7 December 1990 Income Tax Severed Letter - Section 85 transfer by non-tesident; Trusts—dividends paid to corporate beneficiary; Capital gains deduction—sale to spouse; GAAR—sale of shares; Income or capital gain: Rollover of assets followed by immediate sale of assets; Winding-up—cost amount of inventory; Rollover under section 85—benefit conferred on a related person; Deemed dividend on winding-up; Services between related Canadian corporations—paragraph 69(1)(b); Stock dividends; Indirect acquisition of control

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.

QUESTION I50 Section 85 Transfer by a Non-resident

Real property, an interest therein or an option in respect thereof that is owned by a non-resident person (other than a non-resident insurer) does not qualify as “eligible property”, as defined in subsection 85(1.1), for the purposes of an election pursuant to subsection 85(1). Does a non-resident's interest in a partnership, the assets of which are primarily real property, qualify as “eligible property” for the purposes of subsection 85(1)?

RESPONSE

This question was answered at the 1986 tax conference. It is the view of the Department that, for purposes of section 85 of the Act, an interest in a partnership is not considered to be an interest in its underlying assets. Therefore, an interest in a partnership held by a non-resident as capital property would qualify as “eligible property” under paragraph 85(1.1)(a), notwithstanding the fact that the assets of the partnership consist primarily of real property.

However, if a partnership is formed as one of the steps in a series of transactions that is designed to circumvent the provisions of 85(1.1), the provisions of section 245 could apply.

QUESTION I36 Trusts - Dividends Paid to a Corporate Beneficiary

A trust, of which a corporation is the sole beneficiary, receives a taxable dividend on its shares of a taxable Canadian corporation. The trust pays all of its income for the year to the corporate beneficiary and makes a designation pursuant to subsection 104(19) in respect of the taxable dividend, with the result that the taxable dividend is deemed not to have been received by the trust and to be a taxable dividend received on the shares by the corporate beneficiary. Is the corporate beneficiary considered, for the purposes of paragraph 186(4)(b), to own the shares on which the dividend is deemed to have been received?

DEPARTMENT'S POSITION

No.

A beneficiary of a trust is not considered to own trust property. In the absence of any provision that deems trust property to be owned by the beneficiary of the trust, it is our view that a corporate beneficiary does not own the shares in the above circumstances.

QUESTION I29 Capital Gains Deduction - Sale to Spouse

An individual owns all the shares of a corporation. In order to “crystallize” his capital gains deduction, the individual sells his shares to his spouse, elects not to have the provisions of subsection 73(1) of the Act apply, and claims a capital gains deduction under section 110.6 of the Act. Would subsection 245(2) of the Act apply to such transactions and, if so, with what result?

DEPARTMENT'S POSITION

Since there is no indication in the Act that a capital gain must arise from an arm's length disposition in order to be eligible for the capital gains deduction, we generally will not seek to apply subsection 245(2) of the Act in circumstances such as those described.

However, it should be noted that the capital gains deductions set out in subsections 110.6(2), (2.1) and (3) require that the taxpayer dispose of property. If there is merely a transfer in legal title to the spouse, without any change in beneficial ownership, a disposition will not have taken place, by virtue of paragraph 54(c)(v) of the Act.

QUESTION I28 GAAR - Sale of Shares of Cashco

An individual owns all the shares of a corporation (“Cashco”) the assets of which are primarily liquid assets. The individual sells the shares of Cashco to a corporation with which he deals at arm's length (“Purchaseco”), and claims the capital gains deduction under section 110.6 of the Act. Cashco is then would up into Purchaseco which uses the liquid assets to pay the purchase price to the individual. Would subsection 245(2) apply to such transactions?

DEPARTMENT'S POSITION

The explanatory notes issued by the in June 1988 explained the repeal of former subsection 247(1) of the Act by indicating that the provisions of section 245 are broad enough to cover the transactions to which former subsection 247(1) was intended to apply. At the 1986 tax conference we confirmed that subsection 247(1) could apply to a series of transactions such as that described in the question posed. It is therefore our view that subsection 245(2) could apply to such transactions.

QUESTION A3 Income or Capital Gain: Rollover of Assets Followed by Immediate Sale of Assets

With respect to income/capital determinations, what is Revenue Canada's present policy/where:

• (a) An individual rolls a capital asset with an accrued gain to a corporation which he controls and the corporation sells the asset and realizes the gain soon after the rollover?
• (b) A parent corporation rolls a capital asset with an accrued gain to a controlled subsidiary corporation and the subsidiary sells the asset and realizes the gain soon after the rollover?

DEPARTMENT'S POSITION

We addressed these questions at the 1984 and 1983 tax conferences, and our positions then announced remain unchanged. In both situations we are prepared to accept that the transfer of property pursuant to subsection 85(1) of the Act, in itself, does not change the nature of the property transferred, even when the property that is the subject of the transfer sis sold to an arm's length third party within a very short time thereafter.

QUESTION I60 Winding-up - Cost amount of Inventory

In a winding-up to which subsection 88(1) applies, the inventory of the subsidiary is deemed by subparagraph 88(1)(a)(iii) to be disposed of by the subsidiary for proceeds equal to the cost amount thereof to the subsidiary immediately before the winding-up. The “cost amount” of inventory to a taxpayer at any time is defined in subsection 248(1) to mean its value at that time as determined for the purpose of computing the income of the taxpayer. Where the distribution of inventory to the parent on the winding-up does not coincide with the year-end of the subsidiary, is the cost amount of the inventory for the purposes of subparagraph 88(1)(a)(iii):

• (a) its value immediately before the winding-up determined in accordance with the method previously adopted by the subsidiary; or
• (b) its value as determined for purposes of computing the income of the subsidiary at the end of its immediately preceding taxation year?

