29 September 1999 External T.I. 9916965 - CONNECTED SHAREHOLDER, RRSP

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: General comments regarding the term connected shareholder" within the meaning assigned by subsection 4901(2) of the Regulations and the expression "arm's length" used within that definition of that term?

Position: Comments provided.

Reasons: Before an RRSP can acquire shares of a small business corporation, the annuitant under the RRSP has to satisfy certain tests in respect of the particular shares.

xxxxxxxxxx 991696
M. P. Sarazin

September 29, 1999

Dear Sir:

Re Connected Shareholder and Arm's Length

This is in reply to your letter dated June 17, 1999, wherein you requested our views as to whether six unrelated people who each acquire between 5% and 40% of the common shares of a new Canadian-controlled private corporation through their registered retirement savings plans ("RRSPs") would be considered connected shareholders within the meaning assigned by subsection 4901(2) of the Income Tax Regulations (the "Regulations").

You have concluded that the particular corporation satisfies paragraph 4900(12)(a) of the Regulations but you are uncertain as to whether the particular shareholders will be considered to deal at arm's length for purposes of determining whether they would be considered connected shareholders.

Comments

It appears that the opinion you seek relates to specific proposed transactions and, therefore, we bring to your attention Information Circular 70-6R3 dated December 30, 1996, issued by Revenue Canada. Confirmation of tax consequences with respect to proposed transactions involving specific taxpayers will only be provided in response to a request for an advance income tax ruling. However, we can provide you with the following general comments.

The rules governing investment by RRSPs and RRIFs in small business corporations are designed to strike a balance between the integrity of the taxation system in contributing to retirement savings and the benefits of providing an additional source of funds for these small businesses.

The Department of Finance has stated that, in terms of fiscal policy, there are two major reasons for the $25,000 limit and the requirement that shareholders deal at arm's length with the corporation for the purpose of investing in private corporate shares through RRSPs and RRIFs. First of all, if there were no such restrictions in the rules governing RRSPs and RRIFs for private corporations, the concern is that excessive yields on such investments would become unduly inflated to benefit from the tax deferral available for income accumulating on assets held in an RRSP or RRIF. Secondly, if a person's only RRSP holdings consisted of shares in his businesses, his retirement security would be completely tied to his business, which might require the government to provide more support to this person following his retirement. This would be contrary to the underlying overall policy of the taxation system to provide incentives to retirement savings, by encouraging people to save for their retirement.

Connected Shareholder Concept

Subsection 4900(12) of the Regulations allows a trust governed by an RRSP to own shares in a small business corporation provided that the annuitant of the RRSP is not a connected shareholder immediately after the time the property was acquired by the RRSP. A connected shareholder means a shareholder who directly or indirectly owns 10 percent or more of the shares of any class in a corporation or any related company, unless the shareholder deals at arm's length with the corporation and the total reported cost of the shares of the corporation or related corporation of which the annuitant is or is deemed to be an owner is less than $25,000.

Arm's Length

Determining whether or not unrelated persons are dealing at arm's length at any given time is a question of fact. The Department's general views on the meaning of arm's length can be found in the enclosed Interpretation Bulletin IT-419R titled "Meaning of Arm's Length". We are generally of the view that even though unrelated shareholders may together control the corporation this fact alone does not cause them to deal at non-arm's length with the corporation immediately after their RRSPs have acquired shares in this corporation.

Likewise, merely because the shareholders are using their respective RRSPs to acquire shares in the corporation is not of itself a sign that they are not dealing at arm's length with the corporation immediately after such acquisition. This is a question of fact and the Department will examine all the facts and circumstances immediately following such an acquisition to determine whether there is non-arm's length dealing between the shareholders and the corporation. If the shares held in the RRSP perform unusually well, it could be a sign that the shareholders have common interests and are therefore not dealing with the corporation at arm's length.

We trust our comments will be of assistance to you.

Yours truly,

Patricia Spice for Director
Financial Industries Division
Income Tax Rulings and
Interpretations Branch
Policy and Legislation Branch