21 August 1992 External T.I. 9217825 F - Buy-Sell Agreement--Arm's Length

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.

Attention:  19(1)

August 21, 1992

Dear Sirs:

Re:  Subsection 84.1(1) of the Income Tax Act (the "Act")

We are writing in response to your facsimile transmission of June 12, 1992 wherein you requested our views on the impact of the buy-sell agreement, as referred to in our letter of June 4, 1992 (file # 920097), on the determination of whether Mrs. X and Holdco X will be dealing at arm's length for the purposes of subsection 84.1(1) of the Act.  Specifically, you are seeking our view as to whether the buy-sell agreement entered into by Mrs. X and Holdco X pursuant to the divorce settlement of Mr. and Mrs. X would, in and by itself, be sufficient to cause Mrs. X and Holdco X to be considered not to deal with each other at arm's length at the time the shares of Y Co held by Mrs. X are acquired by Holdco X pursuant to such buy-sell agreement such that subsection 84.1(1) of the Act would have application.

In your facsimile transmission you asked us to consider the matter by taking into account the following assumptions:

1.     There is no undue influence on either party to the buy-sell agreement;

2.     There is evidence that the parties have attempted to establish a bona fide purchase price for the shares of Y Co;

3.     There is evidence of "hard bargaining" with respect to the terms and conditions of the buy-sell agreement; and

4.     in all other respects, the parties are dealing in fact at arm's length.

Our Comments

In the response to Question 23 of the Revenue Canada Round Table at the 1986 Annual Conference of the Canadian Tax Foundation, the Department stated that the existence of a buy-sell agreement between two shareholders will not necessarily of itself lead to the conclusion that the parties thereto are not dealing with each other at arm's length.  However, the terms of the buy-sell agreement, the manner in which the buy-out is to be effected, and other relevant factual considerations may bring non-related parties into a non-arm's-length relationship.  The assumption of facts described in 1 to 4 above may be indicators that the parties to the buy-sell agreement are dealing with each other at arm's length.  They are, however, not conclusive.  For instance, one would also have to take into consideration whether, in entering the buy-sell agreement, the parties involved have their own independent interests in mind.  It appears that as far as Mr. X is concerned it would not make any difference as to whether Mrs. X's shares of Y Co are redeemed by Y Co or sold to Holdco X.  In fact, if Mrs. X could obtain a more favourable tax treatment on the disposition of her shares of Y Co to Holdco X, Mr. X could be in a stronger bargaining position in other areas of the divorce settlement.  Consequently, inference could be made that Mr. X and Holdco X, which is controlled by Mr. X, do not have an independent interest in the subject matter of the buy-sell agreement.  Hence, Mrs.X and Holdco X could be considered not to deal with each other at arm's length with regards to the buy-sell agreement.

In summary, and as stated in our letter of June 4, 1992, pursuant to paragraph 251(1)(b) of the Act, it remains a question of fact whether persons not related to each other were at a particular time dealing with each other at arm's length.  Such a determination requires a thorough review and consideration of all the facts and circumstances of a particular situation.

Yours truly,

for DirectorReorganizations and Foreign DivisionRulings DirectorateLegislative and Intergovernmental Affairs Branch