25 July 1994 External T.I. 9407865 - 85(4)

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:

whether capital gain exempt under a tax treaty affect the calculation of the adjusted cost base for purposes of ss.84.1(2) of the Act

Position TAKEN:

No

Reasons FOR POSITION TAKEN:

Not normally be a capital gain included in 84.1(2)(b)

XXXXXXXXXX 940786

Attention: XXXXXXXXXX

July 25, 1994

Dear Sirs:

Re: Adjusted Cost Base and Paid-up Capital of Shares of a Corporation

We are writing in reply to your letter of March 23, 1994 wherein you requested our confirmation as to whether your determination of the adjusted cost base and paid-up capital of the shares of a Canadian private corporation is correct in the situation outlined in your letter. The terms "adjusted cost base" and "paid-up capital" have the meanings assigned by paragraphs 54(a) and 89(1)(c) of the Income Tax Act, respectively.

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").

The situation outlined in your letter appears to relate to an actual situation involving identifiable taxpayers. Accordingly, the applicable District Taxation Office should be consulted with respect to any income tax consequences arising from transactions all or some of which have already been completed. However, we can offer the following general comments.

Where a capital loss realized by a taxpayer on the redemption of a portion of his or her shares of a Canadian corporation is deemed to be nil by virtue of paragraph 85(4)(a) of the Act, the provisions of paragraph 85(4)(b) will apply to increase the adjusted cost base of the remaining shares of the corporation owned by the taxpayer.

Where subsection 84.1(1) of the Act applies, and where the sole consideration received by an individual (hereinafter referred to as the transferor) for the subject shares consists of shares of the purchaser corporation, there will be a reduction of the paid-up capital of the shares of the purchaser corporation received by the transferor as a result of the transfer if such paid-up capital is greater than the greater of the paid-up capital of the subject shares and the adjusted cost base, as determined under paragraphs 84.1(2)(a) and (a.1) of the Act, to the transferor of the subject shares.

For the purposes of determining the adjusted cost base of a share of a corporation for the purposes of section 84.1 of the Act, paragraph 84.1(2)(a.1) will apply where a subject share is acquired by the transferor after 1971 from a person with whom the transferor was not dealing at arm's length, or to a share substituted for such share. The adjusted cost base of such share for the purposes of section 84.1 is the amount, if any, by which the adjusted cost base, as otherwise determined, exceeds the aggregate of

where the share or a share for which the share was substituted was owned at the end of 1971 by the transferor or a person with whom the transferor did not deal at arm's length, the excess of the fair market value of the share or the substituted share, as the case may be, on Valuation Day over the aggregate of

(i) the actual cost on January 1, 1972 of the share or substituted share to the transferor or non-arm's length person, and

(ii) dividends received on the share or substituted share by the transferor or non-arm's length person after 1971 on which an election was made under subsection 83(1) by the corporation which paid the dividend

and

the aggregate of all amounts determined after 1984 under subparagraph 40(1)(a)(i) to be capital gains (or such lesser amount as is established by the transferor to be the amount in respect of which a deduction was claimed under section 110.6) for previous dispositions of the share or substituted share by the transferor or an individual with whom the transferor did not deal at arm's length.

In general, where a transferor acquires a subject share from a non-arm's length individual, the amount of any capital gain realized by the non-arm's length individual on the disposition which is exempt from taxation in Canada by virtue of an exemption contained in a treaty between Canada and another country will not normally be a capital gain included in (b) above.

The comments set out above should not be construed as implying that the Department has reviewed all the transactions described in your letter and agreed with your conclusions.

Yours truly,

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