31 March 1995 External T.I. 9502225 - CAPITAL GAINS EXEMPTION - ANTI-AVOIDANCE RULES

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 the $500,000 capital gains exemption would be available in respect of the disposition of shares that qualify as "qualified small business corporation shares".

Position TAKEN:

May be available.

Reasons FOR POSITION TAKEN:

The anti-avoidance provisions of section 110.6, i.e., subsections 110.6(7) and (8) may apply to deny the capital gains exemption.

			5-950222
XXXXXXXXXX		C. Chouinard

Attention: XXXXXXXXXX

March 31, 1995

Dear Madam:

Re: Capital Gains Exemption

We are writing in response to your letter of November 18, 1994 addressed to the South Shawinigan Taxation Centre which was forwarded to us for reply.

You inquire whether the $500,000 capital gains exemption will be available upon the disposition of the shares of two corporations (Corporation A and B) in a situation you have described as follows: the shares of both Corporation A and B are owned equally by Mr. A and Mr. B. Mr. A and Mr. B want to reorganize the two corporations such that Mr. A will own all of the shares of Corporation A and Mr. B will own all of the shares of Corporation B. In order to accomplish this result, Mr. A's holding corporation would buy Mr. B's 50% interest in Corporation A and Mr. A would transfer his shares in Corporation A to his holding corporation under section 85(1) of the Income Tax Act (the "Act"). Mr. B's holding corporation would proceed in the same fashion as regards the shares of Corporation B. You have asked us to assume for purposes of our response that the shares of both Corporation A and B qualify as "qualified small business corporation shares".

You also inquire whether our response to your question regarding the availability of the capital gains exemption would be different if one of the principal reasons for the sale of the shares was to permit Mr. A and Mr. B to repay to Corporations A and B certain debts that they have contracted and whether there are any tax consequences to Mr. A and Mr. B that you should be aware of.

Our Comments

Written confirmation of the tax implications inherent in particular transactions are given by this Directorate only where the transactions are proposed and are the subject matter of an advance ruling request submitted in the manner set out in Information Circular 70-6R2. The following comments are, therefore, of a general nature only, and are not binding on the Department.

Shares of a corporation may be eligible for the $500,000 capital gains exemption, to the extent of the unused portion of the exemption, if they meet the definition of "qualified small business corporation share" in subsection 110.6(1) of the Act. However, the anti-avoidance rules of subsections 110.6(7) and 110.6(8) of the Act may apply where shares are sold to deny the capital gains exemption.

Paragraph 110.6(7)(a) of the Act denies the capital gains exemption where a capital gain is realized as part of a series of transactions or events to which subsection 55(2) would, but for paragraph 55(3)(b), apply. In addition, the provisions of paragraph 110.6(7)(b) would deny the capital gains exemption where property is disposed of as part of a series of transactions or events in which any property is acquired by a corporation for consideration that is significantly less than the fair market value of the property at the time of acquisition.

In general, subsection 110.6(8) of the Act is an anti-avoidance rule enacted to prevent the conversion of dividend income into exempt capital gains. Subsection 110.6(8) of the Act will apply 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. 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.

With respect to the situation you have described, we note that example 3 of Supplement 1 to Information Circular 88-2 (a copy of which is enclosed) describes a transaction which in certain respects is similar to the one you refer to and that the Department's position with respect to transactions involving a simple transfer of shares to a related corporation would not be viewed as an abuse of the Act read as a whole.

We cannot comment on your second question as the nature of your concern is not clear from your letter. We also cannot respond to your question concerning the tax consequences of the reorganization to Mr. A and Mr. B, since your query in this respect is in the nature of tax advice and the Department does not provide tax planning advice.

We trust that these comments will be of assistance.

Yours truly,

R. Albert
for Director
Business and General Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch