| 19(1) | File No. 5-8851 |
| M. Vallée | |
| (613) 957-2093 | |
| February 15, 1990 |
Dear Sir:
Re: Technical Interpretation - Section 84.1 of the Income Tax Act (the "Act")
This is in reply to your letter dated October 4, 1989, whereby you requested a technical interpretation regarding the application of section 84.1 of the Act in the following hypothetical situation.
1. Mr. A and Mr. B are brothers who own all the shares of Opco, which carries on an active business.
2. Mr. A and Mr. B enter into a shareholders' agreement containing buy-sell provisions applicable upon the death of a shareholder. These provisions require the deceased's estate to sell the shares to the surviving shareholder at a price equal to the fair market value of the shares at the time of such sale.
3. Upon Mr. a's death, a gain is recognized in the deceased's terminal return and the capital gains exemption is claimed to shelter the gain. The executors of the estate, who are Mr. A's children, then sell the shares to Mr. B.
You requested our opinion as to whether the existence of the buy-sell agreement would necessarily imply that Mr. B was not dealing at arm's length with the estate at the time of the sale of the shares. In particular, you requested our opinion as to whether section 84.1 of the Act would apply, with the result that Mr. B would be unable to transfer the newly acquired shares to a corporation in consideration for shares having a paid-up capital greater than the paid-up capital of the transferred shares.
Our Comments
Paragraph 251(1)(b) of the Act, provides that it is a question of tact whether persons not related to each other are dealing at arm's length at a particular time.
It is our view that where a deceased shareholder and a surviving shareholder did not deal at arm's length at the time a buy-sell agreement was entered into, the estate of the deceased and the surviving shareholder do not deal at arm's length when property is sold by the estate to the surviving shareholder pursuant to the agreement.
In the situation which you described, Mr. A and Mr. B, being brothers, would be deemed by paragraph 251(1)(a) not to deal at arm's length when they enter into the buy-sell agreement. Accordingly, it would be our view that when Mr. B acquires the Opco shares from Mr. A's estate pursuant to the buy-sell agreement, he would acquire the shares from a person with whom he was not dealing at arm's length. Consequently, the adjusted cost base to Mr. B of the shares, for the purposes of section 84.1 of the Act, would be subject to reduction by virtue of paragraph 84.1(2)(a.1) of the Act.
Yours truly,
for DirectorReorganizations and Non-Resident DivisionSpecialty Rulings DirectorateLegislative and Intergovernmental Affairs Branch