5 January 1996 Internal T.I. 9525957 - PRICE ADJUSTMENT CLAUSES AND C.G. ELECTIONS

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 a price adjustment clause can be used in conjunction with a subsection 110.6(19) election to avoid the adverse tax consequences flowing from an excessive election?

Position:

It cannot be used.

Reasons:

The election does not constitute a non-arm's length transaction for purposes of subsection 110.6(19) and the Department would not accept this price adjustment clause.

							January 5, 1996

	Ottawa Tax Services Office	HEADQUARTERS
	Business Equity Valuation	C. Chouinard
							957-8953
	Attention: Yvon Lamontagne
							7-952595

Use of Price Adjustment Clauses for Purposes of the Capital Gains Election

This is in response to your memorandum of September 27, 1995, wherein you requested our comments regarding the use of a price adjustment clause to adjust the fair market value of property in respect of which a capital gains election has been filed.

We understand that a taxpayer has filed a capital gains election in respect of shares which trade on a stock exchange. The taxpayer has used a fair market value for purposes of the election which exceeds the price of the shares at the close of the stock exchange on February 22, 1994, since, in his view, the stock market price did not accurately reflect the fair market value of the shares. Although the Department does not agree with the taxpayer's determination of the fair market value of the shares, the taxpayer claims that subsections 110.6(20), (22) and (28) of the Income Tax Act (the "Act"), which apply to excessive elections, will not apply, as a result of the price adjustment clause that was filed with the taxpayer's capital gains election. In the taxpayer's view, the price adjustment clause operates to provide relief from the adverse consequences of the excessive election by adjusting the fair market value of the shares.

In support of his argument that a price adjustment clause can be used to avoid the effects of subsections 110.6(20), (22) and (28) of the Act regarding excessive elections, the taxpayer states that the result of the capital gains election is that the shares were transferred in a non-arm's length transaction and that price adjustment clauses can be used in non-arm's length transactions, where the determination of the fair market value of property is particularly difficult and an error could have serious adverse tax consequences.

As indicated in paragraph 1 of Interpretation Bulletin IT-169, price adjustment clauses are sometimes used where property is transferred in a non-arm's length transaction. Pursuant to subsection 251(1) of the Act, related persons are deemed not to deal with each other at arm's length. Related persons are defined in section 251 of the Act and a person is not considered to be a person related to himself, herself or itself, unless it is specifically provided for, such as in paragraph 251(5)(c), subsection 256(1.5) and paragraph 13(7)(e.1) of the Act. The latter provision is of special interest since it provides that where a taxpayer is deemed by paragraph 110.6(19)(a) to have disposed of and reacquired a depreciable property, the taxpayer is deemed to have acquired the property from himself, herself or itself and, in so doing, not to have been dealing with himself, herself or itself at arm's length. However, this provision only applies for the purposes of paragraphs 8(1)(j) and (p), section 13 and 20 and any regulations made for the purpose of paragraph 20(1)(a) and not for purposes of subsection 110.6(19) of the Act. In our view, paragraph 13(7)(e.1) of the Act would not have been necessary if a taxpayer were considered to be a person related to himself, herself or itself. Therefore, in our view, a taxpayer who is deemed to have reacquired property as a result of the capital gains election cannot be said to have acquired the property from a non-arm's length person. Hence, the taxpayer cannot rely upon a price adjustment clause.

In addition, in our view, the wording of IT-169 makes clear that what is contemplated is a transaction between two persons and not between the same person. For instance, the Interpretation Bulletin refers throughout to the "parties" which, in our view, connotes more than one person. Also, paragraph 1(c) of the Interpretation Bulletin indicates that the Department will recognize a price adjustment clause if "the excess or shortfall in price is actually refunded or paid, or a legal liability therefor is adjusted". It is difficult to conceive that this condition could be met where the transaction that is the object of the price adjustment clause is between the taxpayer and himself, herself or itself.

Notwithstanding our comments above, it should be noted that though IT-169 sets out the Department's position, price adjustment clauses are not binding on the Department, nor is the Department compelled to accept them in every case where they are submitted.

In light of our comments above and the presence in the Act of subsections 110.6(20), (22) and (28), which are intended to prevent an individual from avoiding the tax consequences of an excessive election and to discourage individuals from attempting to shelter post-February 1994 gains by triggering gains in excess of the gains accrued to February 22, 1994, in our view, a price adjustment clause cannot be used by a taxpayer to circumvent the adverse tax consequences which flow from an excessive capital gains election.

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