21 August 1992 External T.I. 9219885 F - Associated Corporations Rule

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 21, 1992

Dear Sir:

Re:  Paragraph 256(1.2)(f) and subsections 256(1) and 256(1.3) of the Income Tax Act ("the Act")

We are writing in response to your letter of June 26, 1992 wherein you requested our view as to what in your view is an unintended result which arises as a result of the interaction of paragraph 256(1.2)(f) and subsections 256(1) and 256(1.3) of the Act as illustrated in the following hypothetical situation.

The Hypothetical Situation

1.     Mr. A owns 100% of the shares of X Ltd.

2.     Mrs. A who is the spouse of Mr. A owns 100% of the shares of Y Ltd.

3.     Mrs. A wishes to freeze her interest in Y Ltd. in favour of a discretionary trust for the benefit of her children who are under the age of 18 by exchanging her common shares of Y Ltd. for fixed value preferred shares of Y Ltd.  The discretionary trust will subscribe for new common shares of Y Ltd.

It is your view that as a result of the transactions described in 3, X Ltd. and Y Ltd., which would not otherwise be associated with each other for purposes of the Act could become associated with each other pursuant to the operation of paragraph 256(1.2)(f) and subsections 256(1) and 256(1.3) of the Act where the shares of Y Ltd. are held by a discretionary trust for the benefit of the children.

Our Comments

Section 256 of the Act establishes certain rules for determining whether corporations are considered to be associated, as well as for determining whether control of a corporation has been acquired for the purposes of the Act.  Subsections 256(1.2) and 256(1.3) of the Act, inter alia, were added in 1988 to expand the scope of section 256.  Subsection 256(1.2) contains special rules for the purposes of determining whether a corporation will be considered to be controlled for purposes of the associated corporation rules.  Paragraph 256(1.2)(f) provides a "look through" or attribution rule where shares of a corporation are held by a trust.  In general, it treats shares of a corporation held by a trust to be owned by its beneficiaries.  In the case of a discretionary trust, all discretionary beneficiaries are deemed to own the shares of the corporation which are held by the trust.  The result of the application of these provisions may be that more than one person can be deemed to own the same shares at the same time.  In addition, of course, the shares are actually held by the trustees of the trust and the rules in paragraph 256(1.2)(f) do not negate this fact.

Subsection 256(1.3) is an attribution rule which provides that shares of a corporation owned by a child who is under 18 years of age, or, as stated on page 499 of the Explanatory Notes to Legislation Relating to Income Tax issued by the Department of Finance in June 1988, treated as being owned by such a child under one of the other provisions of section 256, shall be treated as being owned by a parent of the child for the purposes of determining whether the corporation is associated with any other corporation controlled by the parent.  An exception, however, is provided where it may reasonably be considered that the child manages the business and affairs of the corporation without a significant degree of influence by the parent.  We also refer you to paragraphs 28 to 30 of Interpretation Bulletin IT-64R3, dated March 9, 1992, wherein two examples are given to illustrate the interaction of paragraph 256(1.2)(f) and subsection 256(1.3) of the Act.

Consequently, we agree that the the provisions of paragraph 256(1.2)(f) and subsection 256(1.3) will apply to deem the two corporations described in the hypothetical situation outlined in your letter to be associated with each other.  We are, however, unable to conclude that this is an unintended result.  On the contrary it appears that it was the intention of Parliament, as explicitly expressed in the provisions of paragarph 256(1.2)(f) and subsections 256(1) and 256(1.3) of the Act, that if the conditions of those provisions are met such corporations shall be deemed to be associated for the purposes of the Act.

We trust that our comments will be of assistance.

Yours truly,

for DirectorReorganizations and Foreign DivisionRulings DirectorateLegislative and Intergovernmental Affairs Branch