7 November 1990 Income Tax Severed Letter - Transfers and Loans to Corporation

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:

We are writing in response to your letter dated August 27, 1990 wherein you requested the Department['s interpretation of the application of subsection 74.4(2) of the Income Tax Act (Canada) (the "Act") to the following hypothetical situation.

Facts

• 1. Mr. A, an individual taxpayer, loans $500,000 cash to a corporation ("Holdco") at the beginning of year 1 which bears interest at 10%. Holdco is a family investment holding company in which Mrs. A and her children are common shareholders. Assume further that the conditions specified in subsection 74.4(2) of the Act apply to this situation.
• 2. At the beginning of year 2 Mr. A transfers property to Holdco under section 85 of the Act which has a fair market value of, say, $1,000,000 in exchange for preferred shares redeemable at the same amount. The preferred shares have a dividend rate of 12%.
• 3. On the last day of year 2, Holdco pays a dividend on the preference shares of $120,000 and pays $50,000 in interest owing on the shareholder loan.
• 4. The prescribed rate of interest is 13% for year 2.

You have identified two possible methods which could be used to compute the imputed interest benefit to Mr. A in year 2 under subsection 74.4(2) as shown below.

Method 1 - Aggregate Basis

Fair market value of prpoerty transferred $1,000,000 + $500,000 = $1,500,000

Deemed interest benefit @ 13% 195,000 Less: dividends paid on preferred shares ($120,000) x 5/4 (150,000) interest paid on shareholder loan (50,000) ----- ---- Deemed 74.4(2) benefit Nil

=========
Method 2 - Property by Property Basis

Interest benefit on property transferred for shares:
$1,000,000 @ 13%
130,000
Less adjustment for dividends paid (120,000) x 5/4
(150,000)
-----
----
Net benefit (P)
Nil

=========

Interest benefit on shareholder account:
$500,000 @ 13%
65,000
Less interest paid in year
(50,000)
-----
---
(L) $
15,000
-----
---
Total deemed benefit (P) + (L) $
15,000
-----
---

Where there are multiple transfers of property by an individual to a corporation, you are of the opinion that the interest deemed to have been received by the individual pursuant to subsection 74.4(2) of the Act should be calculated on the aggregate of all the transferred property (Method 1) rather than being calculated on each individual property (Method 2).

In the circumstances where the prescribed rate is 13% and the corporation pays a dividend of 12%, we would generally find it difficult to conclude that one of the main purposes of the transfer of the property to the corporation was to reduce the taxpayer's income. It is possible that the purpose of the second transfer may have been to circumvent the application of subsection 74.4(2) of the Act to the initial transfer of property. It, therefore, does not appear that subsection 74.4(2) would apply to the transfer described in year 2 above.

Therefore the amount to be added to Mr. A's income under subsection 74.4(2) of the Act in year 2 would be the $15,000 determined in (L) above.

The foregoing comments are given in accordance with the guidelines set out in paragraph 21 of Information Circular 70-6R2 dated September 28, 1990.