Revenue Canada Taxation Head Office
B. Dwyer (613) 957-2744
January 24, 1989
Dear: XXXX
Re: Capital Gains Exemption: Non-arm's length disposition
This is in reply to your letter dated November 22, 1988 and our subsequent telephone conversation of January 17, 1989.
You have requested our opinion on the following hypothetical situation:
An individual resident in Canada is the sole shareholder of two corporations, Opco and Holdco. The Opco shares have an accrued capital gain. The individual transfers the Opco shares to Holdco. The individual and Holdco jointly elect under subsection 85(1) of the Income Tax Act (Canada) (the "Act") in respect of the transfer but choose an elected amount that exceeds the adjusted cost base of the Opco shares.
You wish to know whether the individual may claim the capital gains exemption in respect of the capital gain arising on the transfer to Holdco. You also wish to know whether the individual must include any portion of the capital gain in computing adjusted taxable income for purposes of the alternative minimum tax.
Generally, the non-arm's length relationship between the individual and Holdco would not prevent the individual from claiming the capital gains exemption on the transfer to Holdco. The ability of an individual to claim a deduction under section 110.6 of the Act depends on numerous other factors, however, especially if the individual wishes to claim a deduction pursuant to subsection 110.6(2.1) of the Act.
In addition to the rules directly governing the capital gains exemption, you should carefully consider the impact of section 84.1 in this situation. Section 84.1 limits the paid-up capital of the Holdco shares taken back by the individual and, in certain circumstances, may cause the realization of an immediate deemed dividend.
For purposes of computing adjusted taxable income for alternative minimum tax purposes, an individual must include the full amount of any realized capital gain pursuant to paragraph 127.52(1)(d) of the Act. The individual then may deduct amounts claimed under subsections 110.6(2), (2.1) and (3) pursuant to paragraph 127.52(1)(h) of the Act. To the extent a capital gain is eligible for the capital gains exemption, therefore, the net inclusion for minimum tax purposes is the portion of the gain that is not included in calculating income for tax purposes. For example, assume that an individual realizes a $100 capital gain in 1989. The individual must include 2/3 of the capital gain ($66.67) in calculating income for tax purposes. If the individual claims $66.67 as a deduction under section 110.6 of the Act, his net inclusion on account of the capital gain in calculating his adjusted taxable income for minimum tax purposes will be $33.33.
As noted, the opinions expressed in this letter are of a purely general nature and do not take into account considerations that might arise in the context of a specific factual situation. In accordance with paragraph 24 of Information Circular 70-6R, the opinions expressed herein do not constitute an advance income tax ruling and consequently are not binding on the Department.
Yours truly,
for Director Reorganizations and Non-Resident Division Specialty Rulings Directorate Legislative and Intergovernmental Affairs Branch