Principal Issues: Whether a gain on CCPC shares sold to a corporation owned 100% by the taxpayer's brother-in-law would qualify for the capital gains deduction under section 110.6 of the Act.
Position: Question of fact as it depends on the application of section 84.1 and the share and/or non-share consideration received.
Reasons: In general, section 84.1 will apply where an individual transfers shares of a corporation resident in Canada to another corporation with which the individual does not deal at arm's length.
XXXXXXXXXX 2010-038265 T. Posadovsky, CMA
October 20, 2010
Dear XXXXXXXXXX :
Re: Capital Gains Deduction
We are writing in reply to your undated correspondence received on October 4, 2010, concerning the capital gains deduction. You explained that you and your brother-in-law own equal shares of a Canadian-controlled private corporation ("Opco"). You wish to know whether a gain on the sale of your shares to another corporation ("Holdco") owned 100% by your brother-in-law would be eligible for the capital gains deduction under section 110.6 of the Income Tax Act (the "Act").
The fact situation described in your letter appears to relate to a proposed transaction. Confirmation of the income tax consequences of proposed transactions involving specific taxpayers will only be provided in response to a request for an advance income tax ruling. To make such a request the advance income tax ruling must be submitted in accordance with the guidelines set out in Information Circular 70-6R5 dated May 17, 2002. If the situation relates to a completed transaction, a request for the Canada Revenue Agency's views must be made to your local tax services office. Notwithstanding, we are prepared to offer the following general comments.
Our Comments
Capital gains arising from the disposition of certain properties, including "qualified small business corporation shares", as defined in subsection 110.6(1) of the Act, may be eligible for the capital gains deduction. However, in certain non-arm's length dispositions of shares, section 84.1 of the Act could result in either a deemed dividend or a reduction to the paid up capital of any share consideration received.
Section 84.1 may apply where an individual disposes of shares of a corporation resident in Canada ("subject corporation") to another corporation ("purchaser corporation") with which the individual does not deal at arm's length, and immediately after the disposition, the subject corporation would be connected with the purchaser corporation. Either one or both of the following tax consequences may result:
- Where shares in the purchaser corporation are received as proceeds there may be a reduction to the paid up capital ("PUC grind") of those shares.
- Where non-share consideration is received as proceeds, such as cash or a promissory note, the individual may be deemed to have received a dividend.
A PUC grind of the shares issued by the purchaser corporation will preserve the potential for deemed dividends on the redemption of those shares that was inherent in the disposed shares. Alternately, a deemed dividend under section 84.1 would be taxable immediately and could also have an impact on the determination of the proceeds of disposition of the shares of the subject corporation and the resulting capital gain. This is because for capital gains purposes, an amount deemed to be a dividend under section 84.1 is excluded from the proceeds of disposition by virtue of paragraph (k) of the definition "proceeds of disposition" in section 54 of the Act.
Based on the limited information provided, it is our view that section 84.1 would likely apply to the disposition of your Opco shares to Holdco because you are not dealing at arm's length. Whether or not you could make use of the capital gains deduction under section 110.6 of the Act on the disposition of your Opco shares to Holdco is a question of fact, as it would depend on whether or not the Opco shares are "qualified small business shares" and the consequences of the application of section 84.1.
For further information and comments in respect of a non-arm's length sale of shares to a corporation, please refer to Interpretation Bulletins IT489R - Non-Arm's Length Sale of Shares to a Corporation and IT-419R2 - Meaning of Arm's Length, both of which are available on our website at www.cra-arc.gc.ca.
We hope this information is of assistance to you.
Yours truly,
Randy Hewlett
Manager
for Director
Ontario Corporate Tax Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch