Advanced Tax I

ADAM LEVENE

NOTE: The ITA stipulates in s.248(1) that a person includes a corporation and a taxpayer also includes a
corporation. If a section only talks about an individual - then it does not relate to corporations.

I. BASIC CONCEPTS
I) Residence of Corporations

s.2(1)
A person becomes subject to Canadian income tax for the year if the person is resident in Canada at some point in
the year. If so resident in Canada, s.3 requires the person must report all income in the year from Canada and
outside of Canada.

Just as we were concerned with the place of residence of an individual, the same idea holds true when we’re
dealing with the taxing of a corporation.

There are three scenarios regarding the residence of a corporation:

a) s.250(4)(a)
states that if a company was incorporated in Canada after April 26, 1965 the corporation is deemed to be a
resident in Canada for the taxation year.

b) s.250(4)(c)
If incorporated before April 26, 1965, then s.250(4)(c) deems the corporation to be resident in Canada in the
year if:

(i) It carried on business in Canada at any time after April 27, 1965 (this is pursuant to s.253 and The
Queen v Gurd’s Products Ltd (FCA). This is a question of fact.
(ii) it was resident in Canada under the common law test of residency at any time after April 27, 1965.
Note: If it is found to fall under s.250(4)(c) they are deemed always to be resident of Canada thereafter.

c) If the corporation was incorporated outside Canada it will be resident in Canada in the year if it meets the
common law test of residency.

The Common Law Residency Test

DeBeers Consolidated (1906)

Facts: A company was incorporated in South Africa, and that is where the head office is located. The shares
were widely held by people in England and South Africa. As well, shareholder meetings and the actual mining
was done in South Africa. However, pursuant to the corporate constitution, the directors meetings could be held
in either South Africa or England. Apparently some of the more important decisions were made at directors
meetings which were held in England.
Held: The House of Lords stated that the corporate residency is determined by the location of the exercise of the
central management and control of the business. The place of incorporation is irrelevant. Because the
substantial business was held at board meetings in England, that is where the residency of the corporation was.

Management and Control s.97(1)(b) of the Manitoba Corporations Act and s.102 of the Canadian Corporations
Act state that the management of a company is vested in the directors, and therefore where directors meet is
generally where management and control is occurring.

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In some jurisdictions the shareholders may legally take over the management, eg. s.140 MCA and s.146 CBCA,
in which case the common law residency of the corporation would be the place from which the shareholders
exercise their management.

FIEN FACT: Look out for stuff in Unanimous Shareholder Agreements that take away the director’s powers.
This could serve to shift the management and control.

The common law test of residency is always the place of de facto management, that is, the actual site of
management and not the place in which the corporation ought legally to be managed pursuant to its incorporating
documents:

Unit Construction v Bullock

Facts: Three companies incorporated in Kenya (3K) and were wholly owned by a U.K. corporation. The 3K
companies didn’t carry on business in the U.K., and there charters specifically prevented them from holding
board meetings in the U.K. The 3K ran out of $ and the board of the parent company began to call the shots
although the board’s of directors of the three companies continued to meet in Kenya.
Held: The House of Lords held that the residency of 3K was in U.K. notwithstanding the lack of the 3K board
meetings in the U.K. Management and control is a defacto test. What the charter of a corporation says can be
different than actual exercise of control. This is all a question of fact.

EXAM: Look at the actual site of management and control, and not where it ought to be. From this case, it can
be taken that if the Board of Directors of a United States corporation stands aside while Canadian shareholders
actually carry on the management, the corporation will be resident in Canada.

NOTE: The Crossley and Capital Life cases hold that it is theoretically possible for a corporation to have dual
residency if the management and control are equally split between the jurisdictions. In the case of dual residency,
the governing tax statute with Canada may provide some relief.

For instance, Article IV(3) of the Canada-U.S. Treaty resolves any dual residency problem by overriding the
governing domestic laws of Canada and the United States and assigning residency to the country of
incorporation.

Note: In this course we are going to assume that we are dealing only with resident Canadian companies.

II) CONTROL OF A CORPORATION

Note: Assume that 51% constitutes control of a corporation

This is not the same as control(a) in the residency concept. This refers to the control of the actual company, and
not just the business.

NOTE: Throughout the Act, the word control is used in numerous sections. In some sections there will be a
definition which is to be used exclusively for the application of that section (s.186(2)), and in other section there
will be no definition given (s.251(2)).

So we have to look to the common law to define control when no definition is given ...

Buckerfield’s Limited v MNR (Exch. Ct.) and Vina Rug (Canada) Ltd. v MNR (SCC)
Held: Defined control as resting in the shareholder(s) who own sufficient votes to elect the majority of the
company’s board of directors. Generally this will mean owning 51% of the voting shares as an individual
shareholder or in a united group of shareholders.

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The amount of shares required for control is usually 51% but make sure to check the by-laws for the specific
corporation. (For this outline, it is assumed that 51% constitutes control.

Certain sections of the ITA do not refer just to control of a corporation, but refer to control of a corporation,
directly or indirectly in any manner whatever(a)

s.256(5.1)
defines this phraseology to mean where a person or group of persons has any direct or indirect influence that, if
exercised, would result in control in fact of the corporation.
An example of this might be a situation where a person held 49% of the votes and the balance was widely
disposed among many employees of the corporation.

This is a very troublesome definition and could extend to any situation where shares of a corporation were held
by persons who could reasonably be expected to vote their shares in accordance with the wishes of other persons.

Query: What if there isn’t an individual that has 51% of the shares?
Answer: It is unclear how to find the actual control group. RC has found that such a control group (holding 51%)
must have some common interest.

Common Interest = 1. By virtue of family relations.

2. Through a long history of business dealings.

This is a question of fact and is always open to dispute that there is not a common interest. For family it is
harder to argue that there is not a common interest.
REMEMBER: Those sections which have definitions of control will not make use of this.

Query: What if I own 51% of the shares, and my brother owns 13% of the shares, do we form a control group?
Answer: Nope, Southside Car Market is authority that only I would be in control. The fact that a minority
shareholder is related to the holder of 51% is irrelevant.

Query: What if Tony owned 51% of the shares in corporation A, which in turn held 51% of the shares in
corporation B?
Answer: The court in Vineland Quarries v MNR (1966, Excheq Ct) stated that in such a situation, the
shareholder which controls the initial corporation is deemed to control any such linked companies.
NOTE: In the case of Tony, he has control of corporations A and B. Not indirect control. Indirect control refers
to a different situation (see below)

Parthanon Investments Ltd. v MNR (97 DTC 5343 FCA)

- Substantiated the point made in Vineland Quarries.

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RELATED PERSONS:
*ADD in 2(b)*

(A) Individuals:

s. 251(1)
(a) Related persons (i.e., those connected by blood relationship, marriage or adoption) are deemed not to deal
with each other at arm’s length; and
(b) It is a question of fact whether unrelated individuals are dealing with each other at arm’s length at a given
moment. (For the purposes of the course, assume that unrelated persons are dealing at arm’s
length.)

s.251(6) - blood relationship = (a) descendants & siblings

(b) spouse, sibling’s spouse, descendant’s spouse
(c) adopted child or descendant’s adopted child.
Note On Arelated Persons: This does not include uncles/aunts and nieces/nephews. Note also the expanded
definition of spouse in s. 252(4)now includes cohabitees for one year or more, or less if there is a child of the
union. S.251(1) is an irrebuttable presumption.

(B) For Corporations:

To determine if an individual is related to a corp use s.251(2)(b):

s.251(2)
(a) connected by blood/marriage/adoption
(b) corporation & (I) person who controls (II) person related to the person who controls the corp or (iii)
person related to the person in (I) or (II)
(c) two corps controlled by same person or by related persons.
(For proper subsection references for exam, see the Act)

To determine if two corps are related:

refer to s.251(2)(b) and s.251(2)(c) above and s.251(3)

When two corporations are related to the same corporation within the meaning of s.251(2), they shall be deemed
to be related to each other

s.251(4) defines:
Related group means a group of persons each member of which is related to every other member of the group;
Unrelated group means a group of persons that is not a related group (this group would have to be related
through a past history of commerce).
NOTE: If two people are not related, they both cannot be related to the corp by virtue of their ownership.
However, for two corps to be related, it doesn’t make a difference if they are considered to be part of a related
group or not.

s.251(5)
(a) where a related group is in a position to control a corporation, it shall be deemed to be a related group that
controls the corporation whether or not it is part of a larger group by which the corporation is in fact controlled.

