12 September 1989 Income Tax Severed Letter RCT-0158C

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.

No. ATR DATE:

SUBJECT: Sale of Shares-Extended Capital Gain Deduction

REFERENCE: Section 245 and 246; subsections 55(2), 110.6(1) and 186(4); and paragraph 85(1)(e.2)

Facts

• 1. Opco 1 and Opco 2 are Canadian-controlled private corporations and taxable Canadian corporations within the meaning of paragraphs 125(7)(b) and 89(1)(i) of the Income Tax Act (the Act).
• 2. Opco 1 was incorporated in 1967 and all of the 100 issued shares are owned by Mr. X, a resident of Canada, and have been owned by him continuously for a period greater than 24 months.
• 3. Mr. X also owns 100% of the shares of Opco 2 and 50% of the shares of Holdco. The remaining shares of Holdco are owned by Mrs. X, wife of Mr. X.
• 4. Opco 1 operates a restaurant and has operated the business throughout the past 24 months. Included in the assets used in the business is a house (the House) which is used exclusively to provide accommodation for the employees of Opco 1.
• 5. Other than assets used in the restaurant business, Opco 1 has amounts of approximately $65,000 owed to it by Holdco and a promissory note of approximately $225,000 receivable from Opco 2. The latter debt arose in 1986 when Opco 1 loaned funds to Opco 2 so that it could eliminate the mortgage on the restaurant premises. XXX
• 6. Substantially all of the assets of Opco 2 are the premises in which the restaurant business of Opco 1 operates. XXX The land and the building were purchased in 1982 and financed with funds borrowed from Opco 1. Opco satisfies the requirements of paragraph (d) of the definition "qualified small business corporation share" in subsection 110(1) of the Act.
• 7. The fair market value of the House is approximately $100,000 which exceeds the cost amount to Opco 1. The promissory note has a fair market value equal to its book value of approximately $225,000.
• 8. Mr. Y is the son of Mr. X Mr. Y is over 18 years of age, is currently active in Opco 1 and intends to remain active in the business.

Proposed Transactions

• 9. Mr. X will sell to Opco 2, a number of shares of Opco 1 with a fair market value equivalent to the fair market value of the debts receivable by Opco 1 and the House. As consideration therefor, Opco 2 will issue to Mr. X, commons shares having a fair market value equal to the fair market value of the Opco 1 share purchased. The addition to the stated capital of Opco 2 will equal the paid-up capital of the Opco 1 shares sold to Opco 2. Mr. X and Opco 2 will jointly elect pursuant to subsection 85(1) -of the Act in prescribed form and within the time frame referred to in subsection 85(6) of the Act, that the shares of Opco 1 will be disposed of by Mr. X at their adjusted cost base to have been acquired by Opco 2 at the same amount.
• 10. Opco 1 will sell to Opco 2 the debt owed to it by Holdco 2 and the House in exchange for 8% non-cumulative redeemable retractable preferred shares of Opco 2 (the preferred shares) which will have an aggregate redemption amount equal to the value of the property sold. As a condition of the share issue, Opco 2 will be prohibited from making a payment of any kind to any other shareholder of Opco 2 if such payment would reduce the net realizable value of Opco 2 to less than the aggregate redemption amou-nt of outstanding Preferred shares and unpaid dividends. Opco 1 and Opco 2 will jointly elect under the provisions of subsection 85(1) of the Act in prescribed form and within the time frame referred to in subsection 85(60 of the Act, that the agreed amount will equal the cost amounts, as defined in subsection 248(1) of the Act, of the property sold by Opco 1.
• 11. Subsequent to selling the $65,000 debt receivable as described in paragraph 10, Opco 1 will be a "small business corporation" within the meaning of subsection 248(1) of the Act.
• 12. Opco 1 and Opco 2 will enter into an agreement pursuant to which Opco 1 will repurchase all of the shares of its capital owned by Opco 2 for a price equal to fair market value. By the same agreement Opco 2 will repurchase from Opco 1 all of the Preferred Shares for a price equal to their redemption amount.
• 13. Following these transactions, Opco 1 will owe to Opco 2 the sum of $225,000 representing the difference in values between the shares redeemed by Opco 2 and the shares redeemed by Opco 1. Opco 2 will owe to Opco 1 the $225,000 described in 2 above. Opco 1 and Opco 2 will settle payments of these amounts by offsetting one debt against the other.
• 14. Mr. X will then sell the shares of Opco 1 to Mr. Y for fair market value.

Purpose of the Proposed Transactions

• 15. Mr. X wishes to sell all of his shares of Opco 1 to Mr. Y and take advantage of the extended capital gains deduction. By transferring out the debt receivable from Holdco, Opco 1 becomes a small business corporation at the transaction date. By transferring out additional assets, the selling price to Mr. Y is reduced and by retaining assets such as the building and the House in Opco 2, Mr. X has security for the sale of shares to Mr. Y.

Rulings Given

Provided that the preceding statements constitute a complete and accurate disclosure of all the relevant facts and proposed transactions and provided that the proposed transactions are completed in the manner described herein, we confirm the following:

A. Paragraph 85(1)(e.2) of the Act will not apply to the sale, by Mr. X to Opco 2, of the shares of Opco 1 for shares of Opco 2.

B. Opco 1 and Opco 2 are "connected" corporations within the meaning of subsection 186(4) of th Act for purposes of Part IV of the Act and subparagraph 110.6(1)(c)(ii) in the definition of "qualified small business corporation shares".

C. Subsection 55(2) of the Act will not apply in respect of the dividends deemed to have been paid by Opco 2 to Opco 1 on repurchase of the Preferred Shares and by Opco 1 to Opco 2 on the repurchase of its shares from Opco 2. However, nothing in this ruling should be construed as implying that the transactions described herein will not be considered as part of a series of transactions or events for the purpose of subsection 55(2) of the Act in the event of a subsequent disposition of property to an arm'-s length person or a significant increase in the interest in any corporation by an arm's length person.

D. The shares of Opco 1 owned by Mr. X immediately after the transaction described in paragraph 13 will be "qualified small business corporation shares" as defined in subsection 110.6(1) of the Act.

E. Sections 245 and 246 are not applicable to the proposed transactions as described herein.

This ruling wax given in May 1989.

Income tax rulings are issued for the general information of taxpayers, but are considered to be binding on the Department only in respect of the taxpayer to whom the ruling was given.