraph 53(1)(c) provides for a bump to the ACB of property where the property is a share of the capital stock of a corporation and a taxpayer has made a contribution of capital to the corporation, otherwise than by way of loan, by that proportion of such part of the contribution that

     (i)      the amount that may reasonably be regarded as the increase in the fair market value, as a result of the contribution, of the share

      is of

     (ii)      the amount that may reasonably be regarded as the increase in the fair market value, as a result of the contribution, of all shares of the capital stock of the corporation owned by the taxpayer immediately after the contribution.

     In the case at hand, the Taxpayers must have first received the funds upon the disposition of the shares before they made `contribution of capital'.  The denominator in the above formula would be nil because the Vendors do not own any shares of the capital stock of the corporation immediately after the contribution and the paragraph 53(1)(c) bump would be nil. Inanition, as you suggested, the advance of funds to a corporation can only be considered a contribution of capital if they are made by persons who are shareholders. The apparent sequencing of transactions in the case at hand, results in the Taxpayers making their `contributions' when they were no longer shareholders.

3.     In our view, the Department would not be justified in determining capital gains on this disposition without consideration to the repayment of the debt by the Taxpayers.  There is support in MNR v Jean-Paul Demers and Bertrand Fradet (86 DTC 6411 - FCA) (83 DTC 5445 - FC-TD) for the deduction of the repayment of the loans as an outlay or an expense to the extent that they were made or incurred by the Taxpayers for the purpose of making the disposition under subparagraph 40(1)(a)(i) or, alternatively, in determining the sale price of the property that has been sold under subparagraph 54(h)(i). In Demers, the taxpayers sold shares in a company for a stated price of $7,800,000.  As part of the sales agreement they were to pay $1,400,000 (the book value of debt) to the company for a debt with a market value of $600,000.  The Court found that the agreement, properly construed, provided that the taxpayers would use part of the sale price to pay the debt owing to the company.  In that case, it followed that the difference between the face value and the market value of the debt should be deducted from the sale price for the purpose of determining the taxpayers' proceeds of disposition. Alternatively, in looking at the deductibility of the amount under paragraph 40(1)(a)(i), the concurring judge said `if a payment which would otherwise be an outlay within the meaning of the provision results in the taxpayer acquiring property with a value equal to that of the payment, it would be contrary to common sense to treat it as an outlay made `for the purpose of making the disposition'.  In the situation we are concerned with, the Taxpayers do not appear to have acquired any property as a result of the outlay so the payments could be considered to fall under paragraph 40(1)(a)(i).

Based on the above, in our opinion, the repayment of the loans should be taken into consideration in the calculation of the capital gain on the Taxpayers' disposition of the shares.

We trust that our comments will be of assistance.

E. WheelerChiefServices, Public Utilities & Exempt Corporations SectionBusiness and General DivisionRulings DirectorateLegislative and Intergovernmental Affairs Branch