7 July 1991 Income Tax Severed Letter - Application of sections 55, 84.1 and 245 to a particular situation

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.

Dear Sirs:

Re: Section 55, 84.1, 245

We are writing in response to your letter, dated May 31, 1991, in which you request our opinion concerning several contemplated transactions.

We must draw your attention to Information Circular 70-6R2, dated September 28, 1990, wherein it is stated that when a requested interpretation of specific provisions of the law relates to a contemplated transaction, a taxpayer should request an advance ruling, rather than an opinion.

Nevertheless, we can offer general comments. Our understanding of the facts, contemplated transactions and the purpose of the contemplated transactions is as follows:

Facts:

• 1. XXX
• 2. XXX
• 3. XXX
• 4. XXX

Contemplated Transactions

• 5. XXX
• 6. XXX
• 7. XXX
• 8. XXX

Purpose of the Contemplated Transactions

• 9. XXX

You would like us to provide our opinion on the following conclusions set out at page two of your letter:

• 1. XXX
• 2. XXX
• 3. XXX
• 4. XXX
• 5. XXX
• 6. XXX

Our general comments on the issues raised in your letter are as follows:

• 1. Subsection 55(2) of the Income Tax Act, c. 63, S.C. 1970-71-72, as amended ("the Act") has no application unless a corporation resident in Canada has received a taxable dividend (see Capital Gains Strips: A Revenue Canada Perspective on the Provisions of Section 55, John R. Robertson, F.C.A., 1981 Conference Report 81, at pp. 81-82).

Whether or not one of the purposes of a series of transactions is to effect a significant reduction in the portion of a potential capital gain attributable to anything other than income earned or realized by a corporation after 1971 is a question of fact, to be determined on the basis of the facts of each particular situation. The fact that all of a corporation's income was earned after 1971 could not, in and of itself, resolve the matter of whether a capital gain that would have been realized on the disposition of a share of the corporation at fair market value can reasonably be considered to be attributable to something other than income earned or realized by the corporation after 1971. This is because, for example, the value of the shares of the corporation may have increased, owing to the unrealized appreciation of its assets.

• 2. Paragraph 84.1(1)(a) of the Act provides, in certain circumstances, for a paid-up capital reduction for each class of the shares of a purchaser corporation from which shares were issued as consideration for its acquisition of the shares of another corporation. Where no shares of the purchaser corporation are issued as consideration for the shares acquired by it, this provision would not be applicable.
3. Paragraph 84.1(1)(b) of the Act, in certain circumstances, treats a purchaser corporation as having paid a dividend to the transferor of the shares it has acquired where the aggregate of the amount of the increase in the legal paid-up capital of its shares arising as a result of the share transfer and the fair market value of the non-share consideration given by it for the transferred shares exceeds the total of
• (a) the greater of the adjusted cost base, as modified under paragraph 84.1(2)(a) or (a.1), to the transferor of the transferred shares and the paid-up capital of the transferred shares, and
• (b) the total paid-up capital reductions required by paragraph 84.1(1)(a) to be made by the purchaser corporation.

The excess is the amount that is treated as a dividend. Whether or not a dividend will be deemed to have been paid to the transferor will depend on whether an excess exists. Where no excess amount exists, no deemed dividend would arise under this provision.

• 4. Subsection 245(2) of the Act provides that, subject to subsection 245(4), where a transaction is an avoidance transaction, the tax consequences to a person shall be determined as is reasonable in the circumstances in order to deny a tax benefit that would result from that transaction or from a series of transactions that includes that transaction.

An avoidance transaction is defined in subsection 245(3) as a single transaction or one that is a part of a series of transactions where the single transaction or the series results directly or indirectly in a tax benefit, unless the transaction is carried out primarily for bona fide purposes other than to obtain the tax benefit (see Information Circular 88-2, dated October 21, 1988, at para. 3).

The determination of whether a transaction constitutes an avoidance transaction or whether an avoidance transaction results in a misuse of the provisions of the Act or an abuse having regard to the provisions of the Act read as a whole can only be determined following a review of all of the relevant facts.

• 5. Paragraph 20(1)(c) of the Act generally allows the deduction of interest expense on money borrowed to be used for the purpose of earning income from a business or property. Interest expense incurred on borrowed money is generally not deductible in whole or in part when that money is loaned interest-free or at less than a reasonable rate of interest. A loan will not be considered to have been made at a reasonable rate of interest when the rate charged on the loan is less than the rate paid on the money borrowed to make the loan (see Interpretation Bulletin IT-445, date February 23, 1981, at paras. 3 and 6).

A written request should be submitted in accordance with the terms of Information Circular 70-6R2 if you wish to obtain an advance income tax ruling.