19 September 1988 Income Tax Severed Letter RCT 7-3193

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 response to your request to Mr. R. Shultis for a review of your draft publications on section 85.1 of the Income Tax Act (the “Act”). We have reviewed both draft publications, viz., the first, which deals with the legislation as worded in 1983, and the second, which deals with the December 17, 1987 amendments. Our comments, referenced to the appropriate page number in the publications, are as follows:

• p. 3 - in “legal text analyzed” - The reference to Bill C-139 has the potential to mislead the reader since there are two bills dealing with amendments to the Act which are referred to as Bill C-139. The more recent one, which was enacted on September 13, 1988, is likely the one which the reader would identify. We suggest the following wording:

The legal text analyzed in this Tax Analysis was published in the 1987 edition of the Income Tax Act, which consolidates amendments made up to December 19, 1986.

• p. 6 - in “commentaries” - A statement is made that “... no other consideration BUT SHARES may be received by either party.” This statement is correct only with respect to the exchanged shares, since a vendor may also dispose of shares of the corporation other than the exchanged shares (as stated in paragraph 85.1(2)(d)). We suggest adding the following to the end of your statement:

..., notwithstanding that there may be a concurrent exchange of other shares and/or other property which does not qualify for this rollover. Provided it is clear which shares or part-shares of a particular class of the acquired corporation are exchanged for consideration consisting solely of shares or part-shares of a particular class of the purchaser, subsection 85.1(1) may apply. This concept is referred to in paragraph 5 of.

• p. 6 - in “commentaries” - The reference to the receipt of cash instead of fractional shares should be confined to the receipt by a vendor of cash in lieu of receiving a fractional share of a purchaser, and therefore we suggest the following wording:

IT-450 explains the Department's administrative procedure in cases where an amount of cash was received by a vendor in lieu of a fractional share.

• p. 6 - in “commentaries” - Although subsection 85.1(1) does not require a person to file an election, it is possible for persons to cause this provision not to apply. Therefore, we suggest the following wording:

Subsection 85.1(1) is non-elective and it applies automatically, subject to subsection 85.1(2), to the purchaser and, subject to paragraph 85.1(1)(a) and subsection 85.1(2), to the vendor.

• p. 8 - in “any portion” - Although it is true that a partial deferral with respect to the exchanged shares is not possible, a vendor may recognize the gain with respect to shares other than the exchanged shares without recognizing the gain on the exchanged shares. We suggest the following wording, making no reference to partial deferral being unavailable:

This expression prevents the vendor from using subsection 85.1(1) when any part of the capital gain or loss arising from the disposition of the exchanged shares has been included in computing his income for the year.

• p. 8 - in “commentary” - In order to qualify for the ITAR provisions, it is necessary for the shareholder to have owned his shares continuously since December 31, 1971. Therefore, we suggest the following wording in place of the first phrase:

For exchanged shares held by the vendor on December 31, 1971 and thereafter without interruption until immediately before the exchange,...

The deeming provision applies only for three stated purposes. We suggest replacing the word “deemed” with the following:

...deemed for certain purposes (including the calculation of cost and ACB of the new shares to the vendor)...

• p. 9 - in “example” - The references here and subsequently to proceeds and cost could be more precisely described as deemed proceeds and deemed cost, respectively, thereby recognizing that the proceeds and cost would be different amounts were it not for the application of subsection 85.1(1).
• p. 11 - in “example” - In the second last line, the reference to 10% should be to 10.4%. In the last line, the two references to NIL could be cross-referenced to the Solution on page 15, noting that these amounts are subject to change.
• p. 12 - in “beneficially owned” - The words “...ownership of the trust...” should be replaced with the words “...beneficial ownership of the trust property...”
• p. 12 - in “the particular class” - The word “only” should follow the word “receive” in order to obtain the proper meaning.
• p. 12 - in “notwithstanding” - The parenthetical words are examples only and therefore the reference to “i.e.” should be replaced with “e.g.”
• p. 15 - in “summary example” - In the last sentence, the proper meaning will be obtained by placing the word “only” after the words “composed of.”
• p. 15 - in “C Ltd. (purchaser)” - In the first sentence the proper meaning will be obtained by rearranging the words “only represent 8%” to read as “represent only 8%.”
• p. 20 - in “commentary” - Although there is no equivalent to ITAR 26(26), presumably a vendor would obtain the benefit of ITAR 26(3), thereby crystallizing his V-Day protection into the new shares. We suggest adding the following sentence:

However, gains with respect to the period preceding 1972 may continue to be tax-free by virtue of ITAR 26(3).

• p. 21 - in “1st implication” - In subparagraph (b)(i), the words “is of” should be removed from this subparagraph and placed between subparagraphs (i) and (ii). This comment applies also to the quotation on p.26.
• p. 22 - The wording in the first paragraph suggests that the taxpayer has an option with respect to the amount of gain he wishes to recognize immediately and the amount he wishes to defer, whereas no such option exists. We suggest the following wording:

Unlike subsection 85.1(1), subsection 85.1(3) may result in the taxpayer realizing a part of the gain or loss which arises upon the exchange of shares.

• p. 24 - in “substantially all” - The reference to IT-171 is not an appropriate reference for the Department's interpretation of “...all or substantially all...” in the context of subsection 85.1. We suggest the following wording:

The Department has generally accepted these words as meaning 90% or more.

• p. 24 - in “series of transactions” - You have described an example of a series of transactions. However, subsection 248(10) expands the concept of a series to include transactions carried out with a view to subsequently carrying out a series of transactions. We suggest replacing your description with the following:

A series of transactions or events includes a number of related transactions, often carried out to obtain a certain tax advantage. Subsection 248(10) has the effect of expanding the meaning of any reference in the Act to a series of transactions or events to include related transactions completed in comtemplation of such a series.

• p. 27 - in “summary example” - The facts do not describe whether both the fair market value and the principal amount of the note receivable are $15,000.
• p. 30 - in “explanation” - The 1987 amendment to subsection 85.1(1) does not prevent a corporation from issuing shares which it previously issued; however, it does ensure that the shares must be issued by the purchaser in exchange for the exchanged shares. We suggest replacing the explanation with the following:

The revision to the preamble of subsection 85.1(1) ensures that the shares of the purchaser must be ISSUED by the purchaser in exchange for the exchanged shares.

• p. 31 - in “paragraph 85.1(1)(b)” - The reference to section 85.1 should be refined to refer to subsection 85.1(1). Also, since “tax cost” is not a defined term, it should be replaced with the words “deemed cost”.
• p. 32 - in “example” - The example presumes that there are no other outstanding shares of X Ltd. of the class which Mr. Y will receive. This should be added as a fact to the example.
• p. 32 - in “example, after June 3, 1987” - In the note, it is not correct to say that subparagraphs (iii) and (iv) have no application. Rather, they apply to allocate the entire PUC reduction to the one class of shares. We suggest replacing the note with the following:

Since there was only one class of shares involved in the transaction, subparagraphs (iii) and (iv) apply to allocate the entire reduction to that class.

• p. 33 - in second sentence - Since the shares held by Mr. Y will be repurchased by X Ltd., it is not possible for there to be the “same deemed dividends” at some future time. However, since there remains a potential for what could be viewed as double taxation, we suggest omitting the words “...of the same deemed dividends...” from the sentence. Also, it would be appropriate to replace the words “...the paid-up capital of those shares...” with “...the paid-up capital of that class of shares...”

The final calculation of paid-up capital is misleading in that it leads the reader to think that the paid-up capital of the shares, following the repurchase by X Ltd., will be $10,000. The amount of the addition to paid-up capital is correct, however the addition should be with respect to that CLASS of shares rather than the shares themselves. Also, the timing of the add-back is after the time of the repurchase. As the repurchase itself would result in a decrease of $10,000 in the aggregate paid-up capital of this class of shares, the final amount of paid-up capital of this class of shares would be nil. Therefore, we suggest replacing the last line of the example with the following:

$10,000
less: reduction due to the repurchase
by X Ltd. of its shares 10,000
Paid-up capital of the shares of this
class of X Ltd. following the repurchase NIL