2 December 1993 Income Tax Severed Letter 9332665 - Adjustments to ACB of Section 7 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.

                 RULINGS DIRECTORATE
                CORRESPONDENCE SUMMARY

DOCUMENT TYPE:

         Opinion

PRINCIPAL ISSUES:

         1) Whether there is an adjustment under paragraph
         53(1)(j) where new shares, exchanged in accordance
         with subsection 7(1.5), are later sold or
         exchanged.

         2) Whether subsection 7(1.5) applies where employee
         elects under subsection 85(1) a value for shares in
         excess of the acb.

POSITION TAKEN:

         1) 53(1)(j) will apply on sale or exchange of new
         shares.

         2) 7(1.5) applies when section 85 used for exchange
         at cost higher than acb.

REASONS FOR POSITION TAKEN:

         1) 53(1)(j) states there is an adjustment when
         section 7 deems a benefit to be received upon the
         share's acquisition (or sale or exchange where
         7(1.1) applies).  Even though 7(1.5) is stated only
         to be for purposes of 7(1.1), its our view that
         "section 7 deems a benefit to be received" upon the
         ultimate sale or exchange of the new shares and,
         therefore, 53(1)(j) applies.

         2) Section 85 can apply to a share-for-share
         exchange and, therefore, fulfils conditions of
         subsection 7(1.5).  Election to exchange at a cost
         higher than acb will crystallize a gain for the
         e/ee but will not affect the operation of section 7
         and 53(1)(j) at the final disposition of the new
         shares.  Not offensive since crystallizing of gains
         is one of the uses section 85 is put to.

FINANCE OPINION:

         N/A

JURISPRUDENCE:

         N/A

RCT PUBLICATIONS:

         1) 
IT-113R3
 (Benefits to Employees—Stock
         Options), paragraph 14

         2) IC 76-19R2 (Transfer of Property to a
         Corporation Under Section 85)

         3) 
IT-291R
 (Transfer of Property to a 
         Corporation Under Subsection 85(1))

HAA NUMBER:

         4735-1

                                           933266
XXXXXXXXXX                                 (613) 957-8953

Attention: XXXXXXXXXX

December 2, 1993

Dear Sirs:

Re: Subsection 7(1.5) of the Income Tax Act (the "Act")

This is in reply to your facsimile transmission of November 12, 1993, in which you ask for our views concerning the interaction of the above-noted provision and paragraph 53(1)(j) of the Act. Specifically you ask whether there is an addition to the adjusted cost base of shares ("new shares") exchanged for shares ("exchanged shares") in a subsection 86(1) transaction when the new shares are sold. You also ask us to confirm that subsection 7(1.5) will apply to an exchange of shares under subsection 85(1) of the Act if an election is made deeming the exchanged shares to have been disposed of for an amount greater than their adjusted cost base (acb).

Subsection 86(1) of the Act

An addition to the acb of a share occurs under paragraph 53(1)(j) of the Act where, upon the share's acquisition, section 7 of the Act deems a benefit to be received. Where shares of a Canadian-controlled private corporation are to be acquired, the benefit is deemed to be received upon the sale or exchange of the shares (subsection 7(1.1) of the Act). Where shares are exchanged for new shares which have a total value equal to those of the exchanged shares, and the shareholder receives no other consideration for the exchange, subsection 7(1.5) deems the new shares not to be acquired, the new shares to be the exchanged shares, and no disposition or exchange of the exchanged shares to have taken place. Therefore, the section 7 benefit will not accrue until the new shares are sold.

Although subsection 7(1.5) is not stated to apply for the purpose of paragraph 53(1)(j) of the Act, there is a section 7 benefit received (and added to the share's acb) upon the disposition or exchange of the new shares. Since subsection 7(1.5) applies for the purpose of subsection 7(1.1), it is our view that its operation will cause the adjustment under paragraph 53(1)(j) to occur at the time the new shares are sold or exchanged (i.e. when section 7 deems a benefit to be received).

Subsection 85(1) of the Act

Subsection 7(1.5) applies, as noted above, where shares are exchanged for new shares which have a total value equal to those of the exchanged shares, and no other consideration is received. It is our view that, if, pursuant to subsection 85(1) of the Act, the employer and employee elect the proceeds of disposition (to the employee) and the employer's cost of the exchanged shares in an amount greater than the exchanged shares acb to the employee at the time of the exchange, this does not affect the operation of subsection 7(1.5) of the Act.

The employee will be subject to an immediate taxation on the capital gain in the year of the exchange. Upon the eventual sale or exchange of the new shares, the employee will be subject to the income inclusion under paragraph 7(1)(a) in an amount equal to the excess of the fair market value of the new shares at the time they are sold or exchanged over the amount the employee paid for the exchanged shares; and the acb of the new shares will be increased by the amount of this benefit pursuant to paragraph 53(1)(j) of the Act.

The foregoing comments are an expression of opinion only and are not binding on the Department. We trust, however, that they are helpful.

Yours truly,

for Director Financial Industries Division Rulings Directorate