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Comfort Provided for ITA 85.1(5) Share for Share Transfers Between Foreign Corporations

Subsection 85.1(5) of the Income Tax Act (Canada) provides a tax-free rollover of shares where the transferee issues shares to the transferor as long as the exchanged foreign shares are capital property to the transferor.  A recently introduced provision will now restrict the application of 85.1(5) in the following situations:

(i)                 where the transferor and transferee are not dealing at arm’s length immediately before the exchange,

(ii)                where the transferor controls the transferee immediately after the exchange, or

(iii)              where non-share consideration is received.

The CRA provided for further possible amendments to this provision in a Comfort Letter dated December 16, 2005.  The comfort letter was written in response to a review of a transaction involving a corporate reorganization of a widely held foreign corporation that is listed on a prescribed stock exchange.  The reorganization required that Canadian shareholders exchange their shares of two foreign corporations in the same corporate group.  The taxpayer’s concern was that 85.1(5) required that the foreign purchaser corporation “issue” its shares to the vendor shareholder in exchange for shares of another foreign corporation.  Since the shareholder in this case was not “issued” shares but simply acquired them as a result of the exchange, they would not be entitled to the rollover provided under this provision.  The taxpayer was concerned that this result was not consistent with the intention of the provision and therefore the provision should be amended to account for these types of transactions.  The CRA agreed and accordingly, recommended that the provision should be amended by replacing the “issuance” requirement with a requirement that the shareholder “acquire” the shares of a foreign purchaser corporation.  The recommendation is effective for transactions occurring after July 1, 2005.

While every amendment to the Act, presumably, will either clarify outstanding issues that cause confusion about the application of a certain provision or ensure that the policy rationale behind that provision is reflected in its application, it also makes the already complicated piece of legislation governing foreign business activities more complicated.  Hopefully, the benefits of introducing these new amendments will outweigh the disadvantages associated with maneuvering through the ever-changing rules governing foreign business activities of Canadian corporate taxpayers.

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