| 19(1) | 5-7353 |
| H.K. Tilak | |
| (613) 957-2122 |
August 18, 1989
Dear Sirs:
Re: Section 85 of the Income Tax Act
We are writing in response to your letter dated January 5, 3989 in which you requested our views regarding the application of subsection 85(1) of the Income Tax Act (the "Act") in the hypothetical situation described below.
Facts
1. Mr. A is the sole shareholder of Opco, a taxable Canadian corporation.
2. All of the common shares of Opco are qualified small business corporation shares of Mr. A within the meaning of subsection 110.6(1) of the Act. The common shares have a fair market value of $1,000,000 and an adjusted cost base to Mr. A of nil. We have assumed that the common shares of Opco are capital property of Mr. A within the meaning of paragraph 54(c) of the Act.
3. Mr. A transfers one-half of his common shares of Opco to Opco and, in consideration therefor, Opco issues to Mr. A preferred shares having an aggregate paid-up capital equal to one-half of the aggregate paid-up capital of all of the common shares of Opco immediately before the transfer and a fair market value of $500,000 immediately after the transfer.
4. Pursuant to subsection 85(1) of the Act, Opco and Mr. A jointly elect, in prescribed form and in accordance with subsection 85(6) of the Act, in respect of the disposition of the common shares to Opco so that the amount agreed upon in their election in respect of the common shares is $500,000.
It is your view that Mr. A would be eligible to claim a deduction pursuant to subsection 110.6(2.1) of the Act in respect of the capital gain realized by him on the disposition of his common shares to Opco. It is also your view that, although subsection 84(3) of the Act would apply to the disposition of the common shares of Opco and the issue of preferred shares to Mr. A, that subsection would not deem Opco to have paid a dividend to Mr. A as a result of that transaction. Finally, it is your view that neither subsection 84.1(1) or subsection 86(1) of the Act would apply to the disposition of the common shares to Opco.
We agree with your views expressed above for the following reasons. Pursuant to paragraph 85(1)(a) of the Act, Mr. A would be deemed to have received proceeds of disposition in an amount equal to $500,000 and, hence, Mr. A would realize a capital gain of $500,000 on the disposition of the common shares to Opco. Pursuant to subsection 110.6(2.1) of the Act, Mr. A would be eligible to claim a deduction in respect of such capital gain in computing his taxable income for the taxation year in which the disposition takes place provided, of course, that all of the requirements of that subsection are otherwise met. Notwithstanding that paragraph 85(1)(a) of the Act would deem Mr. A to have received proceeds of disposition in an amount equal to $500,000, the amount paid by Opco by issuing preferred shares to Mr. A for the purposes of paragraph 84(3)(a) of the Act would be, pursuant to paragraph 84(5)(d) of the Act, equal to the amount by which the paid-up capital in respect of the class of preferred shares has increased by virtue of the issue is of preferred shares to Mr. A. Because the amount so paid by Opco to Mr. A would be equal to the paid-up capital in respect of the common shares being redeemed, acquired or cancelled by Opco, subsection 84(3) of the Act would not deem Opco to have paid a dividend to Mr. A. Subsection 84.1 of the Act would not apply to the disposition of the common shares to Opco because the common shares of Opco would not be disposed of to another corporation, that is, a corporation other than Opco. Pursuant to subsection 86(3) of the Act, subsection 86(1) of the Act would not apply to the disposition of the common shares because subsection 85(1) of the Act would be applicable to the disposition.
The foregoing comments represent our general views with respect to the subject matter of your letter. The facts of a particular situation may lead to a different conclusion. The foregoing opinions are not rulings and, in accordance with the guidelines set out in Information Circular 70-6R dated December 18, 1978, are not binding on the Department.
Yours truly,
for DirectorReorganizations and Non-Resident DivisionSpecialty Rulings DirectorateLegislative and IntergovernmentalAffairs Branch