Principal Issues: Whether subsection 74.4(2) applies in a particular situation.
Position: No.
Reasons: According to the Law and previous positions.
XXXXXXXXXX 2011-041041 J. Lafrenière (613) 941-2956
September 19, 2011
Subject: Request for Technical Interpretation - Subsection 74.4(2)
Dear Madam,
This is in response to your email of June 14, 2011, in which you asked us for clarification regarding the application of subsection 74.4(2) of the Income Tax Act (the "Act") in the context of a particular situation.
Unless otherwise indicated, any reference in this letter to a statutory provision is a reference to a provision of the Act.
It appears to us that the situation described in your letter and hereinafter summarized could constitute a real situation involving taxpayers. As stated in Information Circular 70-6R5, 2002, it is not the practice of the Directorate to issue a written opinion regarding proposed transactions otherwise than through advance income tax rulings. If your situation involved specific taxpayers and one or more transactions, you should submit all relevant facts and documents to the appropriate Tax Services Office for their opinion. However, we can offer the following general comments that may be helpful to you. It should be noted that the application of one or more provisions of the Act generally requires the analysis of all facts relating to a particular situation. Accordingly, and in light of the fact that your letter only very briefly describes a hypothetical particular situation, our comments below may not be fully applicable in a particular situation.
1) The Particular Situation
You have presented the situation described below ("Present Situation") as part of your request for technical interpretation:
(a) All of the common shares of the capital stock of a corporation ("Opco") were held by 5 shareholders. XXXXXXXXXX We have assumed for the purposes hereof that the shareholders were resident in Canada at all relevant times and that there were no other classes of shares of the issued and outstanding capital stock of Opco.
(b) Some time later, the shareholders of Opco proceeded to the incorporation of a new corporation ("Holdco").
(c) Each of the Opco shareholders transferred to Holdco, on a rollover basis under subsection 85(1), their common shares of the capital stock of Opco. As consideration, Holdco issued to each shareholder rollover preferred shares of its capital stock.
(d) After a few years, each of the Holdco shareholders proceeded with a freeze of its common shares of the capital stock of Holdco on the occasion of the withdrawal of certain shareholders. Subsequently, each shareholder who continued to be involved in Holdco's business ("Active Shareholder") subscribed for new common shares of the capital stock of Holdco for nominal consideration.
(e) Two years later, each of the Holdco Active Shareholders proceeded with a new freeze of its common shares of the capital stock of Holdco to a family trust. Each active Holdco shareholder proceeded with the creation of a family trust, of which the shareholder’s spouse and minor children were the beneficiaries. At that time, Holdco could be considered a "small business corporation" ("SBC") as that term is defined in subsection 248(1), its only asset being shares of the capital stock of Opco, also a SBC.
We understand that the beneficiaries of the income and capital of each trust were the spouse and minor children of the Active Shareholder who proceeded with a freeze of their common shares of the capital stock of Holdco. Those beneficiaries were therefore, at all relevant times, "designated persons" within the meaning of that expression in subsection 74.5(5) with respect to that Active Shareholder. We also understand that at all material times each of the beneficiaries of each trust was a "specified shareholder" as defined in subsection 248(1), as amended by subsection 74.4(2).
Finally, we have assumed that the conditions in subsection 74.4(4) were not satisfied with respect to each trust in the Particular Situation. As a result, subsection 74.4(4), in and of itself, did not make subsection 74.4(2) inapplicable in the circumstances.
