24 June 1981 Income Tax Severed Letter RT 247-045

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.

Subsection 247(1)

This is in reply to your memorandum dated September 5, 1980. Additional information was obtained by us directly from XXX

The situation as we understand it is as follows:

• 1. A Ltd. is a small manufacturer incorporated after 1971 and is owned as follows:

Mr. A 52%
Mr. B 31%
Mr. C 12%
Mr. D 5%

• 2. None of the above individuals are related and all, except Mr. A, actively participate in the operations of the business carried on by A Ltd.
• 3. A new company, H Ltd., will be incorporated.
• 4. B, C and D will transfer their shares in A Ltd. to H Ltd. utilizing the provisions of subsection 85(1). They will receive common shares in H Ltd. as sole consideration on the transfer. The number of common shares to be received by each of B, C and D will be in the same proportion as their relative shareholdings in A Ltd.
• 5. B, C and D will borrow $200,000 from the bank and will subscribe for preference shares of the capital stock of H Ltd. The price to be paid for each such preference share will be equal to its par value.

Each preference share will be redeemable at par value at the option of the holder.

• 6. H Ltd. will then acquire the shares in A Ltd. from Mr. A.
• 7. Mr. A will not elect under subsection 85(1) and will be subject to any capital gain that arises on the disposition of his shares in A Ltd.
• 8. H Ltd. will pay to each of B, C and D sufficient dividends on his common shares to cover his portion of the interest on the loans in 5 above.
• 9. Sufficient preference shares will be redeemed by H Ltd. at par value from B, C and D to enable them to meet the repayment requirements of the loans in 5 above.
• 10. A Ltd. will pay to H Ltd. sufficient dividends to cover the dividends and the redemptions described in 8 and 9 above.

The above situation represents a series of contemplated transactions as opposed to completed transactions and a written opinion on whether or not subsection 247(1) of the Act would be applied should not be given to XXX (See item 23 of Information Circular 70-6R).

In our view, the fact that preferred shares are issued and redeemed in a manner such as that described above would not in and by itself, cause the Department to invoke the provisions of subsection 247(1) of the Act. The taxpayer would appear to be receiving no more on the redemption of the preferred shares than he paid on their issue and therefore he is only getting back his invested capital.

When determining the amount of interest expense that is deductible by an individual who borrows funds to acquire preferred shares, the Department will permit interest expense to the extent of the dividend income after gross-up. For example, 4% would not be deductible where the interest rate on the bank loan is 19% and the rate of dividend is 10%.