30 March 1994 External T.I. 9337225 - SHARES HELD AS INVENTORY

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:

shares held as inventory- application of 84(3) vs. s. 9

Position TAKEN:

	-84(3) applies before section 9 to proceeds less PUC.
	-where PUC exceeds cost, excess is section 9 business 	income

Reasons FOR POSITION TAKEN:

-wording of the Act

XXXXXXXXXX 933722

Attention: XXXXXXXXXX

March 30, 1994

Dear Sirs:

Re: Shares held as inventory

This is in reply to your letter of December 17, 1993 in which you requested a technical interpretation concerning the following hypothetical situation. Unless otherwise stated, all references to a statute are to the Income Tax Act S.C. 1970-71-72, c.63, as amended, consolidated to June 10, 1993 (the "Act").

Taxpayer A holds shares of a corporation as inventory and not as capital property. The shares are shares of a taxable Canadian corporation (the "Corporation") as defined in paragraph 89(1)(i) of the Act. The shares were acquired by Taxpayer A with a paid-up capital, stated capital and cost of $1.00. The shares of the Corporation are now worth $100.00 because the value of the Corporation has risen as a result of its successful business activities in Canada. The Corporation proposes to redeem the shares held by Taxpayer A for the sum of $100.00.

You would like to know whether subsection 84(3) of the Act applies to deem a dividend to be received by Taxpayer A on the redemption of Taxpayer A's shares of the Corporation.

Your comments

You have referred to Question 46 of the Revenue Canada Round Table discussion in the 1984 Canadian Tax Foundation Conference Report, where it is stated that subsection 4(4) of the Act would apply to exclude the application of subsection 84(3) of the Act in a similar situation.

You have submitted that the rules in the Act, particularly the rules relating to the computation of income in Division B of Part I of the Act, must be read in their entirety in order to properly answer the hypothetical question set out above. In your view the more specific provision relating to the redemption of shares (i.e., subsection 84(3) of the Act) should prevail over any more general provisions of the Act such as section 9. You therefore submit that the provisions of subsection 84(3) of the Act would apply to deem the amounts received by Taxpayer A to be a deemed dividend in the amount of $99.00 in the above hypothetical example.

You further submitted that it should not matter in the above hypothetical example whether Taxpayer A is an individual or corporation. To the extent that Taxpayer A is a corporation and has received a dividend which is deductible pursuant to the provisions of section 112 of the Act then the tax results should be the same. However, if a corporate Taxpayer had a $100.00 cost in the shares of the corporation instead of the $1.00 cost as set out in the hypothetical example then subsection 112(4) of the Act would presumably deny any loss on income account which might otherwise be claimed to the extent of the $99.00 deemed dividend received on redemption of the shares of the Corporation.

Our Comments

It appears that the interpretation you seek relates to a proposed transaction to be undertaken by specific taxpayers and, therefore, we bring to your attention Information Circular 70-6R2 dated September 28, 1990 and the Special Release thereto dated September 30, 1992, issued by Revenue Canada, Customs, Excise and Taxation. Confirmation with respect to proposed transactions involving specific taxpayers will only be provided in response to a request for an advance income tax ruling. Where, however, the issue to be considered involves a question of fact, the Department will not rule unless all of the relevant facts are known. Nevertheless, we can offer the following general comments.

Our current position is that, upon a redemption of a share held as inventory rather than as capital property:

a)the difference between the redemption amount and the paid-up capital of the share is deemed to be a dividend paid to, and received by, the shareholder by virtue of subsection 84(3) of the Act;

b)unless the corporation elects capital dividend treatment in respect of the deemed dividend pursuant to subsection 83(2) of the Act, the amount of the dividend will be included as business income of the recipient by virtue of paragraphs 82(1)(a) and 12(1)(j) of the Act;

c)if the shareholder is an individual described in paragraph 82(1)(b) of the Act, an additional amount equal to 1/4 of the deemed dividend will be included in computing the business income of the shareholder by virtue of paragraphs 82(1)(b) and 12(1)(j) of the Act and such shareholder will be entitled to a dividend tax credit in respect thereof by virtue of subsection 121 of the Act;

d)if the shareholder is a corporation, it will be entitled to a deduction under subsection 112(1) of the Act in respect of the deemed dividend provided that the dividend is a taxable dividend received from a corporation described in either of paragraphs 112(1)(a) or (b) and the deduction is not prohibited by any of subsections 112(2.1), (2.2), (2.3) and (2.4) of the Act;

e)to the extent that the paid-up capital of the share exceeds its cost to the shareholder, the excess will be included as business income of the recipient under subsection 9(1) of the Act;

f)Part IV tax will be applicable to the deemed dividend to the extent provided for in subsection 186(1) of the Act subject to the limitations and exceptions set out in section 186(1.1) and sections 186.1 and 186.2 of the Act; and

g)the adjustment to proceeds of disposition under paragraph 54(h)(x) of the Act is not applicable (because that provision is only relevant for the purpose of subdivision c of Division B of Part I of the Act) and, as the Act provides no similar adjustment to proceeds of disposition or cost for the purpose of computing the gain or loss of the shareholder in these circumstances, any deemed dividend arising under subsection 84(3) of the Act on the redemption of shares held as inventory cannot affect or result in any loss being realized by the shareholder as a result of the redemption.

Our comments do not address any potential impact of the measures proposed in the budget of February 22, 1994.

We hope that the above information will be of help to you.

Yours truly,

for Director
Reorganizations and Foreign Division
Rulings Directorate
Legislative and Intergovernmental
Affairs Branch