Principal Issues: Following CRA's answer to question 6.3 of the 2005 APFF Federal Round Table, precisions as to whether, in order for a departing shareholder to avoid the application of GAAR, Opco must be merged with Subco after this latter corporation acquires the shares of the capital-stock of Opco from the departing shareholder.
Position: No.
Reasons: Wording of the Act and previous positions.
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2010-037061
J. Lafrenière
(613) 941-2956
July 7, 2010
Subject: Request for technical interpretation - Question 6.3 of the APFF Federal Round Table 2005
Dear Sir,
This is in response to your letter dated June 9, 2010, in which you requested clarification of our response to the above-noted question regarding the application of sections 84.1 and 245 of the Income Tax Act (the "Act") in the context of a particular situation.
Unless otherwise stated, all references to a statutory section or included provision in this letter are to a section of the Act or one of its provisions.
1) Question 6.3 of the 2005 APFF Federal Roundtable
For the sake of clarity, we have reproduced the question in its entirety, as well as the answer we provided:
Sections 84.1 and 245 of the ITA
Mr. X owns 20% of the issued and outstanding shares of the capital stock of OPCO, a taxable Canadian corporation. Mr. X is not related to the other OPCO shareholders, or to OPCO itself. Following a dispute between Mr. X and the other OPCO shareholders, Mr. X wishes to sell his OPCO shares for $200,000, payable in cash, in order to avoid legal proceedings. OPCO has sufficient cash on hand to pay this amount.
OPCO incorporates a subsidiary ("Subco") and subscribes for shares of Subco for $200,000 in cash. Subco buys the OPCO shares held by Mr. X for $200,000 cash.
Would the CRA apply section 84.1 of the ITA to the sale of the OPCO shares to Subco? What about section 245 of the ITA, given the comments made by the Tax Court of Canada in the Brouillette decision?
CRA Response
First, we feel that it must be determined whether the transactions described in this situation (hereinafter "the Given Situation") are legally effective and in accordance with the applicable corporate law. In this regard, we must, among other things, determine whether applicable corporate law prohibits Subco from acquiring or holding OPCO shares. For the purposes of this question, we will assume that the transactions described above would be legally effective.
We are also assuming, for the purposes of this question, that Subco was not, from a legal standpoint, acting as OPCO's agent with respect to the purchase of the OPCO shares. If such were the case, subsection 84(3) of the ITA would then apply.
We are also assuming that cash or near cash would not form a significant portion of OPCO's assets. We are also assuming that OPCO's business(es) would continue to be carried on by OPCO at all relevant times. Finally, we understand that Mr. X would dispose of his OPCO shares for consideration equal to the fair market value of such shares at the time of disposition and that OPCO would be a "private corporation" as defined in subsection 89(1) of the ITA.
It must also be noted that the wording of this question only provides a brief description of a given hypothetical situation. In the absence of a review of all the facts and circumstances surrounding a given situation, it appears impossible to definitively rule on the potential application of section 84.1 and subsection 245(2) of the ITA in the Given Situation. We can, however, make the following general comments.
Pursuant to paragraph 251(1)(c) of the ITA, it is a question of fact whether, at a particular time, unrelated persons deal with each other at arm's length. However, based on the limited information in this question, nothing would lead us to believe, at first glance, that Mr. X and Subco were not dealing at arm's length with respect to the disposition of the OPCO shares. Based on this, subsection 84.1(1) would probably not apply to the Given Situation.
With regard to subsection 245(2) of the ITA, and assuming that after the acquisition of the shares, Subco would be merged with OPCO by way of an amalgamation or winding-up, we note that the Given Situation would be similar to the example given in paragraph 4 of Supplement 1 of Information Circular IC 88-2. The CRA's position is generally not to apply subsection 245(2) in situations similar or identical to the example given in paragraph 4 of Supplement 1 of Information Circular IC 88-2. However, if Subco were not merged with OPCO following the acquisition of the shares, other elements may have to be considered in order to determine whether subsection 245(2) would apply to the Given Situation.
In closing, we would like to note that application of section 84.1, subsection 84(3) and/or subsection 245(2) of the ITA requires a review of all the facts and circumstances surrounding a specific situation. In this regard, where the taxpayers intend to carry out transactions to which one of these provisions may apply, we recommend that they obtain an advance income tax ruling beforehand.
2) Issue Raised
You queried the reasons for the “requirement” of the Canada Revenue Agency ("CRA") to amalgamate the two corporations. In this regard, you have provided us with two examples where such a "requirement" would, in your view, make it impossible to use this technique. As well, you would like to know our position on a situation where the shares of the capital stock of the corporation acquired by the subsidiary were redeemed or purchased for cancellation immediately after the transaction with the employee rather than proceeding with the amalgamation or winding-up of the corporations.
3) Our Comments on this File
To begin with, we wish to clarify that, in general, the amalgamation of the two corporations is not, in and of itself, a "requirement" of the CRA in the context of a plan similar to the Given Situation.
Specifically, for the purposes of subsection 245(2), whether or not corporations are merged does not necessarily put at risk planning similar to the Given Situation, which is primarily intended to allow a selling shareholder to be taxable on a capital gain rather than a dividend.
Furthermore, we stated in response to Question 6.3 of the APFF 2005 Federal Roundtable that the CRA's position is generally not to apply subsection 245(2) in situations similar or identical to the example given in paragraph 4 of Supplement 1 of Information Circular IC 88-2.
However, in the event that the two corporations were not merged, we had stated that other elements may have to be considered in order to determine whether subsection 245(2) would apply to the Given Situation. The latter statement, although within the scope of the Given Situation, was rather aimed at situations that could involve taxpayers who, for example, would be tempted to use tax base created between Opco and Subco in an abusive manner.
Furthermore, in light of the above comments, whether or not the shares of the capital stock of the corporation acquired by the subsidiary are redeemed should generally not change the tax treatment of the selling shareholder in a situation similar to that described in the statement in Question 6.3 of the APFF 2005 Federal Roundtable.
In closing, we would like to reiterate the statement in the last paragraph of our response to Question 6.3 of the APFF's 2005 Federal Roundtable that the interpretation and application of section 245 requires a review of all the facts and circumstances surrounding a specific situation. In this regard, where the taxpayers intend to carry out transactions to which one of these provisions may apply, we recommend that they obtain an advance income tax ruling before proceeding with such transactions.
We hope that our comments are of assistance.
Best regards,
Stéphane Prud'Homme, Notary, M. Fisc.
for the Director
Corporate Reorganizations and Resource Industry Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch.