Principal Issues: 1) Whether an amended 85(1) election must be filed to correct the agreed amount in a situation where paragraph 85(1)(c.1) is applicable. 2) Whether an individual can amend a subsection 110.6(19) election in 2005.
Position: 1) No. 2) No.
Reasons: Wording of the Act and previous positions. 1) Paragraph 85(1)(c.1) automatically adjusts the agreed amount of the transferred property and consequently, the taxpayers do not have to file an amended 85(1) election. 2) The deadline specified in subsection 110.6(27) to file an amended election has passed. Furthermore, section 600 of the Regulations, which contains the prescribed provisions for the purposes of subsection 220(3.2) of the Act, does not make any reference to elections under subsection 110.6(19) of the Act.
XXXXXXXXXX 2005-012219
S. Prud'Homme
(613) 957-8975
July 7, 2005Dear Sir,
Subject: Request for Technical Interpretation - Incorrect Tax Elections for Prescribed Tax Years
This is in response to your letter of June 16, 2004 to the Tax Technical Interpretation Department of the Montreal Tax Services Office requesting our response. In that letter, you requested our opinion regarding the application of various provisions of the Income Tax Act (the "Act") in a particular situation involving, inter alia, erroneous tax elections relating to statute-barred taxation years of a particular taxpayer.
Unless otherwise indicated, any reference to a statute of law or one of its provisions in this document is a reference to a section of the Act or any of its provisions.
It appears to us that the situation described in your letter and summarized below may be an actual situation involving taxpayers. As explained in Information Circular 70-6R5, it is not the practice of this Directorate to provide comments on proposed transactions involving specific taxpayers otherwise than through an advance income tax ruling. However, we are able to offer the following general comments that may be helpful. It should be noted that the application of one or more provisions of the Act generally requires an analysis of all the facts relating to a particular situation. Accordingly, and given that your letter only briefly describes a hypothetical situation, the comments we provide below may not be fully applicable in a particular situation.
You have presented us with the situation described below (the "Particular Situation") as part of your request for a technical interpretation. The Particular Situation is said to be composed of several transactions that were allegedly carried out in previous years. You have briefly described each of those transactions to us and asked various questions in that regard. For each of those transactions, we have reproduced below their description and your questions relating to them, and we have provided comments.
1) First transaction: tax-free transfer of shares under subsection 85(1)
Description of the first transaction
In XXXXXXXXXX, an individual ("X") held all of the issued and outstanding shares of the capital stock of a particular holding company ("Aco"). Specifically, X held XXXXXXXXXX common shares of the capital stock of Aco. X had subscribed for those common shares for a nominal amount in cash.
X also held all of the issued and outstanding shares of the capital stock of a particular operating company ("Bco"). Specifically, X held XXXXXXXXXX common shares of the capital stock of Bco. X had acquired a portion of those common shares by way of subscription. The other portion of those common shares were acquired from persons dealing at arm's length with X. In XXXXXXXXXX, the XXXXXXXXXX common shares in the capital stock of Bco held by X had a fair market value ("FMV") of $XXXXXXXXXX, an adjusted cost base ("ACB") of $XXXXXXXXXX and a paid-up capital ("PUC") of approximately $XXXXXXXXXX.
We understand that the shares in the capital stock of Aco and Bco held by X were, at all relevant times, capital property to X.
At all relevant times, X was a person resident in Canada for the purposes of the Act. In addition, at all relevant times, each of Aco and Bco was a "taxable Canadian corporation" as defined in subsection 89(1).
In XXXXXXXXXX, X disposed of all of the shares in the capital stock of Bco that X held to Aco. In return, Aco issued a note with a principal amount and FMV of $XXXXXXXXXX, as well as XXXXXXXXXX common shares of its capital stock with an FMV of $XXXXXXXXXX and a nominal PUC.
X and Aco made the subsection 85(1) election in prescribed form and within the time limit set out in subsection 85(6) in respect of the shares of the capital stock of Bco transferred. The amount agreed to by X and Aco in respect of those shares was $XXXXXXXXXX. That amount was determined by the parties because they believed it to be the ACB of the transferred Bco shares. As it turned out, the $XXXXXXXXXX was the PUC of those shares, not their ACB to X (the latter being $XXXXXXXXXX as noted above).
We understand that for purposes of subsection 84.1(1), the ACB of the common shares in the capital stock of Bco to X immediately before the disposition was $XXXXXXXXXX and was not subject to any adjustment pursuant to subsection 84.1(2).
