24 November 1999 External T.I. 9830945 - ATTRIBUTION,

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: Does the fact that dividends are paid only on the first class of special shares affect the calculation of a 74.4(2) benefit in respect of the second class of special shares?

Position: no effect on benefit calculation re: the second class

Reasons: 74.4(2)(f) specifically refers to taxable dividends paid on the shares that were issued as consideration for the transferred property so dividends paid on other shares would not be included in the calculation of a benefit in respect of the shares issued as consideration

XXXXXXXXXX 5-983094
D. Yuen
Attention: XXXXXXXXXX

November 24, 1999

Dear Sirs:

We are writing in response to your letter of November 24, 1998 wherein you requested our comments regarding the application of section 74.4 of the Income Tax Act. All legislative references are to provisions of the Income Tax Act R.S.C. 1985 (5th Supp.) c. 1, as amended.

Situation

1. Mr. and Mrs. X decide to transfer their individually owned investment portfolios to an investment holding company ("Holdco") as part of their overall estate plan. Holdco will be a taxable Canadian corporation and a Canadian-controlled private corporation as defined in subsections 89(1) and 125(7), respectively.

2. As a result of the transfers, Mr. and Mrs. X will receive special shares of the same class of Holdco which will be redeemable and retractable, have a priority on liquidation or dissolution on payment of the redemption amount, will be non-voting and will be non-participating.

3. The portfolios will be transferred by Mr. and Mrs. X , at fair market value, to Holdco with elections filed under subsection 85(1) in respect of the transfers. The aggregate fair market value and redemption amount of the special shares of Holdco issued to the transferor will be equal to the fair market value of the portfolio so transferred

4. After the above transfers, Holdco will issue common shares to the adult children of Mr. and Mrs. X.

5. The main purpose and only purpose for the transfer of the investment portfolios by Mr. and Mrs. X is to facilitate their estate planning and ultimate transfer of assets to their children.

Your Questions

1. If the special shares of Holdco received by Mr. and Mrs. X are non-dividend-bearing shares and Mr. and Mrs. X intend to redeem the shares over a ten year period, would the Canada Customs and Revenue Agency ("CCRA") seek to apply section 74.4 in this situation?

2. Assume that the special shares of Holdco received by Mr. and Mrs. X are dividend-bearing shares with the dividend rate to be determined annually by the board of directors of Holdco. Assume also that Mr. X transfers, at fair market value, a rental property to Holdco, elects under subsection 85(1) in respect of the transfer and receives a second class of special shares as consideration. This class will have similar attributes as the first class of special shares. If Holdco pays a cash dividend on the first class of special shares in sufficient amount such that no benefit will be deemed to have been received under subsection 74.4(2), would the Agency apply section 74.4 in respect of the second class of special shares if no dividend is paid on those shares?

Our Comments

1. Subsection 74.4(2) generally applies to a loan or transfer of property by an individual to a corporation, other than a small business corporation as defined in subsection 248(1), when one of the main purposes of the loan or transfer of property can reasonably be considered to reduce the individual's income and to benefit, either directly or indirectly, a designated person in respect of the individual. The term "designated person", as used herein has the meaning assigned by subsection 74.5(5). The issue of whether it is reasonable to consider that one of the purposes of the transfer of property is to reduce the income of the individual and to benefit, either directly or indirectly, a designated person is a question of fact that must be determined by taking into account all the relevant facts and circumstances of the particular situation.

We are of the opinion that the provisions of subsection 74.4(2) can be applied, subject to subsection 74.4(4), to each of the transfers made by Mr. and Mrs. X to Holdco, if it can reasonably be considered that, at the time of each of the transfers, one of the main purposes of the transfer was to reduce the income of the transferor and to benefit, either directly or indirectly, a designated person in respect of the transferor. Since the common shareholders of Holdco are adult, each of them would not be a designated person in respect of either transferor. Each of Mr. and Mrs. X is a designated person in respect of his or her spouse so the provisions of subsection 74.4(2) may be applicable in the circumstances.

2. If the conditions of subsection 74.4(2) are met with respect to the transfer of the rental property, a benefit will be determined under paragraph 74.4(2)(d); however, there will be no reduction of the benefit pursuant to paragraph 74.4(2)(f) since no dividends will have been paid on the second class of special shares that were received as consideration for the transfer of the rental property. It is our view that, as paragraph 74.4(2)(f) specifically refers to taxable dividends received on the shares that were received as consideration for the transfer of property, that is, the second class of special shares, the fact that dividends were paid on the first class of special shares does not affect the calculation of the deemed interest benefit on the second class of special shares.

These comments are provided in accordance with the guidelines set out in paragraph 22 of Information Circular IC 70-6R3 dated December 30, 1996 issued by Revenue Canada and are not considered binding on the CCRA.

Yours truly,

for Director
Reorganizations and International Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch