7 July 1991 Income Tax Severed Letter - Tax implications in Canada on the disposition of shares in a United States corporation by a resident of Canada

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.

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We are writing in reply to your letter dated December 10, 1990, concerning the tax implications in Canada on the disposition of shares in a United States corporation by a resident of Canada. We apologize for our delay in responding.

Our understanding of the facts is as follows:

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You requested our opinion on the following questions:

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XXX your request should have been made in the form of a request for an advance income tax ruling in accordance with the attached Information Circular 70-6R2 dated September 28, 1990. You will note that paragraph 21 of that Circular states that this Department cannot provide you with an advance ruling with respect to your proposed transaction. Nevertheless, we are pleased to provide an opinion, that, you will note, is not binding on Revenue Canada. As you can appreciate, because the transactions set our in your letter involve the tax laws of both Canada and the United States and we have not been provided with all of the circumstances of your situation, our comments are, by necessity, general in nature.

Our Comments

Question 1

A resident of Canada is subject to Canadian tax on his or her world income. This would include any taxable capital gain arising on the sale of shares in a U.S. company ("shares"). The Canada-United States Income Tax Convention (1990) ("Treaty") allows the United States to tax capital gains derived by a resident of Canada from the sale of real property situated in the United States which is defined to include an United States Real Property Interest ("U.S.R.P.I."). An U.S.R.P.I. is a concept found in U.S. tax law and we suggest that you determine if the shares of U.S. Opco constitute an U.S.R.P.I. by contacting the nearest Internal Revenue Service ("I.R.S.") office or the I.R.S. Attache, United States Embassy, Ottawa, K1P 5T1 (613-238-5335).

If the shares of U.S. Opco constitute an U.S.R.P.I. (a capital gain arising from the sale of the shares is taxable in the United States), the following may be relevant:

• (a) The gain which is liable to tax in the United States may be reduced to the extent of the portion of the gain that is attributable to the period starting on the date that you acquired the shares and ending on December 31, 1984. In order to be eligible for this reduction, the person selling the shares must have owned them on September 26, 1990 and must have been a resident of Canada on that date.
• (b) The person who sells the shares may be entitled to reduce Canadian tax payable by a foreign tax credit in respect of the United States income tax paid as a result of the sale of the shares. This credit may not exceed the Canadian tax attributable to the taxable capital gain arising on the sale of shares.

Where the shares do not constitute an U.S.R.P.I., Canada has the right to tax any gain arising on the sale of such shares and the normal rules with respect to the taxation of capital gain apply to such sale.

Regardless of whether the shares constitute an U.S.R.P.I., any taxable capital gain arising from the sale of such shares may be reduced by the $100,000 capital gains deduction which is available to a person who is resident in Canada throughout the year in which the shares are disposed of.

Question 2

Canada does not impose a conventional estate, succession or inheritance tax. Instead, the Income Tax Act provides that a person who dies is deemed to dispose of most types of property for proceeds equal to fair market value. Specifically, a person who at the time of death owned shares that were capital property, would be deemed to have disposed of the shares immediately before death and to have received proceeds of disposition for the shares equal to the fair market value of those shares at that time. Any taxable capital gains or allowable capital losses resulting from such deemed disposition would be reported on the person's final T1 tax return.

A deemed disposition at fair market value will not occur if the shares have, as a consequence of the death of a person, been transferred to the person's spouse or a trust which, among other things, must provide that the spouse is the sole income beneficiary until his or her death. In this case, any gain that had accrued to the date of death of the person does not have to be recognized until the shares are ultimately disposed of by the spouse or the spousal trust.

Whether the shares are subject to a U.S. capital gains tax on death or to U.S. estate tax is a matter which must be raised with the I.R.S. In the event the U.S. estate tax applies, such tax does not qualify as an income tax for purposes of calculating a foreign tax credit in Canada. Therefore, a person who is liable for U.S. estate tax would not be entitled to reduce his or her Canadian tax by any U.S. estate tax payable to the U.S. This issue is now being considered by the Governments of Canada and the U.S. in discussions that are concerned with amending the Treaty. A copy of the Department of Finance release with respect to these negotiations is attached for your information.

Question 3

Gifts made by a resident of Canada to an organization which is resident in the United States, which is generally exempt from United States tax and which could qualify in Canada to receive deductible gifts if it were created or established and resident in Canada, shall be treated as gifts to a registered charity and are deductible to the extent they do not exceed 20% of income of the taxpayer from United States sources. In other words, donations made to the U.S. organization will be recognized for Canadian tax purposes as if they are donations made to eligible Canadian registered charities. In order to obtain the status that would permit it to receive deductible gifts, the U.S. organization must apply to Revenue Canada as described in paragraph 76(c) & (e) of Information Circular 77-16R3, a copy of which is attached. If the U.S. organization is recognized for Canadian tax purposes and the gift in question is a gift of shares, the person making the gift may elect that his or her proceeds of disposition of the shares be an amount that is between the fair market value and the adjusted cost base of the shares. If the person elects that his or her proceeds of disposition are greater than the adjusted cost base of the shares, the person will realize a taxable capital gain. This elected amount will also be the amount of the gift.

Based on our telephone conversation on February 5, 1991, we understand that the agreement referred to in your letter is an agreement for the transfer of shares to a United States Charitable Remainder Unitrust that will hold the shares. The U.S. charitable organization will be the capital beneficiary of the trust and the person who will transfer the shares to the trust, or a relative, or both, will be income beneficiaries. In addition, you indicated that the income beneficiaries may be able to encroach on capital. We would have to review all the details of such an arrangement before we could provide a binding interpretation of the relevant law. However, the following general comments may be of assistance:

• (a) A transfer of property to a trust having the characteristics mentioned generally constitutes a taxable event for purposes of the Act. The person transferring the property will have proceeds of disposition equal to the fair market value of the property transferred to the trust and would be required to report a taxable capital gain on the transfer of shares. This capital gain could be reduced by the capital gains reduction.
• (b) There will be no taxable event on the transfer of property to a trust by virtue of which there is a change in legal ownership of the property without any change in the beneficial ownership thereof. XXX
• (c) Where an individual settles a trust in which the capital interest is vested in a charity and the income interest is retained by the individual, Revenue Canada may consider that the individual has made a gift to the charity if it is possible to value the amount of the gift. This valuation of the capital interest involves determining the expected fair market value of the property in the trust at the expected time of death of the settler of the trust. Where the property in the trust consists of shares of a private corporation, the value of the shares at the expected time of death of the settlor will be affected, among other factors, by the success of the business carried on by the company, the dividend policy of the board of directors and the right of the income beneficiaries to encroach on capital. In most cases, where the property transferred to the trust consists of shares of a private corporation, it will not be possible to value the capital interest and the amount of the gift would be considered to be nominal.

Although our comments are somewhat general in nature, we trust that they will be of assistance to you.