18 May 1994 External T.I. 9407415 - 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.

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:

How to calculate the annual rate of return by way of dividends under subsection 110.6(9) of the Act.

Position TAKEN:

Question of fact.

Reasons FOR POSITION TAKEN:

Question 16 of the January 10, 1992 CGA Round Table.

 										5-940741
XXXXXXXXXX                  C. Chouinard

Attention: XXXXXXXXXX

May 18, 1994

Dear Sir/Madam:

Re: Capital Gains Exemption - Subsections 110.6(8) and (9) of the Income Tax Act

We are writing in reply to your letter of March 14, 1994 in which you requested our comments regarding the application of the above-captioned provisions of the Income Tax Act (the "Act") in three different situations.

You are concerned with the method of calculating the "average annual rate of return" under subsection 110.6(9) of the Act. Specifically, you ask whether the calculation is based on the original issue price of the share.

Our Comments

The scenarios outlined in your letter appear to relate to actual proposed transactions involving identifiable taxpayers which, as reflected in paragraph 3 of Information Circular 70-6R2, should be the subject of an advance income tax ruling request. The Department will rule on the application of subsections 110.6(8) and (9) of the Act on a case by case basis when all the facts can be determined at the time of the request. Therefore, while we are unable to provide an opinion in respect of the scenarios outlined in your letter, we are 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 90% of the average annual rate of return thereon for that year.

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.

The annual rate of return by way of dividends that a knowledgeable and prudent investor who purchased the shares would expect to receive on the day he or she acquired them is a question of fact. The expectations of a knowledgeable and prudent investor must be determined by assuming that there will be no delay or postponement in the payment of dividends and no failure to pay dividends, that the dividends will be paid each year at a predetermined rate, either fixed or variable and that the share will be eventually sold for an amount equal to that received by the corporation when the share was issued. We are of the view that the return on the shares that are substituted with new shares must be taken into account in determining the annual rate of return and that the average annual rate of return is usually calculated on the basis of the amount invested by a knowledgeable and prudent investor who purchased the shares on the day they were issued.

Unless as otherwise stated, all references to statute are to the Income Tax Act, S.C. 1970-71-72, c.63, as amended and consolidated to June 10, 1993.

We trust that these comments will be of assistance.

Yours truly,

R. Albert
for Director
Business and General Division
Rulings Directorate
Legislative and Intergovernmental
Affairs Branch