(b) where a person has a right under control, either immediately or in the future and either absolutely or
contingently:
(i) to, or to acquire, shares of the corporation to control the voting of the corporation, unless contingent
on death, bankruptcy or permanent disability of an individual, he will be deemed to be in the same position of
control as the current owner.

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 (ii) to cause a corporation to redeem, acquire or cancel any shares of it capital stock owned by other
shareholders of the corporation, the person shall, except when the right is a contingent one dependent on the
death, permanent disability, or bankruptcy of an individual, be deemed to have the same position in relation to
the control of the corporation as the current owner.

(c) where a person owns shares in two or more corporations, the person shall as shareholder of one of the
corporations be deemed to be related to himself, herself, or itself as shareholder of each of the other
corporations.

*SEE PROBLEMS ON RELATED PERSONS, PAGE 2(c)*

INDIRECT CONTROL
s.256(5.1)
Defines indirect control as when an individual holds influence which results in control in fact. This influence is
held in a manner other than through 51%.
- This is defacto control, not direct control.

EXAMPLE: Jim holds 49% of the shares a of a public corporation, which the other 51% is held by 10,000
shareholders. The court will find that he holds such influence that it is equivalent to control in fact.

Interpretation Bulletin 6 R3 Paragraph 19:

- States that if a corporation is completely dependant on a sole supplier or customer, then that party may have
control in fact.
CY: doubts that this is the case.
- The IB also states that if a company relies completely on a manager etc. then that individual may have control
in fact.
CY: A little more probable, but not likely.

II. COMPUTATION OF THE TAXABLE INCOME OF A CORPORATION

A corporations tax year is it’s fiscal period.

Fiscal Period
s.249.1(1)(a)
states that a corporation can pick any fiscal period which ends no more than 53 weeks away. Once a fiscal year
end is picked, it’s permanent. This means that the first fiscal period can be very short, then all subsequent
periods will be 52 weeks in length.

S.249(1)(a)
states that where the Act refers to a taxation year, it means the fiscal period ending in that year.

Note: s.249.1(1)(b) states that certain professional organizations must have a December year end. The only type
of professional organization which this effects in Manitoba is veterinarians.

Note: If in the Act they refer to a calender year, they are referring to a fiscal period.

Filing
s.150(1)(a)
states that a companies return must be filed within 6 months of the fiscal year end.

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Instalments
s.157(1)(a)
states that monthly instalments (which must be paid on or before the last day of each month) paid by a
corporation must be the lesser of:
(a) 1/12 of estimated tax liability (only if you think you are making less this year than last year); and
(b) 1/12 of tax liability of preceding year.
and then
(c) within two months of its fiscal year end (three months if corporation is eligible for the Small
Business deduction which will be taken later and if its taxable income for the preceding year is $200,000 or less)
pay the difference between actual tax liability for the year and its monthly tax instalments.

BUT ... if the payment is based on this years estimation because you think that it’ll be less than last years, and the
corporation doesn’t pay enough, then RC charges interest at the prescribed rate +4%. The interest starts to run
from the first underestimated instalment. If the payment is based on the preceding year and it isn’t enough, no
interest is charged.

s.157(4) and Regulation 5301

Defines First Instalment Base(a) as 1/12 of your tax of the preceding year. The first instalment base is what you
use to pay your first month’s taxes and each month’s subsequent taxes.

Query: What if the taxes owed by the company last year is less than the amount owed this year?
Answer: The balance of the taxes owing must be paid within 2 months of the corporations fiscal year end. (Note
that filing isn’t required for 6 months, so get an accountant to guess!)

Query: What if the taxes owed last year are greater than those owed this year?
Answer: RC will pay back the difference, along with interest at the prescribed rate + 2%. But the interest only
starts to accumulate 6 months after fiscal year end (presuming you wait to pay until two months after your year
end)
s.164(3)(b)
States that no interest to be paid until the day that is 120 days after the end of the year.

S.3 APPLIED

A review ...
Section 3 - Interpreted
s.3(a) Aggregate all sources of business, property, employment, officer, and general source and any deemed
income under s.56
(Basically all of your positive income goes into this section)

s.3(b) Determine the amount, if any, by which

(I) taxable capital gains (this will include taxable capital gains on personal use property except on listed
personal property)
- except from disp of listed personal property

taxable net gain from disposition of listed personal property

Exceeds

(II) allowable capital losses

except from disposition of listed person property

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and
except allowable business investment losses (ABIL’s can be offset against ordinary income, not just against
taxable CGs)

Note: s.3(b) cannot be negative. If losses exceed gains, the entry in this section will be zero. You are restricted
to apply your allowable capital losses against your allowable capital gains.

Note: In relation to listed personal property, these gains are netted out in taxable net gains from disposition of
listed personal property and thus are not included in taxable capital gain.

38 Add s.3(a) + 3(b)

less

Subdivision (e) deductions: s.s. 60-66 (not responsible for)

3(d) Amount arrived at in s.38

less
losses from all sources of business property, employment, office
less
allowable business investment losses

and s.3(d) amount is income

- s.3 will apply the same way to corporations as it does to individuals EXCEPT ...
A) a company will never have employment income;
B) dividends are taxed differently when they’re received by a corporation.

- The following are possible types of income:

a) income from business (either providing services or from the disposition of inventory);
b) income from property (interest, royalties, dividends, etc.)
(c) capital gains (from disposition of capital property).

- A corporation resident in Canada must report its world wide income under s.3 ITA.

DEFINITIONS:

Taxable Canadian Corporation(a) =

s.89(1) defines this as a corporation resident in Canada.

Corporation Resident in Canada(a) = Is a definition which includes both taxable Canadian Corporations and
those which are common law residents.
NOTE: For the purposes of this course, Taxable Canadian Corporations and Corporations Resident in Canada
will both be considered as residents in Canada.

Dividend

s.248
Defines a dividend to be any corporate dividend and includes a stock dividend

Taxable Dividends
s.89(1)

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Taxable dividends are defined in this section to be all dividends except capital dividends (which will be discussed
later - for our purposes right now, all dividends are taxable dividends)

DIVIDENDS AND THE THEORY OF INTEGRATION

RECALL the theory of integration as it relates to dividends for individuals:

$ s. 82(1)
Taxable dividends, for the purpose of this course, include
(a)(ii)(A) the total of all amounts received by a taxpayer in respect of taxable dividends; PLUS
(b) an additional 25% (unless the taxpayer is a registered charitable trust).

$ IN OTHER WORDS, the combined effect of these is to require 125% of total dividends to be included in
income!

$ s. 121 (Tax Credit Section)

When a dividend is received, the taxpayer is entitled to a TAX CREDIT of 2/3 of 25% of the value of the
dividend (i.e., 1/6 of the dividend) [the s.82(1)(b) amount]. Recall that a tax credit is a straight deduction from
total taxes payable (i.e., not just from income). This gives the individual credit for the taxes already paid by the
co.

$ Why is this? A corporation is a separate legal entity (Salomon v Salomon, H.L.), so why should other people
be taxed in respect of its income? Well, the theory of integration taxes both the corporation and the individual so
that the amount paid on the dividend adds up to what the individual would pay. That way, there will be no
differential tax rate for an individual depending on whether he owns a business directly or is a shareholder in a
corporation which owns that business. The tax credit is reimbursement for the tax paid by the company on the
dividend money. Note: every fed. tax credit results in a prov. tax credit.

FOR A CORPORATION ...

s.82(1)(a)(ii)(A)
- A company must include the full amount of the dividend as income.

- s.82(1)(b) does not apply to a corporation. Therefore, a corporation is only including 100% of the dividend in
income, not 125%.

s.112(1)(a) allows a company to subtract the full amount of a dividend. This means that none of the dividend is
actually included.

Query: Why aren’t corporations taxed on dividends?

CY: Remember that dividends are paid on shares by the board of directors. Also don’t forget that solvency tests
will restrict the paying out of these dividends. s.40 MCA and s.42 CBCA state that you can only pay dividends if
after the payment of the dividend there is enough realisable value left to pay all liabilities and stated capital.
Otherwise, the board of directors will become personally liable. (See page 6(a) for a sample balance sheet).
However, for this course we can assume that dividends are properly paid out.
Answer: It is tough to set out a corporate tax rate when there are bunch of different shareholders who are
themselves in different tax brackets. Sure RC could tax the corporation 20% of the dividend received, but then
everything gets screwed up when the corporation pays out dividends to its shareholders. So, to avoid confusion,
RC doesn’t bother taxing the corporation on dividends received.