Questions relating to the first transaction
You asked us whether the agreed amount made by X and Aco in respect of the shares of the capital stock of Bco transferred in XXXXXXXXXX can be corrected and whether an amended form or election (T2057) should be filed in that regard.
Our comments on the first transaction
Paragraph 85(1)(c.1) provides that where the property transferred is capital property and the amount agreed on by the taxpayer and the corporation in their election in respect of the property is less than the lesser of the FMV of the property at the time of the disposition and the cost amount of the property to the taxpayer at the time of the disposition, the amount so agreed on by the taxpayer and the corporation is deemed to be the lesser of the amount so agreed on and the cost amount.
In the first transaction in respect of the Particular Situation, the amount agreed to by X and Aco in their election in respect of the common shares of the capital stock of Bco ($XXXXXXXXXX) was less than the lesser of the FMV of the shares of the capital stock of Bco at the time of disposition ($XXXXXXXXXX) and the cost amount of those shares, to X, at the time of disposition ($XXXXXXXXXX). Consequently, pursuant to paragraph 85(1)(c.1), the amount agreed to by X and Aco was deemed to be $XXXXXXXXXX. Note that the application of paragraph 85(1)(c.1) results in an automatic adjustment to the agreed amount in respect of the transferred property and, as a result, the affected taxpayers do not have to file an amended election in that regard.
Under paragraph 85(1)(a), the agreed amount in respect of the shares in the capital stock of Bco, adjusted pursuant to paragraph 85(1)(c.1) to an amount of $XXXXXXXXXX, was deemed to be, to X, the proceeds of disposition of those shares and to Aco, the cost of those shares.
Furthermore, pursuant to paragraph 85(1)(f), the cost to X of the note issued by Aco was deemed to be $XXXXXXXXXX.
Finally, under paragraph 85(1)(h), the cost to X of the common shares of the capital stock of Aco received as consideration for the disposition of the shares of the capital stock of Bco was deemed to be the amount by which the proceeds of disposition ($XXXXXXXXXX) exceeded the FMV of the note issued by Aco ($XXXXXXXXXX), i.e. $XXXXXXXXXX.
2) Second transaction: election pursuant to subsection 110.6(19)
Description of the second transaction
At the beginning of the XXXXXXXXXX year, X made the election pursuant to subsection 110.6(19), in prescribed form and within the time limit set out in subsection 110.6(24), in respect of the shares of the capital stock of Aco that he held at that time. That was done in order to crystallize some of the unrealized capital gain inhering in those shares on XXXXXXXXXX and thereby utilize the "$100,000 capital gains deduction" that was about to be eliminated. The amount reported by X in respect of those shares was $XXXXXXXXXX. That amount was determined because X believed that the ACB to him of the Aco shares he held at the time was $XXXXXXXXXX.
Questions relating to the second transaction
You are of the view that, at the time X made the subsection 110.6(19) election in respect of the shares of the capital stock of Aco, the ACB to X of those shares was $XXXXXXXXXX (i.e., $XXXXXXXXXX as determined above for the purposes of Part 1), and $XXXXXXXXXX resulting from X's subscription for XXXXXXXXXX common shares of the capital stock of Aco for $XXXXXXXXXX in cash.
You asked whether it is possible to amend this election for specifying the designated amount in respect of the shares of the capital stock of Aco for purposes of subsection 110.6(19) at $XXXXXXXXXX.
Our comments on the second transaction
Subject to subsection 110.6(28), subsection 110.6(27) allowed an election made under subsection 110.6(19) in respect of a property to be deemed to be amended. One of the conditions for the application of subsection 110.6(27), however, is that a prescribed form in respect of the amended election in respect of the property be filed with the Minister before 1998.
Furthermore, under subsection 220(3.2), the Minister may, inter alia, grant permission for an election to be amended where the taxpayer has made a valid election pursuant to a prescribed provision of the Act. However, an election made under subsection 110.6(19) in respect of property is not a prescribed election under section 600 of the Income Tax Regulations.
In view of the above, we are of the view that it would not be possible for X to change X's subsection 110.6(19) election in respect of the shares of the capital stock of Aco.
