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.
Can we apply subsection 55(10 in a situation where a capital gain is eliminated in a manner which would appear to be offensive from a policy perspective.
Problem:
An arm's length purchaser has proposed to purchase all the shares of a taxable Canadian corporation (the "corporation") that derives its value principally from real property. The majority of the Class A and B shares are held by two trusts, each of which is resident in Canada. If the trusts sell their shares to the purchaser they will realize a significant capital gain. To eliminate the capital gain the following transactions are proposed.
1) The articles of the corporation will be amended to create Class X and Y shares. Only the trusts will convert their Class A and B shares to Class X and Y shares.
2) The current trustees of the two trusts will resign and will be replaced by trustees all of whom are resident in the U. K. so the trusts will be resident in the U. K.
3) The paid-up capital of the Class X and Y shares only will be increased to equal the purchase price of the shares.
Analysis:
If the trusts sell their shares without going through the transactions described above they will be subject to tax equal to 25% of their gain. Even if the trusts became a resident of U.K. the gain on the sale of the shares would still be subject to tax in Canada by virtue of paragraph 5 of Article 13 of the Canada - U.K. Tax Convention (the "Treaty"). By increasing the paid-up capital of the classes of shares held by the trusts, the trusts will be subject to Part XIII tax of 15% by virtue of subsections 84(1) and 212(2) and Article 10 of the Treaty. However, by virtue of paragraph 53(1)(b) the adjusted cost base of the shares held by the trusts will be increased by the amount of the deemed dividend so that no gain will be realized when the shares are sold. The taxpayers will have converted a Part I tax of 25% into a part XIII tax of 15%.
Position:
The provisions of subsection 55(1) will apply to the proposed transactions described above for the following reasons:
1. Technically subsection 55(1) does apply.
2. The proposed transactions are designed to circumvent the provisions in certain treaties which allows us to tax gains on the disposition of shares whose value is principally derived from real property.
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