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.
Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.
Principal Issues:
In very broad terms, a corporation had no assets or liabilities at the end of 1995. In relation to paragraph 39(1)(c) of the Income Tax Act (the Act), one of the issues is whether the shareholder owned the shares at the end of 1995. A second issue is whether the corporation was “insolvent” at the end of 1995 for the purposes of clause 50(1)(b)(iii)(B) of the Act.
Position:
It is a question of fact whether the shares were disposed of before the end of 1995. However, the corporation was not considered to be insolvent at the end of 1995. Accordingly, a business investment loss could not be claimed in respect of the shares.
Reasons:
The available evidence indicated that the shareholder intended to wind-up the corporation by December 31, 1995 apply and thus the comments in paragraphs 5 and 9 of IT-126R2 apply. In the case of the second issue, reference was made to the Department’s general position set out in question 58 of the APPF (1992) as well as the OBCA, which indicated that the corporation was not insolvent at the end of 1995.
June 15, 1998
Audit Division HEADQUARTERS
T. H. Law M. Eisner
Technical Advisor (613) 957-2138
Belleville Tax Services Office
980234
Allowable Business Investment Loss - XXXXXXXXXX (the “Shareholder”)
This is in reply to your memorandum of January 26, 1998 in which you asked us for our views on whether the Shareholder has incurred a business investment loss under paragraph 39(1)(c) of the Income Tax Act (the “Act”).
The relevant facts and information is as follows:
1. The Shareholder, with respect to XXXXXXXXXX (the “Corporation”), owned all XXXXXXXXXX of the outstanding common shares (the “Shares”) issued by the Corporation. The adjusted cost base (“ACB”) and the “paid-up capital” (“PUC”) of the Shares, as these terms are defined in section 54 and subsection 89(1) of the Act, was $XXXXXXXXXX and $XXXXXXXXXX, respectively.
2. The Corporation, which was a “Canadian-controlled private corporation”, as defined in subsection 125(7) of the Act, carried on a XXXXXXXXXX business up to the latter part of 1995. During 1995, the Shareholder decided to sell the business assets and wind up the Corporation.
3. All of the Corporation’s assets had been converted to cash or transferred to the Shareholder by XXXXXXXXXX. On XXXXXXXXXX, a shareholders’ resolution was made by the Shareholder under which the dissolution of the Corporation, effective XXXXXXXXXX, was authorised pursuant to paragraph 237(a) of the Ontario Business Corporations Act (“OBCA”). In connection with the dissolution, the resolution dated XXXXXXXXXX authorized the discharge of the Corporation’s liabilities and the distribution of the remaining assets to the sole shareholder of the Corporation. In addition, the Corporation and the Shareholder entered into an agreement on XXXXXXXXXX, which provided that the Corporation would transfer all of its property to the Shareholder who agreed to assume and discharge all of the liabilities of the Corporation up to the value of the assets received by the Shareholder.
4. The 1995 T2 return of the Corporation indicated that the Corporation has no assets, liabilities, or share capital on XXXXXXXXXX. A statement on the T2S(11) indicated that the Corporation, effective XXXXXXXXXX, had been wound up pursuant to section 88 of the Act and its net assets distributed to the Shareholder. In connection with the dissolution of the Corporation, representatives of the Corporation requested a clearance certificate pursuant to subsection 159(2) of the Act on XXXXXXXXXX, which was issued on XXXXXXXXXX.
In the Shareholder’s 1995 T1 return, the Shareholder reported a grossed-up dividend, by virtue of subsections 82(1) and 84(2) of the Act, of $XXXXXXXXXX in connection with the winding-up of the Corporation’s business. In addition, the Shareholder was allowed to claim a loss (i.e., $XXXXXXXXXX less a mandatory reduction in respect of a capital gains deduction claimed in 1994 (the “Loss”)) as a business investment loss (the “BIL”) with respect to the Shares. The amount of $XXXXXXXXXX represented the taxpayer’s computation of her ACB of the Shares.
Issues
Paragraph 39(1)(c) of the Act requires that subsection 50(1) of the Act be applicable or that there be a disposition of property to a person with whom the taxpayer was dealing at arm’s length. The latter test cannot be met in this case because the Shareholder does not deal at arm’s length with the Corporation (See paragraph 11 of Interpretation Bulletin IT-444R “Corporations - Involuntary Dissolutions”). The issues then are whether the Shareholder “owned” the Shares on XXXXXXXXXX for the purposes of paragraph 50(1)(b) of the Act and whether the Corporation was “insolvent” for the purposes of clause 50(1)(b)(iii)(A) of the Act at the end of 1995.
