3 August 1995 External T.I. 9507225 - 55(2)

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:

Would 55(2) apply in a situation involving transactions between related parties including a trust whose beneficiaries are shareholders?

Position TAKEN:

As situation was specific, only general comments were provided.

Reasons FOR POSITION TAKEN:

questions of fact and previous policy of not commenting on specific situations.

		5-950722
XXXXXXXXXX	D. Yuen

Attention: XXXXXXXXXX

August 3, 1995

Dear Sirs:

Re: Subsection 55(2) of the Income Tax Act

We are writing in response to your letter of March 10, 1995 wherein you requested our opinion on the following hypothetical situation.

Situation

Mrs. L owns 50% of the issued and outstanding shares of P Inc. and the remaining 50% of the shares are owned by a non-related party with whom Mrs. L deals at arm's length. P Inc. is a Canadian-controlled private corporation which, as used here and subsequently, has the meaning assigned by subsection 125(7).

Mrs. L is the mother of R and S who each own 50% of the issued and outstanding shares of S Inc., a Canadian-controlled private corporation.

Mrs. L, R, S, R's two children and S's three children are all income beneficiaries of a testamentary trust (Estate L) which was established on the death of Mr. L in 1969. The income of the trust is allocated among any or all of the income beneficiaries at the sole discretion of the trustees of the trust (Mrs. L, R and S).

S Inc. is indebted to Estate L in the amount of $150,000. Estate L is indebted to Mrs. L in the amount of $150,000.

Mrs. L will sell her shares of P Inc. to S Inc. for fair market value. As consideration, Mrs. L will receive preferred shares of S Inc. which will be redeemable at the current fair market value of the shares of P Inc. and bear a monthly non-cumulative dividend equal to 3/4 of 1% of the redemption value.

Mrs. L and S Inc. will make a joint election under subsection 85(1) so that the shares will be transferred at their adjusted cost base which has the meaning assigned by section 54.

P Inc. will declare and pay a dividend of $300,000 to its shareholders. S Inc., as a 50% shareholder, will receive $150,000.

S Inc. will use the proceeds of the dividend to repay the amount owing to Estate L. Estate L will use the proceeds received to repay the amount owing to Mrs. L who will then gift $75,000 to each of R and S.

It is your view that P Inc. will be paying a dividend which would significantly reduce the capital gain S Inc. would realize on a disposition of the shares of P Inc. The dividend would be in excess of income earned or realized after 1971 by P Inc.

Your Question

Would the provisions of subsection 55(2) apply in this situation?

Our Comments

The situation described in your letter appears to involve actual proposed transactions in respect of specific taxpayers. Confirmation as to the tax consequences of actual proposed transactions involving specific taxpayers can only be provided in the context of an advance tax ruling. The procedures for requesting an advance tax ruling are outlined in Information Circular 70-6R2 dated September 28, 1990 issued by Revenue Canada, Taxation ("IC 70-6R2"). However, we will provide the following general comments.

Subparagraph 55(5)(e)(i) deems brothers and sisters to not be related for purposes of section 55 and as a result they would not be a related group within the meaning of subsection 251(4). The mother would be related to her son and daughter individually but would not be related to a member of a related group that controls a corporation (assuming that it would be a group that controls the corporation). Thus the application of subsection 55(2) to any disposition of property to a person (the mother) who is not related to the corporation receiving a dividend in the series of transactions or events would not be precluded by subparagraph 55(3)(a)(i).

Subparagraphs 55(5)(e)(ii) and (iii) deem Estate L not to be related to S Inc., since S Inc. is not related to each beneficiary of Estate L (for the reasons described in the preceeding paragraph). Acccordingly, subparagraph 55(3)(a)(i) would not operate to preclude the application of subsection 55(2) since the dividend received by S Inc. was received as part of a series of transactions that resulted in a disposition of property ($150,000) to Estate L, an unrelated party.

R and S are not related to S Inc. because they are not part of a related group that controls that company. Acccordingly, subparagraph 55(3)(a)(i) would not operate to preclude the application of subsection 55(2) since the dividend received by S Inc. was received as part of a series of transactions that resulted in a disposition of property ($75,000) to each of R and S who are unrelated parties.

The foregoing comments are given in accordance with the practice referred to in paragraph 21 of IC 70-6R2 and are not binding on Revenue Canada.

Yours truly,

for Director
Reorganizations and Foreign Division
Income Tax Rulings and Interpretations Directorate
Policy and Legislation Branch

ENDNOTES

¹ All statutory references in this letter are to the Income Tax Act (Canada), R.S.C. 1985 (5th Supp.) c. 1, as amended (the "Act").