Principal Issues: Whether 245(2) would apply to a transaction where a corporation transfers property to another corporation and receives shares of the capital stock of the transferee corporation, thereby increasing the paid-up capital of the shares held by individuals?
Position: General comments provided.
Reasons: The CRA is presently reviewing files including similar transactions to determine whether 245(2) would apply as a general rule in these types of transactions.
FEDERAL TAX ROUNDTABLE
APFF CONFERENCE 2010
Question 21
Paid-up capital
Opco is a Canadian-controlled private corporation for the purposes of the Income Tax Act (the "Act"). It operates a seniors' residence and owns real estate used in its business and investments.
The shares of Opco are held in equal parts by X, Y and Z (the "Taxpayers") and qualify as qualified small business corporation shares for purposes of the Act.
The business carried on by Opco involves various business risks. For the sole purpose of shielding certain of Opco's assets from the commercial risks relating to its business, the Taxpayers have agreed to the following transactions:
- the creation of a new corporation ("Propertyco") and the subscription for shares of the latter by the Taxpayers;
- the transfer by the Taxpayers of shares of the capital stock of Opco to Propertyco. In consideration for that transfer, Propertyco issues Class F Shares to the Taxpayers;
- the repurchase by Opco of the shares of its capital stock held by Propertyco;
- the subscription for shares in the capital stock of Propertyco by Opco;
- the transfer of real estate held by Opco to Propertyco. In consideration for that transfer, Propertyco issues Class F shares to Opco;
- the transfer of investments held by Opco to Propertyco. In consideration for that transfer, Propertyco issues Class F shares to Opco;
- the repurchase of the shares of the capital stock of Propertyco held by Opco.
As a result of the issuance of Class F Shares in the capital stock of Propertyco to Opco in consideration for the transfers of the properties and investments, the paid-up capital for tax purposes of the issued and outstanding Class F Shares held by the Taxpayers increases by a total amount of one hundred thousand dollars ($100,000).
Do the provisions of section 245 apply to the transactions detailed above, or to any of them, so as to justify a reduction in the paid-up capital of the Class F shares of Opco held by the Taxpayers?
CRA Response
Subsection 245(2) provides that, where a transaction is an avoidance transaction, the tax consequences to a person shall be determined as is reasonable in the circumstances in order to deny a tax benefit that would result from that transaction or from a series of transactions that includes that transaction.
The term "tax benefit" is defined as a reduction, avoidance or deferral of tax or other amount payable or an increase in a refund of tax or other amount under the Act.
In a case such as the one presented above, the tax benefit could be the increase in the paid-up capital of the shares held by individuals, which would reduce the deemed dividends resulting from any eventual repurchase of the shares. That is the conclusion reached by the CRA in some cases it has previously reviewed.
Furthermore, an avoidance transaction is a single transaction carried out primarily for the purpose of obtaining a tax benefit. Where a transaction, which is primarily motivated by tax objectives, is part of a series of transactions that is primarily carried out for non-tax purposes, the single transaction is nevertheless an avoidance transaction. The fact that the series of transactions has bona fide non-tax purposes does not preclude a transaction with a tax purpose that is part of the series from being an avoidance transaction. In addition, as stated by the Supreme Court of Canada in The Queen v. Trustco Canada Mortgages, 2005 DTC 5547, " [i]f there are both tax and non-tax purposes to a transaction, it must be determined whether it was reasonable to conclude that the non-tax purpose was primary."
Consequently, even if the facts were to show that the principal purpose of the series of transactions is to reduce business risk, it would be necessary to examine the principal purpose of each transaction in the series of transactions or events. The CRA has determined in the past that some of the transactions in circumstances similar to those described above have as their principal purpose the obtaining of a tax benefit such as the creation of paid-up capital and the increase (or transfer) of that paid-up capital or a portion thereof to individuals. The corporation that sustained a corresponding decrease in paid-up capital was not at a disadvantage because subsection 112(1) generally allowed it to deduct an amount equal to its additional dividends.
The CRA is concerned about these types of transactions involving the creation and transfer of paid-up capital to individuals. The CRA has already concluded in some of these types of cases that avoidance transactions are caught by subsection 245(4) and that the general anti-avoidance rule applies. The CRA is currently reviewing additional cases that are similar in their results but have some variations. As a result of this review, it is possible that the CRA may apply subsection 245(2) generally to these types of situations where there is an avoidance transaction or transactions.
Sylvie Labarre
(613) 946-5357
October 8, 2010
2010-037322