2 November 2010 Internal T.I. 2010-0366301I7 - Attribution of Trust Income and Gain

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.

Principal Issues: 1) Was there a transfer of property so as to engage the attribution provisions in subsection 75(2)? 2) Would the PAC assist Son? 3) Would the attribution provisions in subsection 75(2) apply?

Position: 1) Yes 2) No 3) Yes

Reasons: 1) The property transferred is an ownership interest in either XCo or #Co 2) The PAC was never triggered and it is too late to do so 3) As a capital beneficiary of Trust, the growth shares could revert back to Son pursuant to 75(2)(a)(i) and moreover, as sole trustee until XXXXXXXXXX , Son has sole control of the growth shares pursuant to 75(2)(a)(ii) and (b).

									November 2, 2010

Calgary Taxation Services Office				HEADQUARTERS
Aggressive Tax Planning Audit Section			Income Tax Rulings
		  								Directorate
Attention: Mangalika Fernando					Dominic Tiu
									(613) 957-8981

									2010-036630

XXXXXXXXXX

We are writing in response to your email communication of May 4th, 2010 requesting our assistance in determining whether subsection 75(2) of the Income Tax Act (the "Act") would apply to attribute all or part of the income and capital gain received or receivable by the XXXXXXXXXX (the "Trust") from the XXXXXXXXXX Common Shares it held in XXXXXXXXXX (the "#Co"), to XXXXXXXXXX (the "Son").

In our opinion, subsection 75(2) of the Act would apply to attribute all income of the Trust from the growth shares to Son and all capital gains realized by Trust on the disposition of the growth shares to Son.

Our understanding of the relevant facts is as follows:

1. The # Co was incorporated on XXXXXXXXXX and on incorporation, Son was issued the original XXXXXXXXXX Common Shares for a nominal cost of $XXXXXXXXXX per share.

2. XXXXXXXXXX ("Settlor") established the Trust on XXXXXXXXXX with a gold coin for the benefit at any time of Son, XXXXXXXXXX and any of their children, whether born or adopted, as may be living at that time. At the time the Trust was created, the Trustee was Son, the son of Settlor.

3. The relevant terms of the trust are as follows:

• Clause XXXXXXXXXX states that on the Distribution Date, to distribute the income from the Trust Property as it is comprised on the Distribution Date among such of the Beneficiaries, other than the Parents as are living on the Distribution Date in such respective shares and on such conditions as the Trustee, in the sole and unfettered discretion of the Trustee, determines.
• Clause XXXXXXXXXX states that on the Distribution Date, to distribute the capital of the Trust Property as it is comprised on the Distribution Date among such of the Beneficiaries as are living on the Distribution Date in such respective shares and on such conditions as the Trustee, in the sole and unfettered discretion of the Trustee, determines.
• Clause XXXXXXXXXX states that the Trustee may pay or distribute all or any part of the income from the Trust Property at any time and from time to time to or for the benefit of any one or more of the Beneficiaries, other than the Parents to the exclusion of any one or more of these Beneficiaries and may determine the amount to be paid or distributed to or for the benefit of any of these Beneficiaries.
• Clause XXXXXXXXXX states that the Trustee may pay or distribute all or any part of the capital from the Trust Property at any time and from time to time to or for the benefit of any one or more of the Beneficiaries, to the exclusion of any one or more of these Beneficiaries and may determine the amount to be paid or distributed to or for the benefit of any Beneficiary.
• Clause XXXXXXXXXX states that without limiting the generality of Clause XXXXXXXXXX , but subject to the trusts herein set out, the Trustee may invest or reinvest all or any part or parts of the Trust Property, in the absolute discretion of the Trustee, in any form of investment whatsoever and the Trustee is entitled to borrow on the security of all or any part or parts of the Trust Property and to exercise all such other powers incidental to ownership of the Trust Property as if the Trustee were the beneficial owner of the Trust Property.
• Clause XXXXXXXXXX states that the Trustee may either accumulate or retain the income from the Trust Property and income which is so accumulated becomes and forms part of the capital of the Trust Property and income which is retained remains income from the Trust Property; provided that the Trustee may only accumulate income (as distinguished from retaining income) by instrument in writing, which instrument may be signed either before or after the effective date of the accumulation.

4. As part of an estate freeze on XXXXXXXXXX , the following transactions were completed:

• Son transferred XXXXXXXXXX common shares of XXXXXXXXXX ("XCo") to #Co in exchange for XXXXXXXXXX Preferred Shares of #Co ("freeze shares"). XCo and Son jointly elected in prescribed form to have the provisions of subsection 85(1) of the Act apply to the transfer. The freeze shares were given a redemption value of $XXXXXXXXXX per share or a total of about $XXXXXXXXXX , subject to a price adjustment clause ("PAC"); and
• The Trust subscribed for XXXXXXXXXX Common Shares ("growth shares") of #Co for a nominal cost of $XXXXXXXXXX per share or an aggregate total cost of $XXXXXXXXXX .

5. On XXXXXXXXXX , at the request of the President of XCo, the company received a formal valuation of the company as at XXXXXXXXXX from an unrelated professional valuator. The valuation report gave the company an estimated per common share value of $XXXXXXXXXX based on their intrinsic value as a "private company" investment. The difference between the value attributed to the freeze shares by Son of $XXXXXXXXXX on XXXXXXXXXX and their estimated FMV of $XXXXXXXXXX as of XXXXXXXXXX as established by the valuation report is approximately $XXXXXXXXXX .

