15 January 1992 Income Tax Severed Letter 9132125 - 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.

913212
                                           S. Shinerock
                                           (613) 957-2108
24(1)

Attention: 19(1)

January 15, 1992

Dear Sirs:

Re: Subsections 55(2) and 110.6(7) of the Income Tax Act (the "Act")

We refer to your letter of November 14, 1991 in which you requested our views on the tax implications of the reorganization of a taxable Canadian corporation ("Opco"), within the meaning of paragraph 89(1)(i) of the Act, all of the common shares of which are owned by 24(1)(the "Shareholders"). We also acknowledge the telephone conversation (19(1)/Shinerock) that took place on December 17, 1991.

                      24(1)

The Shareholders desire to transfer the business assets of 24(1) to a Newco pursuant to the provisions of subsection 85(1) of the Act in exchange for preference shares of Newco having a redemption amount equal to the net fair market value of such assets.

Prior to such transfer, the Shareholders will have transferred a certain number of their Opco shares to Newco, also pursuant to subsection 85(1) of the Act. Newco will redeem the preference shares and Opco will purchase for cancellation its common shares (a proportionate number of which will then be owned by Newco, and which have an adjusted cost base of less than 24(1)) from Newco at an amount equal to the redemption amount of the Newco preferred shares. As a result of such redemption and purchase for cancellation, each of Opco and Newco will be deemed by paragraph 84(3)(b) of the Act to have received a taxable dividend. Subsequent to these transactions, you indicated that the Shareholders may sell either the common shares of Newco or Opco to an arm's length party. Adjusted cost base has the meaning assigned by paragraph 54(a) of the Act.

Specifically, you requested that we confirm that the provisions of subsection 55(2) of the Act would not apply to the subsection 84(3) dividends referred to above. In support of your view that subsection 55(2) of the Act would not apply, you reason that since the Shareholders would realize a capital gain on the disposition of their shares of Opco or Newco, as the case may be, which capital gain would reflect the value of either 24(1), as the case may be, then, as stated in your letter, there would be no "...significant reduction in the portion of the capital gain that, but for the dividend, would have been realized on a disposition at fair market value of any share of capital stock immediately before the dividend."

You also asked us to confirm that the provisions of subsection 110.6(7) of the Act would not apply to deny the claim for a capital gains exemption pursuant to either subsection 110.6(2.1) or 110.6(3) of the Act as a result of the disposition by the Shareholders of their common shares of either Opco or Newco. Opinions

From the contents of your letter, it is clear that the above situation refers to specific taxpayers and describes certain transactions that the taxpayers would like to carry out. Confirmation of the tax consequences of specific proposed transactions will only be provided in response to a request for an advance income tax ruling. The procedures for requesting an advance ruling are set out in Information Circular 70-6R2 dated September 28, 1990, and if you wish to submit such a request, we would be pleased to consider it. Consequently, we regret that we are unable to offer any comments on the subject matter of your letter. Nevertheless, we are able to provide you with the following general comments in response to your enquiry.

Application of subsection 55(2) of the Act

Subject to subsection 55(3) of the Act, subsection 55(2) of the Act applies whenever a corporation receives a taxable dividend in respect of which it is entitled to a deduction under subsection 112(1) of the Act as part of a transaction or event or a series of transactions or events one of the results of which (in the case where the corporation is deemed to have received such a dividend under subsection 84(3) of the Act) was to effect a significant reduction in the portion of the capital gain that, but for the dividend, would have been realized on a disposition at fair market value of any share of capital stockof a corporation, and that could reasonably be attributable to anything other than income earned or realized by any corporation after 1971 ("Safe Income") and before the transaction or event or the commencement of the series of transactions or events referred to in paragraph 55(3)(a) of the Act. Thus, it is clear that subsection 55(2) of the Act is intended to apply to the conversion of a capital gain into a deductible dividend by a corporate holder of shares of the capital stock of another corporation. It has no application whatever to individuals, and does not take into consideration any capital gain that might be realized by an individual on the disposition of the shares of a corporation which is subject to the application of subsection 55(2) of the Act.

Paragraph 55(3)(a) of the Act will only apply to except a dividend from the application of subsection 55(2) provided that such dividend is not received as part of a transaction or event or a series of transactions or events described in either of subparagraph 55(3)(a)(i) or (ii) of the Act. For example, if the dividend arises as a result of the transfer of the assets of one corporation to another corporation, and if those corporations do not deal at arm's length with one another, then provided that the transfer is not part of a transaction or event or a series of transactions or events referred to herein, subsection 55(2) of the Act will not apply to the dividend. If however, a disposition of any property takes place, e.g. any of the shares of one or both of these corporations held by a shareholder who is a corporation or an individual is disposed of to an arm's length person, and if the disposition is part of a transaction or event or a series of transactions or events which included the dividend, then subsection 55(2) of the Act would apply to that dividend.

For the purposes of 55(2) of the Act, we would also point out that if the shares of one or more corporations are owned by siblings, then each such corporation would be deemed to be dealing at arms length with one another by virtue of paragraph 55(5)(f) of the Act.

Subsection 55(2) of the Act will not apply if the provisions of paragraph 55(3)(b) of the Act are met. For these provisions to apply, the transferee corporation, which must also be a shareholder of the particular corporation referred to in paragraph 55(3)(b), must receive the proportion of the fair market value of each type of property of the particular corporation that the aggregate fair market value, immediately before the transfer of such property, of the shares of the particular corporation owned by the transferee corporation, is of the fair market value, immediately before such transfer, of all the issued shares of the capital stock of the particular corporation at that time. For a detailed discussion on the rules of paragraph 55(3)(b) of the Act, you may wish to refer to papers given by Mr R. Read and Mr M. Hiltz of this Department, which papers have been published in the 1988 Conference Report and the 1989 Conference Report, respectively.

Application of subsection 110.6(7) of the Act

If the provisions of subsection 55(2) of the Act would apply to a dividend received by a corporation, and the shares of that corporation are subsequently sold by the shareholder thereof to another person, the provisions of subsection 110.6(7) of the Act would not generally apply to deny the claim for a capital gains exemption by the shareholder under either of subsection 110.6(2.1) or 110.6(3) of the Act. If however, the disposition of such shares is part of a series of transactions or events which would include a transfer of property of a corporation that is subject to the provisions of paragraph 55(3)(b) of the Act, then paragraph 110.6(7)(a) of the Act would apply to deny any deduction under either of subsection 110.6(2.1) or 110.6(3) of the Act.

Since you have indicated that the Shareholders may sell the shares of Opco or Newco to an arm's length third party subsequent to the transfer of the business assets of 24(1) to Newco, it is our view that the transfer would be part of a series of transactions or events that would include the sale of the shares of Opco or Newco. Consequently, the provisions of subsection 55(2) of the Act would likely apply to deem the dividends arising from the redemption of the preference shares of Newco and the purchase for cancellation of the common shares of Opco to be proceeds of disposition, unless the provisions of paragraph 55(3)(b) are met.

If paragraph 55(3)(b) applies to exempt the dividends from the application of subsection 55(2), then as indicated above, the provisions of paragraph 110.6(7)(a) will apply to deny any capital gains exemption which might otherwise be available on the sale of the shares of Opco or Newco. Yours truly,

for Director Reorganizations and Foreign Division Rulings Directorate Legislative and Intergovernmental Affairs Branch

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