Section 84.1

Subsection 84.1(1) - Non-arm’s length sale of shares

Cases

Wild v. Canada (Attorney General), 2018 FCA 114

transactions to bump PUC did not abuse s. 84.1 prior to use of such PUC to strip surplus

Mr. Wild stepped up the adjusted cost base of his investment in a small business corporation (PWR) by transferring his PWR common shares to two new Holdcos for him and his wife in exchange for preferred shares of the Holdcos, and electing under s. 85 at the right deemed proceeds amount to use up his capital gains exemption. However, the paid-up capital of those preferred shares was ground down to essentially nil under s. 84.1.

The solution was for PWR to then transfer high basis assets to the Holdcos in consideration for preferred shares of the same class, so that the PUC of the preferred shares held by Mr. Wild personally could be bumped due to the class-averaging rule in s. 89(1).

Dawson JA reversed the finding of the Tax Court that there was an abuse under s. 245(4) that should be remedied by grinding the PUC of Mr. Wild’s preferred shares down to what his starting (nominal) PUC had been. She stated (at para. 32):

Because the tax-free distribution of retained earnings section 84.1 is intended to prevent has not occurred section 84.1 has not, to date, been mis-used or abused.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 245 - Subsection 245(4) surplus-stripping transactions were not subject to GAAR before the surplus had in fact been stripped 353

Fiducie famille Gauthier v. Canada, 2012 FCA 76, aff'g 2011 DTC 1343 [at 1917], 2011 TCC 318

fees borne by transferee were "consideration"

The taxpayer, a family trust, made a non-arm's-length sale of shares to a numbered corporation ("4041763 or "404") for a promissory note of approximately $2.6 million. 404 then immediately sold the shares at arm's length to a third party ("Keolis") for approximately $2.8 million. The lower sale price on the first transfer reflected that it had been determined that 404 would bear the cost of professional fees, relating to the structuring of the sale to Keolis, of $233,786.

Archambault J. affirmed the Minister's position that the amount of these professional fees was "consideration" received by the taxpayer. That amount was therefore added to variable D in s. 84.1(1)(b), resulting in an increase in the dividend deemed to be received by the taxpayer. Archambault J. stated (at para. 16):

I accept the definition of consideration laid down in Currie and referred to by Judge Lamarre in Republic National Bank, above, and the definition in Black's Law Dictionary, according to which "consideration" can encompass "[t]he inducement to a contract... [s]ome right, interest, profit or benefit accruing to one party, or some forbearance, detriment, loss, or responsibility, given, suffered, or undertaken by the other." By agreeing to be billed for the fees related to the sale of the shares in the place of Fiducie, 404 was, in a sense, undertaking Fiducie's responsibility. A benefit therefore accrued to Fiducie.

The Court of Appeal dismissed the appeal on the basis that the question of who was responsible for the fees, between the taxpayer and 404, was a question of fact. Noël J.A. stated (at para. 15):

Nothing would have prevented the parties from allocating the fee charges differently if that had been their agreement. However, given the evidence, the onus was on the appellant to show that the reduction of the share price, as explained by the tax professional, was not intended to reflect the fact that 4041763 had made the payment on its behalf. This the appellant has not done.

Locations of other summaries Wordcount
Tax Topics - General Concepts - Fair Market Value - Shares 250

Canada v. Olsen, 2002 DTC 6770, 2002 FCA 3

reference to s. 186(4) test included related definition

The taxpayer transferred shares of a corporation ("Leader") to corporations controlled by the taxpayer's children and spouses in consideration for promissory notes. Noël J.A. held that, as s. 186(4) provided that a payor corporation is connected with a particular corporation for purposes of Part IV when the former is controlled by the latter, the term "control" could only have the meaning assigned to it by subsection 186(2). Therefore, it followed that the reference to s. 186(4) in s. 84.1(1) included a reference to the notion of control as defined in s. 186(2), with the result that the taxpayer was deemed to receive a dividend based on the fair market value of the promissory notes received by him. (A submission of the Crown that the deemed dividend should be calculated instead on the basis of the fair market value of the transferred shares was rejected. S.84.1(1)(b), which like s. 69(1)(b), only applied where the parties did not deal at arm's length, provided for its own fair market value computation.)

See Also

Crean v Canada (Attorney General), 2019 BCSC 146

share sale for Newco note generated s. 84.1 dividend before its rectification

The executed documents indicated that an individual (Thomas) sold his shares of a corporation (Crean Holdings) to the Newco of his brother (Michael) in consideration for a promissory note of the Newco. When the tax advisor realized this was a mistake giving rise to a deemed dividend under s. 84.1, the parties applied successfully in the B.C. Supreme Court for a rectification order redoing the written agreement to provide that Thomas sold his shares to Michael directly for a promissory note, and that there was an immediate on-sale by Michael of those shares to his Newco in consideration for it assuming the promissory note.

Burke J relied on the terms of an agreement in principle that had been signed before the transactions were implemented which provided for a direct sale from Thomas to Michael and provided that “the transaction will be structured, to the extent possible, so that Tom receives capital gains treatment.” She also accepted the tax advisor’s testimony that, consistent with the agreement in principle, he had been instructed to provide for a direct sale and that the failure of the documents to so provide was an error on his part.

She accordingly found that the two brothers had a “prior definite and ascertainable agreement” to which the rectified written agreement was giving effect (para. 85).

Locations of other summaries Wordcount
Tax Topics - General Concepts - Rectification & Rescission a sale agreement rectified to turn it into a 2-step sale that no longer generated a s. 84.1 dividend 301

1245989 Alberta Ltd. v. The Queen, 2017 TCC 51, rev'd sub nom. Wild v. Canada, 2018 FCA 114

the use of class PUC-averaging to bump the PUC of personally-held shares was an abuse of s. 84.1

In order to protect the assets of an Alberta an oil field rental company (“PWR”), whose sole shareholder was Mr. Wild and whose shares of PWR had a fair market value of $2.3 million and nominal adjusted cost base (“ACB”) and paid-up capital (“PUC”), the following transactions occurred:

  1. Mrs. and Mr. Wild respectively incorporated and subscribed $100 for the Class A common shares of two Alberta corporations (“1251” and “1245”).
  2. Mr. Wild exchanged 16.4 of his 110 Class A PWR shares for 348.5 Class C preferred shares of 1251, giving rise to a capital gain (as a result of a s. 85(1) elected amount greater than the shares’ ACB), for which he used part of his available capital gains exemption. The Class C preferred shares had a nominal PUC under s. 84.1.
  3. PWR transferred Class 8 equipment to 1251 under s. 85 in consideration for 348.5 Class C preferred shares of 1251 (i.e., the same number as in 2), resulting in a bump to the PUC of Mr. Wild’s Class C preferred shares due to PUC averaging.
  4. 1251 redeemed the 348.5 Class C preferred shares of PWR, and PWR purchased for cancellation the 16.4 Class A common shares held by 1251, in each case in consideration for a $348,500 promissory notes, with the two notes then being set off.
  5. There now followed 3 transactions similar to 2 to 4 above, starting with Mr. Wild transferring his remaining 96.3 PWR shares to 1245 for 1989 Class E shares of 1245 giving rise to a capital gain (as a result of a s. 85(1) elected amount greater than the shares’ ACB), for which he used the balance of his available capital gains exemption. The Class E shares had a nominal PUC under s. 84.1.
  6. PWR transferred land and depreciable property to 1245 under s. 85 in consideration for assumed debt and for 1826 Class C preferred shares of 1251, resulting in a bump to the PUC of Mr. Wild’s Class C preferred shares due to PUC averaging.
  7. 1245 redeemed the 1826 Class C preferred shares of PWR, and PWR purchased for cancellation 86 of the 93.6 Class A common shares held by 1245, in each case in consideration for a $1,827,500 promissory note, with the two notes then being set off.
  8. Mr. Wild transferred his 348.5 Class C preferred shares of 1251 (see 2) to 1245 under s. 85 to 1245 in consideration for Class E preferred shares
  9. 1251 redeemed those Class C preferred shares for a $348,500 promissory note.