DEPARTMENT'S POSITION

The cost amount of each property described in an inventory of the subsidiary, for purposes of subparagraph 88(1)(a)(iii), is the value of each property immediately before the winding-up determined in accordance with the valuation method previously adopted by the subsidiary.

QUESTION I 49

Rollover Under Section 85 - Benefit Conferred on a Related Person

Paragraph 22 of Information Circular 76-19R2 states that the Department will generally not apply paragraph 85(1)(e.2) where a transferor receives retractable shares from the corporation “provided that prior to the transfer, the transferee has shareholder's equity equal to the retraction amount”.

This interpretation of paragraph 85(1)(e.2) of the Act would affect many arrangements including a “classic” estate freeze where common shares of Opco are transferred to a Newco for retractable preferred shares and common shares of Newco are issued to offspring of the transferor. Is this in fact Revenue Canada's administrative practice?

DEPARTMENT'S POSITION

The above quoted comment related to a concern which arose in the context of a particular fact situation and does not accurately reflect the Department's general position in the area.

A Supplement to the Information Circular is presently being prepared which will clarify that statement.

QUESTION I 58

Deemed Dividend on Winding-Up

On the winding-up of a closely-held taxable Canadian corporation, where the provisions of subsection 88(1) of the Act do not apply, subsection 69(5) of the Act may result in the corporation's becoming liable for income tax. This liability will normally be assumed by the shareholder(s) who receive the property distributed on the winding-up. For purposes of determining the amount of any deemed dividend under the provisions of subsection 84(2) of the Act, is this liability deducted in the determination of “... the amount or value of the funds or property distributed or appropriated ...”?

DEPARTMENT'S POSITION

Our position on this matter remains as stated in response to question #34 of the Revenue Canada Round Table at the 1988 Canadian Tax Foundation Conference. The amount of the deemed dividend would be reduced by the fair market value of a corporate liability so assumed.

QUESTION I 94

Services Between Related Canadian Corporations - Paragraph 69(1)(b)

Both Company A and Company B, a wholly-owned subsidiary of Company A, are taxable Canadian corporations. Company A, because of its size and structure, provides certain services for the benefit of Company B. Company A and Company B have entered into a service agreement which requires Company A to perform the services and requires Company B to compensate Company A for providing the services.

Assuming that the compensation provided by the service agreement is sufficient for Company A to recover its cost of providing the services, would paragraph 69(1)(b) of the Act apply to deem Company A to have received fair market value consideration for providing the services?

DEPARTMENT'S POSITION

Generally, paragraph 69(1)(b) of the Act will not apply to the provision of services. Where, however, in addition to providing services, Company A supplies other materials or goods with the result that it may be considered to have “disposed of anything”, paragraph 69(1)(b) of the Act could apply to the disposition of such materials or goods.

QUESTION I 83

Stock Dividends

Subject to certain exceptions, subsection 248(1) provides that the “amount” of a stock dividend is the amount by which the paid-up capital of the corporation that paid the dividend is increased by the payment of the dividend. Subsection 43(2) of the Canada Business Corporations Act provides that if shares of a corporation are issued in payment of a dividend, the amount to be added to the stated capital account for the class of shares issued in payment of the dividend should be the declared amount of the dividend stated as an amount of money.

Consider the situation where an individual owns all the issued shares of a taxable Canadian Corporation that declares a stock dividend. The declared amount of the dividend is stated as a nominal amount of money but the shares that are issued are redeemable for a greater amount. Assuming that subsection 15(1.1) of the Act would not otherwise apply, would the amount of the taxable dividend be equal to the nominal amount added to stated capital?

DEPARTMENT'S POSITION

Subject to certain adjustments set out therein, paragraph 89(1)(c) of the Act provides that the “paid-up capital” in respect of a class of shares of the capital stock of a corporation is “... an amount equal to the paid-up capital in respect of the class of shares at the particular time, computed without reference to the provisions of this Act ...”

Accordingly, if the applicable corporate law allows for a nominal amount to be added to the stated capital account of the class of shares as a result of a stock dividend, the “amount”, as defined in subsection 248(1) of the Act, of the stock dividend would be that nominal amount, unless paragraph (a) or (b) of that definition applies.

QUESTION I 67

Indirect Acquisition of Control

Subsection 256(7) of the Act provides rules where control of a corporation shall be deemed not to have been acquired. What is the Department's position in the following situation?

Mr. A acquires from a related person the shares of Co. Y, which has a wholly-owned subsidiary, Co. Z. It seems clear that subparagraph 256(7)(a)(i) of the Act applies to the acquisition of the shares of Co. Y. However, the shares of Co. Z were not acquired, and it can be argued that the acquisition of the shares of the parent company, Co. Y, did not result in an acquisition of control of Co. Z.

DEPARTMENT'S POSITION

Where paragraph 256(7)(a) of the Act applies to deem that no change of control will have occurred in respect of the parent, Co. Y, the Department also considers that there has been no change in the ultimate control of its subsidiary, Co. Z.

However, subclause 187(4) of the Draft Legislation to Amend the Income Tax Act and Related Statutes issued by the Department of Finance on July 13, 1990 proposes to amend paragraph 256(7) of the current Act to ensure that, effective for redemptions, acquisitions and cancellations of shares occurring after 1989, the exception provided in paragraph 256(7)(a) of the Act will apply not only to a particular corporation upon the acquisition of its shares, but also to any corporations that may be controlled by the particular corporation.