4 May 1993 External T.I. 9305575 F - Group Control

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:  Proposed paragraph 84.1(2)(e) of the Income Tax Act (Canada)(the "Act")

We are writing in response to your letter of February 17, 1993 wherein you requested our interpretation of the application of paragraph 84.1(2)(e) of the Act, as proposed in Bill C-92 given third reading in the House of Commons on April 1, 1993 ("Bill C-92"), in two hypothetical situations.

First Situation

1.     Individual A owns all of the shares of Aco and holds those shares as capital property. The fair market value of the shares is $800,000. The adjusted cost base and paid-up capital of the shares is $1. The terms "capital property", "adjusted cost base" and "paid-up capital", as used here and subsequently, have the meanings assigned by paragraphs 54(b), 54(a) and 89(1)(c) of the Act.

2.     Aco is a small business corporation which, as used here and subsequently, has the meaning assigned by subsection 248(1) of the Act.

3.     At the time of the disposition described below, each share of Aco will be a qualified small business corporation share ("QSBC share") which, as used here and subsequently, has the meaning assigned by subsection 110.6(1) of the Act.

4.     A wants to retire and B, an individual who is not related to A and who deals at arm's length with A wishes to acquire the shares of Aco through his holding company Bco of which B owns all of the voting shares.

5.     In order to utilize the capital gains deduction under subsection 110.6(2.1) of the Act, A will sell the Aco shares to Bco. A and Bco will jointly elect under subsection 85(1) of the Act at an agreed amount of $500,000. A will receive non-share consideration of $500,000 and non-voting preferred shares of Bco with a paid-up capital of $1 and which will have a redemption amount of $300,000 and will be retractable over a period of five years. Upon the sale, A will realize a capital gain of approximately $500,000. The term "capital gain", as used here and subsequently, has the meaning assigned by paragraph 39(1)(a) of the Act.

6.     After the sale described above, A will retire from Aco.

Your Comments

It is your concern that, despite the fact that A and B are not related to each other, proposed paragraph 84.1(2)(e) of the Act would apply to deem Bco to be controlled by a group consisting of A and B, even though Bco is in fact controlled by B who owns all of the voting shares of Bco. As a result, A would be deemed not to deal at arm's length with Bco and A would be deemed by paragraph 84.1(1)(b) of the Act to have received a dividend of approximately $500,000 at the time of sale rather than a capital gain.

Our Comments:

We agree that proposed paragraph 84.1(2)(e) of the Act would apply to deem Bco to be controlled by a group consisting of A and B, for the purposes of paragraph 84.1(2)(b) of the Act. However, the provisions of subparagraph 84.1(2)(b)(i) of the Act require that the taxpayer (A) be one of a group of less than 6 persons that immediately before the disposition controlled the subject corporation (Aco).

Proposed subparagraph 84.1(2)(e)(i) of the Act states that, for the purposes of paragraph 84.1(2)(b) of the Act, a group of persons in respect of a corporation means any 2 or more persons each of whom owns shares of the capital stock of the corporation. Since B did not own any shares of Aco immediately before the disposition, there is no group (A and B) which controlled the subject corporation (Aco) immediately before the disposition. Since the requirements of subparagraph 84.1(2)(b)(i) of the Act are not met, it is our view that paragraph 84.1(2)(b) of the Act will not be applicable in the situation.

It is a question of fact whether persons not related to each other are at a particular time dealing with each other at arm's length. Provided A deals at arm's length with B and Bco, it is our view that the provisions of subsection 84.1(1) of the Act will not apply to the disposition by A of his Aco shares to Bco.

Second Situation

1.     Individuals X, Y and Z are not related to each other. Each of X, Y and Z owns one-third of the shares of XYZ Co and each holds those shares as capital property. The aggregate fair market value of the shares is $1,500,000 or $500,000 for each shareholder. The adjusted cost base and paid-up capital of the shares to each shareholder is $1.

2.     XYZ Co is a small business corporation.

3.     At the time of the disposition described below, each share of XYZ Co will be a QSBC share.

4.     X wishes to retire and to sever his involvement with XYZ Co.

5.     X will sell his shares of XYZ Co to a holding company, YZ Co, all of the voting shares of which will be owned by Y and Z. X will receive non-voting preferred shares of YZ Co which will be retractable over a five year period for $500,000 and will have a paid-up capital of $500,000.

6.     After the sale described above, X will retire from XYZ Co.

Your Comments

It is your concern that, even though Y and Z own all the voting shares of YZ Co and therefore control it, proposed paragraph 84.1(2)(e) of the Act will apply to deem X, Y and Z to be members of a group of less than 6 shareholders who control YZ Co. As a result, X would be deemed not to deal at arm's length with YZ Co and paragraph 84.1(1)(a) of the Act would apply to reduce the paid-up capital of X's preferred shares of YZ Co to $1.

Our Comments:

It is our view that proposed paragraph 84.1(2)(e) of the Act contemplates the situation described above since subparagraph (i) thereof indicates that a person holding any shares (rather than only voting shares) of the capital stock of the corporation will be considered a member of a group and subparagraph (ii) thereof may encompass a situation where one or more members of a group have 100% control of the corporation and there exist other members of that group.

Accordingly, in the situation described above, X would be deemed by paragraph 84.1(2)(b) of the Act not to deal at arm's length with YZ Co, for the purposes of section 84.1 of the Act.

Additional Comments

1.     It is our view that any restriction on the right of retraction of a share will affect the fair market value of that share. In the two situations described above, the retraction of the shares over a five-year period may result in tax consequences arising from the difference in value between the shares that are sold and the shares that are received as consideration therefor.

2.     Certain comments expressed above are based on proposed legislation in Bill C-92 and are relevant only to the extent that the proposed legislation is enacted in substantially the same form as proposed in Bill C-92.

The foregoing comments are given in accordance with the practice referred to in paragraph 21 of Information Circular 70-6R2 dated September 28, 1990 and are not binding on Revenue Canada.

Yours truly,

for DirectorReorganizations and Foreign DivisionRulings DirectorateLegislative and Intergovernmental Affairs Branch