31 October 2003 Internal T.I. 2003-0034757 - Non Arms Length Transfer 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 CCRA.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.

Principal Issues: Whether the provisions of paragraph 84.1(2)(a.1) apply to a situation where the shares, which were originally acquired in a non-arm's length transaction, were subsequently disposed of and reacquired in arm's length transactions.

Position: Yes.

Reasons: Plain reading of the law. This result is also consistent with the policy of the provision.

October 31, 2003

George Luszczewski Headquarters
Verification and Enforcement Division Income Tax Rulings Directorate
Hamilton TSO Fiona Harrison

2003-003475
XXXXXXXXXX

This is in reply to your memorandum of August 11, 2003, wherein you requested our comments with respect to the applicability of section 84.1 of the Income Tax Act (the "Act") to the following factual situation:

XXXXXXXXXX.

TSO Position

It is your position that the provisions of paragraph 84.1(1)(b) will apply to the transaction on XXXXXXXXXX, to deem a dividend to have been paid to XXXXXXXXXX. More specifically, you believe that the provisions of paragraph 84.1(2)(a.1) apply not only to the original XXXXXXXXXX common shares of XXXXXXXXXX. which were still held by XXXXXXXXXX but also to the XXXXXXXXXX common shares acquired back from the employees in arm's length transactions (the "Reacquired Shares").

Under paragraph 84.1(2)(a.1), where a share disposed of by a taxpayer was acquired after 1971 from a person with whom the taxpayer was not dealing at arm's length, the adjusted cost base of the share to the taxpayer is modified to exclude any capital gains exemption in respect of a previous disposition of the share or a share for which the share was substituted.

It is your position that, while the Reacquired Shares had most recently been purchased from persons with whom the taxpayers were dealing at arm's length, they had previously been acquired by the taxpayers from treasury. Under paragraph 84.1(2.01)(a), where a corporation issues a share to a taxpayer, the taxpayer and the corporation are deemed not to be dealing at arm's length with each other. Consequently, you have sent proposal letters to XXXXXXXXXX proposing to adjust their income, in the XXXXXXXXXX taxation year, to include the taxable amount of the dividends computed under the provisions of paragraph 84.1(1)(b).

Taxpayers' Position

The taxpayer's accountant maintains that the reduction for the capital gains exemption under subparagraph 84.1(2)((a.1)(ii) only applies to shares that were acquired by the taxpayer from a person with whom he was not dealing at arm's length. Consequently, she concludes that the XXXXXXXXXX Reacquired Shares do not meet this criteria and that the capital gains exemption previously claimed in respect of these shares should not be used to reduce the adjusted cost base of the XXXXXXXXXX common shares disposed of in the XXXXXXXXXX taxation year.

Our Position

We agree with your position that the Reacquired Shares were acquired in XXXXXXXXXX from XXXXXXXXXX, a person with whom XXXXXXXXXX were deemed by paragraph 84.1(2.01)(a) to not deal at arm's length, and that accordingly, the adjusted cost base of these shares should be modified as required under subparagraph 84.1(2)(a.1)(ii) in respect of the capital gains exemption claimed on the disposition of the XXXXXXXXXX common shares of XXXXXXXXXX. Consequently, we are in agreement with the position taken in your proposal letter.

Yours truly,

Mark Symes
Corporate Reorganizations Section 1
Income Tax Rulings Directorate
Policy & Legislation Branch