Principal Issues: An individual ("A") holds shares in a holding corporation ("HOLDCO") with a high adjusted cost base due to a capital gains deduction crystallization undertaken in the past. HOLDCO owns investment property and shares in an operating corporation ("OPCO"). A third party is interested in the OPCO shares. A would first dispose of his HOLDCO shares in favour of OPCO, in consideration for shares of OPCO with the same tax attributes. HOLDCO would then redeem its shares owned by OPCO. Finally, A and HOLDCO would dispose of their OPCO shares in favour of the third party. Whether section 84.1 or 245 would apply in the given fact situation.
Position: General comments provided. Section 84.1 would apply if it is established that A and the third party do not deal with each other at arm's length with respect to the disposition of the OPCO shares. This may be the case where the third party is party to a transaction which lacks commercial reality, for the only purpose of accommodating A. Subsection 84(2) or 245(2) may also be applicable if the given fact situation involves surplus stripping.
Reasons: Wording of the Act.
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2004-007895
S. Prud'Homme
(613) 957-8975
June 29, 2004
Dear Sir,
Subject: Request for a technical interpretation of sections 84.1 and 245 of the Income Tax Act
This is in response to your email of May 31, 2004 in which you requested our opinion regarding the potential application of sections 84.1 and 245 of the Income Tax Act (the "Act") in a particular situation.
Unless otherwise indicated, all statutory references herein are to provisions of the Act.
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 in the form of an advance income tax ruling. If your situation involved specific taxpayers and one or more completed transactions, you should submit all relevant facts and documentation to the appropriate Tax Services Office for its opinion. 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.
1) Particular Situation
You have presented us with the situation described below (the "Particular Situation") as part of your request for a technical interpretation.
(a) An individual ("A") held 500,000 preferred shares of the capital stock of a holding company ("HOLDCO"). Those preferred shares had a fair market value ("FMV") and adjusted cost base ("ACB") to A of $500,000 and a paid-up capital ("PUC") of $100. The $500,000 ACB of the preferred shares resulted from transactions that allowed the "crystallization" of the capital gains deduction under subsection 110.6(2.1).
We understand that A resided in Canada at all relevant times.
(b) HOLDCO held stock market investments as well as participating shares in the capital stock of an operating company ("OPCO").
We understand that HOLDCO and OPCO were resident in Canada at all relevant times.
(c) A and a corporation unrelated to A ("UNRELATEDCO") agreed that the shares of the capital stock of OPCO held by HOLDCO would be sold to UNRELATEDCO. You stated that at no time would A or HOLDCO have any interest, stock or otherwise, in UNRELATEDCO.
(d) A wished to take advantage of the high ACB that existed in respect of the preferred shares of HOLDCO. Accordingly, instead of HOLDCO transferring its stock market investments to another corporation and A then selling his shares in the capital stock of HOLDCO to UNRELATEDCO, the transactions described below took place.
(e) A first transferred the preferred shares of the capital stock of HOLDCO that A held to OPCO. In return, OPCO issued to A shares of its capital stock. Those OPCO shares had a FMV and ACB to A of $500,000, as well as a PUC set at $100.
(f) HOLDCO then redeemed the shares of its capital stock held by OPCO. You indicated that, with respect to this redemption, subsection 55(2) did not have an adverse effect because the ACB to OPCO of the preferred shares of HOLDCO's capital stock was their FMV of $500,000.
(g) Finally, A and HOLDCO disposed of their shares in the capital stock of OPCO to UNRELATEDCO.
2) Your Question respecting the Particular Situation
You wish to know whether section 84.1 or subsection 245(2) applies in the context of the Particular Situation.
3) Our Comments on the Particular Situation
First, it should be noted that your letter only briefly describes a hypothetical situation. Among other things, the information you provided regarding the shareholding in HOLDCO and OPCO is incomplete. In addition, your letter does not provide any information with respect to the shareholders' equity of HOLDCO and OPCO, the exact nature of the assets owned by HOLDCO and OPCO, the tax attributes of those assets, and the use that would be made of those assets in connection with and following the transactions described. Your letter also provides no information with respect to the consideration paid by UNRELATEDCO to A and HOLDCO, and with respect to the consideration paid by HOLDCO to OPCO in connection with the redemption of the preferred shares of HOLDCO's capital stock. In particular, no mention is made of the source of the funds or property paid by UNRELATEDCO and HOLDCO as consideration for the transaction described above. Nor do you provide any details as to what OPCO would do with the consideration received from HOLDCO or what OPCO's status would be after the transaction described above. Finally, you do not describe how the "crystallization" of the capital gains deduction under subsection 110.6(2.1) in respect of the shares of the capital stock of HOLDCO held by A would have occurred.
In the absence of the above-mentioned information, it is therefore impossible for us to give a definitive opinion on the potential application of section 84.1 or subsections 84(2) and 245(2) in the Particular Situation. However, we can make the following general comments.
To begin with, we believe that it should be determined whether the transactions described in the Particular Situation are legally valid and in compliance with applicable corporate law. In this regard, it should be determined, inter alia, whether the applicable corporate law prohibits the acquisition or holding by OPCO of shares of the capital stock of HOLDCO.
With respect to section 84.1, and assuming that OPCO would be connected to UNRELATEDCO immediately after the acquisition of the shares of OPCO from A and HOLDCO, we are of the view that, depending on the facts and circumstances surrounding the Particular Situation, A could be not dealing at arm's length with UNRELATEDCO with respect to A's disposition of the shares of OPCO described in (1)(g) above. Section 84.1 could therefore apply in this regard. This could in particular be the case if it turns out that UNRELATEDCO is party to certain transactions that have no real commercial basis, for the sole purpose of accommodating A. Thus, for example, section 84.1 could be applicable in the event that UNRELATEDCO pays a purchase price for the shares of OPCO's capital stock that exceeds the intrinsic value of OPCO's assets immediately prior to the implementation of the proposed reorganization. To the extent that section 84.1 is applicable in the Particular Situation, a dividend would be deemed to be paid by UNRELATEDCO to A, and received by A upon the disposition of the shares of OPCO described in (1)(g) above.
Regarding the potential application of subsection 84(2), it would be necessary to determine whether any funds or property of HOLDCO are distributed or otherwise appropriated in any manner to A in connection with the Particular Situation. To the extent that subsection 84(2) is applicable in the Particular Situation, a dividend would be deemed to be paid by HOLDCO to A on the preferred shares of the capital stock of HOLDCO. Note that if it were determined that A was a shareholder of OPCO shortly before the above-described transaction took place, then it would also be necessary to determine whether any funds or property of OPCO were distributed or otherwise appropriated in any manner to A in connection with the Particular Situation, which would engage the application of subsection 84(2).
Furthermore, the practice of the Income Tax Rulings Directorate is generally to rule on the application of subsection 245(2) only after examining all the facts and circumstances surrounding the transactions, and then only in the context of an advance ruling request. However, we are of the view that transactions or series of transactions of the type described above could, depending on the facts and circumstances of a particular situation, engage the application of subsection 245(2). Indeed, certain plans could result in surplus stripping situations for a particular corporation.
In conclusion, and due to the fact that your letter does not contain several essential pieces of information, we are unable to comment on other tax implications that may result from the Particular Situation.
We hope that our comments are of assistance.
Best regards,
Stéphane Prud'Homme, Notary, M. Fisc.
For the Director
Corporate Reorganizations and Industrial Resources Division
Income Tax Rulings Directorate
Policy and Planning Branch