12 August 1994 External T.I. 9325945 - PAID-UP CAPITAL

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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

						5-932594
XXXXXXXXXX						Tim Bryant

Attention: XXXXXXXXXX

August 12, 1994

Dear Sir:

Re: Request for Technical Interpretation of Subparagraph 84(1)(c.3)(iii)

We are writing in response to your letter of September 10, 1993 in which you have requested a technical interpretation of subparagraph 84(1)(c.3)(iii) of the Income Tax Act ("the Act").

You have described the following hypothetical situation in your letter:

1.A is a shareholder of Opco, a Canadian controlled private corporation.

2.A owns 5% of the issued and outstanding non-voting common shares of Opco. The shares are qualifying small business corporation shares. A has no other interest in Opco. A's shares have a paid-up capital and adjusted cost base of $100,000 and a fair market value of $1,000,000.

3. A proposes to crystallize a capital gain in the shares of Opco by transferring them to Holdco, a corporation incorporated under the Ontario Business Corporations Act (the "OBCA"). Holdco is wholly-owned by A immediately before the transaction (A owns one common share issued for $1). A will shelter the attendant capital gain with his capital gains exemption.

4.In order to limit the capital gain on the transfer to the amount of his available capital gains exemption, A and Holdco elect under subsection 85(1) of the Act to fix the proceeds of disposition of the shares of Opco at $600,000.

5.In issuing the common shares of Holdco, the sole director of Holdco (i.e. A) elects under clause 24(3)(a) of the OBCA to add to the stated capital of the common shares issued to A on the exchange an amount equal to the paid-up capital of the shares of Opco transferred to Holdco. There is no tax planning purpose to the reduction as section 84.1 of the Act does not apply to the exchange and subsection 85(2.1) of the Act would otherwise reduce the paid-up capital of the shares to the amount elected on the exchange less the value of any non-share consideration.

The question is whether Holdco could subsequently increase the paid-up capital of the common shares of Holdco to $600,000 without triggering a deemed dividend ($600,000 is the amount that would otherwise have been fixed by subsection 85(2.1) as the paid-up capital of the common shares if no election under clause 24(3)(a) of the OBCA had been made).

You submit that subparagraph 84(1)(c.3)(iii) should apply on the basis that the corporation took an action which reduced the paid-up capital of the shares (as would otherwise have been determined by the Act) from $600,000 to $100,000. Therefore, in your view, it should be possible for the corporation to add this amount back to the paid-up capital of the shares without triggering a deemed dividend. Furthermore, this interpretation would not offend subparagraph 84(1)(c.3)(i) since it does not increase the paid-up capital to a level that is higher than it would have been had no election under clause 24(3)(a) of the OBCA been made.

Our Views

In order for subparagraph 84(1)(c.3)(iii) to apply on the increase in the paid-up capital in respect of the shares of any particular class of the capital stock of a corporation, there must be an action by which the corporation converts into paid-up capital, in respect of that class of shares, any of its contributed surplus that arose after March 31, 1977 on the reduction by the corporation of the paid-up capital in respect of that class of shares. This wording implies that there must exist an amount to reduce, which would indicate that the paid-up capital was, at least temporarily, set at a higher amount and was subsequently reduced to a lower amount.

Clause 24(3)(a) of the OBCA permits a corporation (Holdco), that issues shares in exchange for property (the Opco shares) of a person (A) who immediately before the exchange does not deal with the corporation at arm's length, to add any amount, up to the fair market value of the consideration it received for the shares, to the appropriate stated capital account. Holdco used this provision to set the stated capital of the corporation at $100,000. It was not initially set at a higher amount and then subsequently reduced.

We agree that in the absence of clause 24(3)(a) of the OBCA, subsection 85(2.1) would have reduced the paid-up capital of the Holdco shares to the agreed amount ($600,000). However, in our view, the act of setting the stated capital of these shares at $100,000 in accordance with clause 24(3)(a) of the OBCA does not constitute a reduction by Holdco of the paid-up capital in respect of that class of shares for the purposes of subparagraph 84(1)(c.3)(iii).

The foregoing comments are given in accordance with the practice of providing non-binding opinions referred to in paragraph 21 of Information Circular 70-6R2 dated September 28, 1990.

Yours truly,

for Director
Reorganizations and Foreign Division
Rulings Directorate
Policy and Legislation Branch