| 24(1) | 902009 |
| L.A. McCarron-McGuire | |
| (613) 957-2092 | |
| 19(1) |
October 18, 1990
Dear Sirs:
Re: Request for Technical Interpretation Subsections 110.6(3) and 110.6(8) of the Income Tax Act (the "Act")
We are writing in response to your letter, dated August 16, 1990, regarding the application of the above noted provisions of the Act to the following hypothetical situation:
1. Prior to November 21, 1985 an individual resident in Canada transferred all of the common shares of an operating company ("Opco") to a holding company ("Holdco"), on a tax-deferred basis pursuant to subsection 85(1) of the Act in consideration for preferred shares of Holdco.
2. The preferred shares of Holdco have a paid-up capital and a fixed redemption amount equal to the fair market value of the Opco shares transferred and have a fixed, non-cumulative dividend rate. Their adjusted cost base to the holder thereof is less than their fair market value. They are not prescribed shares, within the meaning of Regulation 6205.
3. The only other issued capital of Holdco consists of common shares which are owned by individuals resident in Canada. The common shares of Holdco and the common shares of Opco are prescribed shares within the meaning of Regulation 6205.
4. Since the issuance of the preferred shares of Holdco, no dividends have been paid on the common shares of either Holdco or of Opco, and no dividends have been paid on the preferred shares of Holdco.
5. During all relevant taxation years, Holdco has had sufficient net assets to redeem its preferred shares, and would have had sufficient net assets to redeem its preferred shares even if dividends had been paid on the preferred shares.
You have asked for our views on whether the capital gains deduction provided for by subsection 110.6(3) of the Act in respect of a capital gain realized on a redemption of the preferred shares or on a disposition of the common shares of Holdco would be denied by virtue of the application of subsection 110.6(8) of the Act.
Our comments
It is a question of fact whether, having regard to all of the circumstances, a significant portion of a capital gain that arises on the disposition of a share can reasonably be attributable to the fact that dividends were not paid on a share (other than a prescribed share) of a corporation. Although we cannot make a final determination because we may not be apprised of all of the relevant facts, we are willing to offer the following general comments regarding the hypothetical situation described above.
Redemption of preferred shares of Holdco:
In our view it would not be reasonable to conclude that a significant portion of the capital gain that would arise on the redemption of the preferred shares is attributable to the fact that dividends were not paid on shares of Holdco during the year of redemption or any preceding taxation year because the capital gain realized on the redemption of the preferred shares of Holdco would appear to be attributable to the difference between the fair market value of the common shares of Opco as at the date of transfer of those shares to Holdco and the elected amount in respect of such shares for the purposes of paragraph 85(1)(a).
Thus, in our view, the capital gains deduction provided for by subsection 110.6(3) of the Act in respect of the capital gain realized on the redemption of the preferred shares of Holdco would not be denied by virtue of the application of subsection 110.6(8) of the Act.
Sale of common shares of Holdco:
In our view it may, depending on the facts, be reasonable to conclude that a significant portion of the capital gain that would arise on a sale of the common shares of Holdco would be attributable to the fact that dividends were not paid on the preferred shares of Holdco because the funds that were not used by Holdco to pay dividends on its preferred shares would have remained in Holdco or in Opco and accrued to the benefit of the holders of the Holdco common shares.
Thus, depending on the facts, the application of subsection 110.6(8) to a capital gain arising on a sale of the common shares of Holdco may result in a denial of the capital gains deduction provided for in subsection 110.6(3).
The foregoing expressions of opinion are given in accordance with the practice referred to in paragraph 21 of Information Circular 70-6R2 dated September 28, 1990 and are not binding on Revenue Canada, Taxation.
Yours truly,
for DirectorateReorganizations and Non-resident DivisionRulings DirectorateLegislative and Intergovernmental Affairs Branch