Consequently, based on our understanding of the facts and pursuant to subparagraph 110.6(19)(a)(i), the shares of the capital stock of Aco held by X would have been deemed to have been disposed of by X at the end of XXXXXXXXXX for proceeds of disposition equal to the amount designated for those shares, i.e., $XXXXXXXXXX. On the other hand, under subparagraph 110.6(19)(a)(ii), those shares of the capital stock of Aco would have been deemed to have been reacquired by X immediately after that time at a cost equal to the amount designated in the election form, i.e., $XXXXXXXXXX. The ACB to X of the XXXXXXXXXX common shares of the capital stock of Aco would therefore have been $XXXXXXXXXX.
3) Third transaction: crystallization of the balance of the capital gains deduction
Description of the third transaction
In XXXXXXXXXX, X and Aco entered into a transaction for the purpose of crystallizing a portion of X's subsection 110.6(2.1) capital gains deduction. Specifically, X disposed of XXXXXXXXXX common shares of the capital stock of Aco to Aco. In exchange, Aco issued XXXXXXXXXX preferred shares of its capital stock. The redemption value of those preferred shares was equal to the total FMV of the XXXXXXXXXX common shares of Aco's capital stock transferred, or $XXXXXXXXXX. We understand that the PUC of the preferred shares was nominal.
X and Aco made the subsection 85(1) election in prescribed form and within the time limit set out in subsection 85(6) in respect of the XXXXXXXXXX common shares of the capital stock of Aco transferred. The amount agreed to by X and Aco in respect of those shares was XXXXXXXXXX. Given that the ACB to X of the XXXXXXXXXX common shares of the capital stock of Aco immediately before their transfer was determined to be $XXXXXXXXXX ($XXXXXXXXXX x XXXXXXXXXX shares/XXXXXXXXXX shares), X realized a capital gain of $XXXXXXXXXX ($XXXXXXXXXX - $XXXXXXXXXX) and a taxable capital gain of $XXXXXXXXXX (XXXXXXXXXX x 3/4) as a result of the transfer of those shares, in respect of which a capital gains deduction pursuant to subsection 110.6(2.1) was claimed.
X and Aco carried out a transaction identical to the one described above in XXXXXXXXXX.
Finally, X and Aco carried out a third transaction similar to those described above in XXXXXXXXXX, the only difference being that the amount agreed by X and Aco in respect of the XXXXXXXXXX common shares of the share capital then transferred was $XXXXXXXXXX.
Questions relating to the third translation
You asked whether the ACB to X of the common shares in the capital stock of Aco, immediately before they are transferred to Aco, can be adjusted to take into account the change that X wishes to make to the subsection 110.6(19) election in respect of the common shares in the capital stock of Aco discussed above in Part 2.
Our comments on the third transaction
It should first be noted that we have assumed that the common shares in the capital stock of Aco would, at all relevant times, have been "qualified small business corporation shares" within the meaning of section 110.6(1).
As noted in Part 2 above, we are of the view that it would not be possible for X to change X’s subsection 110.6(19) election in respect of the shares of the capital stock of Aco. Consequently, and in particular pursuant to subparagraph 110.6(19)(a)(ii), the ACB to X of the XXXXXXXXXX common shares of the capital stock of Aco held at the beginning of year XXXXXXXXXX was $XXXXXXXXXX.
Based on the foregoing and our understanding of the facts, the ACB to X of the XXXXXXXXXX common shares of Aco retained by X was $XXXXXXXXXX ($XXXXXXXXXX x XXXXXXXXXX shares / XXXXXXXXXX shares). In addition, pursuant to paragraph 85(1)(g), the total cost to X of the preferred shares of the capital stock of Aco received as consideration for the disposition of the common shares of the capital stock of Aco was deemed to be the total proceeds of disposition, i.e., $XXXXXXXXXX ((2 x $XXXXXXXXXX) + $XXXXXXXXXX). Of course, to the extent that X was effecting a sale of shares of the capital stock of Aco to which subsection 84.1(1) applied, X's ACB of those shares for purposes of section 84.1 would be required to be reduced by the amount in respect of which a deduction had been claimed pursuant to section 110.6.
In conclusion, and due to the fact that your letter does not contain several essential pieces of information, it is not possible for us to comment on other tax implications that may result from the Particular Situation.
We apologize for the delay in responding to your request. We hope that our comments will be of assistance.
Stéphane Prud'Homme, Notary, M. Fisc.
For the Director
Corporate Reorganizations and Resource Industries Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
c.c. Marc Lemyre
Tax Technical Interpretation Service
Montreal Tax Services