.EXAMPLE:

Butch Nepon owns Nepon Inc., a corporation which owns Butch’s Generic Soft Drink Shop.

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If Butch owned the shop personally, he would pay tax on income earned from that source (T).

Since the corporation owns it, the corporation must pay tax on that income (T 1) while Butch must pay tax on the
dividends he receives from the corporation (T2).

Theoretically, T should equal (T1 + T2). We don’t want to penalize Butch for owning a corporation. Here’s how it
works:

(1) Nepon Inc. has a taxable income of $1,000. Corporations pay 20% tax, including provincial tax, so Nepon
Inc.’s total tax payable would be $200 leaving it with retained earnings and potential dividends of $800.

(2) Butch gets $800 in dividends and declares 125% of this = $1,000. He is in the 29% tax bracket, so:
(a) Federal tax = 29% x $1,000 = $ 290.00
(b) Tax credit = 1/6 x $800 = $ 133.33 -
(c) Net federal tax = $290 - $133.33 = $ 156.67
(d) Provincial tax = 52% x $156.67 = $ 81.47 +
(e) Butch’s total tax = $156.67 + $81.47 = $ 241.14

(3) Add this to the corporate tax paid ($200.00) and the total tax paid on the shop’s income is $441.14. Therefore
Butch is left with $558.86.

(4) If Butch had been a sole proprietor, his tax would have been:
(a) Federal tax = 29% x $1,000 = $ 290.00
(b) Provincial tax = 52% x $290 = $ 150.80
$ 440.80

True, the two figures aren’t exactly the same, but they’re close. Had the provincial rate been 50%, which is what
s. 121 assumes because of variation between provinces, everything would have been hunky-dory.

How does this work? In essence, the tax credit has the effect of negativing the tax paid by the corporation, or
vice-versa, so that there are no additional ramifications of owning a business through a corporation rather than
directly:

(1) The corporation pays 20% tax (both federal and provincial) on its net s. 3 income, leaving 80% of
income as retained earnings, declared as dividends.

(2) The individual pays tax on 125% of the dividend (which corresponds to 100% of net corporate
incomeC125% x 80% = 100%) (regardless of what tax bracket the individual is in), but gets a 1/6
federal tax credit, which has the following ripple effect:
Let D = dividend = 80% of net corporate income (i.e., remainder after 20% tax)
(a) Federal tax credit: 1/6 (D)
(b) Provincial tax credit: 50% x [1/6 (D)] = 1/12 (D)
(Note that provincial tax is calculated as 50% of net federal tax, which means the
taxpayer benefits from another 50% of the s. 121 tax credit.) Savings on
Provincial tax
TOTAL: [1/6 (D)] + [1/12 (D)] = 3/12 (D) = 1/4 (D)

(3) 1/4 D = 25% x (80% corporate income) = 20% corporate income = TOTAL CORP. TAX

Under the above circumstances integration is brought about by s.82 and s.121 as follows:

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 (a) The corporate tax rate of 20% leaves the corporation with 80% of the initial corporate income to be
paid out as a dividend. s.82 will impute the original income of the corporation to the individual shareholder
receiving the dividend by including in the shareholders income 125% of the dividend amount.

(b) s.121 then has the algebraic effect of reducing the individual shareholder tax from what it would
normally be, by a tax credit which is equal to the tax of $20 which the corporation has already paid.

NOTE: When the business tax rate or the individuals tax rate significantly changes (eg corporation taxed at 45%)
then the Theory of Integration is thrown way off kilter, and the existence of the corporation completely changes
the amount of tax being

*SEE PAGE 9 + 10 of EM for an EXAMPLE of the THEORY OF INTEGRATION*

NOTE: The result of this is that an individual who is in the 50% tax bracket, will end up only paying
approximately 30% tax on dividends, so as not to duplicate payments made by the corp.

s.112 WHEN A CORPORATION RECEIVES A DIVIDEND ....

Individual - Corporation A - Corporation B - Corporation C

- Corporation C is taxed at 20%, Corporations A, B and the individual receive dividends as the money moves
down the line.

s.112
A tax at every level of corporations would be impossible to calculate by RC. So the only tax being paid is the
20% by corporation C, and then the individual must calculate the tax when he receives the dividend.

