| 913444 | |
| S. Shinerock | |
| 24(1) | (613) 957-2108 |
19(1)
February 24, 1992
Dear Sirs:
Re: Subsection 110.6(8) of the Income Tax Act (the "Act") and Subsection 6205(2) of the Income Tax Regulations ("ITR")
We refer to your letter of December 9, 1991 in which you requested a technical interpretation on the application of subsection 110.6(8) of the Act and subsection 6205(2) of the ITR to the hypothetical fact situation described below.
Several years ago, pursuant to the provisions of subsection 85(1) of the Act, a taxpayer who is an individual transferred his 24(1) interest in the common shares of a taxable Canadian corporation ("Opco") to a Holdco specially incorporated for that purpose. Taxable Canadian corporation has the meaning assigned by paragraph 89(1)(i) of the Act. In exchange for the common shares of Opco, Holdco issued redeemable and retractable preferred shares having a redemption value equal to the fair market value of the common shares so transferred. At the time of the transfer of the Opco shares to Holdco, it was intended to issue common shares of Holdco to the taxpayer's son in order to allow a portion of the future growth of Holdco to accrue to the son.
However, because of 24(1) common shares of Holdco were issued solely to the taxpayer in addition to the preferred shares. The common shares of Holdco would constitute prescribed shares for the purposes of subsection 110.6(8) of the Act and section 6205 of the ITR. No dividends have been paid on the preferred shares from the time of their issue, and the taxpayer intends to sell either the common shares or the preferred shares of Holdco, thus realizing a substantial capital gain.
It is your view that the capital gain arising on the disposition of common shares of Holdco would not be subject to the provisions of subsection 110.6(8) of the Act, since the preferred shares of Holdco would be prescribed shares pursuant to subsection 6205(2) of the ITR. In this regard, you maintain that the main purpose test set out in subparagraph 6205(2)(a)(i) of the ITR would be met in respect of the preferred shares of Holdco, in that the main purpose of the arrangement described above was to permit an increase in the property of Holdco to accrue to the son, and that this would be so notwithstanding that this purpose was thwarted by the 24(1)
You also advance the view that even if the preferred shares of Holdco would not be prescribed shares described in subsection 6205(2) of the ITR, the capital gain arising on the disposition of the preferred shares of Holdco would also not be subject to the provisions of subsection 110.6(8) of the Act, since the capital gain would not be referable to the fact that no dividends were paid on such shares, but rather to the value of the preferred shares inherent in the property (i.e. the common shares of Opco) for which the preferred shares were issued. In your letter under reference, you referred to a previous opinion issued by this Directorate in support of your view.
Opinions
It appears that your request for an opinion involves both a specific taxpayer and a completed transaction. Since the responsibility for determining the tax consequences arising from completed transactions rests with the district taxation offices, the appropriate district taxation office may, upon disclosure of all the relevant facts, be able to assist you in clarifying the tax consequences pertaining thereto.
Although we cannot comment directly on your situation, we are able to provide you with the following general comments pertaining to the application of subsection 110.6(8) of the Act and subsection 6205(2) of the ITR to circumstances similar to the one described by you.
Whether the main purpose of an arrangement is to permit any increase in the value of property of a corporation to accrue to prescribed shares that are "other shares" described in subsection 6205(2) of the ITR is of course a question of fact on which we make no comment. However, in order for a main purpose to exist, the prescribed shares described in subsection 6205(2) of the ITR must be issued pursuant to an arrangement described in that subsection such that at the time the shares are issued or at the end of the arrangement, the "other shares" would be owned by a person described clause 6205(2)(a)(ii)(A) of the ITR. In the situation described above, such a person would have been the son of the taxpayer. If an arrangement referred to herein is not properly carried out or, as described in the above situation, is frustrated, then it is our view that a main purpose cannot possibly exist with respect to the son. However, it may be noted that the main purpose test may be met where the increase in the value of the property of a corporation accrues to other shares which would be prescribed shares provided that such shares are owned by a person described in subclause 6205(2)(a)(ii)(A)(I) of the ITR.
In line with our previous opinion expressed on the subject, provided that the fair market value of the preferred shares of Holdco would be equal to the fair market value of the property in respect of which the preferred shares were issued, and further provided that the value of such property would be maintained up to and including the time that the preferred shares would be disposed of, one would not expect that the provisions of subsection 110.6(8) of the Act would apply to deny the capital gains exemption claimed in respect of the disposition. However, we do point out that the non-payment of dividends on the preferred shares would, for the purposes of subsection 110.6(8) of the Act, taint any capital gain that may be realized on a subsequent disposition of the common shares notwithstanding that the preferred shares would have previously been disposed of or would no longer exist. Of course, it is a question of fact as to whether it may reasonably be concluded that a significant part of the capital gain on such common shares would be attributable to the fact that dividends were not paid on the preferred shares prior to the disposition of the common shares.
Yours truly,
for DirectorReorganizations and Foreign DivisionRulings DirectorateLegislative and Intergovernmental Affairs Branch