Principal Issues: Whether, in a given fact situation, subsection 84.1(1) would apply to deem a dividend to have been received by an individual who received a term note in consideration of shares of the capital stock of a "subject corporation" transferred to a "purchaser corporation"?
Position: General comments provided.
Reasons: All the conditions in subsection 84.1(1) are met except whether the disposing individual is dealing at non-arm's length with the purchaser corporation. It is a question of fact whether the disposing individual is not dealing at arm's length with the purchaser corporation pursuant to paragraph 251(1)(c). Subsection 84.1(1) would apply if the purchaser corporation is controlled, directly or indirectly in any manner whatever by the individual.
| 2004-009287 | |
| XXXXXXXXXX | Guy Goulet, CA, M.Fisc. |
| (613) 957-9768 | |
| December 20, 2004 |
Dear Sir,
Subject: Application of section 84(1)
This is in response to your letter of August 19, 2004 requesting our comments on the application of section 84.1 in the Particular Situation described below.
Unless otherwise indicated, all statutory references herein are to provisions of the Income Tax Act (the "Act").
Particular Situation:
The Particular Situation as you have presented it to us is as follows:
1. Mr. A held all the issued and outstanding shares of the capital stock of Aco.
We have assumed that the shares of the capital stock of Aco were "capital property" to Mr. A within the meaning of the definition in subsection 248(1).
2. Mr. B held all the issued and outstanding shares of the capital stock of Bco.
3. Mr. A and Mr. B were not related persons within the meaning of subsection 251(2) or non-arm's length persons within the meaning of subsection 251(1).
4. Mr. A wished to dispose of the interest he held in Aco. Bco was willing to acquire that stake.
5. Consequently, Mr. A disposed of all of the shares of the capital stock of Aco that he held to Bco for a price corresponding to the fair market value of those shares.
6. Bco borrowed from a financial institution so as to finance part (half) of the purchase price of the shares of the capital stock of Bco. The other half of the purchase price was financed by the issuance by Bco to Mr. A of a term note bearing interest at the market rate and payable in three equal instalments over the three years following the date of the sale.
Your Questions:
You wish to know whether section 84.1 is applicable in the particular situation. In particular, you would like the following questions answered:
1. Will the CRA's position in F-1999-0008405 be revised following Silicon Graphics Limited v. The Queen, 2002 DTC 7112 (F.C.A.)? That case dealt with the application of section 84.1 in a situation where the vendor held, immediately after the sale of its shares, a debt instrument with a value equal to 80% of the value of the purchaser's assets.
2. Would the CRA's conclusions in F-1999-0008405 have been different if the value of the debt security held by the vendor immediately after the sale had been 50% or 25% of the value of the purchaser's assets? Is this proportion a more or less strict unit of measurement to which the CRA refers in determining whether or not there is a non-arm's length relationship between two persons?
3. With respect to the Particular Situation, would the CRA's position be different if Bco had issued a demand note to Mr. A instead of a term note?
4. What are the key features required by CRA for a note to qualify as a term note?
5. Would subparagraph 256(6)(b)(i) apply in the Particular Situation?
6. Could subsection 245(2) apply in the Particular Situation?
Your Analysis:
You are of the view that section 84.1 should not apply in the Particular Situation since Mr. A is dealing at arm's length with Bco. In addition, you are of the view that the fact that Mr. A owns a term note owed by Bco would not be a factor that would lead to the conclusion that Mr. A would have de facto control of Bco. You are of the opinion that, unlike a demand note holder, the holder of a term note has no real influence over the issuing corporation since he cannot force the corporation to repay him the amount of the term note at his request before maturity. The issuing corporation is therefore not at the mercy of the decisions of the holder of a term note.
Finally, you consider that even if Mr. A had influence over Bco the exercise of which would result in de facto control, section 256(6) would apply since the reason for Mr. A's having such influence would be to safeguard his rights in Bco. To support your positions, you refer to the Silicon Graphics Limited case.
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 advance ruling. Furthermore, it is the responsibility of the relevant Tax Services Office to determine whether completed transactions have received appropriate tax treatment. However, we can offer the following general comments which may not be fully applicable in the particular situation.
In general, subsection 84.1(1) provides special tax consequences where an individual resident in Canada disposes of shares that are capital property of a class of the capital stock of a corporation resident in Canada (the subject corporation) to another corporation (the purchaser) with which the individual does not deal at arm's length and, immediately after the disposition, the subject corporation would be connected with the purchaser within the meaning of subsection 186(4) if the references in that subsection to "payer corporation" and "particular corporation" were read as references to "subject corporation" and "purchaser”, respectively.
In the Particular Situation, it is clear that the conditions of subsection 84.1(1) would be satisfied, except for the existence or not of a non-arm's length relationship between Mr. A and Bco. We agree with you that if Mr. A and Bco are not related to each other by virtue of paragraph 251(2)(b), then Mr. A and Bco would not be deemed to not deal with each other at arm's length under paragraph 251(1)(a).
However, and in accordance with paragraph 251(1)(c), whether unrelated persons are dealing at arm's length at a particular time is a question of fact. Thus, unrelated persons may or may not be dealing at arm's length, depending on the facts and circumstances of a particular situation. In this regard, each transaction or series of transactions must be considered individually. With respect to the Particular Situation, it is impossible for us to determine whether Mr. A and Bco are not dealing at arm's length with each other since such a determination would require an analysis of all the facts and circumstances surrounding a particular situation and your letter only briefly describes a hypothetical particular situation. However, we refer you to paragraphs 22 to 26 of Interpretation Bulletin IT-419R2, Meaning of Arm's Length, dated June 8, 2004, which set out the general guidelines followed by the CRA in determining whether or not persons are dealing with each other at arm's length at a particular time. Paragraph 23 of Interpretation Bulletin IT-419R2 states, inter alia, that the courts have applied the following tests to determine whether a transaction was between non-arm's length persons:
- A common mind directs the bargaining for both parties to a transaction;
- The parties to a transaction act in concert without separate interests;
- There is de facto control.
With respect to the third test, we refer you to paragraphs 19 to 23 of Interpretation Bulletin IT-64R4 (Consolidated), Corporations: Association and Control, which set out the general guidelines followed by the CRA in determining whether a person or group of persons has de facto control of a corporation. Among the general factors, set out in paragraph 23 of that Bulletin, for determining whether de facto control exists is the ownership of a large debt of a corporation which may become payable on demand. It is also noted in that paragraph that the CRA considers that the composition of the board of directors and control of day-to-day management and operation of the business should also be considered.
In document F-1999-0008405, to which you refer, the CRA issued a general comment to the effect that section 84.1 could apply where an individual who sells the individual’s shares of a corporation to another corporation (the “purchaser") receives in consideration a demand loan security the value of which would be equal to 80% of the total value of the purchaser's assets. This general comment is based on the criteria set out in IT-64R4. Following the Silicon Graphics Limited case, the CRA indicated at the annual conference of the Canadian Tax Foundation on September 30, 2002, in Toronto (see Question 4 of the October 30, 2002 Technical News, No. 25), that it did not intend to modify the criteria in IT-64R4 because of the Silicon Graphics Limited decision and preferred to wait for the Federal Court of Appeal to rule on other cases, including Mimetix Pharmaceuticals Inc. v. The Queen, 2001 DTC 1026 (T.C.C.). In 2003 and 2004, the Federal Court of Appeal rendered decisions on de facto control in Mimetix Pharmaceuticals Inc. v. The Queen, 2003 DTC 5194 (F.C.A.), as well as in 9044-2807 Québec Inc. v. The Queen, 2004 DTC 6141 (F.C.A.) and The Queen v. Lenester Sales Ltd et al, 2004 DTC 6461 (F.C.A.). As a result of those decisions, the CRA indicated at the 2004 Canadian Tax Foundation annual conference held in Toronto on September 28, 2004 that there was no need to change its position on de facto control and that it was of the opinion that the criteria contained in paragraphs 21 and 23 of Interpretation Bulletin IT-64R4 remained valid for determining whether a person or group of persons has de facto control of a corporation.
On the other hand, the question of whether the conditions for the application of section 256(6) are satisfied at a particular time in a particular situation is a question that must be resolved after a full examination of all the relevant facts, circumstances and documents. It is, of course, impossible to offer any opinion on this issue in the context of this request for a technical interpretation.
Finally, the practice of the Income Tax Rulings Directorate is generally to rule on the application of subsection 245(2) only after reviewing all the facts and circumstances surrounding the transactions, and then only in the context of an advance ruling request.
We hope that our comments will be of assistance.
Best regards,
Maurice Bisson, CGA
for the Director
Corporate Reorganizations and Resource Industries Division
Income Tax Rulings Directorate
Policy and Planning Branch