- The dividends which are being moved from corporation to corporation are not new income, and have already
been taxed at the corporate rate through C.

Difficulties arise with the theory of integration because in reality:

1) The combined federal and provincial corporate tax rate on income earned by a corporation is not always the
theoretical 20% due to federal tax policy (integration is not always sought to be achieved) and also due to varying
provincial corporate tax rates among the provinces, and

2) The provincial personal income tax rate on the individual shareholder receiving the dividend is not generally
the theoretical 50% but normally is higher.
IE: MB has a 52% rate (see s.4(4) of the MBITA)

*SEE CHARTS ON PAGES 13-16 TO SEE HOW THESE DIFFICULTIES OCCUR*

Chart II - Page 13
- This chart illustrates the effect of a higher provincial tax rate on the theory of integration. The MB tax rate for
individuals is 52%, results in the individual paying only slightly higher tax (.02%) then he or she would have to
if they were earning the income through a sole proprietorship.
Chart III - Page 14
- This chart illustrates the theory using a Canadian Controlled Private Corporation earning active business income
ineligible for the small business deduction. As shown, this does not effect the Integration Theory very much. It
results in an individual earning income through the corp paying 1/2% higher taxes then he or she would have to
pay if the money was not flowed through the corporation but rather received directly by the individual.
Chart IV - Page 15

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- This chart illustrates the theory of integration for a Canadian Controlled Private Corporation earning investment
income. This type of corporation is taxed at 25%. In this case, the interposition of a corporation results in 3.25%
more tax then if the money was flowing directly to the individual.
Chart V - Page 16
- This chart shows the effect on the Theory when the federal and provincial combined rate for corporations is
45%. This is when the theory is thrown out of whack as if you allow the money to flow through a corporation as
opposed to directly to the individual, you will end up paying 17% more tax.

NOTE: Deferring Dividends prevents the Theory of Integration from fully applying since as we all know, the
theory requires that the individual receive a dividend. This means that if the corporation holds onto the profits
(even after the 20% corporate tax), then a portion of tax owing on that money will be held back from RC. This is
a viable tax planning alternative since then the corporation can make use of the money until a dividend is
eventually paid out, and nothing forces a corporation to pay a dividend. Therefore, there is still an advantage to
be gained where the retained earnings are left in the corporation such that the second level of tax is deferred.
- For example, if the individual shareholder is paying tax at a combined federal and provincial tax rate of
44% (ignoring surtaxes), then earning income in a corporation rather than directly in his or her hands will defer
about 24% tax.

Summary
1) Integration means that there is no overall saving or cost in tax when income is earned through or a corporation
or an individual.
2) When assumptions of integration are ignored, the theory is thrown off, making taxes higher when income is
taxed at the corporate level and then at the individual level as opposed to just the individual level.
3) Even if the theory is off, you can still defer paying tax through earning income through the corporation.

(C) Corporate Tax Rates

- Tax rates of companies are a function of two different things:
a) category of company;
b) type of income the company is earning.

GENERALLY:
S.123(1)(a)
of the Act sets the initial federal tax rate on corporate income at 38%
NOTE: The tax rate is not dependent on the quantum of annual income - i.e. corporations do not have
progressive tax rates in the way that individuals do. It is a flat rate regardless of income.

HOWEVER:
S.124(1)
reduces the rate to 28% if the income is earned in a province in Canada (as contrasted with being earned in a
foreign country)
- This section is known as the provincial tax credit and anticipates that provinces will be levying their
own provincial corporate rate of tax on top of the federal tax.

- This rate applies "taxable income earned in a province" which shifts our attention to s.124(4)(a) (which
defines province) and ultimately Reg. 400-413.

PROVINCIAL: Each province has it's own tax rate which it applies to corporations.

Q. So which province taxes a company which carries on extra-provincial business?

A. Regulations 400-413 of the Act sets out rules which determine which province has the
right to apply its provincial tax rate to the companies income. All provinces have agreed

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 to use and abide by these rules. (Don’t worry about these regulations, unless they are highlighted in this
outline).

IN MANITOBA s.7(1) of the provincial act (Chapter I10, 1980 RSM) states that a corporate rate of 17% will be
paid on income which is earned in the year in Manitoba. S.7(5) cross references to s.124(4)(a) of the Act and
therefore applies the above mentioned regulations to determine if Manitoba can tax the corporate income.