The Minister applied GAAR to reduce the PUC of the Class E preferred shares (steps 5 and 8) to a nominal amount.

Before confirming this assessment, Lyons J first noted that it had essentially been conceded that the transactions resulting in a PUC bump to Mr. Wild’s shares (steps 3 and 6) were avoidance transactions, and then, turning to the abuse test under s. 245(4), found (at paras 85, 98, 100 and 104):

Combined, subsection 89(1) and section 84.1 deal with the computation of PUC involving the PUC grind where there is a non-arm’s length transfer of shares by an individual from one corporation to another. … Together, these prevent the extraction of corporate surplus tax-free in such circumstances and preclude the return of an amount of capital tax-free in excess of an investor’s original contribution….

[T]he appellants took deliberate steps…to defeat the application of section 84.1 and what it was intended to prevent by misusing [PUC averaging under] subsection 89(1)….

[T]he object, spirit and purpose of section 84.1 is clear. Individual taxpayers should not be allowed to use their capital gains exemption to strip corporate surpluses by entering into non-arm’s length transactions which are similar to those addressed in section 84.1 nor obtain excess PUC tax-free. …

[T]he…transactions…achieved a result (extraction of corporate surplus indirectly and use of his exemption) that section 84.1 was intended to prevent and defeats its underlying rationale and did so by misusing the PUC computation in subsection 89(1) to trigger the share averaging thus artificially inflated the PUC in The Shares held by Mr. Wild without any new capital contribution made by him.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 245 - Subsection 245(4) use of PUC-averaging rule to bump outside PUC was abusive 261
Tax Topics - Income Tax Act - Section 245 - Subsection 245(5) assessment of PUC without current income effect 32

Poulin v. The Queen, 2016 TCC 154, briefly aff’d sub nomine Turgeon v. The Queen, 2017 FCA 103

sale to employee's Holdco with not upside and no risk for employee was non-arm's length

CRA successfully applied s. 84.1 to a transaction in which one of the two major shareholders of a Quebec CCPC (Mr. Turgeon) agreed to sell some preferred shares of the CCPC to a newly formed Holdco of its controller (“Hélie Holdco”) in consideration for a promissory note bearing interest at 4% and which was to be repaid over a number of years out of dividends or redemption proceeds received by Hélie Holdco from the CCPC. D’Auray J noted that this employee had no risk, and Hélie Holdco had no upside as its only assets and liabilities were the prefs and the note, both with frozen values – so that Hélie Holdco essentially was just an accommodation party. She stated (at para. 101, TI translation):

Hélie Holdco served only to participate in the transaction for the benefit of Mr. Turgeon, thereby permitting him to strip the surplus of [the CCPC] free of tax by virtue of utilizing the capital gains deduction.

At the same time as Mr. Turgeon was arranging this “sale” to Hélie Holdco, he formed a new Holdco to purchase preferred shares of the other major shareholder. D’Auray J found this second transaction to be an arm’s length one (so that s. 84.1 did not apply) even though it occurred on quite similar terms (under advice from a common tax advisor) to the Hélie Holdco one, as they each were advancing their own interests (arranging an exit on advantageous terms, and acquiring control of the CCPC, respectively.)

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 251 - Subsection 251(1) - Paragraph 251(1)(c) sale to the special-purpose Holdco of an independent employee was essentially a surplus-stripping transaction rather than an arm’s length sale 605

Fiducie Famille Gauthier v. The Queen, 2011 DTC 1343 [at 1917], 2011 TCC 318, aff'd 2012 FCA 76

agreement to bear costs was additional consideration

The taxpayer, a family trust, made a non-arm's-length sale of shares to a numbered corporation for a promissory note of approximately $2.6 million. The numbered corporation then immediately sold the shares at arm's length to a third party ("Keolis") for approximately $2.8 million. The lower sale price on the first transfer reflected that it had been determined that 404 would bear the cost of professional fees, relating to the structuring of the sale to Keolis, of $233,786.

Archambault J. affirmed the Minister's position that the amount of these professional fees was "consideration" received by the taxpayer. That amount was therefore added to variable D in s. 84.1(1)(b), resulting in an increase in the dividend deemed to be received by the taxpayer. Archambault J. stated (at para. 16):

I accept the definition of consideration laid down in Currie and referred to by Judge Lamarre in Republic National Bank, above, and the definition in Black's Law Dictionary, according to which "consideration" can encompass "[t]he inducement to a contract... [s]ome right, interest, profit or benefit accruing to one party, or some forbearance, detriment, loss, or responsibility, given, suffered, or undertaken by the other." By agreeing to be billed for the fees related to the sale of the shares in the place of Fiducie, [the numbered corporation] was, in a sense, undertaking Fiducie's responsibility. A benefit therefore accrued to Fiducie.

Words and Phrases
consideration
Locations of other summaries Wordcount
Tax Topics - General Concepts - Substance 227

Estate of the late Donald Mills v. The Queen, 2010 DTC 1301 [at 4078], 2010 TCC 443, aff'd 2011 DTC 5124, 2011 FCA 219

no bad debt deduction

The taxpayer exchanged shares for a promissory note. Under s. 84.1(1)(b), the receipt of the promissory note resulted in a deemed dividend. The issuer of the note defaulted. Sheridan J. cited Terrador Investments (99 DTC 5358) for the proposition that, once the note was deemed to be a dividend paid to the taxpayer, it was no longer a "debt owing." Therefore, the default could not give rise to a bad debt deduction under s. 20(1)(p).

McMullen v. The Queen, 2007 DTC 286, 2007 TCC 16

arm's length: negotiation based on self-interest

The taxpayer and an unrelated individual ("DeBruyn") accomplished a split-up of the business of a corporation ("DEL") of which they were equal common shareholders by transactions under which (i) DeBruyn converted his (Class A) common shares into Class B common shares, (ii) the taxpayer sold his Class A common shares of DEL to a newly-incorporated holding company for DeBruyn's wife ("114") for a purchase price of $150,000, (iii) DEL issued a promissory note to 114 in satisfaction of a $150,000 dividend declared by it on the Class A shares, (iv) 114 as signed the promissory note to the taxpayer in satisfaction of the purchase price for the Class A shares, (v) the taxpayer transferred the promissory note owing to him by DEL to a holding company ("HHCI"), and HHCI purchased assets of the Kingston branch of the business of DEL in consideration for satisfaction of the promissory note.

In finding that the sale of the Class A shares of DEL by the taxpayer to 114 was a transaction between persons dealing with each other at arm's length, Lamarre J. noted (at pp. 292-293) that the actions of the taxpayer and the DeBruyns in negotiating the share sale transaction were governed by their respective perceptions of their own self interest, that "buyer and seller do not act in concert simply because the agreement which they seek to achieve can be expected to benefit both" and that "it cannot be concluded that parties have acted in concert simply because they have used the same financial advisors". Accordingly, s. 84.1 did not apply.

Lloyd v. The Queen, 2002 DTC 1493 (TCC)

Although the taxpayer signed an agreement with a holding company for the sale of shares in a company ("READ") to the holding company, Bowman T.C.J. found that the transaction was not completed, so that there was no disposition for purposes of s. 84.1. Among other things, none of the stipulated consideration was ever paid by the holding company and the directors of READ did not approve the transfer as required by the articles.

Locations of other summaries Wordcount
Tax Topics - General Concepts - Effective Date taxpayer can attack own transaction as legally ineffective 130
Tax Topics - General Concepts - Tax Avoidance taxapyer can argue legally ineffective transactions 131
Tax Topics - Income Tax Regulations - Schedules - Schedule II - Class 3 64

Administrative Policy

29 November 2016 CTF Roundtable Q. 6, 2016-0669661C6 - 84.1 and the Poulin/Turgeon Case

Poulin is consistent with CRA's previous statements on employee buycos

CRA largely repeated a statement made at the 2016 APFF Roundtable, Q.20 (also in response to the Poulin decision) respecting employee buyco arrangements, that the employee buyco could be established to be an accommodation party and, thus, not dealing at arm’s length with the employee-shareholder vendor, where, for example:

  • the employee-buyco assumes no economic risks;
  • the employee-buyco does not benefit from acquiring the Opco shares;
  • the employee-buyco has no interest other than to enable the employee-shareholder to realize a capital gain and benefit from the capital gains deduction; or
  • the employee-buyco has no role independent of the employee-shareholder or the operating corporation.

CRA went on to state that this position is consistent with its discussion at the 2012 Annual Conference.

7 October 2016 APFF Roundtable Q. 20, 2016-0655831C6 F - Employee Buycos and the Poulin Case

Poulin accepted

CRA accepts the finding in Poulin that the structuring of a sale transaction so that the vendor secured a tax advantage (the capital gains deduction) “does not mean that the parties acted in concert without separate interests.” Respecting the accommodation party aspect of that case, it stated:

Hélie Holdco… incurred no economic risk in participating in the transaction, did not derive any benefit from the purchase of shares, had no interest other than to allow the employee/shareholder to realize a capital gain and benefit from the deduction, and had no function independent of the employee/shareholder or the operating corporation - and, in short, it only participated in the transaction as an accommodation for the benefit of the employee/shareholder.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 251 - Subsection 251(1) - Paragraph 251(1)(c) Poulin distinction between accommodation parties and tax advantaged arm’s length dealings accepted 164

2 May 2016 External T.I. 2016-0633351E5 F - Descarries Case and Document no. 2015-0610711C6

purpose of 84.1 not restricted to monetization transactions

In rejecting a submission that 2015-0610711C6 had improperly reversed 2005-0134731R3 F on the basis that the purpose of section 84.1 is only “to prevent persons from monetizing their lifetime CGD outside the context of an actual sales transaction occurring on a market basis,” whereas 2015-0610711C6 “involved a taxpayer who, with a view to retiring, embarked on a process of business succession with a family member similar to one that could be undertaken with an arm's length third party…[so] that the purpose of section 84.1 was not circumvented.,” CRA indicated that the purpose of s. 84.1 was stated more broadly in the Explanatory Notes and in Descarries, and added:

[W]e understand your concerns about the application of section 84.1 in the context of an intergenerational transfer of a family business between a parent and children. Nevertheless, the mandate of the Canada Revenue Agency is to administer the Act as drafted… .

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 245 - Subsection 245(4) Descarries not to be construed narrowly 164

24 November 2015 CTF Roundtable Q. 11, 2015-0610711C6 - Impact of the Descarries decision

abuse of s. 84.1 to use basis stepped up under CGD to create a capital loss permitting surplus extraction

In 2005-0134731R3 F, Mr. X realized a capital gain of selling all of the common shares of HOLDCO to his children in consideration for promissory notes, but did not claim the capital gains deduction (“CGD”) under s. 110.6(2.1). On a redemption by HOLDCO of all of the HOLDCO preferred shares owned by Mr. X, which had nominal paid-up capital (“PUC”) and a high adjusted cost base (“ACB”) as a result of a previous crystallisation of the CGD, Mr. X realized a deemed dividend and a capital loss. A portion of the capital loss was applied to offset the capital gain that arose on the earlier sale of the HOLDCO common shares to the children.

Following the Descarries decision (2014 TCC 75) would CRA still issue such a ruling? CRA responded:

In Descarries…the individual shareholders of…OKA… exchanged their OKA shares for shares of another corporation (“NEWCO”), some of which (the “NEWCO V-day Shares”) had low PUC and a high ACB equal to the FMV of the OKA shares on V-Day (December 22, 1971). As a result, the V-Day value of the OKA shares became isolated/crystallized in the ACB of the NEWCO V-day Shares.

The NEWCO V-day Shares were repurchased, giving rise to a deemed dividend to the individual shareholders as well as a capital loss that was applied to offset a capital gain realized earlier in the same series of transactions. ...

The [2005-0134731R3] transactions result in the extraction of corporate surplus as capital gains. Furthermore, such capital gains are offset or reduced by capital losses realized on a disposition of shares whose ACB was increased by the CGD or V-day value.

In these circumstances and based on the Descarries decision, the CGD or the V-day value has been used to enable corporate surplus to be distributed to the shareholders tax-free, in a manner contrary to the object, spirit and purposes of section 84.1.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 245 - Subsection 245(4) contrary to GAAR to use basis stepped up under CGD to create a capital loss permitting surplus extraction 462

2014 Ruling 2014-0526361R3 F - Post Mortem Pipeline

step up of PUC of freeze pref shares for purposes of pipeline transaction

An estate of B, and a spousal trust for which B had been the spouse, which on death acquired (Class F) preference shares of a portfolio investment company (Investmentco) at a stepped-up tax cost, will effectively step-up the paid-up capital of their shareholdings by selling their its preference shares to a Newco for Newco preference shares with a high PUC. After a specified period, Newco will amalgamate with Investmentco, and the estate will start gradually retracting its (high PUC/basis) preference shares.

Ruling respecting non-application of s. 84.1 to the transfer of the preference shares.

See detailed summary under s. 84(2).

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 84 - Subsection 84(2) step up of PUC of freeze pref shares for purposes of pipeline transaction 271

25 November 2012 CTF Roundtable, 2013-0479402C6 - Employee Buycos - comments from CRA Panel

stock option Buyco not at arm's length

Employees of Opco received Opco shares as incentives under an Opco employee share ownership plan ("ESOP"). Under the terms of the ESOP, on retirement or other termination of employment, the employees would be required to dispose of these shares. To facilitate the disposition of such shares on retirement or other termination, Opco incorporates another corporation ("Buyco"), and Buyco purchase the departing employee's Opco shares. CRA stated:

[G]iven the degree of accommodation provided by Buyco to the departing employees and the parties' lack of separate interests, the better view is that the employees and Buyco are generally not dealing at arm's length. This view is consistent with several of our published documents (2007-0243171C6, 2002-0166655, and 2004-0103061E5) as well as the jurisprudence (Petro-Canada v. The Queen (2003 DTC 94) (confirmed by the Federal Court of Appeal (2004 DTC 6329)) and RMM Canadian Enterprises Inc. et al. v. The Queen (97 DTC 302)). Accordingly, in ruling requests on this type of transaction, considered in 2012, we refused to confirm that section 84.1 would not apply to deem employees to receive a dividend from a Buyco on the disposition of their Opco shares.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 251 - Subsection 251(1) - Paragraph 251(1)(c) stock option share Buyco not at arm's length 184

3 July 2012 External T.I. 2012-0443421E5 F - 84.1 and partnership

use of partnership to avoid s. 84.1 could be attacked through challenge to partnership validity or applying s. 245(1) re circumvention of s. 84.1

A and B are Canadian-resident spouses who have not utilized their capital gains exemption and who each hold 50 Class A shares (the only issued and outstanding shares) of their family farm corporation ("Milkco," a CCPC which has carried on a dairy farming business for 20 years) having an fair market value of $500,000 an adjusted cost base and paid-up capital of $50, and qualifying under s. 110.6(1) as shares of the capital stock of a family farm corporation. They also each hold a 1/2 "interest in a family farm partnership" as defined in s. 110.6(1), namely, in a general partnership (“Grainco”), which has operated a cereal growing farm for three years, with each such 1/2 interest having an ACB of $50.

