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M.F. Symes (613) 957-2110
JUL 20 1988
Dear Sirs:
Re: Subsection 55(2) and section 183.1 of the Income Tax Act (Canada) (the "Act")
This is in reply to your letter of February 16, 1988 in which you requested our views concerning the following three hypothetical situations:
Situation 1
Mr. A owns all the shares of a corporation, Opco. The fair market value of the shares is $100. The paid-up capital and the adjusted cost base to Mr. A of the shares is $1. Mr. A incorporates a new corporation, Holdco, wholly-owned by him. Mr. A transfers his shares of Opco to Holdco, and receives as consideration therefor preferred shares of Holdco that are retractable by the holder for $100. Mr. A and Holdco file a joint election under subsection 85(1) of the Act; the amount agreed upon by Mr. A and Holdco in their election in respect of the Opco shares ("the Agreed Amount") is $1.
Situation 2
This hypothetical situation is the same as Situation 1 except that the Agreed Amount is $100.
Situation 3
ACo. is a corporation, 50% of the shares of which are owned by XCo. a corporation wholly-owned by Mr. X, and 50% of the shares of which are owned by YCo., a corporation wholly-owned by Mr. Y. Mr. X and. Mr. Y are not related to one another. Mr. X, XCo., Mr. Y, and YCo. all deal at arm's length with ACo. The income earned or realized by ACo. after 1971 and before the commencement of the series ("Safe Income") is $100, $50 of which is attributable to the shares owned by XCo., and $50 of which is attributable to the shares owned by YCo. The shareholding of ACo. has not changed since its incorporation. Pursuant to a buy-sell provision of a shareholders' agreement, Opco redeems its shares held by XCo. for an amount equal to their fair market value, $60.
Your Questions
1. Would the exception set out in subsection 183.1(6) of the Act apply to the acquisition of the Opco shares by Holdco in Situations 1 and 2?
2. If the answer to Question 1 is no, would the provisions of Part 11.1 of the Act apply to the transactions described in Situations 1 and 2?
3. In Situation 3, would subsection 55(2) of the Act apply to the dividend which would be deemed by subsection 84(3) of the Act to be received by XCo. upon the redemption of its ACo. shares, assuming that the amount of the deemed dividend exceeded the amount of Safe Income attributable to those shares?
Our Opinions
Question 1
No.
It is our opinion that the wording "...to the extent that... section 84.1... applied..." in subsection 183.1(6) of the Act has the effect that the subsection 183.1(6) exception does not apply to an acquisition of shares where section 84.1 of the Act applied to the acquisition but did not result in a reduction in the paid-up capital of any shares or in any dividend being deemed to have been received.
Question 2
No.
it is our opinion that section 183.1 of the Act would not apply to the hypothetical transactions described in Situations 1 and 2, in and by themselves, because the condition set out in paragraph 183.1(1)(c) of the Act would not be met.
Provided that the amendments to the Act contemplated in Bill C-139 tabled in the House of Commons on June 30, 1988 are enacted as proposed, it is also our opinion that section 183.1 of the Act as proposed therein would not apply to the hypothetical transactions described in Situations 1 and 2, in and by themselves.
Question 3
Yes.
It is our opinion that the provisions of subsection 55(2) of the Act would apply to the deemed dividend described in Situation 3. The dividend would be deemed to be received as part of a transaction described in paragraph 55(3)(a) of the Act. The dividend would be deemed to be received under subsection 84(3) of the Act, and accordingly in applying subsection 55(2) of the Act to the dividend, it is only the results of the dividend, and not the purposes of the dividend, which must be considered. Therefore, the fact that a subsection 84(3) deemed dividend arises in the context of a buy-sell provision of a shareholders' agreement should not be relevant in the application of subsection 55(2) of the Act to the dividend.
The expressions of opinion in this letter are not rulings and are not binding on Revenue Canada, Taxation as explained in paragraph 24 of Information Circular 70-6R.
Yours truly,
for Director Reorganizations and Non-Resident Division Specialty Rulings Directorate Legislative and Intergovernmental Affairs branch