S. 84.1(2.1) indicates that for purposes of the adjusted cost base reduction under s. 84.1(2)(a.1)(ii)) respecting a non-arm’s length transfer of shares by a resident individual to a corporation, where a capital gains reserve is claimed under s. 40(1)(a)(iii) by the individual or a non-arm's length individual (herein referred to as the "transferor") and it is possible for the transferor to claim the capital gains exemption (“CGE”), the CGE is deemed to be claimed by the transferor in the maximum amount irrespective of whether it is in fact claimed. Could the application of s. 84.1(2.1) result in a transferor (e.g., a father transferring to his children’s corporation) being deemed to have claimed CGE in the maximum amount where the transferor claims a capital gains reserve under s. 40(1)(a)(iii) but has no intention of claiming the CGE even though there is unused CGE room available?
For example, Father transfers shares of Opco (a small business corporation whose shares are eligible for the CGE) to his children in consideration for a note that is payable over 10 years, claims the capital gains reserve, but does not claim the CGE. The children transfer the Opco shares to a new Holdco in consideration for a note of Holdco, with a view to Opco dividends funding note repayments.
CRA indicated that it is irrelevant to the application of s. 84.1(2.1) that the transferor may have room that he wishes to retain for future use. S. 84.1(2.1) does not look to such plans for using the capital gains exemption, and effectively deems all the available room to be used. In the example, the children are deemed to receive a dividend on their receipt of the Holdco note.
CRA provided three examples illustrating the interrelationship between the s. 84.1(2) ACB adjustment, the amount of CGE actually claimed and the amount of unutilized CGE at the end of the year of the transfer.
Example 1
The non-arm’s length transferor realized a $100,000 capital gain, claimed a $50,000 reserve and claimed a $25,000 CGE while still having $25,000 unclaimed CGE at the year end. Result: the transferor is deemed to have claimed a CGE re the entire $100,000 capital gain.
Example 2
Same as example 1, except that the transferor had no unclaimed CGE at the year end – resulting in the CGE deemed to have been claimed only re $50,000 of the capital gains.
Example 3
Same as Example 1, except that the transferor had $10,000 of unclaimed CGE at the year end – resulting in the CGE deemed to have been claimed only re $70,000 of the capital gains.