A and B each roll their shares of Milkco into Grainco for additional partnership interests in Grainco.

Five years later, after the FMV of the interests in Grainco have appreciated to $1.5 million and such interests continue to qualify as interests in a family farm partnership, A (and then B several days later) transfers his or her partnership interest in Grainco to a newly-incorporated corporation (“Holdco,” or "Managementco") - in which each of A and B holds common shares with an ACB of $50) in consideration for a note receivable of $750,000 and claims the capital gains exemption. As Grainco now only has one partner (Holdco), it is dissolved by operation of law (with a view to the application of s. 98(5).)

In noting that s. 245(2) could apply on the basis of an abusive avoidance of s. 84.1, CRA stated:

With respect to the potential application of section 84.1 to the transactions described above, we are of the view that this provision could be applicable, in particular, where, for example, the legal existence of the partnership is not recognized or the partnership acts as agent or nominee for the ownership of shares of the capital stock of a corporation. Thus, if the legal existence of Grainco could be called into question or if the latter acted as an agent of A and B, section 84.1 could apply to the disposition of the shares of the capital stock of Milkco to Holdco. …

[A]s noted in the Explanatory Notes of the Department of Finance, section 84.1 is “an anti-avoidance rule designed to prevent the removal of taxable corporate surplus as a tax-free return of capital through a non-arm’s length transfer of shares by an individual resident in Canada to a corporation.” A scheme that allows an individual to strip a private corporation of its surpluses through a reorganization that would result in indirect holding of its shares through a partnership appears to circumvent the application of section 84.1. …

[A]llowing a taxpayer, other than a corporation, to carry out a reorganization allowing a change in ownership of the shares of a private corporation by transferring them to a partnership in order to subsequently dispose of the partnership's interest to another corporation with which the taxpayer does not deal at arm's length could be a stratagem to strip the surplus of a corporation and circumvent section 84.1.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 245 - Subsection 245(4) s. 245(2) has been applied to the use of a partnership to avoid s. 84.1 498

7 October 2011 Roundtable, 2011-0412121C6 F - Interaction between S. 84.1 and S. 85(2.1)

s. 84.1 can "apply" and thereby prevail over s. 85(2.1) even where there is no s. 84.1 grind

Where shares with a high PUC and low ACB are transferred by an individual under s. 85(1) to Holdco for shares with the same high-low attributes, s. 84.1(1) takes precedence over s. 85(2.1), so that a "grind" of paid-up capital will not occur under the s. 85(2.1) formula given the satisfaction of all the conditions for the application of s. 84.1(1), even though the grind under s. 84.1(1)(a) is nil (i.e., s. 84.1 is still considered to "apply" in that circumstance).

Words and Phrases
apply
Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 85 - Subsection 85(2.1) s. 85(2.1) does not apply where s. 84.1(1) applies even if there is no grind under the s. 84.1(1)(a) formula 160

5 October 2007 APFF Roundtable Q. 10, 2007-0243171C6 F - Surplus Stripping

treatment of Employeeco purchase depends on whether it has a separate economic interest
Scenario (a)

Mr. X, who holds all of Opco, exchanges all of his Opco common shares for retractable preferred shares of Opco. Mr. X then subscribes to 65% of the common shares of Opco, and a newly-incorporated corporation held by key employees (“Employeeco”) subscribes to 35% of the common shares of Opco. Mr. X disposes of 35% of his preferred shares to Employeeco, with Employeeco paying the purchase price by retracting the preferred shares so acquired by it.

Scenario (b)

Employeeco uses funds borrowed from a financial institution to acquire the 35% of the Opco common shares held by Mr. X, with the loan being repaid out of dividends paid out of future profits.

Scenario (c)

Same as (b) except that the purchase price is owing by Employeeco to Mr. X until paid off out of OPco dividends.

Scenario (a)

CRA indicated that (similarly to 2014 APFF Roundtable, Q. 2.4) it did not appear that Employeeco had a separate economic interest in acquiring the Opco preferred shares held by Mr. X, other than to accommodate Mr. X, and that the funds required for this acquisition would invariably come from Opco, which was and would continue to be controlled by Mr. X. Accordingly, it was “very likely that Mr. X and Employeeco would not, factually, be dealing at arm's length in respect of Mr. X's disposition of the Opco preferred shares” so that a dividend would be deemed to be paid by Employeeco to Mr. X under s. 84.1(1)(b). As a secondary position, CRA would consider applying s. 245(2) on a surplus-stripping rationale.

Scenarios (b) and (c)

CRA stated that “nothing would lead us to believe, at first glance, that Mr. X and Employeeco would not be dealing with each other at arm's length’ given that “Employeeco seems to have a separate economic interest in acquiring 35% of the common shares of the capital stock of Opco from Mr. X and such transaction does not seem to have been effected to accommodate Mr. X” so that’s. 84.1(1) would probably not apply. A review of s. 245(2) would require more facts.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 251 - Subsection 251(1) - Paragraph 251(1)(c) leveraged Employeeco buyout could be an arm’s length transaction 125

12 January 2005 External T.I. 2004-010616 -

Under transactions in which Mr. A sells a portion of his shares of a family farm corporation ("Farmco") to a newly incorporated subsidiary ("Xco") of an unrelated individual (Mr. X) for a cash consideration of $500,000 which Mr. A then lends to Farmco, with Farmco using the loan proceeds to redeem the Farmco shares held by Xco, would be considered to be non-arm's length transactions that were subject to s. 84.1(1)(b). Such transactions also could be subject to s. 245(2).

9 January 2004 External T.I. 2003-0037425 - Application of Section 84.1

A farming partnership between a husband and wife transfers its business to a newly-incorporated corporation ("Opco") whose common shares are held by the husband and wife and which issued promissory notes and preferred shares in consideration for the acquired business. Later, the husband and wife transfer their partnership interests in the partnership to a Newco for consideration that includes a note with a principal amount that is in excess of the adjusted cost base of the transferred partnership interest by $500,000 each, and receives redeemable retractable preferred shares for the balance of the consideration.

Respecting whether s. 84.1 would apply to the transfer of the partnership interests, the Agency questioned the validity of the partnership following the transfer of its business to Opco and also indicated that the application of s. 245 to the series of transactions would be considered.