6. On XXXXXXXXXX , as part of the sale of XCo, all of the shares of #Co were also sold to an unrelated third party. The portion of the proceeds of dispositions allocated to #Co was reported by the shareholders of the # Co as follows:

Trust, XXXXXXXXXX Common Shares: $XXXXXXXXXX
Son, XXXXXXXXXX Common Shares: XXXXXXXXXX
Son, XXXXXXXXXX Preferred Shares: XXXXXXXXXX

7. Trust reported a XXXXXXXXXX capital gain of $XXXXXXXXXX and a XXXXXXXXXX capital gain reserve of $XXXXXXXXXX . The XXXXXXXXXX capital gain reserve was reported subsequently as follows:

XXXXXXXXXX : $ XXXXXXXXXX (or $XXXXXXXXXX in TCG)
XXXXXXXXXX : XXXXXXXXXX (or $XXXXXXXXXX in TCG)

8. On XXXXXXXXXX , XXXXXXXXXX and XXXXXXXXXX , both residents of XXXXXXXXXX were appointed as additional trustees of the Trust. Son, the sole trustee up until then, is a resident of XXXXXXXXXX . As a consequence, the Trust claimed the entire amount of the XXXXXXXXXX capital gain as being subject to tax by the Province of XXXXXXXXXX and not the Province of XXXXXXXXXX .

Our Comments

Pursuant to subsection 75(2) of the Act, where, by a trust created in any manner whatever since 1934, property is held on condition

(a) that it or property substituted therefor may

(i) revert to the person from whom the property or property for which it was substituted was directly or indirectly received (in this subsection referred to as "the person"), or

(ii) pass to persons to be determined by the person at a time subsequent to the creation of the trust, or

(b) that, during the existence of the person, the property shall not be disposed of except with the person's consent or in accordance with the person's direction,

any income or loss from the property or from property substituted for the property, and any taxable capital gain or allowable capital loss from the disposition of the property or of property substituted for the property, shall, during the existence of the person while the person is resident in Canada, be deemed to be income or a loss, as the case may be, or a taxable capital gain or allowable capital loss, as the case may be, of the person.

Did Trust directly or indirectly receive any property from Son?

To the extent the rollover of the XCo shares on XXXXXXXXXX preceded the issuance of the #Co growth shares on the same date, it is our view that Son transferred property to Trust when he gave up a portion of his ownership interest in the equity of #Co as a consequence of:

• the undervaluation of the freeze shares received as consideration; and
• the issuance of XXXXXXXXXX growth shares to Trust.

On the other hand, to the extent the rollover of the XCo shares on XXXXXXXXXX is preceded by the issuance of the #Co growth shares on the same date, it is our view that Son transferred property to Trust when he gave up a portion of his ownership interest in the equity of XCo as a consequence of:

• the issuance of XXXXXXXXXX growth shares to Trust.; and
• the undervaluation of the freeze shares received as consideration.

As noted in the Estate of David Fasken., 49 DTC 491, at p.497, P.

"The word "transfer" is not a term of art and has not a technical meaning. It is not necessary to a transfer of property from a husband to his wife that it should be made in any particular form or that it should be made directly. All that is required is that the husband should so deal with the property as to divest himself of it and vest it in his wife, that is to say, pass the property from himself to her. The means, by which he accomplishes this result, whether direct or circuitous, may properly be called a transfer."

The Tax Court of Canada recently confirmed the principle that the shift in value resulting from an undervaluation of exchanged common shares is a transfer of share rights attributable to existing equity from the former holders of common shares to the new common shareholders: Garron et al 2009 DTC 1287 (TCC). Consistent with the reasoning in Kieboom, 92 DTC 6382 (FCA), this is a transfer of property.

In our view, the reasoning in Kieboom also supports the view that the growth shares held by the Trust may be viewed as substituted for the equity transferred by Son for purposes of the Act (i.e. including subsection 75(2)) pursuant to subsection 248(5).

The existence of the PAC in the original Share Purchase Agreement does not assist Son because at no time were the original proceeds represented by the freeze shares adjusted pursuant to it.

Was the property (or property substituted for it) held by the Trust on condition that it may revert to Son or to persons to be determined by Son after the Trust was created?

As Son is a capital beneficiary of the Trust, it is our opinion that the Trust at all relevant times held the growth shares on condition that they may revert to Son within the meaning of subparagraph 75(2)(a)(i).

As Son was the sole trustee of the Trust from XXXXXXXXXX until XXXXXXXXXX , it is also our view that during that time period, the Trust held the growth shares on condition that they may revert to persons to be determined by Son, within the meaning of paragraph 75(2)(a)(ii). Moreover, during that time frame, Trust could not dispose of the growth shares except with Son's consent and in accordance with Son's direction, within the meaning of paragraph 75(2)(b).

Accordingly, pursuant to subsection 75(2), all income of Trust from the growth shares and all capital gains realized on disposition therefrom are deemed to be income and capital gains of Son. As you advise that Son is a resident of the Province of XXXXXXXXXX , it is our view that the entire capital gain would appear to be subject to tax in that Province.

For your information a copy of this communication will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency's electronic library. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayers.

Robin Maley
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch