Principal Issues: Whether a shareholder is deemed to own all the shares of the corporation pursuant to 256(1.4)(a) because of the shareholders' agreement in the situation described?
Position: Yes
Reasons: Wording of 256(1.4).
XXXXXXXXXX 2004-009699
R. Gagnon
November 10, 2004
Dear Madam,
Subject: Section 256(1.4) of the Act
This is in response to your email of October 1, 2004, in which you asked us for our views on the application of subsection 256(1.4) in the situation described below. Specifically, you asked whether, in the situation described below, Aco and Zco would be associated with each other by reason of, inter alia, subsection 256(1.4).
Unless otherwise indicated, all statutory references herein are to provisions of the Income Tax Act (the "Act").
Facts
1. Aco and Zco are "taxable Canadian corporations" as defined in subsection 89(1) and "Canadian-controlled private corporations" as defined in subsection 125(7).
2. Mr. X holds all of the issued and outstanding shares of the capital stock of Aco, and has effective (de jure) control of Aco for the purposes of the Act.
3. The issued and outstanding capital stock of Zco consists of only 100 common shares. Mr. X and Mr. Y each hold 50 common shares of the capital stock of Zco. Mr. X and Mr. Y form a group of persons who have effective control of Zco.
4. Mr. X and Mr. Y are not related persons within the meaning of section 251(2).
5. Mr. X and Mr. Y entered into a shareholders' agreement with respect to their interests in Zco. The shareholders' agreement provides, inter alia, that one shareholder (Mr. X or Mr. Z) of Zco has the option to acquire all of the common shares of the capital stock of Zco held by the other shareholder, if the latter is unable to carry on his employment for a period of more than 12 months due to a temporary disability.
Our Comments
It appears to us that the situation described in your letter may be an actual situation involving taxpayers. The Canada Revenue Agency ("CRA") does not generally provide written opinions on proposed transactions otherwise than by way of an advance ruling. Furthermore, it is the responsibility of the relevant Tax Services Office to determine whether completed transactions have received appropriate tax treatment. We can, however, offer the following general comments which may not apply in full to the situation submitted.
In a situation as described above, it appears to us that paragraph 256(1.4)(a) would deem Mr. X to hold the common shares of the capital stock of Zco held by Mr. Y. As a result, Mr. Y would hold all of the common shares of the capital stock of Zco. The fact that Mr. Y would be deemed by virtue of paragraph 256(1.4)(a) to hold the common shares of the capital stock of Zco held by Mr. X would not change the effect of paragraph 256(1.4)(a) for Mr. X.
Therefore, it appears to us that Aco and Zco would be associated with each other pursuant to paragraph 256(1)(b).
Best regards,
Maurice Bisson, CGA
for the Director
Corporate Reorganizations and Resource Industries Division
Income Tax Rulings Directorate
Policy and Planning Branch