28 March 2003 External T.I. 2002-016665 -

84.1 may apply to partial buyout by Holdco for independent employees

Mr. and Mrs. A, and Mr. and Mrs. B, hold 26%, 12%, 26% and 12%, respectively of the common shares of a small business corporation (“OPc”) and two unrelated individuals (X and Y) each hold 12% of the Opco shares. X and Y incorporate “Xyco,” roll their Opco shares into Xyco and Xyco uses a bank borrowing to fund the purchase of the Opco shaes of Mrs. A and Mrs. B. If Xyco and Opco do not amalgamate, Xyco will service its debt through dividends on its Opco shares.

In indicating that s. 84.1 may apply, CRA stated:

While there may be arm's length bargaining concerning the price to be paid for the shares of Opco, the shareholders appear to be acting in a highly interdependent manner to avoid tax on the transactions. In our view, Xyco may be viewed as merely accommodating the shareholders by structuring the transactions in this manner, since it does not appear to have any independent interest in acquiring the shares of Opco.

4 November 1998 T.I. 980169

A partnership that transfers shares will be considered to be a person and a taxpayer for purposes of s. 84.1.

23 December 1993 External T.I. 5-932688 -

RC's practice is to apply s. 84.1 where the conditions for its application are present given that its provisions do not give RC any administrative discretion in its application. Accordingly, s. 84.1 will apply where a son of the taxpayer incorporated a holding company which purchased the taxpayer's shares for a promissory note payable over a ten-year period even when it is clear that the purchase price was equal to the fair market value of the shares and the purchased corporation had minimal retained earnings.

1993 A.P.F.F. Round Table Q. 4

It is not relevant to the application of s. 84.1 whether the subject corporation and the purchaser corporation were connected before the disposition in question; i.e., there is no requirement that they become connected.

29 January 1990 T.I. (June 1990 Access Letter, ¶1264)

The sale by Mr. and Mrs. A of all the shares of Holdco to a corporation owned by their daughter and son-in-law in consideration for a promissory note bearing a commercial rate of interest gives rise to a deemed dividend under s. 84.1(1)(b) equal to the amount by which the principal amount of the promissory note exceeds the greater of the paid-up capital of the shares of Holdco and their adjusted cost base.

18 December 1989 T.I. (May 1990 Access Letter, ¶1220)

An estate which acquires shares of a deceased person under a testamentary trust acquires the shares from a person with whom it was not dealing at arm's length.

October 1989 Revenue Canada Round Table - Q.11 (Jan. 90 Access Letter, ¶1075)

s. 84.1 will not apply where an individual taxpayer exchanges common shares of a corporation for preferred shares of the same corporation - because the shares will not be disposed of to another corporation.

18 Aug. 89 T.I. (Jan. 90 Access Letter, ¶1082)

s. 84.1 does not apply to the disposition by an individual of 1/2 of his common shares of Opco to Opco in exchange for preference shares of Opco because the common shares of Opco would not thereby be disposed of to another corporation.

Articles

Anthony Strawson, Timothy P. Kirby, "Vendor Planning for Private Corporations: Select Issues", 2017 Conference Report, (Canadian Tax Foundation), 11:1-28

Use of holding companies to create CDA and s. 84.1, to defer tax on a sale by individual shareholders (pp. 11:19-20)

  • Opco is a CCPC.
  • Opco has an individual shareholder owning 100 class A common shares with an FMV of $10 million and an ACB of $100.
  • The purchaser is willing to pay the full purchase price for Opco shares in cash on closing.

The shareholder incorporates a holding corporation (Newco) and transfers 50 percent [fn 52: The optimal percentage of shares to roll to Newco may be slightly more or less than 50 percent, but 50 percent is used here for simplicity.] of his or her class A common shares with an FMV of $5 million to Newco on a rollover basis. Newco then exchanges its 50 class A common shares for 50 class B common shares (non-voting) on a taxable basis pursuant to subsection 85(1) by electing at an FMV of $5 million. As a result of this transaction, ignoring the nominal ACB, Newco realizes a capital gain in the amount of $5 million and a taxable capital gain of $2.5 million. This results in an increase to Newco’s CDA balance of $2.5 million and an increase to Newco’s RDTOH account of $766,666.67….

The shareholder then sells, in two equal tranches, his or her remaining shares to Newco in exchange for a shareholder loan in the amount of $5 million. [fn 53: To elect for a dividend to be a capital dividend and a dividend to be a taxable dividend, the sale to Newco must occur in two separate tranches so that two separate deemed dividends arise.] Because the requirements of section 84.1 are met on this transfer, Newco is deemed to have paid two dividends to the shareholder of $5 million in aggregate (again ignoring the nominal ACB). Newco then elects for the first dividend to be a capital dividend from Newco’s CDA and the second dividend to be a taxable dividend that is intended to recover Newco’s existing RDTOH balance….

Newco then sells its high ACB shares of Opco to the purchaser with no additional capital gain or loss being realized. The benefit of the application of section 84.1 is that it allows a shareholder to potentially recover the CDA and RDTOH balance through the application of section 84.1, while also increasing the intercorporate cost base of the shares sold to the purchaser.

GAAR analysis of use of s. 84.1 (p. 11:24)

[O]n initial consideration, reliance on a specific anti-avoidance rule to obtain a beneficial tax deferral seems to fall within the scope of abusive tax avoidance because “the outcome defeats the rationale of the provision relied upon.” [ Lipson, 2009 SCC 1, at para. 40]

Nonetheless, the apparent abuse is tempered by the fact that, potentially, marginally greater tax will be payable on the ultimate distribution from Newco than would otherwise be payable if the deferred proceeds are distributed as dividends. Furthermore, the Act contains many provisions that are intended to facilitate tax deferrals, particularly when funds continue to be retained in corporate solution….

David Wilkenfeld, "Section 84.2 Update", Tax for The Owner-Manager, Vol. 2, No. 1, January 2002.

Paragraph 84.1(1)(b)

Administrative Policy

11 October 2019 APFF Roundtable, Q.1

s. 84.1 dividend can generate dividend refund

In 2002-0128955, CRA indicated that a deemed dividend under s. 84.1(1)(b) would not generate a dividend refund (DR). CRA has now stated:

[W]e have come to the conclusion that the position described in the Interpretation no longer represents the position of the CRA. In particular, according a DR to a corporation deemed to have paid a dividend by virtue of paragraph 84.1(1)(b) provides in our view a result that is more compatible with the integration principle enshrined in the Income Tax Act.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 129 - Subsection 129(1) reversal of position that s. 84.1(1)(b) dividends do not generate dividend refunds 132

25 November 2012 Roundtable, 2013-0479401C6 F - Employés et Achat Ltée – commentaires panel ARC

generally a deemed dividend on repurchase of departing employees’ shares by employer-funded Buyco

In order to facilitate the disposition of shares of departing employees who had purchased their shares under an employee share ownership plan, Opco forms and injects funds into a new company (Buyco), which uses those funds to purchase the employee’s Opco shares. In finding that there generally would be a resulting deemed dividend under s. 84.1, CRA stated:

Given the nature of the arrangements offered to resigning employees by Buyco and the absence of separate interests of the participating parties, it is logical to consider that employees and Buyco are generally not dealing at arm's length. … As a result, for advance ruling requests considered in 2012, we refused to confirm that resigning employees would not be deemed, under section 84.1, to have received a dividend from Buyco on the disposition of their Opco shares.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 251 - Subsection 251(1) - Paragraph 251(1)(c) Buyco that is formed by employer to purchases departing employees’ shares is NAL 108

5 October 2012 APFF Roundtable, 2012-0454091C6 F - GRIP and deemed dividend pursuant to 84.1(1)(b)

unnecessary in s. 89(14) for s. 84.1 to have deemed dividend to be paid on shares

Mr and Mrs X hold all the shares of Corporation A and B, respectively (both private corporations). Mr X sells all his shares of Corporation A to Corporation B in consideration for a promissory note, resulting in his receipt of a deemed dividend under s. 84.1(1)(b) that is less than the GRIP of B. In finding that this dividend can be designated under s. 89(14) as an eligible dividend notwithstanding that Mr X does not hold any shares of B, CRA stated (in its summary, with very similar comments in the French body):

Subsection 89(14) and the definition of "eligible dividend" in subsection 89(1) do not refer to dividends paid (or received, as the case may be) "to a shareholder of any class of shares of its capital stock" as provided in subsection 83(2) nor to a dividend paid "on shares of its capital stock" as provided in subsection 129(1). The wording used in the "eligible dividend" provisions is different. Therefore, to be an "eligible dividend" as defined in subsection 89(1) and pursuant to the designation provided for in subsection 89(14), the individual does not have to be a shareholder of any class of shares of the capital stock of the corporation and the deemed dividend paid or received pursuant to paragraph 84.1(1)(b) does not have to be paid by the corporation on shares of its capital stock.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 89 - Subsection 89(14) s. 84.1 deemed dividend paid to an individual could be an eligible dividend notwithstanding him not being a shareholder of the payer 247

Subsection 84.1(2) - Idem [Non-arm’s length sale of shares]

See Also

Emory v. The Queen, 2010 DTC 1074 [at 2901], 2010 TCC 71

The taxpayer and another individual ("Chen") owned 27% and 73%, respectively of the shares (being common shares) of a corporation ("Sona"). S. 84.1(1) deemed the taxpayer to receive a dividend when she and Chen transferred their shares of Sona to a corporation ("Ontario Inc.") that was mostly owned by Chen but in which she held 5% of the common shares and for consideration that in her case was paid in cash. This result occurred because the taxpayer was deemed by s. 84.1(2)(b) not to deal at arm's length with Ontario Inc. Woods J. stated (at para. 41) "the fact that the appellant owned a small number of shares in Ontario Inc. has unfortunately resulted in the application of this section."

Administrative Policy

25 July 1994 T.I. 940786

Where a transferor has acquired a subject share from a non-arm's length individual, the amount of any capital gain realized by the non-arm's length individual on the disposition, which is exempt from taxation in Canada by virtue of an exemption contained in a treaty between Canada and another country, will not normally be a capital gain included in s. 84.1(2)(a.1)(ii).

13 April 1994 External T.I. 5-940501 -

An individual owns all the voting shares of a corporation ("Opco") and shares (including non-voting special shares) of Opco representing approximately 65% of the equity of Opco. A group of 20 arm's length employees own the balance of the non-voting special shares.

Ss.84.1(2)(b) and (e) would apply to deem the employees not to deal at arm's length with a new holding company ("Holdco") to which all the shareholders of Opco transferred their shares in exchange for shareholdings in Holdco which mirrored their shareholdings in Opco notwithstanding that, in fact, only the one individual controlled Opco and Holdco.

30 November 1991 Round Table (4M0462), Q. 10.1 - Non-Arm's Length Relationship and Death (C.T.O. September 1994)

Shares acquired by a taxpayer from his deceased spouse are acquired from a person with whom the taxpayer is not dealing at arm's length and are, therefore, subject to the reduction in adjusted cost base under s. 84.1(2)(a.1).

Paragraph 84.1(2)(a.1)

See Also

Pomerleau c. La Reine, 2016 TCC 228, aff'd 2018 FCA 129

GAAR applied to converting soft ACB (generated from crystallizing the capital gains deduction) into pseudo-hard ACB under s. 53(1)(f.2) for use in extracting surplus

The family Opco was held by a holding company (Groupe Pomerlau Inc.), whose Class F shares were held by the taxpayer, his mother and his three siblings. Their Class F shares had a nominal paid-up capital (“PUC”) and an adjusted cost (“ACB”) that had been stepped up in 1989 through a share exchange transaction which had utilized the capital gains deduction. The following transactions were then implemented.

  1. The taxpayer’s mother gifted a portion of her Class F shares to the taxpayer, which he was deemed under s. 69(1)(c) to acquire at a cost equal to their fair market value (“FMV”) of $0.2 million.
  2. The taxpayer and his sister Gaby then transferred all their Class F shares of Groupe Pomerlau Inc. under s. 85(1) to a holding company of the taxpayer (P Pom Inc.) in consideration for Class G shares with a deemed cost equal to their FMV (of $0.6 million, in the taxpayer’s case) but with a modest PUC, and for Class A shares with nominal ACB and PUC.
  3. Gaby then gifted the Class G shares so received by her (with an FMV of $0.4 million) to the taxpayer (without gain realization) as well as $1 million of Class A shares (thereby realizing a capital gain in that amount).
  4. The taxpayer then retracted all $1 million of his Class G shares of P Pom Inc, thereby realizing a deemed dividend and capital loss of $0.995 million - but with that capital loss being denied under s. 40(3.6) and added to the ACB of his Class A shares of P Pom Inc. under s. 53(1)(f.2).
  5. The taxpayer then transferred all of his Class A shares of P Pom Inc. under s. 85(1) to a new personal holding company (Gestion Pierre Pomerlau Inc.) in consideration for Class A shares having an FMV of $20.4 million and nominal ACB and PUC, and Class C shares with a PUC and FMV of $1.994 million, with the Class C shares immediately being retracted by him.

After noting (at para. 56) that the rollover transfer in 5 above of the taxpayer’s Class A shares to Gestion Pierre Pomerlau Inc. did not result in a reduction of the PUC of the Class C shares received by him, given that the prohibition in s. 84.1(2)(a) and (a.1) from using “soft ACB” did not apply to this transaction, Favreau J went on to agree with the Minister’s position that this transaction’s avoidance of s. 84.1 was abusive (so that a deemed dividend was appropriately assessed under s. 245(2)), stating (at paras. 80, 81, 83, 85, TaxInterpretations translation):

When the taxpayer proceeded with the redemption of the 1,010,328 Class G shares of P Pom Inc., they had a paid-up capital of $15,700 and an adjusted cost base corresponding to their fair market value, namely, $1,010,328. The adjusted cost base of those shares was wholly derived from capital gains deductions claimed by the taxpayer, his mother and his sister under section 110.6 of the Act in their crystallization transaction… .

One of the consequences of this redemption was to generate to the appellant a capital loss of $994,628, which was transferred by the operation of subsection 40(3.6) of the Act to the adjusted cost base of the Class A shares which he held in P Pom Inc. That accomplished, the appellant claims to have thereby transformed that which had been “soft” adjusted cost base into “hard” adjusted cost base not caught by the adjusted cost base reduction provisions of subsection 84.1(2) of the Act. …

This series of transactions permitted the appellant, on the redemption of the Class G shares of Gestion Pierre Pomerlau Inc., to extract as a tax-free return of capital, $994,628 derived from the surplus of his corporation by virtue of utilizing his capital gains deduction and that of his mother and sister. …

But for already having isolated the so-called “soft” adjusted cost base in the Class G shares of P Pom Inc. in order to generate a capital loss from their redemption, with a resulting increase in the adjusted cost base of the Class A shares of P Pom Inc., it would not have been possible to avoid the tax consequences arising under section 84.1 of the Act.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 245 - Subsection 245(4) abusive avoidance of s. 84.1 by converting soft into hard ACB 245

Côté-Létourneau v. The Queen, 2010 DTC 1116 [at 3092], 2007 TCC 91

The Court rejected a submission of the taxpayers that shares issued to them by a corporation were not acquired by them: an Order for them to acquire shares, there is no need for there to be a corresponding disposition of the shares.

