30 June 1989 Ministerial Letter 58138 F - Application of GAAR to the Acquisition of an Employee's Shares Purchase Plan

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 245 of the Income Tax Act (Canada) (the "Act")

This is in response to your letter of April 11, 1989, in which you requested our views on the application of the general anti-avoidance rule ("GAAR") contained in section 245 of the Act to the acquisition of an employee's shares purchase plan in the hypothetical fact situation described below.

Opco is a private corporation, within the meaning of paragraph 89(1)(f) of the Act, which does not have a class of shares outstanding that are purchased and sold in the manner in which such shares normally are purchased and sold by any member of the public in the open market.  The majority of the voting shares of Opco are held by Holdco which is also a private corporation.

Opco has established an employee share purchase plan (the "Plan") pursuant to which employees of Opco, who deal at arm's length with Opco, and Holdco subscribe for common shares of Opco.  The issue price for shares issued under the Plan is the fair market value of such shares at the time of issuance.  under the terms of the Plan, n employee is required to dispose of his shares of Opco issued under the Plan (the "Purchased Shares") for fair market value consideration upon the cessation of his employment.  Such disposition is either to Holdco, at Holdco's option, or to Opco.

For purposes of this letter it is assumed that an employee holds the Purchased Shares as capital property.  Assuming that the Purchased Shares held by an employee have appreciated in value between the time of his acquisition and the cessation of his employment with Opco, a disposition of the Purchased Shares to Holdco would result in the employee realizing a capital gain while the disposition of the Purchased Shares to Holdco would result in the employee realizing a capital gain while the disposition of the Purchased Shares to Opco could result in a dividend being deemed by subsection 84(3) of the Act to be received by the employee in lieu of or in addition to a capital gain.  Capital gains treatment may result in a lower tax liability to the employee than deemed dividend treatment.

You have requested our opinion as to whether the general anti-avoidance rule ("GAAR") contained in section 245 of the Act would apply to the acquisition of Purchased Shares by Holdco rather than Opco.

You have also requested our opinion as to the application of GAAR to the following variations of such an acquisition:

(1)     the Purchased Shares are acquired by Opco shortly after their acquisition by Holdco; or

(2)     the acquisition of the Purchased Shares by Holdco is funded by a dividend from Opco to Holdco on a separate class of shares owned by Holdco.

Opinions

As the application of GAAR to any situation depends upon the particular facts and surrounding circumstances, it is very difficult to comment on such application in the abstract.  The comments contained herein should be considered with this in mind.

In the hypothetical fact situation described above, the tax benefit, within the meaning of subsection 245(1) of the Act, would be the tax saved by the employee as a result of receiving capital gains treatment, rather than deemed dividend treatment, on the disposition of his Opco shares.

The purchase by Holdco of an employee's shares of Opco would be an avoidance transaction, within the meaning of subsection 245(3) of the Act, if its primary purpose were to obtain the aforementioned tax benefit.

If Opco were to acquire the Purchased Shares from Holdco shortly after their acquisition by Holdco, the acquisition of such shares by Holdco would, in our view, be primarily for the purpose of obtaining the above-noted tax benefit and would therefore be an avoidance transaction.  Similarly, if the Holdco's purchase price for the Purchased Shares were funded by a dividend from Opco, the acquisition of the Purchased Shares by Holdco may well constitute an avoidance transaction.

Assuming that there is an avoidance transaction in the relevant series of transactions, GAAR would apply to such series unless it may reasonably be considered that the transaction would not result directly or indirectly in a misuse of any of the provisions of the Act or an abuse having regard to the provisions of the Act read as a whole (subsection 245(4) of the Act).

The Act contains several provisions designed to prevent the conversion of dividend or other income into capital gains, including section 84.1 and Part II.I of the Act.  The following statement is contained in item 25 of Information Circular 88-2:

     Provisions, such as those mentioned above (sections 84.1  and 183.1, among others) indicate the circumstances in which amounts received by a shareholder of a corporation from the corporation on a disposition of shares or other property are to be accounted for as a dividend.  If as a result of a series of transactions a shareholder realized a capital gain on the disposition of property and a transaction in the series is an avoidance transaction, subsection 245(2) will be applied to the transaction if it is determined that the series of transactions was carried out to thwart the purpose of the provision in question.

Part II.1 of the Act would not apply in this case as Opco is not a corporation described in subsection 183.1(1) ("public or similar companies").  GAAR may be applicable to arrangements involving corporations other than public or similar companies which are similar to those arrangements is to convert employment income or dividend income into proceeds of disposition.  An example of the first type of arrangement would be the issuance of preferred shares to employees where the redemption amount thereof varies with profits of Opco (i.e. so as to approximate a bonus) and the purchase of such shares by Holdco.  An example of the second type of arrangement would be the payment of a stock dividend comprised of low paid-up capital shares and the subsequent acquisition of such shares by Holdco.  "Paid-up capital" has the meaning assigned by paragraph 89(1)(c) of the Act.  The hypothetical situation described herein does not appear to involve such a conversion of employment or dividend income of an individual to a capital gain.

In the hypothetical situation described herein, section 84.1 of the Act would not apply to the transfer of the Purchased Shares by an employee to Holdco and would not appear to have been improperly avoided in the manner contemplate in the quoted extract from Information Circular 88-2.

In conclusion, we are of the view that GAAR would not generally be applicable to arrangements such as the hypothetical situation described herein or the variations thereof.  however, the particular circumstances of any real situations would have to be examined before a final determination could be made as to the application of GAAR thereto.

The above comments are only an expression of opinion and are not binding on Revenue Canada, Taxation as explained in Information Circular 70-6R.

Yours truly,

for Director Reorganizations and Non-Resident DivisionSpecialty Rulings Directorate Legislative and Intergovernmental Affairs Branch