17 August 1989 Ruling 58431 F - Transfer of Shares

August 17, 1989

Dear Sirs:

Re:  Paragraphs 85(1)(e.2) and 110.6(7)(b) of the Income Tax Act ("the Act")

This is in reply to your letter of July 24, 1989 wherein you requested our opinions on the application of the above-referenced provisions of the Act to the following hypothetical situation:

     "Individual taxpayer owns 75 per cent of the common shares of a Canadian-controlled private corporation (Opco).His shares are estimated to have a fair market value of approximately $750,000. Paid up capital of his shares is $5,000. Adjusted cost base of his shares $100,000.  Taxpayer wishes to transfer his shares to a holding company. Taxpayer has incorporated a holding company (Holdco), and presently holds all 10 issued $1 par value common shares. Taxpayer plans to exchange his shares of Opco for $5,000 $1 par value common shares of Holdco. Opco uses all or substantially all its' assets in an active business carried on in Canada.Taxpayer has owned the Opco shares for approximately fifteen years.Taxpayer has never claimed a capital gains deduction and has no cumulative net investment loss".

Your specific questions and our responses are as follows:

Question 1

     "Will s.85(1)(e.2) apply if the agreed amount isa)  $100,000 b)  $600,000 c)  $750,000on the basis that the individual taxpayer is considered to have conferred a benefit on Holdco?"

Response

The provisions of paragraph 85(1)(e.2) of the Act will apply in both (a) and (b) above.  However, we note that the adjustment to the agreed amount would be minimal.

Question 2

     "Will the taxpayer be able to claim a capital gains deduction to the extent that the agreed amount exceeds his adjustment cost base and a taxable capital gain arises, or will s.110(7)(b) deny the capital gains deduction on the basis that the shares of Holdco were, before the exchange, consideration that was significantly less than the fair market value of the property acquired at the time of acquisition?"

Response

In our view, the provisions of paragraph 110.6(7)(b) of the Act would only apply if the corporation acquired the shares of Opco for consideration which was significantly less than the fair market value of the shares of Opco.  Whether the consideration is significantly less than the fair market value is a question of fact, however, in your example we would no consider the difference significant and the provisions of paragraph 110.6(7)(b) of the Act would not be applicable.

Yours truly,

for DirectorReorganizations and Non-Resident DivisionSpecialty Rulings DirectorateLegislative and IntergovernmentalAffairs Branch