Words and Phrases
acquisition

Administrative Policy

2017 Ruling 2016-0629511R3 - Post-Mortem Planning and Extraction of "Hard ACB"

pipeline transfer of inherited shares for their "hard" ACB (excluding CGD and V-Day step-up by deceased)

CRA ruled on a pipeline involving Opco shares inherited by an individual whose ACB consisted of both “soft” ACB (attributable to V-Day value basis of the deceased and the deceased’s use of the capital gains deduction immediately before death) and “hard” ACB (attributable to the further step-up in the shares’ ACB under s. 70(5).) The proposed transactions entailed the s. 85(1) transfer by him to a Newco of his Opco shares for notes in an amount close to the transferred shares’ hard ACB and preferred shares as to the balance – followed by an amalgamation (or wind-up) of the Opcos over a year later and gradual repayment of the notes on a redacted timetable.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 84 - Subsection 84(2) pipeline transfers of shares with both “soft” and “hard” ACB 625

9 October 2015 APFF Roundtable Q. 14, 2015-0595631C6 F - Indirect Monetization of CGD

individual cannot effectively use the ACB of shares previously stepped-up using the capital gains deduction to create a loss to offset a gain on the sale of common shares

Following Descarries, CRA will no longer issue rulings in which an individual can in effect use shares (e.g., preferred shares) whose ACB was stepped up using the capital gains deduction ("CGD") (by redeeming those shares to create a deemed dividend and a capital loss) to offset or reduce a capital gain on a disposition of his or her common shares. CRA articulates the common thread between Descarries and such a now-GAARable transaction as follows:

Such transactions effectively accomplish a distribution of surplus of a corporation in the form of a capital gain even while such capital gain is reduced by a capital loss sustained from the disposition of shares whose ACB arose from the CGD or from the FMV of such shares on V-Day.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 245 - Subsection 245(4) Descarries not consistent with use of ACB on a previous capital gains crystallizatin to create a capital loss for use on a sale 155

9 October 2015 APFF Roundtable Q. 7, 2015-0595561C6 F - Computation of adjusted cost base and section 84.1

terminal-return capital gains exemption claimed on bequested shares grinds their ACB for s. 84.1 purposes to the family beneficiaries

The capital gains deduction was claimed in the terminal return of an individual (X) for shares which were bequeathed to his son, and the son then transferred these shares to his holding company. The principal issue, respecting whether s. 84.1(2)(a.1)(ii) applied to grind the ACB of his shares (by the amount of this claim) for purposes of the application of s. 84.1 to the share transfer to the holding company, turned on this question: was a deduction under s. 110.6 claimed respecting a previous disposition of the shares by an individual with whom the son did not deal at arm’s length?

In responding affirmatively, CRA stated that "the relation between the parties is to be evaluated at the moment giving rise to the application of section 110.6." Since the disposition giving rise to the capital gain for which the deduction was claimed was deemed by s. 70(5)(a) to have occurred immediately before X’s death (when X obviously was not dealing at arm’s length with his son), the s. 110.6(2.1) claim ground the shares’ ACB for s. 84.1 purposes.

10 August 2015 External T.I. 2015-0602751E5 - Capital gains deduction and section 84.1

statement of purpose and simple examples of s. 84.1 application

The taxpayer and his wife acquire all the shares, qualifying as qualified small business corporation shares, of a corporation (the "Corporation") directly from XX (the "Shareholder") in consideration for a promissory note having a principal amount equal to the fair market value of the acquired shares. They then transfer the shares to their newly-incorporated holding company ("Holdco") and use the funds of Holdco and the Corporation to repay the promissory note. CRA stated:

Section 84.1 of the Act is designed to ensure that a distribution of the retained earnings of the Corporation to you and your wife after the sale that would be taxed as a dividend if it had been paid directly to you remains taxed as a dividend after the transfer of the shares of the Corporation to Holdco (the conditions of application of section 84.1 would seem to be met because you and your wife would not deal at arm's length with Holdco and both Holdco and the Corporation would be connected for purposes of that provision).

…[B]ecause you and your wife would acquire the shares from the Shareholder (i.e. a person with whom you are not dealing at arm's length), subparagraph 84.1(2)(a.1)(ii) of the Act provides that the adjusted cost base, to you and your wife, of the Corporation shares would be reduced by the amount of capital gains deduction claimed under section 110.6… by the Shareholder.

… If instead of selling the shares to you and your wife, the Shareholder had sold the shares of the Corporation to Holdco and received a note, subsection 84.1(1)(b) of the Act might apply to deem the Shareholder to have received a dividend on the disposition of the shares.

Finance

2017 CTF Finance Roundtable, Q.9

Finance is struggling with whether it is possible to provide relief for intergenerational transfers of businesses without generating quite substantial losses of tax revenues.

2017 CTF Finance Roundtable, Q.8

There will not be a complete carve-out for pipeline transactions. It is difficult to see how the current results obtained using pipelines do not invoke the same policy concerns that other non-arm’s length transfers do – for example, the inter vivos 84.1 transfers that are more explicitly covered in the changes to s. 84.1(2)(a.1).

However, Finance is considering some form of relief to avoid the double taxation (once on the deceased, and twice on the estate) that could arise, especially where a death occurred before July 18, 2017.

Articles

Joint Committee, "Part D of Tax Planning Using Private Corporations – “Converting Income into Capital Gains” Proposals", 2 October 2017 Joint Committee Submission

Effect of expanded rule on post-mortem transfers (pp. 8-14)

The expanded s. 84.1 rule produces a greater impediment to the transfer of family businesses from one member to another, whether from one generation to another or between siblings (and during lifetime or post‐mortem), with the result that the tax system would favour third‐party sales. For instance, in Example 1 below, the daughter will have a disincentive to retain her common shares of Opco since substantial additional tax will be realized if the preferred shares bequeathed to her are redeemed rather than included in a third-party sale:

Example 1

On death, Mrs. X owned preferred shares in an Opco having a nominal PUC and ACB which she acquired on an estate freeze, with her daughter, who is active in the business, holding the common shares. Under proposed s. 84.1, neither the estate nor daughter is permitted to employ “pipeline” planning to avoid double tax on death, because for purposes of s. 84.1 the ACB to the estate or her will be reduced by the capital gain deemed to be realized by Mrs. X on death. It is possible that the estate could avoid the double tax if the preferred shares are redeemed within one year of death and an s. 164(6) election is made to carry back the capital loss to offset the capital gain realized on death. However, this planning may not be practical:

  • It may not be possible to redeem the shares within the estate’s first taxation year, for example, because of required cooperation of other shareholders or insufficient liquid assets.
  • The estate might be a graduated rate estate.
  • Under draft s. 120.4(4), all or a portion of the capital gain arising on the deemed disposition of shares on death might be recharacterized as a taxable dividend and considered to be “split income.”
  • Various stop loss rules like s. 40(3.6) also may limit the use of a loss carryback, for example, potentially as a result of the estate realizing other capital gains in its first taxation year, or where shares were previously left to a spousal trust or are held in an alter‐ego or joint partner trust.