NOTE: Page XXI of our Act lists the 1996 Provincial Corporate Tax Rates

TOTAL CORPORATE TAX =

FEDERAL TAX RATE (28%) + PROVINCIAL RATE (?)

Unlike personal income tax calculations, the provincial rate is not just a percentage of the federal amount. For
corporations, it is a straight add-on.

REGULATIONS 400-413 DETERMINING WHO CAN TAX....

1. Reg. 402(2) states that a province may only tax a corporation's income if the company has
a permanent establishment in the province.

"Permanent Establishment" is defined at regulation 400(2) as a fixed place of business of the corporation,
including an office, branch, mine, oil well, farm, timberland, factory, workshop, or warehouse.
(see page 1940 of Act for full def'n)

2. Reg. 402(1) states that when a company has a permanent establishment in only one prov.
that prov. can tax all of the companies income no matter where it was earned.

3. If the corporation has no P.E. in a particular province, that province cannot tax any of the corporation’s income
even if it earns revenue in the province or has employees in the province.

4. Reg. 402(3) states that where a company has a permanent establishment in more than one province, we must
look at the following formula to determine how it is to be taxed. (formulae are based on revenues earned in the
various provinces and salaries paid to employees in the various provinces).

FORMULA: A. What proportion of salaries for the corporation were paid in that prov.?
B. What proportion of gross revenues were made in that prov.?
C. What is the average of these two fractions?

eg. 1/4 of salaries were paid out in the province.

2/4 of gross revenues were made in the province.
Therefore, 1/4 + 2/4 = 3/8 of corporate income can be taxed at the provinces rate.
2
NOTE: s.248(1) defines gross revenues which basically are all amounts received or receivable in the year
otherwise that as or on account of capital and all amounts included in computing the taxpayer’s income from a
business or property for the year.

SO FOR GENERIC CORPORATIONS IN MANITOBA....

S.123(1)(a) Sets the federal corporate tax rate at 38%

S.124(1) Provides for a 10% tax rate reduction
S.7(1) of the Manitoba Act puts the provincial rate at 17%

12
 THE CORPORATION IS TAXED AT 45%

Note: Most provinces impose a provincial corporate tax rate of 15% or 16%, but Alberta’s rate has in the past
been 3-4% below that.

d) Categories of Corporations

- Although the general corporate tax rate is 45% in Manitoba, there a further reductions to either or both of the
federal and provincial portions of this rate for certain categories of corporations.

- There are basically four categories of corporations:

1. Public Corporations [ All are taxed at 28% (fed.) + 17% (prov.) = 45% ]

Definition is found at s.89(1) (page 702), but we're most concerned with the requirement that the company have
a class or classes of shares of the capital stock of the corporation listed on a prescribed stock exchange in Canada.
Reg. 3200 lists the prescribed stock exchanges as Alberta, Montreal, Toronto, Vancouver or Winnipeg.

NOTES: Because the net corporate tax rate is much larger than the assumed 20% in the
Theory of Integration, the tax actually paid in such a situation will be much higher. However,
public shareholders will usually earn money through stock trading, and as a result not put a lot of pressure on the
company to declare a
dividend.

NOTE: For manufacturing and processing public corporations, the federal rate is reduced by another 7%.

2. Private Corporations other that CCPC’s [ All are taxed at 28% (fed.) + 17% (prov.) = 45% ]

As defined in s.89(1), these are corporations which are resident in Canada, but are not
public corporations nor are they controlled by public corporations.

Note: For manufacturing and processing private corporations, the federal rate is reduced by another 7%.)

Note: Private Corporations other than CCPC’s may also have to pay 33.33% federal tax on certain dividend
income (remember, dividends aren’t part of taxable income) which tax is refunded when the dividend income is
in turn later dividended out.
(This will be discussed later in the outline)

3. Canadian Controlled Private Corporation (CCP(C) [ 3 tax rate....discussed below ]

As defined at s.125(7) such a corporation is resident and incorporated in Canada.

And is a private company.

It is also a corporation that is not controlled, directly or indirectly, by one or more non
residents or by one or more public corporations, or any combination of such.

