29 April 1994 External T.I. 9336285 - ARM'S LENGTH SALE OF SHARES

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.

5-933628
XXXXXXXXXX P. Diguer

Attention: XXXXXXXXXX

April 29, 1994

Dear Sirs:

Re: Subsection 245(2) of the Income Tax Act (Canada) (the "Act")

This is in reply to your letter dated December 10, 1993 as amended by your letter dated February 11, 1994 in which you
requested the Department's views on whether subsection 245(2) of the Act would apply in the following situation:

A Co is a taxable Canadian corporation all of the issued and outstanding shares of which are owned by Mr. A. Opco is a taxable Canadian corporation the issued and outstanding shares of which are owned by A Co (60%) and a group of 20 employees of Opco excluding Mr. A (40%). A Co and Opco are amalgamated to form a new corporation ("Amalco") pursuant to section 87 of the Act. A new corporation ("Newco") is formed by the employees who transfer to Newco all of their shares of Amalco on a taxable basis (subject to the availability of the capital gains deduction pursuant to section 110.6 of the Act), or on a tax deferred basis pursuant to subsection 85(1) of the Act. This is followed by the sale by Mr. A to Newco of his shares of Amalco pursuant to an agreement that provides, inter alia, that over a term of years, the Amalco shares owned by Mr. A would be purchased by Newco. All employees are unrelated to each other and to A Co. In addition, Newco and Mr. A and the employees and Mr. A are dealing at arm's length at all times with each other. Over the term of the agreement, Newco would fund the purchase of the Amalco shares from Mr. A from a combination of bank financing, share subscriptions or contributions by Newco shareholders, but it is likely that the most significant source of funds will be the distribution of current Amalco profits to Newco by way of dividends. You have further indicated that the consideration paid by Newco to Mr. A will not include shares of Newco. You have asked that we assume that the application of section 55 is not at issue because any profit distributed to Newco would be paid out of Opco's income earned or realized, within the meaning of paragraph 55(5)(b) of the Act ("safe income"). The above structure would allow Mr. A and the employees to avail themselves, to the extent permitted by law, of the capital gains deduction pursuant to section 110.6 of the Act.

Opinion requested

You ask whether the provisions of subsections 84.1(1) or 245(2) of the Act would be considered to apply.

Our comments

84.1

Generally, we agree with your conclusion that where a vendor is dealing at arm's length with a purchaser corporation,
subsection 84.1(1) of the Act does not apply to the sale of shares of a subject corporation to redetermine, as dividends, the non-share consideration received by the vendor on the sale of the shares of the subject corporation.

245(2)

Whether it could reasonably be considered that any of the avoidance transactions described in your letter would result in a misuse of any provision of the Act or an abuse having regard to the provisions of the Act read as a whole, such that subsection 245(2) would apply, is a determination that could only be made after a review of all the relevant facts and circumstances of a particular situation. Generally, it is the Department's practice to undertake such a review only in response to a request for an advance income tax ruling.

The procedures for requesting advance income tax rulings are set out in Information Circular 70-6R2 dated september 28,
1990 issued by Revenue Canada, as amended by the Special Release dated September 30, 1992. Nevertheless, we offer
the following general comments.

While it is not possible to offer a firm opinion on the application of subsection 245(2) in the context of a hypothetical situation, we do not see any reason to consider that there has been a misuse or abuse of subsection 84.1(1) of the Act in the above situation. It appears to us that section 84.1 was not intended to apply in this type of transaction. Subsection 245(2) could be considered to apply where it is determined that a series of transactions was carried out to thwart the purpose of section 84.1 and this simply does not appear to be the case here as the sale of the Amalco shares is to Newco which we assume is really an arm's length purchaser for the purpose of that provision.

The position stated in Information Circular 88-2 that the amalgamation of two corporations as outlined in paragraph 4 of Supplement 1 would not be considered abusive continues to apply.

We realize that the purpose of the series is to allow Mr. A to access the capital gains deduction while disposing of his
interest in Opco, and that the disposition of his interest could have been achieved through other means with vastly
different tax consequences as suggested in your letter of February 11, 1994. We realize also that the amalgamation of Opco and A co is carried out to allow Mr. A to access the capital gains exemption, since a sale of the Opco shares by A Co would not permit this. Nevertheless, given the definition of qualified small business corporation share in subsection 110.6(1) (paragraph (e) in particular) and the facts of the situation, most notably, the assumed fact that the purchaser and seller deal at arm's length, we do not see a misuse of subsection 84.1 of the Act in the circumstances.

In formulating our reply, consideration was not given to other provisions of the Act such as section 55 which may apply in a specific situation involving the disposition of property. Moreover, the question of whether M. A is dealing at arm's length with Newco and the employees for the purposes of section 84.1 of the Act, is a question of fact upon which we offer no opinion. On this question however,

we should point out that in our view, the fact that the shareholders of Newco are employees of Opco is a factor that may be relevant in determining whether or not the parties are dealing at arm's length with each other. Finally, we cannot confirm that section 84.1 would not apply upon the transfer to Newco by the employees of their shares in Amalco. While the employees may generally be dealing at arm's length with Newco, they would be acting in concert when they sold their shares of Amalco to Newco.

Accordingly, they probably could not be considered to be dealing at arm's length with Newco at the time of the transfer.

The foregoing represents our general views with respect to the subject matter of your letter. The foregoing opinions are not rulings and in accordance with the guidelines set out in Information Circular 70-6R2 dated September 28, 1990 are not binding on Revenue Canada, Customs, Excise and Taxation.

Yours truly,

for Director
Reorganizations and Foreign Division
Rulings Directorate
Legislative and Intergovernmental
Affairs Branch