25 April 1994 External T.I. 9408775 - 84(3)

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

			940877

XXXXXXXXXX A. Seidel

Attention: XXXXXXXXXX

April 25, 1994

Dear Sirs:

This is in reply to your facsimile dated April 7, 1994 in which you requested a technical interpretation concerning the application of subsection 84(3) of the Income Tax Act to the redemption of shares by a corporation.

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

A person holds shares of a taxable Canadian corporation (the "Corporation"), as defined in paragraph 89(1)(i) of the Act, as inventory and not as capital property. At the time the shares were acquired by the person the paid-up capital, stated capital and cost of the shares was equal to the fair market value of the shares. The fair market value of the shares of the Corporation now exceeds the paid-up capital of the shares. The Corporation proposes to redeem the shares for their fair market value.

Your Analysis

In your view the redemption of the shares by the Corporation will give rise to a deemed dividend under subsection 84(3) of the Act to the extent that the fair market value exceeds the paid-up capital of the shares. Subsection 84(9) of the Act confirms that a redemption is a disposition of the shares. Accordingly, subsection 9(1) of the Act would also require the inclusion in income of the gain on the disposition of the shares. However, subsection 4(4) of the Act provides that no amount is required to be included in the income of a person in a taxation year to the extent that the amount has already been included in income. You have asked for our views as to which takes precedence, subsection 9(1) or 84(9) of the Act.

Our Comments

The situation described in your letter appears to involve a series of actual proposed transactions and accordingly, should be the subject of an advance income tax ruling. Should you wish to request an advance income tax ruling on these or other proposed transactions, please refer to the procedures outlined in Information Circular 70-6R2. Although we are unable to provide you with any opinion with respect to the specific transactions described in your letter, we can provide you with the following general comments.

It is our view that the following provisions of the Act apply to the redemption of shares 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) of the Act 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 subsection 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.

These comments are provided in accordance with the guidelines set out in paragraph 21 of Information Circular 70-6R2.

Yours truly,

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