M. Vallée (613) 957-2093
XXXX
APR 25 1989
Dear Sirs:
Re: Subsections 84(3) and 6(15) of the Income Tax Act (the "Act")
This is in reply to your letter, dated December 22, 1988, whereby you request an interpretation regarding the application of subsections 84(3) and 6(15) of the Act in the following hypothetical fact situation.
Assumed Facts
1. A corporation resident in Canada (the "Corporation") lends money (the "Loan") to an employee (the "Employee") by virtue of the Employee's office or employment with the Corporation.
2. The terms of the Loan
(i) require the Employee to use all of the funds to purchase shares (the "Shares") in the capital of the Corporation, and pledge the Shares to the Corporation as security for repayment of the Loan, and
(ii) limit the corporation's remedy in the event of default to acquisition of the Shares and require the Corporation to forgive any balance owing on the Loan after such realization of its security.
3. The Employee uses the borrowed funds to acquire Shares, pledges the Shares to the Corporation and ultimately defaults on the Loan.
4. The Corporation realizes on its security by acquiring the Shares and forgives the balance of the Loan.
5. At the time of acquisition, the balance of the Loan forgiven exceeds the paid-up capital of the Shares..
You are requesting our confirmation that, in the circumstances set out above, we would consider that subsection 4(4) of the Act would apply with the results that
(a) no deemed dividend under subsection 84(3) of the Act would arise, and
(b) the Employee would be required to include the amount of the Loan forgiven by the Corporation on acquisition of the Shares in computing his income from an office or employment under subsection 6(15) of the Act.
You are of the opinion that a strict reading of the Act would result in a double taxation, since a dividend would be deemed, pursuant to subsection 84(3) of the Act, to be paid to the Employee, to the extent that the Loan outstanding at the moment the Corporation acquires the Shares exceeds their paid-up capital. In addition to this deemed receipt of a dividend, the Employee would be required to include the amount of the Loan forgiven in computing his income from an office or employment, by virtue of subsection 6(15) of the Act, thus resulting in double taxation.
Our Comments
Assurance as to the tax consequence of a contemplated transaction can only be given in response to a request for an advance income tax ruling. The procedure for requesting an advance income tax ruling is outlined in Information Circular 70-6R, published by Revenue Canada, Taxation on December 18, 1978. If you wish to obtain any binding commitment with respect to an actual case with facts similar to your example, an advance income tax ruling application should be submitted. Although we are unable to provide any binding assurance with respect to the query you have raised, we have stated our observations below.
We are of the opinion that the interaction of subsections 6(15) and 84(3) of the Act does not result in a double taxation in the hypothetical situation herein described. However, we are of the opinion that the application of section 79 could warrant the application of subsection 4(4) of the Act under different circumstances.
In your example, the acquisition by the Corporation of the Shares and the forgiveness of the balance of the Loan result in two different effects of the same transaction. A dividend is deemed by subsection 84(3) of the Act to be paid upon the acquisition of the Shares by the Corporation, while the benefit enjoyed by the Employee upon the forgiveness of the balance of the Loan is taxed by virtue of subsection 6(15) of the Act. The amount of the dividend that must be included in his income is equal to the excess of the price paid by the Corporation for the acquisition of the Shares over their paid-up capital, while the amount that must be included in his income by virtue of subsection 6(15) of the Act is the amount of the Loan forgiven minus any payment in relation thereto. In the present case, the acquisition of the Shares by the Corporation would represent partial payment of the Loan, and therefore, the value of this payment would reduce the amount forgiven by the employer. Consequently, tax would not be levied on the same income twice and subsection 4(4) of the Act would not apply in this case.
However, we are of the opinion that the provisions of subsection 4(4) of the Act would apply to the extent that the taxpayer also realized a taxable capital gain by virtue of the application of section 79 of the Act.
These comments are given in accordance with the practice set out in Information Circular 70-6R dated December 18, 1978.
Yours truly,
for Director Reorganizations and Non-Resident Division Specialty Rulings Directorate Legislative and Intergovernmental Affairs Branch