S. Parnansone (613) 957-2097
DEC 4 1986
Dear Mr XXXX
Re: Capital Gains Exemption
This is in response to your letter of October 6, 1986. The following comments will reply to your questions.
Draft section 6205 of the Income Tax Regulations ("Regulations")
Draft section 6205 of the Regulations originally released on November 21, 1985 by the Department of Finance, was subsequently revised in Release No. 86-68 dated May 5, 1986, a copy of which is enclosed herewith. The revised draft (paragraph e) prescribes certain shares issued in estate freeze type of transactions. The draft regulations do not have the force of law as they have not been published in the Canada Cassette and we are unable to advise when and in what form they will eventually be enacted into law.
Ordinarily, subsections 110.6(8) and (9) of the Income Tax Act (the "Act") do mot apply to deny a taxpayer the capital gains exemption in respect of a capital gain realised on the sale of prescribed shares which is attributable to the non- payment of dividends or the payment of dividends of less than 90% of the average annual rate of return on such prescribed shares. However, where the transactions are found to be abusive of the capital gains exemption other tax avoidance provisions may be applicable to deny the capital gains exemption.
Non-arm's length transfers
Generally speaking, the fact that a capital gain is realised on a transfer of capital property to a person not dealing at arm's length with the taxpayer does not, in and by itself, preclude the gain from qualifying for the capital gains exemption under subsections 110.6(2) and (3) of the Act.
Paragraph 13(7)(e) of the Act,
You refer to a situation where a father realises a capital gain on the sale to his son of an asset depreciated under Part XVII of the Regulations and claims the capital gains exemption under section 110.6 of the Act.
In our view, paragraph 13(7)(e) of the Act will apply to the son's acquisition of the property, since the property is depreciable property of a prescribed class in his hands.
Although they are not depreciable property of a prescribed class by virtue of section 1105 of the Regulations, Part XVII assets are depreciable property as defined in paragraph 13(21)(b) of the Act. Since the transaction in your example occurs after 1971, the son will be acquiring depreciable property of a prescribed class rather than a Part XVII asset by virtue of paragraph 1702(1)(k) of the Regulations.
On the disposition of depreciable property acquired before 1972, if the capital cost is less than the fair market value on valuation day and the proceeds of disposition (we are assuming this is your situation), subsection 20(1) of the Income Tax Applications Rules, 1971 ('ITAR') applies. The application of subsection 20(1) of the ITAR is discussed in Interpretation Bulletin IT-217 (enclosed). Generally speaking, the application of subsection 20(1) of the ITAR and paragraph 13(7)(e) of the Act to the situation you have described will result in the following:
(a) the father's proceeds of disposition (the "deemed proceeds") will be deemed to be equal to the aggregate of his capital cost and the excess of sales proceeds to the son over the fair market value on valuation day; the father's deemed proceeds constitute the "transferor's proceeds of disposition" in clause 13(7)(e)(i)(B) of the Act, and,
(b) the son's cost will be equal to the original capital cost to his father plus 1/2 of the excess of selling price over fair market value on valuation day. Further if the father claims a capital gain exemption under section 110.6 of the Act, the son's cost will be reduced accordingly.
You may wish to note that for purposes of subdivision c of Division B of Part I of the Act, the adjusted cost base of depreciable property is its capital cost, pursuant to paragraph 54(a) of the Act.
We trust the above comments will be of assistance.
Yours truly,
ORIGINAL SIGNED BY ORIGINAL SIGNÉ PAR D. B. MORPHY
for Director General Specialty Rulings Directorate Legislative and Intergovernmental Affairs Branch
SP/hm