8 August 1996 External T.I. 9616635 - NO ATTRIBUTION ON THE RETURN OF PROPERTY TO A SPOUSE

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:

attribution on a return of property to the spouse who originally acquired the property

Position:

no reverse attribution as the return of property is not a transfer of property

Reasons:

previous correspondence dated May 19, 1982, March 15,1983, July 25, 1989 5-8134

A. Humenuk
XXXXXXXXXX							961663

Attention: XXXXXXXXXX

August 8, 1996

Dear Sirs:

Re: Attribution

We are replying to your letter of May 1, 1996, in which you pose a hypothetical situation involving a series of transactions relating to the transfer of shares between spouses and ask how the attribution rules would apply in that particular situation.

In the situation you describe, an individual (spouse A) transfers his shareholdings in a corporation to his spouse (spouse B) in exchange for a non-interest bearing promissory note with the stated value of the note being the fair market value of the shares so transferred. Relying on section 73(1) of the Income Tax Act (the Act), spouse A reports no gain on the disposition at that time. At a later time, when the fair market value of the shares has increased threefold, spouse B transfers some of the shares back to spouse A in exchange for a cancellation of the initial promissory note and the acceptance of promissory note with a stated value equal to the excess of the fair market value of the returned shares at the time of the second transfer over the value of the promissory note cancelled. Both individuals later sell their respective shareholdings to an unrelated third party.

You ask what portion of the gain realized by spouse B would attribute to spouse A both in respect of the return of shares to spouse A and in respect of the subsequent disposition of shares to an unrelated party. In addition, you ask whether any portion of the gain realized by spouse A on the ultimate disposition to a third party would attribute to spouse B. Finally, on the assumption that the promissory note issued in connection with the return of the shares was interest-bearing and that the interest was in fact paid within 30 days of the end of the calendar year, you ask whether such interest would attribute to spouse A who was required to pay the interest, thereby offsetting the deduction you assume would otherwise be available to him in respect of the interest paid.

The particular circumstances outlined in your letter appears to relate to a factual situation involving specific taxpayers. As explained in Information Circular 70-6R2 "Advance Income Tax Rulings", it is not our practice to comment on proposed transactions involving specific taxpayers other than in the form of an advance income tax ruling. Should your situation involve a specific taxpayer and a transaction that is already in progress, you may wish to submit all relevant facts and documentation to the appropriate Tax Service Office for their views. However, we are prepared to offer the following general comments which may be of assistance to you. The comments which follow are based on the assumption that the transactions are not excluded from the attribution rules for any other reason, such as the residency of the transferor, death of either spouse or the breakdown of the marriage.

In our view a transfer of property or property substituted for such property back to spouse A is a reversion of the original transfer and not a separate transfer. Accordingly, no gain is recognized by either spouse when spouse B returns some of the shares to spouse A. Any capital gain realized on the ultimate disposition of the shares to a third party by either spouse will be included in the income of spouse A either by reason of section 74.2 of the Act or because it is the original holder of the shares who disposes of them. Because spouse A did not opt out of subsection 73(1) and the promissory note does not bear a rate of interest equal to or greater than the rate of interest prescribed by Regulation, section 74.5 of the Act does not apply to prevent the application of section 74.2 to the disposition of shares by spouse B. The transaction in which a portion of the shares were returned to spouse A would not affect the amount of gain to be recognized in respect of the remaining shares disposed of at a later date nor the amount to be attributed in respect of that subsequent disposition to a third party.

Since the transfer of property, or property substituted for such property, back to spouse A is not considered to be a separate transfer, no amount of the gain ultimately realized by spouse A will attribute to spouse B even if the transaction is set up to be a transaction to which section 74.1 might otherwise apply.

The issuance of a promissory note in exchange for the returned shares is not a transfer of property in itself, but a promise to transfer property at a future date. Since the transfer of shares in exchange for that promissory note constitutes a return of property to spouse A, it is our view that section 74.5 of the Act will not preclude the application of the attribution rules on any future transfer of property which is made pursuant to that promissory note. When a promissory note issued in the circumstances you describe includes a requirement to pay interest, attribution will also apply to any income arising from the investment of property transferred in satisfaction of either the requirement to pay interest or the requirement to transfer the face value of the promissory note.

In your analysis of the tax consequences relating to interest paid on the second promissory note, you assume that any interest paid by spouse A to spouse B to obtain a return of his property would be deductible under paragraph 20(1)(c) of the Act. It is our view that such interest would not, in all likelihood, be deductible, for reasons similar to that set out in Parthenon Investments Ltd. v. The Queen (93 D.T.C. 1171). Looking at the transactions as a whole, it is doubtful that spouse A's purpose in obtaining a return of the shares would be for the purpose of earning income, especially since any income earned on those shares attributes to spouse A regardless of which spouse holds the shares. On the other hand, the stated amount of interest paid to spouse B is not property income earned by spouse B but represents a transfer of property from spouse A.

While these comments represent our views on this subject generally, the tax consequences of a particular transaction or series of transactions is dependent upon the relevant facts. However, we draw your attention to subsection 74.5(11) of the Act which applies to ensure that no attribution will occur in the situation where a series of transactions have been constructed for the purpose of attributing income to another individual who has less income.

We trust our comments will be of assistance to you.

Yours truly,

J.A. Szeszycki
for Director
Business and Publications Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch