22 February 1988 Income Tax Severed Letter RCT 7-2320

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.

This is in reply to your memorandum dated November 16, 1987 wherein you request our opinion on the following situation.

XXX

• 5. The only other shareholder of XXX is XXX who owns the only common share issued by XXX
• 6. The fair market value of the property transferred was established (estimated) at XXX by your office.
• 7. The contract between XXX and XXX contains a price adjustment clause.

You ask the following four questions:

• 1. Is the paid-up capital of the special shares of XXX and their fair market value equal to the difference between the fair market value of the rental property and the non-share consideration?
• 2. Should the fair market value be determined now to ensure no benefit is conferred to the common shareholder of a subsequent date based on the lower value for the special shares?
• 3. Does the XXX redemption value on liquidation, dissolution or winding-up have any effect on the fair market value of the special shares?
• 4. If the fair market value of the special shares is found to be less than the difference between the fair market value of the rental property and the non-share consideration could any excess be a benefit conferred on the common shareholder for the purpose of paragraph 85(1)(e.2) of the Act?

Our Comments

• 1. The paid-up capital of a share for income tax purposes is defined under paragraph 89(1)(c) of the Act. It is first computed for a class of shares before being calculated for a particular share, and is based on the "legal" paid-up capital. The legal paid-up capital is determined pursuant to the act under which the corporation was formed.

Subsection 31(2) of the Business Corporation Act of Ontario (R.S.O. 1980 C.54), states that "Where the shares of a corporation are without par value ...its "issued capital" shall be expressed in Canadian or other currency... and is an amount equal to the total... together with the amount of the consideration for which the shares without par value... were issued and together with such amount... by the by-law of the corporation may be transferred thereto and less such decreases in issued capital as from time to time have been affected by the Corporation in accordance with this Act."

It is our view that at the time of issue of the special shares, an amount equal to the net consideration received by Ontario should have been added to the paid-up capital of the class of shares to which the special shares belong. However, in determining the amount of the "legal" paid-up capital at a particular time, we must consider the adjustments thereto that may be made by the corporation and in determining the "fiscal" paid-up capital, we must consider the adjustments to the "legal" paid-up capital provided for in paragraph 89(1)(c) of the Act. For that reason, we are not in a position to express a definite opinion on the amount of the paid-up capital of the special shares issued by Ontario.

• 2. It is our view that any adjustment to the fair market value of the transferred assets should be made before the 1985 taxation years of the corporations become statute-barred, to assure that any future computation based on the fair market value of the shares or their paid-up capital that may have tax consequences is correct.
• 3. It is our view that all the conditions attached to the special shares may have, to some extent, an effect on the fair market value of such shares. However, we would like to point out that the valuation of assets is not within the purview of our responsibilities.
4. Paragraph 85(1)(e.2) of the Act applies where the fair market value of the property transferred (the rental property) exceeds the greater of
• i) the fair market value of the consideration received, and
• ii) the agreed amount in the election,

and it is reasonable to regard any portion of such excess as a gift made by the taxpayer to or for the benefit of any other shareholder of the corporation.

In the situation submitted, XXX is the sole shareholder of XXX and the only "other shareholder" of XXX. Any increase in value of the common share of XXX held by XXX due to the fact that the fair market value of the rental property received by it exceeds the fair market value of the consideration given would be reflected in a decrease of an equal amount of the fair market value of the shares of XXX held by XXX. Because of this fact, even if it is arguable that technically XXX gave a benefit to the "other shareholder" of XXX it is our view that XXX would have an argument to the effect that it is not reasonable to regard the excess as a gift since his financial position before and after the transactions is exactly the same. However, to make a final decision, we would have to consider all transactions, if any, that occured prior or after the transfer and that may be considered as part of the series of transactions that includes the transfer of the rental property.

We trust that the above comments will be of assistance.