| 19(1) | File No. 5-8346 |
| C. Robb | |
| (613) 957-2744 |
April 30, 1990
Dear Sirs:
Re: Interpretation Bulletin IT-140R3
We are responding to your letter of July 6, 1989 in which you requested our position with respect to the determination of the fair market value of shares of a company when the shares are subject to a buy-sell agreement between individuals who are not dealing at arm's length and when there are corporate-owned life insurance policies in place. We apologize for the delay in responding to your letter. We will respond to your questions in the order in which you presented them.
Question 1:
If a non-arm's length buy-sell agreement requires that fair market value be used to determine the value of the deceased's shares and such value is to be determined excluding life insurance proceeds, would Revenue Canada, Taxation ("RCT") view the buy-sell agreement as determinative of value at the time of the sale of those shares by the estate (or buy-back of those shares by the company) and would that value be the same as the value of those shares immediately before death pursuant to subsection 70(5) of the Income Tax Act (Canada) (the "Act")?
Response:
Subject to the comments in paragraphs 40 and 41 of Information Circular 89-3 and provided that the buy-sell agreement meets the criteria set out in paragraphs 29 to 31 of that circular, the buy-sell agreement would normally be determinative of value and such value would be the same at both the time of sale or buy-back and immediately before death. The exclusion of the insurance proceeds will be permitted where the exclusion does not invalidate the test of the reasonableness of the fair market value estimate. As well, the business purpose and bona fide nature of the agreement must not be compromised.
Question 2:
If the non-arm's length buy-sell agreement provides a formula or stated amount that is below fair market value and the tax consequences pursuant to subsection 70(5) of the Act are based on the fair market value, would that same fair market value be used by RCT at the time of the sale of those shares by the estate or the buy-back of those shares by the company (i.e., would life insurance proceeds be excluded)?
Response:
A buy-sell agreement that does not represent a reasonable estimate of fair market value of the shares at the time the agreement was entered into will not be considered determinative of value. Therefore, it is conceivable that the fair market value applied to the deemed disposition pursuant to subsection 70(5) of the Act may differ from the value at the time of the sale of those shares by the estate or the buy-back of those shares by the company.
Question 3:
Interpretation Bulletin IT-140R3 implies that RCT accepts buy-sell agreements that were executed between arm's length parties as being the determinative factor in establishing the fair market value of the shares that are subject to the buy-sell agreement. Is this RCT's position?
Response:
RCT is normally prepared to accept buy-sell agreements between arm's length parties as determinative of value where the agreement complies with the policies set out in paragraphs 17 to 28 of Information Circular 89-3.
Question 4:
This question assumes that a company has two shareholders each owning 50% of the outstanding common shares and 100% of one of two classes of preferred shares. The aggregate redemption price of the surviving shareholder's preferred shares would equal the amount paid in plus the amount of the life insurance proceeds received by the company on the death of the deceased shareholder. Would RCT view the payment of the life insurance premiums by the company as a benefit conferred on the preferred shareholders, or would the premiums be treated in the same fashion as premiums paid by a company that does not have the special preferred share classes i.e., the premiums would be simply nondeductible corporate expenses?
Response:
Provided the company is the beneficiary of the life insurance policies we would not generally apply subsection 15(1) to the shareholders with respect to the premiums paid by the company. Therefore, the premiums would be treated in the same fashion as a company which does not have the special preferred shares i.e., they are simply not deductible by the company.
The comments set out in this letter are of a general nature and do not take into account the numerous additional considerations that might arise in the context of specific factual situations. In accordance with paragraph 24 of Information Circular 70-6R, the comments expressed herein do not constitute an advance income tax ruling and consequently are not binding on Revenue Canada, Taxation.
Yours truly,
for DirectorFinancial Industries DivisionRulings Directorate