17 July 1986 Income Tax Severed Letter RCT 60415 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.

Decision Summary

Resource Industries Section

Reference: Sections 85(1), 20(1)(c) and 245(2)

Subject: - Fair market value of asset with associated tax liability - Deductibility of interest

Facts

1. To purchase a Canadian resource property from an arm's length party, A Co borrows the total purchase price of $5M.

2. After a short period of time A Co decides to transfer to B Co, a newly incorporated sister corporation, the Canadian resource property it purchased using a section 85 rollover.

elected amount: $1 total consideration: $5M preferred shares

3. B Co has no other asset.

4. Since the Canadian resource property is a mining property, the initial purchase transaction will create a CDE pool that may be written off by A Co at 30% per year. The transfer to B Co leaves all the expenses in A Co where the write-off may be more effectively used.

Queries

1. Should A Co be allowed to deduct the interest on the borrowing of $5M even though the fair market value of the preferred shares taken back would only be $2.5M if B Co were to be liquidated immediately after the transfer?

2. If B Co was in a position, because it had other assets, to redeem the preference shares for $5M after the transfer, should we apply subsection 245(2) of the Act of A Co and B Co? Section 15(1) of the Act would not be applicable, it seems, because A Co was not a shareholder before the transaction.

Decision

A Co should be allowed to deduct interest on the borrowing of $5M.

Section 245(2) is not applicable in this situation.

Rationale

If dividends on the preferred shares can be expected to be paid at the time of the transfer, then the value of the shares is $5M notwithstanding that upon immediate redemption only $2.5M could be realized. It has always been our policy to allow a deduction for interest (in the case of preferred shares) equal to the amount of the dividends actually received.

Because of our position on 85(1)(e.2) (that taxpayers must take back consideration in shares or otherwise in an amount equal to the fair market value of the property without taking into account any tax liability associated with the ownership of the asset) we cannot apply 245(2) in this situation.