17 June 1997 External T.I. 9700935 - CAN GAIN ATTRIB TO INSUFF DIV BE CARVED OUT

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:

insufficient dividend rule; if a significant portion of the accrued gain in respect of shares is attributable to the lack of dividends paid on other shares, but the shareholder disposes of the shares to a corporation by means of an 85(1) election for an amount equal to the shares' fair market value less the amount that can reasonably be attributed to the insufficient dividend, will 110.6(8) apply to deny the capital gains deduction?

Position:

Prorating the accrued capital gain to carve out the proportion of the gain that is attributable to the lack of dividends will not necessarily shelter the gain from the application of subsection 110.6(8).

Reasons:

Since it is a question of fact as to whether a significant part of a capital gain is attributable to the fact that dividends were not paid on a share, the Department has not established strict guidelines as to how to calculate the portion of a capital gain that is attributable to insufficient dividends.

A. Humenuk
XXXXXXXXXX 970093

Attention: XXXXXXXXXX

June 17, 1997

Dear Sirs:

Re: Subsection 110.6(8) of the Income Tax Act

We are replying to your letter of December 24, 1996, in which you enquire whether it would be reasonable to conclude, in a particular situation, that a significant portion of a capital gain is attributable to the fact that insufficient dividends were paid on certain shares.

In the situation you describe, the value of the common shares in a corporation has increased and part of that increase, amounting to $150,000, is attributable to the fact that dividends have not been paid on the corporation's preferred shares. This represents a significant portion, but not all, of the increase in value of the common shares. You have asked for confirmation that subsection 110.6(8) of the Income Tax Act (the "Act") will not apply to deny a capital gains deduction to a shareholder who transfers the common shares of the corporation to a holding corporation pursuant to an election under subsection 85(1) of the Act, if the capital gain triggered is equal to the difference between the total inherent capital gain and the amount of the gain attributable to inadequate dividends on the preferred shares.

Whether a significant portion of a capital gain is attributable to the fact that dividends were not paid on a share or that the dividends paid on such a share were less than ninety percent of the average annual rate of return, as defined in subsection 110.6(9) of the Act, will depend on the facts and circumstances of a particular situation. The confirmation of the tax consequences of a specific transaction is only given by way of an advance income tax ruling, as described in Information Circular 70-6R3 "Advance Income Tax Rulings" dated December 30, 1997, and is restricted to proposed transactions. The following comments are therefore of a general nature.

Subsection 110.6(8) of the Act will apply if it may reasonably be concluded, having regard to all the circumstances, that a significant part of a capital gain is attributable to the fact that dividends were not paid on a share (other than a prescribed share) of a corporation. In interpreting the phrase "a significant part of the capital gain", it is our view that the determination of what constitutes a significant part of the capital gain is a question of fact which must be decided in each particular case having regard, as the subsection states, to all the circumstances. Accordingly, the question as to what constitutes "a significant part of the capital gain" for the purposes of subsection 110.6(8) of the Act cannot be resolved by the application of any strict guidelines. Although in many cases this question may be appropriately answered by ascertaining the proportion or percentage of the capital gain that is attributable to the non-payment of adequate dividends, there may be circumstances where it is appropriate to consider the amount or magnitude, expressed in dollars, of the accrued gain that is attributable to the lack of adequate dividends.

The fact that no dividend or an inadequate dividend is paid in a particular year does not, in and of itself, mean that subsection 110.6(8) of the Act will automatically apply to deny the capital gains deduction. Rather, it is necessary to ascertain whether it may reasonably be concluded, having regard to all the circumstances, that a significant part of the capital gain is attributable to such fact.

We trust our comments will be of assistance to you.

Yours truly,

C. Chouinard
for Director
Business and Publications Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch