8 March 1994 External T.I. 9329275 F - Capital Gains Exemption

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.

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Attention:  XXXXXXXXXX

Dear Sir:

RE:  110.6(8) of the Income Tax Act ("the Act)"

This is in response to your letters of October 5 and November 5, 1993 in which you requested our opinion regarding whether subsection 110.6(8) of the Act will apply under particular circumstances to deny to certain shareholders the capital gains exemption found in subsection 110.6(2.1) of the Act.

You described a situation where upon incorporation a corporation's share structure consisted of a number of common shares owned evenly by six arm's-length individuals and a number of preferred shares (not prescribed shares for the purposes of subsection 110.6(8)) also owned evenly by the same six individuals. The common shares were acquired for a nominal cost. The preferred shares carry an entitlement to a non-cumulative annual dividend equal to the average commercial loan rate for the year plus one percent.

While the maximum dividends on the preferred shares were paid in respect of two of the seven years since incorporation, none were paid in respect of the other five years.

You are concerned with whether subsection 110.6(8) of the Act will apply to deny the capital gains exemption on a capital gain crystallized on the common shares which is based on their fair market value after taking into consideration the non-payment of dividends on the preferred shares. You also query whether it would matter whether the non-payment of dividends was based on the actual amount of dividends or on the present value of such dividends.

Our Comments:

The facts outlined in your letter appear to relate to actual proposed transactions involving particular taxpayers and therefore a binding determination from Revenue Canada regarding the applicability or inapplicability of subsection 110.6(8) can only be obtained by way of an advance tax ruling request following the procedures outlined in Information Circular 70-6R2. We are, however, prepared to offer the following general comments.

Subsection 110.6(8) of the Act will apply to deny a capital gains exemption deduction if it may reasonably be concluded, having regard to all the circumstances, that a significant part of a capital gain is attributable to the fact that dividends were not paid on a share (other than a prescribed share) of a corporation or, if paid, were less than a required amount.

In interpreting the phrase "a significant part of the capital gain" it is our view that the determination of what constitutes a significant part of the capital gain is a question of fact which must be decided in each particular case having regard, as the subsection states, to all the circumstances. Accordingly, the Department has not developed detailed or specific guidelines in respect of this issue. While we are of the view that in many cases this question is appropriately answered by ascertaining the proportion or percentage of the capital gain that is attributable to the non-payment of adequate dividends, we are also of the view that there may be circumstances where it is appropriate to consider the amount or magnitude, expressed in dollars, of the capital gain that is so attributable.

Regarding your query whether one must take into account the time-value of the unpaid dividends in determining whether a significant part of a proposed capital gain is attributable to that failure to pay dividends, we submit the answer is in the affirmative. Such a determination is one of fact which would require taking into account, among other things, prevailing rates of return on various investments.

We hope these comments will be of assistance.

R. Albert for DirectorBusiness and General DivisionRulings DirectorateLegislative and Intergovernmental Affairs Directorate