17 October 1983 Income Tax Severed Letter

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.

October 17, 1983

Mr. P.Pinkus, Director Provincial and International Relations Division, Revenue Canada Taxation, Room 472, Metcalfe Building, 88 Metcalfe, Ottawa, Ontario.

Re: Canada-United Kingdom Income Tax Convention Article XIII(4)(a)

Your letter of September 27th concerns the method of determining if the value of shares is derived principally from real property situated in Canada. Unfortunately there is not an easy, categorical answer as to whether one looks at gross asset values or net asset values taking into account the liabilities of the company. An example will explain the problem.

Assume that a U.K. company owns all the shares of a Canadian subsidiary whose only asset consists of real estate worth $100. In this case any gain or a sale of the company's shares would be taxable. However, if gross asset values were the single, unalterable test it would be relatively easy to arrange for a change in status of the Canadian subsidiary shares before their sale simply by arranging for it to borrow $100 and argue that since its assets now consisted of cash of $100 and real estate of $100, the value of the shares would no longer derive mainly from its real estate.

One should, I believe, look at net asset values and attempt to assign debt to the assets to which it reasonably relates. In the example on page 2 of the XXXX letter, the reasonable view is that the value of the shares derives principally from the Canadian real estate and to allow the gross asset value test to produce a different result would in my view be quite wrong. However, it would also be open to game playing if we were to confirm that in all cases the net asset test would be used. It would be possible in the circumstances set out in the XXXX letter to arrange to fully mortgage the Canadian properties, transfer the funds to the U.S. subsidiary and reduce the mortgage on the U.S. properties before the shares are sold in order to demonstrate that the share value derives mainly from the U.S. property. Thus, whichever test is used is subject to manipulation.

Perhaps the best way to answer the XXXX enquiry is to indicate that generally one would look to net asset values assigning debt to where it reasonably relates. However, we recognize that there will be circumstances where this test can be manipulated and if there is any evidence of manipulation in contem- plation of a share sale, we would not feel bound by the net value test - particularly in those circumstances where the increase in the value of the shares is mainly attributed to an increase in the value of the Canadian real estate.

I recognize that this is not a fully satisfying reply but I don't see any alternative. Certainly it would be folly to indicate that in all circumstances we would look only at a single measure - be it gross or net values. This valuation issue has not been raised in the treaty negotiations that I have participated in and, thus, I don't think that we can look to any understanding on the part of the negotiators for help in settling the issue.

Please give me a call if you would like to discuss the issue further. I would be grateful if you could send me a copy of any reply that is sent to XXXX

Director, Tax Policy and Legislation Branch