Translation disclaimer
This translation was prepared by Tax Interpretations Inc. The CRA did not issue this document in the language in which it now appears, and is not responsible for any errors in its translation that might impact a reader’s understanding of it or the position(s) taken therein. See also the general Disclaimer below.
Principal Issues:
In the particular situation:
1. Whether paragraph 85(1)(e.2) applies.
2. Whether the price adjustment clause can be recognized.
3. Whether an amended election pursuant to 85(7.1) is required to give effect to a price adjustment clause.
Position:
1. Yes.
2. General comments.
3. Yes.
Reasons:
1. It is reasonable to conclude that one spouse desired to confer a benefit on the other spouse by receiving consideration which is less than the fair market value of the property transferred.
2. Question of fact. But on the basis of Guilder News Co (1983) Ltd, the price adjustment clause, in the particular situation, could be ignored.
3. Paragraph 26 of IC 76-19R3 holds that an amended election must be filed in order to give effect to a price adjustment clause.
NOTE DE SERVICE
DATE November 15, 2002
FROM Ms. Christiane E. Joly TO Income Tax Rulings Directorate
Section 443-5-1
Montreal Tax Services Office Guy Goulet
(613) -957-9768
FILE 2002-016242
SUBJECT: XXXXXXXXXX - Subsection 85(7) of the Act
This is in response to your memo of September 6, 2002, in which you requested our opinion as to whether the taxpayer referred to above must file an amended election to give effect to a price adjustment clause or whether this clause applies automatically to adjust the FMV of the consideration received, as claimed by the taxpayer.
For the purposes of our opinion, we have reviewed the following documents provided by you:
- Certificate of Amendment to the Articles of XXXXXXXXXX Corporation (the “[Corporation") dated XXXXXXXXXX;
- Resolution of the sole director of the Corporation dated XXXXXXXXXX regarding:
o Certificate of Amendment;
o Share certificates;
o Exchange of issued and outstanding Class A shares for Class D shares;
o Fair market value;
o Subscription and issuance of shares;
o Resignation of an officer;
o Officer.
- Excerpts from the valuation report of the Movable Property Valuation Section of your Tax Services Office ("TSO") dated October 15, 2001.
- Letter dated June 20, 2002 from you to the taxpayer's representative outlining the proposed assessment.
- The August 14, 2002 letter from the taxpayer's representative containing representations in response to your letter of June 20, 2002.
In addition, unless otherwise indicated, all legislative references herein are to provisions of the Income Tax Act (the "Act").
Facts and Assumptions Relevant to this Case
Initial situation (on XXXXXXXXXX)
- XXXXXXXXXX ("Madame") and XXXXXXXXXX ("Monsieur") were spouses and therefore related persons for the purposes of the Act.
- The issued and paid-up share capital of the Corporation at that date was:
Shareholder Class A Class B
Madame XXXXXXXXXX XXXXXXXXXX
Monsieur XXXXXXXXXX
Total XXXXXXXXXX XXXXXXXXXX
- The Corporation was incorporated under the authority of Part 1A of the Quebec Companies Act (R.S.Q., c. C-38).
- Madame was the sole director of the Corporation.
Transactions carried out on XXXXXXXXXX
- The Corporation obtained a certificate of amendment from the "Inspecteur général des institutions financières du Québec" amending its articles as follows:
o The description of share capital was repealed and replaced by a new description (Classes A, B, C and D shares).
o The XXXXXXXXXX outstanding Class A shares were exchanged by their holders, share for share, for XXXXXXXXXX Class D shares.
- The sole director of the Corporation determined that the FMV of the Corporation's Class A shares was, immediately prior to the exchange, $XXXXXXXXXX per share, for a total of $XXXXXXXXXX allocated as follows:
Shareholder Number of Class A shares FMV fixed by resolution
of the Administrator
Madame XXXXXXXXXX XXXXXXXXXX
Monsieur XXXXXXXXXX XXXXXXXXXX
Total XXXXXXXXXX XXXXXXXXXX
- Madame filed an election pursuant to subsection 85(1) in respect of this share exchange, a summary of which follows:
Description of shares transferred XXXXXXXXXX
FMV XXXXXXXXXX
ACB XXXXXXXXXX
Agreed amount XXXXXXXXXX
Consideration received XXXXXXXXXX
- Following the exchange, XXXXXXXXXX Class A shares were issued to Monsieur at a price of XXXXXXXXXX ($XXXXXXXXXX) per share, for a total of XXXXXXXXXX ($XXXXXXXXXX).
- Madame resigned as sole director of the Corporation.
- Finally, Monsieur was appointed President of the Corporation until the next shareholders' meeting.
- Class A shares are voting and participating shares.
- The principal rights and privileges attached to Class D shares are:
o Fixed dividend;
o Redeemable at the holder's option at the redemption value;
o Redemption value: FMV of property received, as ratified by the Board of Directors, less the FMV of any other consideration paid by the Corporation.
o Adjustment: Standard price adjustment clause.
- In XXXXXXXXXX, the Movable Property Valuation Section of your TSO determined that the FMV of the XXXXXXXXXX Class A shares exchanged by Madame was $XXXXXXXXXX rather than $XXXXXXXXXX, a difference of $XXXXXXXXXX (more than a XXXXXXXXXX% increase).
- We understand that the taxpayer has not contested the valuation made by the Agency's Movable Property Valuation Section. We therefore assume that the amount of the appraisal is accepted by the parties.
Your Position on this Case
You have taken the position that paragraph 85(1)(e.2) applies to this case. You believe that it is reasonable to consider that Madame intended to confer a benefit on Monsieur.
However, you have offered the taxpayer the opportunity to avoid the application of this paragraph by filing an amended election pursuant to subsection 85(7.1). In your view, the price adjustment clause does not automatically modify the subsection 85(1) election. An amended election must be filed to make the price adjustment clause effective. You rely on Information Circular IC-76-19R3 to support your position.
Application of paragraph 85(1)(e.2)
Paragraph 85(1)(e.2) applies where a taxpayer uses subsection 85(1) to confer a benefit on a person related to the taxpayer. This specific anti-avoidance rule applies if both of the following conditions are met:
-
- the FMV of the property transferred exceeds the greater of the FMV of the consideration received and the agreed amount; and
- it is reasonable to consider that the taxpayer desired to confer a benefit on a person related to the taxpayer (other than a corporation that is a 100% subsidiary of the taxpayer immediately after the disposition).
It appears to us, in light of the documentation provided, that the first condition is met, since the FMV of the Class A shares ($XXXXXXXXXX) that Madame disposed of is greater than the greater of the redemption value of the Class D shares ($XXXXXXXXXX) that she received in consideration and the agreed amount ($XXXXXXXXXX).
As for the second condition, it is clear that the result of the transaction was that Madame conferred a benefit on Monsieur. The more difficult question to answer is whether it is reasonable to consider that this was desired. In order to answer this question, a full examination of all the relevant facts is required. In the present case, it seems reasonable to us to conclude that Madame desired to confer a benefit on Monsieur since, as sole director of the Corporation, it was she who chose to set the redemption value of the Class D shares at an amount lower than the FMV of the Class A shares transferred in consideration.
The taxpayer's representative has advised you that, according to the Erickson case ([1988] 2 CTC 2380), the rules of 85(1)(e.2) are applicable in the case of a gift and that, for there to be a gift, there must be an intention to give. In our opinion, this case was heard prior to the amendments made to the Act on July 1, 1988 (S.C. 1988, c.55, s. 58(4)) and its conclusions on the concept of gift are therefore no longer relevant to the interpretation of paragraph 85(1)(e.2) for the purposes of the present case. Indeed, paragraph 85(1)(e.2) was amended by introducing the concept of "benefit … conferred on a person related to the taxpayer" instead of the former concept of "making a gift to another shareholder".
We therefore agree with you that paragraph 85(1)(e.2) applies in this case.
Price adjustment clauses
Taxpayers regularly use price adjustment clauses to protect themselves against certain unintended tax consequences, such as those set out in paragraph 85(1)(e.2). By way of administrative relief, the Agency recognizes such clauses if, among other things, "[t]he agreement reflects a bona fide intention of the parties to transfer the property at fair market value and arrives at that value for the purposes of the agreement by a fair and reasonable method" (Paragraph 1(a) of Interpretation Bulletin IT-169 Price Adjustment Clauses -- August 6, 1974).
Whether the parties used a fair and reasonable method to determine FMV is a question that must be resolved in light of a full examination of all the relevant facts. It is difficult for us to reach a conclusion on this issue, as we do not have all the relevant facts.
However, it could be argued that the significant discrepancy between the FMV set by the taxpayer and the amount of the Agency's valuation demonstrates that the taxpayer made no real effort to determine the FMV of the shares. The jurisprudence has shown that a price adjustment clause can be ignored in cases where there is no good faith effort to determine the FMV of a property (See: Guilder News Co (1963) Ltd v. M.N.R. [73 DTC 5048]). On this basis, it seems to us that you would be free to ignore the price adjustment clause and therefore maintain an assessment under 85(1)(e.2).
Effect of the price adjustment clause
In the event that you decide to recognize the price adjustment clause, we agree with your position that the taxpayer must file an amended election to give effect to the price adjustment clause.
Both the jurisprudence and our administrative positions indicate that having a price adjustment clause does not automatically retroactively change the sale price.
As indicated in paragraph 26 of Information Circular IC 76-19R3, our position is that for such a change to occur, an amended election must be filed by taxpayers with the implications set out in subsection 85(8).
For your information, unless exempted, a copy of this memorandum will be severed using the Access to Information Act and will be available in the Legislative Access Database (LAD) located on the mainframe of the Canada Customs and Revenue Agency. 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, the Legislative Access Bank version can be provided. Alternatively, the client may request a severed copy using the Privacy Act criteria, which does not remove client identity. Requests for this latter version should be made by you to Ms. Jackie Page at (819) 994-2898. A copy will be sent to you for delivery to the client.
Best regards,
Maurice Bisson, CGA
for the Director
Corporate Reorganizations
and Resource Industries Division
Income Tax Rulings Directorate
Policy and Legislation Branch
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, 2002
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, 2002
Email this Content