Taxpayer’s Position
It is the position of the Shareholder’s representatives that the payments made in respect of the Shares in 1995 did not result from a redemption or cancellation of the Shares and that the amount of $XXXXXXXXXX represented a return of PUC in respect of the shares under subsection 84(4) of the Act. It is their view that subsection 84(4) of the Act can apply to a return of PUC to the Shareholder without the redemption or cancellation of the Shares. As support for this position in their submission ofXXXXXXXXXX, a copy of the share register was provided to you which indicated that the Shareholder owned the Shares on XXXXXXXXXX . Accordingly, they are of the view that the Shares were outstanding on XXXXXXXXXX and all the requirements of subparagraph 50(1)(b)(iii) of the Act were met. The result is that the Shareholder is entitled to claim the Loss as a BIL.
Position of Tax Services Office
It is your position that the Corporation, in the latter part of 1995, redeemed the XXXXXXXXXX common shares of the Shareholder under subsection 84(3) of the Act. This is evidenced by the fact that the Balance Sheet of the Corporation, as at XXXXXXXXXX, indicated an amount of nil in respect of share capital and the T2S(11) indicated that the Corporation had been wound up by XXXXXXXXXX. Since the Shareholder did not deal at arm’s length with the Corporation with respect to the redemption, it is your view that the requirement in subparagraph 39(1)(c)(ii) of the Act, which requires a disposition of shares in an arm’s length transaction, has not been satisfied. In addition, it is also your view that paragraph 50(1)(b) of the Act is not applicable because that provision requires a taxpayer to have owned the shares at the end of the taxation year. As a result, the Loss on the disposition of the shares should be treated as a capital loss rather than a BIL.
You have also indicated that if the PUC of the Corporation was reduced pursuant to the provisions of subsection 84(4) of the Act and the Shareholder owned the Shares at the end of 1995, it is your view that the Corporation at the end of 1995 was not “insolvent” for the purposes of clause 50(1)(b)(iii)(A) of the Act. In that regard, you have referred to question 58 of the APPF (1992) in which the Department stated the following:
“It is our opinion that the word “insolvent” should be given its ordinary meaning since the term is not defined in the Act. The dictionary defines “insolvent” as follows: “unable to pay its debts.” Accordingly, it is our opinion that a corporation possessing neither assets nor liabilities at the end of a taxation could not as a general rule be considered insolvent for the purposes of subparagraph 50(1)(b)(iii) of the Act.”
A general summary of the Corporation’s actions during 1995 are that its business was wound up, its assets converted to cash and distributed to the Shareholder, the dissolution of the Corporation was authorized by special resolution, and its liabilities were extinguished or arrangements made for the payment of them. In connection with these actions, we have made reference to the OBCA. Paragraph 237(a) of the OBCA provides that a corporation can be dissolved when a special resolution has been passed which authorises the dissolution. For the purposes of effecting the dissolution authorized under paragraph 237(a) of the OBCA, subsection 238(1) of the OBCA provides for the preparation of articles of dissolution in which information must be included to the effect that the corporation has no debts or obligations and that, after satisfying all its debts and obligations, the remaining property has been distributed to its shareholders. Upon the receipt of the articles of dissolution, the Director (whose authority is described in section 278 of the OBCA) would proceed to effect a certificate of dissolution under section 239 of the OBCA.
In connection with the above comments, paragraph 2 of Interpretation Bulletin IT-126R2 “Meaning of Winding-Up” (the “Bulletin”) indicates that subsection 84(2) of the Act applies to the distribution by a corporation to its shareholders where any positive steps are taken towards the winding-up, discontinuance or reorganization of its business as well as where any positive steps are taken toward the formal dissolution of a corporation. In addition, subsection 84(3) of the Act is only applicable to a redemption, acquisition, or cancellation of shares “(otherwise than by way of a transaction described in subsection (2)).” Similarly, subsection 84(4) of the Act does not apply where subsection 84(2) of the Act is applicable. Consequently, it is our view that subsection 84(2) of the Act applies to the distribution of the assets by the Corporation to the Shareholder. Subsection 84(2) of the Act also contemplates “non-dividend” treatment in respect of the return of PUC to the shareholders during the winding-up process (see paragraph 84(2)(b) of the Act). Based on the facts provided to us, we disagree that the Shareholder and Corporation intended to distinguish between the normal winding-up process and a transaction caught by subsection 84(3) or (4) of the Act.
Nonetheless, your first issue concerns the timing of the disposition of the Shares because, if they were disposed of prior to the end of 1995, subsection 50(1) of the Act would not apply as the Shareholder did not own the Shares at the end of that year. In connection with this issue, we refer you to paragraph 9 of the Bulletin, which indicates that as a result of subparagraph (b)(i) of the definition of “disposition” in section 54 of the Act, there is a disposition when shares are cancelled and that this generally occurs when the certificate of dissolution is issued. As a further comment, the latter part of paragraph 9 of the Bulletin states that “even though the formal dissolution of a corporation has not occurred, the Department will consider that there is a disposition of the shares when subsection 88(1) or (2) applies to the corporation in the circumstances described in 5 above.”
