8 April 1985 Income Tax Severed Letter RCT 5-7616 F

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:

RE:     Farm Asset Transfers

This is in reply to your letter of April 8, 1985, in which you requested our views on two types of intercorporate transfers of farming assets.

In your first example the shares of a corporation ("Farmco") fail to qualify as shares of a family farm corporation, within the meaning of paragraph 70(10)(b) of the Income Tax Act (the "Act"), because the corporation owns shares of a second corporation ("Realco") which is engaged in non-farming activity. The shares of Realco were acquired after 1971. You are considering a reorganization in which Father, the original and sole shareholder of Farmco, incorporates Holdco having stated capital greater than the stated capital of Farmco. Farmco transfers its shares of Realco to Holdco, pursuant to an election under subsection 85(1) of the Act, for consideration of one low paid-up capital common share of Holdco plus cash equal to Farmco's cost amount (as defined in subsection 248(1) of the Act) of the transferred shares of Realco. The elected amount is equal to Farmco's cost amount of the Realco shares. The fair market value of the transferred shares of Realco is substantially in excess of their cost amount. Farmco has a preferred earnings amount, as defined in subsection 181(2) of the Act, which is less than its retained earnings.

In our opinion, none of the provisions of subsections 15(1) or 245(2) or paragraph 85(1)(e.2) of the Act would be applied in the circumstances described. Subsection 181(5) of Act may apply to these arrangements if the purpose test in that subsection is met because the shares of Holdco issued to Father on incorporation have a high stated capital which may shelter future distributions by Holdco from Part II tax.

The possible application of subsection 181(5) could be avoided by issuing low stated capital shares to Father on incorporation, and treating any additional capital contribution as contributed surplus.

In the second situation which you have described each of two brothers owns 50% of the issued shares of Farmco. The shareholdings have remained unchanged since incorporation. Farmco's assets, in addition to farm equipment and inventories, include two parcels of land each of which has the same cost amount, within the meaning of subsection 248(1) of the Act, and the same fair market value, which is higher than the cost amount. The land was acquired by Farmco after 1971. Farmco has a preferred-earnings amount, as defined in subsection 181(2) of the Act, which is less than its retained earnings. Each brother wishes to acquire a direct interest, through his own corporation, in one of the two parcels of land.

You have proposed a reorganization in which each brother would form a Newco with nominal paid-up capital. Each Newco would borrow cash from a bank, and would then acquire a parcel of land from Farmco, in consideration of assumption of a mortgage and a cash payment and one common share Farmco and each transferee would elect in respect of the land transfer under subsection 85(1) of the Act, at an elected amount equal to the adjusted cost base of the transferred land. This would be followed by a repurchase by each transferee for a nominal amount of the common share issued to Farmco.

In our view the proposed transactions would result in the application of one or more of paragraphs 55(1)(a), 85(1)(e.2) and subsection 245(2).

The taxpayers could accomplish their objective through the use of a butterfly transaction. Each brother could sell his shares of Farmco to his Newco, pursuant to an election under subsection 85(1), taking back shares of the transferee in consideration. As Farmco's land, inventories and equipment all appear to be business assets they would all have to be transferred to A Co. and B Co. to satisfy the requirements of paragraph 55(3)(b) of the Act. Farmco would elect with each Newco to transfer to each 50% of Farmco's assets in consideration for the assumption of debt and high/low preference shares of the transferee. The redemption amount would be the excess of the fair market value of the assets transferred over the amount of the debts assumed by the transferee. Following the transfer of assets, the Newcos would redeem their preference shares and Farmco would acquire its common shares held by the Newcos for cancellation for consideration in each case equal to the proceeds of redemption received on the Newco's preference shares. The deemed dividends arising on the cross redemptions and cancellations would be deductible by the recipients pursuant to subsection 112(1) of the Act, and would only be subject to Part IV tax pursuant to paragraph 186(1)(b) of the Act, based on any dividend refunds claimed by the payors.

It is our opinion that the butterfly reorganization suggested here would preclude the application of subsections 55(1), 55(2), 15(1), 245(2) and paragraph 85(1)(e.2) of the Act.