Principal Issues:
1. In the light of the decision of the Federal Court of Appeal in the case of The Queen v Sommerer, will subsection 75(2) apply in the two situations?
2. In the case of a poor valuation of the fair market value of the transferred assets, if a Price Adjustment Clause is provided for and the conditions listed in paragraph 1.5 of Income Tax Folio S4-F3-C1 are met, will CRA recognize the validity of the Price Adjustment Clause?
Position: General comments.
Reasons: Previous positions.
FEDERAL INCOME TAX ROUNDTABLE 11 October 2013
2013 APFF CONFERENCE
Question 7
Sommerer - Application of subsection 75(2)
In Canada v. Sommerer (footnote 1), the Federal Court of Appeal ("FCA") upheld the decision of the Tax Court of Canada ("TCC ") to the effect that subsection 75(2) does not apply to a person who sells property to a trust at FMV in a legally recognized sale transaction even though that person is a beneficiary of the trust.
The FCA thus reiterated that the only possible interpretation of subsection 75(2) is to the effect that only the settlor, or a subsequent transferor who could be considered a settlor, may be the "person" to whom reference is made in subsection 75(2).
Questions to the CRA
a) In light of that decision, what is the CRA's position as to whether or not subsection 75(2) applies in the following situations?
For the sake of clarity, the objective of this question is to obtain the CRA's comments on the application of subsection 75(2) in the context of transactions at FMV and not on the determination of FMV.
Situation 1:
An individual ("Mr. X") held common shares of the capital stock of a corporation ("Corporation"). Mr. X was also the beneficiary of a resident trust ("Trust") but was not the settlor.
In order to effect an estate freeze, Mr. X exchanged, pursuant to section 51, his common shares of the corporation and received as consideration from the corporation:
- only preferred shares. In addition, Mr. X subscribed for common shares of the capital stock of the Corporation;
- preferred shares and common shares.
In both cases, the preferred shares had a redemption value equal to the FMV of the exchanged common shares. The new common shares had a nominal value. For the purpose of this situation, you assumed that subsection 51(2) was not applicable. Subsequently, Mr. X proceeded to sell his new common shares at their FMV to the Trust.
Situation 2:
An individual ("Mr. X") held a rental property and was also the beneficiary of a resident trust ("Trust") but was not the settlor.
2.a) Mr. X proceeded with the sale of his income property to the Trust at its FMV.
2.b) Would the answer be the same if:
(i) Mr. X, at the time of the sale of the property, took back an interest-bearing amount owing?
(ii) Mr. X, at the time of the sale of the property, took back a non- interest-bearing amount owing?
(iii) the Trust obtained a bank loan to finance the purchase of the building?
b) In the event of a faulty determination of the FMV of the transferred property, and a price adjustment clause was provided and the conditions listed in paragraph 1.5 of Income Tax Folio S4-F3-C1: Price Adjustment Clauses were satisfied, would the CRA give effect to this price adjustment clause in the situations described above?
CRA response
We have assumed that the sale of property to Trust by Mr. X is a sale according to the rules, principles and concepts in force in Quebec, more particularly those provided for in the Civil Code of Québec ("C.C.Q."). The property sold, being the common shares in Situation 1 and rental property in Situation 2, is hereinafter the "Property".
Taking into account the FCA’s decision in Sommerer, the sale of the Property by Mr. X to Trust, at a stipulated price and for consideration equal to its FMV, does not result in the income from the Property being attributed to Mr. X by virtue of ITA subsection 75(2). However, the Property acquired by Trust must not be a property substituted for a property otherwise contributed by Mr. X.
As stated by the FCA in CIT Financial Ltd v. Canada (footnote 2):
“The jurisprudence is clear that the determination of fair market value is a question of fact rather than a question of law. … There is ample authority for the proposition that a trial judge is entitled to arrive at his own opinion as to value.”
In Carr v. The Queen (footnote 3), the TCC noted that the legal definition of "fair market value" adopted by Canadian courts was:
“...the highest price an asset might reasonably be expected to bring if sold by the owner in the normal method applicable to the asset in question in the ordinary course of business in a market not exposed to any undue stresses and composed of willing buyers and sellers dealing at arm's length and under no compulsion to buy or sell.
This judicial definition reflects the key elements of the definition of "fair market value" in Information Circular IC-89-3 (footnote 4).
Determining in this case whether a consideration comprising a balance of sale or money reflects the FMV of the Property is a valuation issue that cannot be decided by the Income Tax Rulings Directorate.
Finally, as stated in Income Tax Folio S4-F3-C1 ("Folio"), the CRA will recognize a price adjustment clause in computing the income of all parties where all of the conditions described in paragraph 1.5 of the Folio are met. In addition, paragraphs 1.7 and 1.10 of the Folio give examples of adjustments to the consideration or describe the tax implications that arise from such adjustments.
Danielle Bouffard
957-2747
2013-049572
FOOTNOTES
Note to reader: Because of our system requirements, the footnotes contained in the original document are shown below instead:
1 2012 FCA 207.
2 2004 FCA 201.
3 2004 TCC 434.
4 IC89-3 Policy Statement on Business Equity Valuations