17 August 1989 Income Tax Severed Letter AC58431 - Capital Gains Deduction - Acquisition of Shares for Less than Fair Market 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.

5-8431
             19(1)                           A. Cameron
                                             613-957-2115

August 17, 1989

Dear Sirs:

Re:      Paragraphs 85(1)(e.2) and 110.6(7)(b) of the 
         Income Tax Act ("the Act")

This is in reply to your letter of July 24, 1989 wherein you requested our opinions on the application of the above-referenced provisions of the Act to the following hypothetical situation:

         "Individual taxpayer owns 75 per cent of the common
         shares of a Canadian-controlled private corporation
         (opco).  His shares are estimated to have a fair market
         value of approximately $750,000. Paid up capital of his
         shares is $5,000.  Adjusted cost base of his shares
         $100,000.  Taxpayer wishes to transfer his shares to a
         holding company.
         Taxpayer has incorporated a holding company (Holdco),
         and presently holds all 10 issued $1 par value common
         shares.
         Taxpayer plans to exchange his shares of Opco for $5,000
         $1 par value common shares of Holdco.
         Opco uses all or substantially all its' assets in an
         active business carried on in Canada.
         Taxpayer has owned the Opco shares for
         approximately fifteen years.
         Taxpayer has never claimed a capital gains deduction and
         has no cumulative net investment loss".

Your specific questions and our responses are as follows:

Question 1

"Will s.85(1)(e.2) apply if the agreed amount is
         a)  $100,000
         b)  $600,000
         c)  $750,000
on the basis that the individual taxpayer is considered to have
conferred a benefit on Holdco?"

Response

The provisions of paragraph 85(1)(e.2) of the Act will apply in both (a) and (b) above. However, we note that the adjustment to the agreed amount would be minimal.

Question 2

         "Will the taxpayer be able to claim a capital gains
         deduction to the extent that the agreed amount exceeds
         his adjustment cost base and a taxable capital gain
         arises, or will s.110(7)(b) deny the capital gains
         deduction on the basis that the shares of Holdco were,
         before the exchange, consideration that was
         significantly less than the fair market value of the
         property acquired at the time of acquisition?"

Response

In our view, the provisions of paragraph 110.6(7)(b) of the Act would only apply if the corporation acquired the shares of Opco for consideration which was significantly less than the fair market value of the shares of Opco. Whether the consideration is significantly less than the fair market value is a question of fact, however, in your example we would no consider the difference significant and the provisions of paragraph 110.6(7)(b) of the Act would not be applicable.

Yours truly,

for Director Reorganizations and Non-Resident Division Specialty Rulings Directorate Legislative and Intergovernmental Affairs Branch