Principal Issues: [TaxInterpretations translation]
Can subsection 74.2(1) of the Income Tax Act (the "Act") apply to the capital gain realized by the spouses in the situation where that capital gain relates to shares originally held by individuals who subsequently transferred them to their respective holding companies shortly before those holding companies transferred a portion therof to the individuals' respective spouses?
Position: Subsection 74.2(1) could apply.
Reasons:
The term "indirectly" and the expression "by any other means" stated in the preamble to subsection 74.2(1) of the Act could refer to an inter-spousal transfer made through a partnership.
October 30, 2002
Trois-Rivières Tax Services Office Headquarters
Lucie Vermette, CGA
(613) 957-2092
Attention: Mr. Jean-Noël Vandal
2002-013407Technical Interpretation: Subsection 74.2(1) of the Act
This is in response to your fax of April 11, June 20 and July 18, 2002, in which you requested our opinion on the above subject. We apologize for the delay in responding to your request.
FACTS
In XXXXXXXXXX, two individuals transferred to their respective holding companies a portion of the shares they personally held in the XXXXXXXXXX company. In XXXXXXXXXX, the two individuals transferred their remaining shares in XXXXXXXXXX to their respective holding companies.
In XXXXXXXXXX, the holding companies each disposed of a portion of the XXXXXXXXXX shares that the individuals had transferred to the holding companies in XXXXXXXXXX to the respective spouses of the individuals controlling such companies. The amounts for both transactions were payable with non-interest-bearing notes.
In XXXXXXXXXX, the XXXXXXXXXX shares acquired by the two spouses were exchanged for another class of shares in the same company.
In XXXXXXXXXX, XXXXXXXXXX was amalgamated with another company and both spouses received shares in the new amalgamated company. They subsequently disposed of those shares and realized a capital gain.
QUESTION
Can subsection 74.2(1) of the Income Tax Act (the "Act") apply to the capital gain realized by the spouses in the situation where that capital gain relates to shares originally held by individuals who subsequently transferred them to their respective holding companies shortly before those holding companies transferred a portion thereof to the individuals' respective spouses?
OUR COMMENTS
Subsection 74.2(1) provides inter alia that where an individual (the transferor) has lent or transferred property, either directly or indirectly, by means of a trust or by any other means whatever, to or for the benefit of a person (the “recipient”) who is the individual’s spouse or common-law partner, the taxable capital gain realized by the recipient is deemed to be the taxable capital gain of the transferor. The purpose of subsection 74.2(1) is to prevent the splitting of capital gains between spouses.
The word "indirectly" is defined as follows in Jolin's "Canada Tax Words and Phrases": "Not taking the straight or nearest course to the end aimed at"; "Roundabout"; "Devious". The word "indirectly" is defined in the dictionary as follows: "Qui fait un ou plusieurs détours" [“That taking one or more detours” (TaxInterpretations translation)] or "Qui comporte un ou plusieurs intermédiaires” [“That which includes one or more intermediaries” (TaxInterpretations translation)].
In Fasken v. MNR, 49 DTC 491, the President of the Exchequer Court made the following comments (cited in The Queen v. Albert Kieboom, 92 DTC 6382 FCA) regarding the word "transfer":
The word "transfer" is not a term of art and has not a technical meaning. It is not necessary to a transfer of property from a husband to his wife that it should be made in any particular form or that it should be made directly. All that is required is that the husband should so deal with the property as to divest himself of it and vest it in his wife, that is to say, pass the property from himself to her. The means by which he accomplishes this result, whether direct or circuitous, may properly be called a transfer.
The words "indirectly" and "indirectement" could therefore be given a very broad meaning in the case of a transfer of property between spouses, since a transfer in itself already includes the concept of "indirectly". The expression "by any other means" can refer to any means or conduit.
In the present situation, there may be arguments that an actual transfer was first made by the individuals to their respective holding companies before any further transfer took place between their holding companies and their respective spouses. However, it is important to note that the second transfer of shares by the individuals to their respective holding companies, which took place in XXXXXXXXXX, is very closely related to the transaction in which the holding companies disposed of the shares to the spouses in XXXXXXXXXX. It is therefore plausible to establish a link between the two transactions and thus argue that the individuals transferred the shares to their holding companies and then exercised control over the transfer of those shares to the spouses before selling them to a third party. That decision-making control on the part of the two individuals, sole shareholders of their respective holding companies, could be comparable to that found in the Kieboom case.
In our opinion, the wording of subsection 74.2(1) is very broad, and this subsection could be applied in the situation you have submitted to us, since we consider it possible that an indirect transfer of the individuals' shares to their spouse was effected through their respective holding companies. We are of the view that the shares disposed of by the spouses in XXXXXXXXXX constitute substituted property for the property transferred indirectly by the individuals, and that subsection 74.2(1) will result in the capital gain realized by the spouses being attributed to the individuals.
We have also considered the application of subsection 74.5(6)-Back to back loans and transfers in this situation. This subsection indicates that where an individual has transferred property to another person (the third party) and the third party transfers the property to a specified person (including a spouse by virtue of subsections 74.5(8) and 74.5(5)), for the purposes of inter alia section 74.2, the property transferred by the third party is deemed to be transferred by the individual to the specified person. The existence of this anti-avoidance rule reinforces the general spirit of the Act, which is that the attribution rules apply to transfers of property between spouses unless the conditions set out in the exception rules found in section 74.5 are met. It appears that none of those exceptions apply in the present situation. In particular, subsection 74.5(1) does not apply since the consideration for the transfer of the shares to the spouses consists of an interest-free note. In our opinion, subsection 74.5(6) is not in itself necessary in the present situation, since subsection 74.2(1) already provides for the concept of indirect transfer, as stated in the previous paragraph. However, subsection 74.5(6) constitutes an additional argument.
We wish to point out that we have not examined all the transactions in this case, nor have we analyzed other possible tax consequences. We have focused our analysis primarily on subsection 74.2(1).
For your information, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Customs and Revenue Agency's electronic library. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, the electronic library version can be provided. Alternatively, the client may request a severed copy using the Privacy Act criteria, which does not remove client identity. Requests for this latter version should be made by you to Ms. Jackie Page at (819) 994-2898. A copy will be sent to you for delivery to the client.
Should you require any additional information regarding this matter, please do not hesitate to contact us.
Best regards,
Ghislaine Landry, CGA
Manager
Individuals, Business and Partnerships Section
Business and Partnerships Division
Income Tax Rulings Directorate
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