23 April 1985 Income Tax Severed Letter RCT 5-7470

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.

Dear Sirs:

This is in reply to your letter dated February 19, 1985 wherein you requested our opinion on the application of subsection 247(1) of the Act to the following hypothetical situation:

Mr. X acquired prior to 1972 all the shares of Opco which have a paid-up capital of $100, V-Day value of $1000, and present fair market value of $1500. Mr. X transfers these shares to Holdco, exclusively for shares of Holdco having a paid-up capital equal to 50% of the sum of the paid-up capital of the Opco shares being transferred and their V-Day value. In the example above, this amount will be 50% of ($100 + $1000), or $550.

Under the provisions of section 84.1(1)(b) of the Act, the required reduction in the adjusted cost base of the shares received will be as follows:

The lesser of
  Adjusted cost base of Opco shares           $1000
  Paid-up capital of Holdco shares            $ 550  lesser - $ 550
minus
  Paid-up capital of Opco                                       100
  ACB reduction                                               $ 450
  ACB of Holdco shares as otherwise elected under Section 85  $1000
  Less 84.1(1)(b) reduction                                     450
  Revised adjusted cost base of shares of Holdco              $ 550

Since the revised adjusted cost base of $550 is equal to the paid-up capital of the Holdco shares, it is your understanding that the taxpayer can have Holdco redeem shares up to the total amount of the paid-up capital, $550 tax free.

Our Comments

We agree with you that the provisions of paragraph 84.1(1)(b) of the Act will apply to the above-described situation and reduce the adjusted cost base of the Holdco shares to $550. If, as you mentioned Holdco redeems its shares held by Mr. X, it has to pay fair market value for it otherwise the provisions of subsection 69(1) of the Act will apply to deem the proceeds of disposition to be equal to the fair market value of the shares. Accordingly, on the redemption, the following tax consequences will arise:

Amount paid or deemed to be paid                          $1500
Less:
  Paid-up capital                                           550
Deemed dividend pursuant to subsection 84(3) of the Act   $ 950
Proceeds of disposition pursuant to 54(h)  ($1500 - $950) $ 550
Less:
  Adjusted cost base                                        550
  Capital Gain                                            $   0

It is therefore our view that on the redemption of the Holdco's shares Mr. X will be deemed to have received a dividend equal to $950.

On the other hand, if Holdco reduces the paid-up capital of its shares by $550 and pays this amount to Mr. X, pursuant to subparagraph 53(2)(a)(ii), the amount paid will reduce the adjusted cost base of the Holdco shares of Mr. X to zero but no amount will be included in the income of Mr. X at that time. Generally, the Department will not apply the provisions of subsection 247(1) of the Act where the provisions of subsection 84.1(1) of the Act have been applied.

We trust these comments will be of assistance to you.