Effect of expanded rule on inter vivos transfers (pp. 15-17)

Examples 3 (not summarized) and 4 (below) demonstrate the typical situation whereby (i) the current rules somewhat favour a sale of a corporate business to an arm’s length third party rather than to family members, and (ii) the proposed rules would make this tax incentive significantly larger.

Example 4

Bob sells the shares of Opco (having a FMV of $6 million and nominal PUC and ACB) directly to his children, and receives a $6 million promissory note as consideration. The value of Opco mostly is attributable to goodwill. The children subsequently transfer the Opco shares into a new holding company and repay the promissory note to Bob over time using cash flow and the debt capacity of Opco.

Under proposed section 84.1, if the children transfer the Opco shares into a holding company, the children’s ACB for s. 84.1 purposes would be reduced from $6,000,000 to nil because of the capital gain realized by Bob, a non‐arm’s length party. As a result, they would be deemed to receive a taxable dividend on the $6,000,000 ultimately paid to them to fund payments under the promissory note, and pay significantly more tax than on a sale by Bob of Opco directly to a third party.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 246.1 490

Subparagraph 84.1(2)(a.1)(ii)

Cases

Pomerleau v. Canada, 2018 FCA 129

GAAR applied to converting soft ACB (generated from crystallizing the capital gains deduction) into pseudo-hard ACB under s. 53(1)(f.2) for use in extracting surplus

An individual taxpayer engaged in transactions to extract surplus from a family holding corporation (Groupe Pomerleau Inc.) to the extent that the ACB of his shares and some shares of his sister had previously been stepped-up utilizing the capital gains deduction. Ignoring the significant complicating effect of the transactions with his sister, he transferred his shares under s. 85(1) to a new holdco (“P Pom”) in consideration for Class G shares of P Pom (with a nominal paid-up capital and a deemed cost equaling the “soft” ACB of the transferred shares, and for Class A common shares of P Pom with a nominal PUC and ACB. P Pom then redeemed the Class G shares, resulting in the deemed realization of a dividend and a capital loss equaling most of the amount of the redemption proceeds. Such capital loss was denied under s. 40(3.6) and added to the ACB of his common shares of the corporation under s. 53(1)(f.2). This s. 53(1)(f.2) bump was not caught by s. 84.1(2), so that he could transfer the bumped common shares to a personal holding company (“Holdco”), taking back high PUC shares of Holdco, which he promptly redeemed. In the result, he extracted $2M from the corporate group, of which approximately half corresponded to the deemed dividend received by him, and the other half, corresponding to the “soft” ACB of the shares was received free of tax – even though the PUC and “hard” ACB of the shares was nominal. For a more detailed summary of the facts, see the TCC summary.

The Minister’s assessment of a deemed dividend under s. 245(2) effectively treated the ACB of the shares that were transferred to Holdco as not having been stepped-up under s. 52(1)(f.2). In confirming the decision below to uphold this assessment, Noël CJ stated (at paras. 65, 77, 79 TaxInterpretations translation):

The logic underlying this adjustment [in s. 84.1] rests on the fact, discussed above, that the paid-up capital and the ACB of the shares concerned reflect only the amounts which have been subjected to tax. …

The object and spirit of this provision, or its rationale, is to prevent amounts which have not been subjected to tax to serve in extracting surplus of a corporation free of tax. Subsection 84.1(2) proceeds with this goal in targeting amounts which, while forming part of the ACB of the shares concerned, have not been subjected to tax and have been excluded in the computation of the paid-up capital of new shares. To this end, subparagraph 84.1(2)(a.1)(ii) requires going beyond the ACB of the shares concerned – or of the shares for which they are substituted – and enquiring as to the source of the funds which constituted them in order to ascertain if they were subjected to tax. …

This rationale was circumvented by the plan implemented by the appellant. Of the amount of $1,993,812 that he withdrew, $994,628 represented amounts as to which no income tax had been paid.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 245 - Subsection 245(4) purpose of s. 84.1 was broader than the application of its words 469

Subsection 84.1(2.1)

Administrative Policy

29 May 2018 STEP Roundtable Q. 17, 2018-0744141C6 - S.84.1 and Capital Gains Reserve

the claiming of a capital gains reserve on a s. 84.1 transfer can result in a s 84.1 deemed dividend on a subsequent transfer

S. 84.1(2.1) indicates that for purposes of the adjusted cost base reduction under s. 84.1(2)(a.1)(ii)) respecting a non-arm’s length transfer of shares by a resident individual to a corporation, where a capital gains reserve is claimed under s. 40(1)(a)(iii) by the individual or a non-arm's length individual (herein referred to as the "transferor") and it is possible for the transferor to claim the capital gains exemption (“CGE”), the CGE is deemed to be claimed by the transferor in the maximum amount irrespective of whether it is in fact claimed. Could the application of s. 84.1(2.1) result in a transferor (e.g., a father transferring to his children’s corporation) being deemed to have claimed CGE in the maximum amount where the transferor claims a capital gains reserve under s. 40(1)(a)(iii) but has no intention of claiming the CGE even though there is unused CGE room available?

For example, Father transfers shares of Opco (a small business corporation whose shares are eligible for the CGE) to his children in consideration for a note that is payable over 10 years, claims the capital gains reserve, but does not claim the CGE. The children transfer the Opco shares to a new Holdco in consideration for a note of Holdco, with a view to Opco dividends funding note repayments.

CRA indicated that it is irrelevant to the application of s. 84.1(2.1) that the transferor may have room that he wishes to retain for future use. S. 84.1(2.1) does not look to such plans for using the capital gains exemption, and effectively deems all the available room to be used. In the example, the children are deemed to receive a dividend on their receipt of the Holdco note.

CRA provided three examples illustrating the interrelationship between the s. 84.1(2) ACB adjustment, the amount of CGE actually claimed and the amount of unutilized CGE at the end of the year of the transfer.

Example 1

The non-arm’s length transferor realized a $100,000 capital gain, claimed a $50,000 reserve and claimed a $25,000 CGE while still having $25,000 unclaimed CGE at the year end. Result: the transferor is deemed to have claimed a CGE re the entire $100,000 capital gain.

Example 2

Same as example 1, except that the transferor had no unclaimed CGE at the year end – resulting in the CGE deemed to have been claimed only re $50,000 of the capital gains.

Example 3

Same as Example 1, except that the transferor had $10,000 of unclaimed CGE at the year end – resulting in the CGE deemed to have been claimed only re $70,000 of the capital gains.

28 April 2016 External T.I. 2015-0594461E5 - Subsection 84.1(2.1)

intention to not claim exemption on future recognition of reserve is irrelevant

Does the phrase “the amount in respect of which a deduction under section 110.6 was claimed in respect of the transferor’s gain from the disposition shall be deemed to be” deem a transferor to have claimed a capital gains exemption where a capital gains reserve is taken in respect of the disposition of shares to which section 84.1 applies, even where the transferor does not claim or intend to claim in the future any capital gains exemption in respect of the disposition?

CRA responded:

Subsection 84.1(2.1)…essentially treats the transferor as having claimed, to the extent that the transferor has unused capital gains exemption room in the year in which the disposition took place, a capital gains deduction on the disposition, irrespective of whether such exemption was actually claimed, because the reserve could potentially be eligible for a capital gains exemption when brought into income in the future. … [T]he effect…is to treat a capital gain on a property to be sheltered by the capital gains exemption when there is unused capital gains exemption room in the year of the disposition regardless of whether such capital gains exemption room has been saved to cover a capital gain that could be realized on a disposition of other properties in a subsequent year.