2096 Ruling 9531093 - C.G. EXEMPTION - INTERNAL CRYSTALLIZATION

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:

1.Whether the transfer of common and special shares to a corporation in exchange for other shares of the corporation constitutes a disposition within the meaning of section 54 of the Act?

2.Whether subsection 110.6(8) will apply to deny the capital gains exemption claimed under subsection 110.6(2.1) of the Act?

3.Whether GAAR would apply to the proposed transactions?

Position:

1.The transfer would constitute a disposition.

2.Subsection 110.6(8) will not apply.

3.GAAR will not apply.

Reasons:

1.The share attributes of the new shares are sufficiently different from the attributes of the common and special shares to give rise to a disposition.

2.The common shares qualify as "prescribed shares" within the meaning of paragraph 6205(1)(a) of the Income Tax Regulations and, as regards the special shares, there is no indication that the taxpayer structured his affairs in such a manner as to convert unpaid dividends into capital gains.

3.The Department has sanctioned the use of internal crystallizations for purposes of claiming the capital gains exemption.

									3-953109
XXXXXXXXXX

Attention: XXXXXXXXXX

XXXXXXXXXX, 1996

Dear XXXXXXXXXX:

Re: XXXXXXXXXX
Advance Income Tax Ruling

This is in reply to your letters of XXXXXXXXXX, in which you requested an advance income tax ruling on behalf of the above-mentioned taxpayers with respect to the proposed transactions described below.

To the best of your knowledge and that of your clients, none of the issues involved in this ruling is being considered by a Tax Services Office or a Taxation Centre in connection with any tax return already filed and none of such issues is under objection.

FACTS

XXXXXXXXXX (the "Company") was incorporated XXXXXXXXXX.

2.The company was dormant from XXXXXXXXXX. During this period, XXXXXXXXXX operated XXXXXXXXXX as a proprietorship.

3.In XXXXXXXXXX transferred the XXXXXXXXXX business to the Company pursuant to subsection 85(1) of the Income Tax Act (the "Act").

4.The authorized capital of the Company from XXXXXXXXXX consisted of XXXXXXXXXX preference shares and XXXXXXXXXX common shares.

5.The common shares carry the right to dividends and the right to vote.

6.On XXXXXXXXXX the letters patent of the Company were amended to authorize the issuance of XXXXXXXXXX special class B shares.

7.The attributes of the special class B shares are as follows:

-Non-voting.

-Non-cumulative dividends at the rate of XXXXXXXXXX% per year on the amount paid up on the shares.

-Preference over all other classes of shares of the Company, except preference shares, upon dissolution.

-Redeemable at the option of the Company for the amount paid up on the shares, plus any declared and unpaid dividends.

-Retractable at the option of the shareholder for the amount paid up on the shares.

8.The shareholdings of the Company from XXXXXXXXXX to the present date are as follows:

XXXXXXXXXX

9.No dividends have been paid on any of the shares since XXXXXXXXXX.

PROPOSED TRANSACTIONS

10.XXXXXXXXXX will crystalize their capital gains exemption on both the common and special class B shares held by them by exchanging the common shares for class C special shares and the special class B shares for class D shares, both of which will be authorized by amending the articles of incorporation of the Company to provide for class C and class D shares.

11.The class C shares will have the following attributes:

-Non-voting.

-Non-cumulative dividends, as declared by the board of directors, not to exceed XXXXXXXXXX% per month of the redemption amount.

-Redeemable at the option of the Company for the redemption amount plus any declared and unpaid dividends.

-Retractable at the option of the holder for the redemption amount plus any declared but unpaid dividends.

-The redemption amount will be set at $100 per share, subject to a "price adjustment clause" should a different amount be established by Revenue Canada or the courts.

-Preference over all other classes of shares of the Company upon dissolution.

12.The class D shares will have the same attributes as the class C shares, except that they will carry the right to cumulative dividends of XXXXXXXXXX% per year based on the redemption amount.

13.The articles of incorporation will also contain a restriction on the payment of dividends on any other class of shares if the payment would result in the Company having insufficient assets to redeem the class C shares.

14.XXXXXXXXXX will transfer his XXXXXXXXXX class B shares with a fair market value of $XXXXXXXXXX to the Company in exchange for XXXXXXXXXX class D shares. The transfer will be done pursuant to subsection 85(1) of the Act, at an elected amount equal to the fair market value of the class B shares.

15.XXXXXXXXXX will each transfer their XXXXXXXXXX common shares with an aggregate fair market value of $XXXXXXXXXX to the Company in exchange for XXXXXXXXXX class C shares. These transfers will also be done pursuant to subsection 85(1) of the Act. The elected amount for each of XXXXXXXXXX common shares will be an amount equal to the fair market value of these shares.

16.XXXXXXXXXX will claim the capital gains exemption under subsection 110.6(2.1) of the Act in respect of the special class B shares and the common shares transferred to the Company.

17.Immediately after the above transactions are completed, XXXXXXXXXX will each subscribe for XXXXXXXXXX new common shares for $XXXXXXXXXX.

PURPOSE OF THE PROPOSED TRANSACTIONS

18.XXXXXXXXXX wish to crystallize the accrued capital gains on both the common and the special class B shares held by them.

RULINGS

Provided that the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, proposed transactions, and purpose of the proposed transactions, and the proposed transactions are completed as described above, our rulings are as follows:

A.The transfer of the class B special shares to the Company in exchange for class D shares will constitute a disposition within the meaning of paragraph 54 of the Act.

B.The transfer of the common shares to the Company in exchange for class C shares will constitute a disposition within the meaning of paragraph 54 of the Act.

C.Subsection 110.6(8) of the Act will not apply to deny any deduction that XXXXXXXXXX may otherwise be entitled to claim under subsection 110.6(2.1) of the Act.

D.Subsection 245(2) of the Act will not apply as a result of the proposed transactions, in and by themselves, to redetermine the tax consequences confirmed in the rulings given.

This Ruling should not be seen as confirmation of the accuracy or treatment of the values referred to herein and neither should it be interpreted as confirming that either the common shares or the special class B shares of the Company are "qualified small business corporation shares", as this is a question of fact the determination of which is not covered by this Ruling.

These rulings are subject to the limitations and qualifications set out in Information Circular 70-6R2 dated September 28, 1990, and are binding on the Department provided the proposed transactions described in paragraphs 8, 12, 13 of this Ruling are completed by XXXXXXXXXX.

Our rulings are based on the Act in its present form and do not take into consideration any proposed amendments to the Act.

Yours truly,

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