5 May 1993 External T.I. 9238885 F - Shareholder Agreement and Dealing at 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.

XXXXXXXXXX

Attention:  XXXXXXXXXX

Dear Sirs:

RE:  Sections 251 and 84.1 and subsection 245(2) of the Income Tax Act (the "Act")

We are writing in response of your letter of December 30, 1992 wherein you requested our view on your interpretation of the above-referenced provisions of the Act with respect to the situation outlined in your letter. Such situation is summarized as follows:

A and B are brothers and each of them owns 50% of Opco. They have entered into a shareholders' agreement which provides, among other things, that on the death of either A or B, the surviving shareholder of Opco or his nominee is obligated to purchase at fair market value the shares of Opco owned by the deceased person from his estate. Subsequent to A's death, B incorporates a holding corporation ("Holdco") and causes Holdco to purchase the shares of Opco held by A's estate (the "Estate") by having Holdco issue to the Estate a demand promissory note having a fair market value equal to the fair market value of the shares of Opco so purchased. Holdco and Opco then amalgamate to form Amalco.

It is your view that

1.     by virtue of A's death, the Estate is not related to B and thus the Estate deals at arm's length with B and, therefore, with Holdco;

2.     based on the conclusion in 1 above, the rules in section 84.1 of the Act would not apply to deem a dividend to have been paid by Holdco and received by the Estate; and

3.     the rules in subsection 245(2) of the Act would not apply in such circumstances.

Our Comments:

The situation outlined in your letter appears to relate to actual proposed transactions and identifiable taxpayers and, therefore, should be the subject of an advance income tax ruling. Confirmation as to the income tax consequences of proposed transactions will only be given in the context of an advance income tax ruling. The procedures for making a request for an advance income tax ruling are outlined in Information Circular 70-6R2, dated September 28, 1990, and the related Special Release thereto. We can, however, offer the following general comments.

Since we do not have details concerning the executors and beneficiaries of the Estate, we are unable to provide any comments as to whether we agree with your interpretation that the Estate is not related to either of B or Holdco. However, even if it were to be determined that the Estate is not related to either of B or Holdco, paragraph 251(1)(b) of the Act states that it is a question of fact whether persons not related to each other were at a particular time dealing with each other at arm's length. It is our view that where a deceased shareholder did not deal at arm's length with the surviving shareholder at the time a buy-sell agreement was entered into, the estate of the deceased and the surviving shareholder would not normally be considered to deal at arm's length when property is sold by the estate to the surviving shareholder pursuant to the agreement. References in this regard can be drawn from paragraphs 2 and 3 of Interpretation Bulletin IT-140R3, dated April 14, 1989. Consequently, in the situation described in your letter we would expect that paragraph 84.1(1)(b) of the Act will apply to deem a dividend to have been paid by Holdco and received by the Estate equal to the amount by which the fair market value of the demand promissory note of Holdco exceeds the greater of the paid-up capital of the shares of Opco so transferred and the adjusted cost base (as determined under subsection 84.1(2) of the Act) to the Estate.

We trust the above will be of assistance.

Yours truly,

for DirectorReorganizations and Foreign DivisionRulings DirectorateLegislative and Intergovernmental Affairs Branch