Paragraph 5 of the Bulletin indicates that even though the formal dissolution of a corporation is not complete, the corporation is considered to have been wound up for the purposes of subsections 88(1) and (2) of the Act when there is substantial evidence that the corporation will be dissolved within a short period of time. In the case at hand, all of the liabilities of the Corporation were provided for by XXXXXXXXXX and all the remaining property had been distributed to the Shareholder by XXXXXXXXXX. It seems to us that the Shareholder intended to fall within the comments in paragraph 5 of IT-126R2 and that, there was, in fact, substantial evidence that the Corporation would be dissolved within a short period of time subsequent to the end of 1995 (e.g., the T2S(11) indicated that the Corporation, effective XXXXXXXXXX, had been wound up pursuant to section 88 of the Act). In these circumstances, it may be possible to argue that the Shareholder disposed of the Shares prior to the end of 1995 in accordance with paragraph 9 of the Bulletin. Such timing would then coincide with the receipt of the proceeds of disposition, which is generally the fair market value of the assets distributed to the Shareholder less those liabilities assumed by the Shareholder. Having said this, we recognize the merits of the argument that the shares are cancelled, and thus disposed, only when the certificate of dissolution is issued. While it would likely be necessary to seek legal advice if such an argument were to be pursued, this issue becomes moot as a result of the following comments on the insolvency issue.
The remaining issue is whether the Corporation was “insolvent” for the purposes of clause 50(1)(b)(iii)(A) of the Act at the end of 1995. In relation to this requirement, subsection 238(1) of the OBCA indicates that the interests of creditors in respect of a corporation that is to be dissolved are to be satisfied by the corporation before property is to be distributed to its shareholders. With respect to this requirement, the Shareholder, pursuant to the agreement described in 3 above entered into on XXXXXXXXXX, agreed to assume and discharge all of the liabilities of the Corporation up to the value of the assets received. As it is our understanding that the Corporation had distributed its assets to the Shareholder by the end of XXXXXXXXXX, we have presumed that the agreement refers to those assets. In our view, based on the understanding that the Corporation did not have any outstanding liabilities at the end of the year, it follows that the Corporation was not insolvent at the end of 1995 and that, consistent with the excerpt from question 58 of the APPF (1992), the shareholder would not be entitled to claim a BIL in respect of the Loss. Rather, the Loss should be treated as being a capital loss. However, consistent with the comments in the first sentence of paragraph 5 of the Bulletin, it appears that the Shareholder could be permitted to recognize the Loss with respect to the 1995 taxation year.
You may wish to seek a valuation of the shares as of XXXXXXXXXX. For example, since articles of dissolution had not been filed by XXXXXXXXXX and the Corporation would have still owned certain intangible assets (e.g., incorporation costs), the shares may be considered to have some value and therefore would not meet the condition described in clause 50(1)(b)(iii)(C) of the Act.
As a final matter, it should be noted that the Shares are common shares as opposed to preference shares that might have a redemption feature attached to them. The purchase for cancellation of common shares would generally require the approval of the Shareholder. There has been no information provided that would indicate that the Corporation intended to purchase the shares for cancellation, as a transaction separate from the winding-up process.
If you require further technical assistance, we would be pleased to provide our views.
For your information, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the legislation Access Database (LAD) on the Department’s mainframe computer. 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 taxpayer. Should your client request a copy of this memorandum, they can be provided with the LAD version or they may request a copy severe using the Privacy Act criteria which does not remove client identity. Requests for this latter version should be made by you to Jackie Page at (613) 957-0682. The severed copy will be sent to you for delivery to the client.
Jim Wilson
Section Chief
Business, Property & Employment Section II
Business and Publications Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch
- 6 -
All rights reserved. Permission is granted to electronically copy and to print in hard copy for internal use only. No part of this information may be reproduced, modified, transmitted or redistributed in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, or stored in a retrieval system for any purpose other than noted above (including sales), without prior written permission of Canada Revenue Agency, Ottawa, Ontario K1A 0L5
© Her Majesty the Queen in Right of Canada, 1998
Tous droits réservés. Il est permis de copier sous forme électronique ou d'imprimer pour un usage interne seulement. Toutefois, il est interdit de reproduire, de modifier, de transmettre ou de redistributer de l'information, sous quelque forme ou par quelque moyen que ce soit, de facon électronique, méchanique, photocopies ou autre, ou par stockage dans des systèmes d'extraction ou pour tout usage autre que ceux susmentionnés (incluant pour fin commerciale), sans l'autorisation écrite préalable de l'Agence du revenu du Canada, Ottawa, Ontario K1A 0L5.
© Sa Majesté la Reine du Chef du Canada, 1998
Email this Content