11 July 1994 External T.I. 9335805 - "DIVIDEND REQ'T" ON GIFTED SHARES WITH 118.1(6) ELECTION

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.

Principal Issues:

Part V tax and the requirement that a charity obtain a suitable return on investment in a corporation with which it does not deal at arm's length

1. Is the amount of debt relating to preferred shares and the disbursement quota of the private foundation based on FMV or the elected amount under 118.1(6).

2. Would the deemed dividend on redemption qualify as interest for the purposes of the tax?

3. Can the FMV of shares be discounted to reflect the distress conditions which would occur if the corp was required to redeem the shares in order for the charity to avoid the Part V tax?

Position TAKEN:

1. FMV 2. yes 3. no

Reasons FOR POSITION TAKEN:

1. the amount designated by the donor under 118.1(6) is only for the purpose of the donor's charitable donation and the donor's proceeds of disposition.

2. 84(3)(b) deems the shareholder to have received the dividend equal to ... and thus for the purposes of 188(4)(b) it is a dividend received.

3. Determination of FMV is a question of fact but it does not take into account hypothetical events which may or may not happen in the future

		Rulings Directorate
XXXXXXXXXX	A. Humenuk
		933580

Attention: XXXXXXXXXX

July 11, 1994

Dear Sirs:

Re: Part V Tax on Non-qualified Investments of a Charity

We have been asked to reply to your letter of September 3, 1993 addressed to Norman Rocheleau of our Charities Division concerning a private foundation's liability for Part V tax in respect of preferred shares held by it. We apologize for the delay in our response.

In the comments that follow, unless otherwise stated, all statute references are to the Income Tax Act S.C. 1970-71-72, c.63 as amended, consolidated to June 10, 1993 (the "Act").

In the situation you describe, an individual will donate preferred shares of various related corporations to a private foundation. Since the directors of the foundation are not dealing at arm's length with these corporations, these shares will be considered non-qualified investments as defined in paragraph 149.1(1)(e.1) of the Act in the hands of the foundation. The shares are redeemable, retractible and carry a variable dividend rate as set by the directors. The shares have a retraction value of $XXXXXXXXXX dollars and a paid up capital of $XXXXXXXXXX The individual intends to elect under subsection 118.1(6) of the Act to use his adjusted cost base of the shares, $XXXXXXXXXX, as the proceeds of disposition of the shares and as the value of the donation for the purpose of subsection 118.1(1) of the Act.

You pose the following questions.

Is the dividend requirement described in paragraph 189(3)(c) of the Act based on fair market value of the shares or on the cost to the taxpayer?

If it is based on the fair market value, would a deemed dividend on the redemption of the shares satisfy the dividend requirement? In other words, can Part V tax be avoided through the redemption of the shares?

Is the disbursement quota of the charity based on the fair market value of the shares at the time the gift is made or on the amount designated by the donor?

If the disbursement quota is based on the fair market value, can the value of the shares be discounted to reflect distress conditions which would be necessary if the shares were redeemed?

Our Views

We do not confirm the tax implications resulting from proposed transactions except by way of an advance income tax ruling as described in Information Circular 70-6R2 "Advance Income Tax Rulings" dated September 28, 1990 and Special Release thereto dated September 30, 1992. However, we are prepared to offer the following general comments which may be of assistance to you.

We assume that the dividend requirement referred to in your letter is the amount of dividends which would need to be paid in the year or 30 days thereafter in order for the private foundation to avoid the payment of Part V tax. In determining the Part V tax payable for a particular taxation year in respect of a non-qualified share which was last acquired by the foundation after April 21, 1982, the amount of the debt is deemed under subsection 189(2) of the Act to be the cost amount of the share to the foundation and the amount of any dividends received by the foundation is likewise deemed to be interest received in respect of that debt. Since subsection 118.1(6) of the Act restricts the use of the amount designated by the donor to the amount of the donor's proceeds of disposition arising from that disposition of the capital property and to the amount used in calculating the donor's charitable donation deduction or tax credit, the cost amount to the foundation is determined in accordance with paragraph 69(1)(c) of the Act (i.e. the fair market value of the shares at the time the gift is made).

A deemed dividend as described in paragraph 84(3)(b) will qualify as a dividend received on the shares for the purpose of paragraph 189(3)(c) of the Act.

Subject to certain exclusions, the disbursement quota of a charitable foundation as defined in paragraph 149.1(1)(e) of the Act is based on the amount of the gifts for which receipts have been issued in prescribed form. The total amount of these gifts should accord with the amount shown on the receipts in accordance with subparagraph 3501(h)(ii) of the Income Tax Regulations. For a gift of property other than cash, the amount shown on the receipt should be the fair market value of the capital property at the time the gift was made, regardless of whether or not the donor intends to make an election under subsection 118.1(6) of the Act.

The determination of the fair market value of the shares involves a finding of fact; further information concerning the Department's policy with respect to valuation can be found in Information Circular 89-3 "Policy Statement on Business Equity Valuation". However, it is our view that a discount factor based on the assumption that the corporation may be asked to redeem the shares would not be appropriate.

While we trust that our comments will be of assistance to you, we would caution that they do not constitute an advance income tax ruling and are, accordingly, not binding upon the Department with respect to any particular transaction.

Yours truly,

P.D. Fuoco
for Director
Business and General Division
Rulings Directorate
Legislative and Intergovernmental
Affairs Branch
c.c. R.A. Davis, Charities Division