27 February 1997 Internal T.I. 9627837 - XXXXXXXXXX - FRANCHISE VALUE

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.

		February 27, 1997

	Toronto North Tax Services Office	HEADQUARTERS
	Audit Division	B. Kerr
		957-8953
	Attention: Rudy Quadrini
		962783

Crystallization of Capital Gains

This is in response to your letter of August 19, 1996, concerning the crystallization of capital gains in order to claim the capital gains deduction.

We understand that XXXXXXXXXX was the sole shareholder of XXXXXXXXXX ("OPCO"), a small business corporation that operates a XXXXXXXXXX franchise. On XXXXXXXXXX transferred all of his OPCO shares to XXXXXXXXXX ("HOLDCO") in exchange for common shares of HOLDCO in accordance with the provisions of subsection 85(1) of the Income Tax Act (the "Act"). XXXXXXXXXX also made an election in respect of his HOLDCO shares in accordance with the provisions of subsection 110.6(19). As a result, XXXXXXXXXX claimed a capital gains deduction of $XXXXXXXXXX in respect of the OPCO shares under subsection 110.6(2.1) and $XXXXXXXXXX in respect of his HOLDCO shares under subsection 110.6(3) of the Act for his XXXXXXXXXX taxation year.

You believe that the franchise agreement with XXXXXXXXXX As a result you feel that the fair market value of the applicable shares is less than that reported by the taxpayer and have asked us whether the crystallization should be denied or whether the provisions of subsection 245(2) could apply.

You have also asked us to comment on the various stop-loss rules that may apply in the event of a future capital loss or allowable business investment loss on the imminent disposition of the HOLDCO shares.

Our Comments

We have reviewed the T2057 that was filed by the taxpayer and, provided that the fair market value of the OPCO shares is not less than $XXXXXXXXXX, have concluded that the taxpayer elected an amount that was within the limits specified under the provisions of subsection 85(1) of the Act in that the amount was greater than the adjusted cost base and less than the fair market value of the OPCO shares and that the provisions of paragraph 84.1(1)(a) were properly applied to reduce the paid up capital of the HOLDCO shares to an amount equal to the adjusted cost base of the OPCO shares and that since no other consideration was received the application of paragraph 84.1(1)(b) did not result in a deemed dividend at that time. In addition, since the HOLDCO shares have a fair market value equal to the fair market value of the OPCO shares, we are satisfied that the HOLDCO shares would have a cost equal to the elected amount by virtue of paragraph 85(1)(h) of the Act.

We have also reviewed the T664 filed by the taxpayer and have concluded that subsection 110.6(19) may not apply by virtue of subclause 110.6(20)(a)(i)(B)(I) since the amount designated appears to result in a taxable capital gain that exceeds the amount that would be determined under paragraph 110.6(3)(a) for his XXXXXXXXXX taxation year.

The determination of fair market value of both the OPCO and HOLDCO shares is a question of fact, the determination of which falls within the responsibility of the Valuations Section of the Audit Directorate or the Equity Valuations Section of your Tax Services Office.

Subsection 245(4) of the Act provides that subsection (2) does not apply to a transaction where it may reasonably be considered that the transaction would not result directly or indirectly in a misuse of the provisions of the Act or abuse having regard to the provisions of the Act, other than this section, read as a whole. In our view, the provisions of subsection 245(2) would not apply since the taxpayer has properly complied with the provisions of subsections 85(1), 84.1(1), and 110.6(2.1) as a result of the disposition of his OPCO shares. For additional comments concerning the application of subsection 245(2) of the Act involving dividend stripping or the capital gains exemption, refer to example 25 of Information Circular 88-2 and examples 3 and 4 of the supplement thereto.

We regret that we cannot comment on the tax implications arising on a future disposition of the HOLDCO shares since there are numerous possibilities which are dependent on the particular facts at that time.

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