(f) Several years later, Holdco's Active Shareholders set up a corporate asset protection structure and introduced certain key employees into the shareholding structure. The stages of the corporate reorganization were as follows:
(i) creation of a new family trust by each Active Shareholder involved in Holdco's business, whose spouse and minor children were the beneficiaries;
(ii) creation of a new corporation ("Group Opco") for the protection of Opco's assets;
(iii) creation of a new corporation ("Opco 2") for Opco's day-to-day operations;
(iv) Opco subscribed for common shares of the capital stock of Group Opco for a nominal amount (initial subscription);
(v) Group Opco subscribed for common shares of the capital stock of Opco 2 for a nominal amount (initial subscription);
(vi) Opco transferred all of its assets (excluding excess cash and investments) to Group Opco, on a rollover basis under subsection 85(1). As consideration, Opco assumed the liabilities of Opco and issued to Opco a promissory note and preferred rollover shares of its capital stock (i.e. non-voting, dividend-paying, redeemable, non-voting shares for an amount equal to the value of the consideration received on the issue of those shares). The property transferred by Opco was all of its business property, including its capital property and eligible capital property;
(vii) Group Opco transferred to Opco 2, on a subsection 85(1) rollover basis, its accounts receivable, inventory and goodwill. As consideration, Opco 2 assumed the accounts payable of Group Opco and issued to the Group Opco a note and common shares of its capital stock;
(viii) The newly created family trusts and certain key employees subscribed for common shares of the capital stock of Group Opco for a nominal amount;
(ix) Group Opco purchased for cancellation the common shares of its capital stock held by Opco for an amount equal to the subscription price for the latter;
(x) Holdco and Opco amalgamate;
(xi) each family trust shareholder of Holdco was wound-up and its assets (i.e. common shares of the capital stock of Holdco) were distributed to a holding corporation controlled by the Active Shareholder who had proceeded with a freeze of their interest in Holdco in favour of a family trust, as described in step e) above.
We have assumed that, with respect to each trust, the holding corporation controlled by the Active Shareholder was a beneficiary of that trust.
2) Your questions respecting to the Particular Situation
You are asking whether subsection 74.4(2) applies with respect to the Particular Situation, considering that Group Opco and Opco 2 may not qualify as SBCs and that each newly created trust in subsection (f)(i) above shall have among its beneficiaries, at all relevant times, "designated persons" as defined in subsection 74.5(5) in respect of a particular Active Shareholder. In that regard, you referred to advance ruling number 9831863 in which our Directorate ruled that subsection 74.4(2) does not apply where a corporation transfers property to another corporation even if it is reasonable to consider that one of the main purposes of the transfer is to benefit a designated person.
Also, if we determine that subsection 74.4(2) is applicable to the Particular Situation, you have inquired as to which shares interest would be calculated, as provided in that subsection, given that the only shares held personally by the Active Shareholders are the shares of their personal holding corporation.
3) Our comments respecting the Particular Situation
Briefly, subsection 74.4(2) may apply to a transfer or loan of property, where one of the main purposes of the transfer or loan may reasonably be considered to be to reduce the income of the individual and to benefit, either directly or indirectly, by means of a trust or by any other means whatever, a person who is a designated person in respect of the individual. Subsection 74.5(5) defines the term "designated person", which includes, inter alia, in respect of an individual who transfers or lends the property, the spouse of the individual and a child under 18 years of age.
Furthermore, the question of whether it is reasonable to consider that one of the main purposes of the transfer of a property is to reduce the income of the individual and to benefit, either directly or indirectly, a designated person is a question of fact that must to be resolved in the light of all the circumstances and particularities of each case.
Subsection 74.4(2) may apply in a transfer or loan of property by an individual to a corporation. Subsection 74.4(2) should not apply where a corporation, rather than an individual, transfers or lends property to a corporation, unless it can be demonstrated that an individual has, indirectly, by way of a trust or otherwise, transferred or loaned property to the corporation or that subsection 74.5(6) applies.
In the Particular Situation, it appears, prima facie, that the transactions described in subsection (f)(vi) above would not result in the application of subsection 74.4(2), even at a time when Group Opco and Opco 2 would no longer qualify as an SBC.
We emphasize that this opinion is not an advance ruling and does not bind the CRA with respect to a particular factual situation.
We hope that these comments are of assistance.
Best regards,
Maurice Bisson, CGA
Manager
Corporate Reorganizations and
Resource Industry Section
Corporate Reorganizations and
Resource Industry Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch