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: The application of section 84.1 of the Income Tax Act
We are writing in response to your letter of September 17, 1993 wherein you requested the Department's comments on the application of section 84.1 of the Income Tax Act (the "Act") in the following factual situation, as outlined in your letter.
- an individual ("Mr.A") owned 100% of OpCo (a QSBC) and was actively trying to sell the company to an arm's length party. A valuation is established at $250,000 and Mr. A receives professional advice that the sale can be completed by having the prospective purchaser incorporate a HoldCo, have Mr. A sell his shares to the HoldCo, claim his enhanced capital gains exemption, and the purchaser could then amalgamate OpCo with HoldCo and have the borrowing used to buy-out Mr.A inside of the OpCo.
- sale negotiations take place between 1987 and 1991 with various parties. During this period, Mr.A's son becomes more involved in the company and in 1992 puts forward an offer to buy out his father in the same format as described above.
- Mr. A accepts his son's offer in 1992. Son incorporates HoldCo and HoldCo gives Mr. A a $250,000 note payable for the shares of OpCo. The note is to be paid off over the next ten years out of the profits generated by OpCo. OpCo has very little retained earnings as at the date of sale (approx. $40,000) and there is no intention of stripping the retained earning out of OpCo to pay off the note.
In your view, this situation gives rise to a deemed dividend pursuant to paragraph 84.1(1)(b) of the Act, instead of a capital gain when Mr.A takes back the note payable from his son's HoldCo. You state that section 84.1 of the Act can be an extremely unfair provision in that it can cause a fair market value sale to be 1/3 more expensive for a blood relative to transact than for an unrelated individual.
You ask the following two questions in relation with the above transactions.
1) Given the Department's comments in paragraph 9 of IT-489 (dealing with old section 84.1 - pre 1985) not to apply section 84.1 of the Act in certain circumstances and assuming that it could be verified to the Department's satisfaction that:
- the sale price was equal to fair market value, - Mr. A is no longer involved with the control and management of OpCo and that son, as new owner of OpCo, has assumed full control and management of the company as at the date of purchase, - the transactions were not so structured for tax reasons, would the Department consider not applying section 84.1 of the Act to such a sale?
2) Alternatively, if the Department is not prepared to recognize the "factual" arm's length nature of the sale, would the Department be willing to make an administrative concession and allow the outstanding note to be replaced with preferred shares and only apply section 84.1 of the Act to the amount of the note that has actually been paid off to date.
Our Comments:
We agree with you that section 84.1 of the Act can have application in a situation such as described above, where the non share consideration (the note) exceeds the greater of the paid-up capital and adjusted cost base as determined for the purposes of that provision. As you pointed out, the comments in paragraph 9 of IT-489 applied to old section 84.1 of the Act and are no longer considered relevant.
Section 84.1 of the Act is clear in its requirements and does not provide for any exceptions or for any administrative discretion in its application. The Department's practice is to apply section 84.1 of the Act where the conditions for its application are present.
Moreover, the Department could not allow the outstanding note to be replaced with preferred shares.
We regret that our response could not be more favourable.
The above comments are our general comments on the subject matter outlined in your letter.
We hope these comments are of assistance.
Yours truly,
for DirectorReorganizations and foreign DivisionSpeciality Rulings DirectorateLegislative and Intergovernmental Affairs Branch
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© Her Majesty the Queen in Right of Canada, 1993
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© Sa Majesté la Reine du Chef du Canada, 1993
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