30 March 1987 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.

XXXX

C. Savage 957-8953

March 30, 1987

Dear Sirs:

Re: XXXX

This is in response to your letter or July 21, 1986 wherein you requested further clarification of our position with respect to the application of subsection 55(2) of the Income Tax Act to the above transactions.

We understand that you consider the possible application of subsection 55(2) to the transactions in question as inconsistent with the practice of Revenue Canada with respect to similar transactions in which a sale of certain corporate assets to an arm's length party is preceded by a "reorganization" which divides corporate assets in a tax-free manner prior to the sale.

You have described such a reorganization as allowing the shareholders of a corporation to dispose of their underlying interest in the assets by disposing of their shares of the corporation. As a result the shareholders realize a capital gain measured by reference to the adjusted cost base of the shares of the corporation or a pro-rata portion thereof. The corporation does not realize a gain.

We understand that in your opinion it is irrelevant whether the property that is the subject of the sale is transferred to a corporation, the shares of which will be acquired by the arm's length party, or whether the property which is not to be sold is transferred to another corporation prior to the sale of the shares of the transferor corporation. In either case you consider that the portion of the gain that would have been realized by the corporation on the sale of the subject property is converted into a taxable dividend which is deductible under subsection 112(1).

We have some difficulty with the analogy you have drawn. It is only in the case in which the selling corporation transfers the subject property to the arm's length party that the gain which would have been realized by the corporation will have been converted into a dividend. In the other situation the value of the unwanted property which will have been transferred out of the corporation will bear no logical relationship to the fair market value of the property which will remain in the corporation.

In any event, we can again assure you that the practice of the Rulings Directorate has been consistent with respect to the application of subsection 55(2) to those transactions on which a corporation transfers property to an arm's length party in consideration for shares which are subsequently redeemed. It has been the practice of this Directorate to apply the provisions of subsection 55(2) to a dividend received on such a redemption unless the arm's length party is described in and acquires the property in a manner described in paragraph 55(3)(b).

The proposed amendment to enact subsection 85(10) was tabled in the House of Commons in August, 1950. The proposed subsection provided that a corporation which received a taxable dividend in respect of a share which was received as consideration for property transferred under section 85 was required to treat the entire dividend as a gain from the disposition of a capital property. The proposed subsection 85(10) was not to apply to any dividend received by a corporation except where such a dividend was part of a transaction or series of transactions which resulted in a disposition of any property to a person with whom the recipient was dealing at arm's length.

The proposed subsection 85(10) was tabled in the House of Commons together with proposed amendments to section 55 which also addressed the realization of proceeds of disposition of a share in the form of a tax-free dividend. The proposed amendments were complementary. Proposed subsections 55(3) and (4) were to be applicable mutatis mutandis to subsection 85(10). Certain definitions, contained in proposed subsection 55(5) were to have been applicable for the purposes of subsection 85(10). Subsection 55(2) was not to have applied to those circumstances where subsection 85(10) applied.

The proposed subsection 85(10) was not enacted when amendments to section 55 were enacted in February, 1981. However, the transactions addressed by the proposed subsection 85(10) were encompassed by subsection 55(2) as enacted. Since the subsection referred to a reduction in a capital gain that would have been realized on the disposition of any share, it included a capital gain inherent in a share issued as consideration for an asset acquired in an arm's length transaction which was subject to a section 85 transaction. Revenue Canada has interpreted subsection 55(2) continuously in this manner. We refer you to the comments of John Robertson at page 104 of the 1981 Canadian Tax Foundation Report.

XXXX

Our letter of February 11, 1986 stated that our view is based on the understanding that the facts described therein are correct. We requested that we be notified of any discrepancies, either as to the chronology or description of events. Since we have not yet been advised of any discrepancies, we assume that you are in agreement with the description.

We have advised the District office that, as explained herein and in our letters of February 11 and April 25, 1986 addressed to XXXX and in our meeting of July 11, 1986, we continue to be of the view that subsection 55(2) applies to the transactions in question.

Yours truly,

Director General Specialty Rulings Directorate Technical and Intergovernmental Affairs Legislative and Intergovernmental Affairs Branch