NOTE: Cy seems to say that directly or indirectly is akin to "control in fact" as defined at s.256(5.1). So, if 50%
of a corporation are owned by a resident of Canada, and 50% are owned by a non-resident, the company would
still be a CCPC.
Note: S.125(7) is a negative definition, if there is no non-resident control, then you are a CCPC.

13
NOTE: S.251(5)(b) sets out that where a non-resident has an option (eg. through shareholder agreements etc.) or
right to acquire shares in a CCPC, that person is deemed to already have those shares for the purpose of
determining control.
- This turns out to be very important as income earned in a CCPC is the only type of corporate income,
as we will see, that will allow us to come close to integration.

4. "No-Label" Corporation
This is simply any company which is not a private nor public corporation under the above categories. For
example, non-resident corporations and controlled subsidiaries of public corporations.

- This type of company cannot be found described anywhere in the ITA. This category is used when a corp does
not fit into any of the other definitions. These types of corporations are covered by sections of the act which deal
with corporations of all types.

- The tax rate for these companies would be 45%.

Parthenon Investments Ltd. v. The Minister of National Revenue (97 DTC 5343)
- Issue, whether the appellant was a CCPC within the meaning of s.125(7)(b)
- Facts, All the voting shares of the appellant were owned by Pacific Canada, and all of the voting shares of
Pacific Canada were owned by Pacific International Equities Inc. (Pacific U.S.), an American corporation, which
in turn was owned approximately 2/3 by F.M.E. Investments Ltd and one-third by H.S.M. Investments Ltd, both
Canadian resident corporations.
- MNR took the position that the fact that the appellant was indirectly owned by Pacific U.S. was enough to make
it ineligible under the provision, as there was indirect control by a non-resident. This was even though the U.S.
corp was ultimately controlled by a Canadian corp.
- Held, the appellant was a CCPC. In this case, control rested ultimately in the hands of Canadian residents.
NOTE: This contradicted RC IT 458 R, which suggested that if you have a chain of companies, one of which is a
non-resident along the way, it would not be possible for one of the other companies in the chain to be a CCPC.

TAX RATES FOR CCPCs

A. Active Business Income (up to $200,000 per year)

This income is taxed at 21%. 12% federal and 9% provincial. This rate is only applicable
to CCPC's which have less than $15 million taxable capital in the preceding year as calculated under s.125(5.1)
(formula is on page 1006) of the Act. This rate breaks down as follows:
s.123(1)(a) Fed ITA - 38%
s.124(1) Fed. ITA - - 10%
s.7(1) Man. ITA - + 17%
s.125(1) Fed ITA - - 16%
s.7(3) Man. ITA - - 8%
21%

B. Investment Income (includes specified business income, income from property and taxable capital gains
income)

This income is taxed at 51.67% initially. 34.67% federal and 17% provincial. However,
once the dividend occurs 26.67% of the federal tax is refunded so the final rate is 25%.
Meaning 8% federal and 17% provincial. (This throws you about 3 1/4% away from integration). The rate breaks
down as follows:

14
 s.123(1)(a) Fed ITA - 38%
s.123.3(a) Fed. ITA - + 6.67%
s.124(1) Fed. ITA - - 10%
s.7(1) Man. ITA - + 17%
51.67%

26.67% s.129(1) and 129(3) Fed ITA (when 25% retained earnings are dividended out.

C. Active Business Income (greater than $200,000 per year)

This income is taxed at 45%. 28% federal and 17% provincial.

Note: For manufacturing and processing the federal rate is reduced another 7%. This is only for active business
income in excess of $200,000 for the year.)

D. Personal Service Business Income

This income is taxed at 45%. 28% federal and 17% provincial.

Note: May also have to pay 33.33% federal tax on certain dividend income (remember, dividend’s aren’t part of
taxable income) which tax is refunded when the dividend income is in turn dividended out. (This will be
discussed later in the course)

E. For Corporations Which are Neither Public nor Private

This income is taxed at 45%. 28% federal and 17% provincial.

Note: For manufacturing and processing the federal rate is reduced another 7%.

This means that only A. comes even close to achieving integration. (With investment income not that far off)
LOOKING AT CCPC INCOME....

START: Begin at a rate of 45% and then look at the income to see if the rate should be reduced.

Active Business Income

S.125(7) Defines this type of income as any business carried on by the corporation other than a specified
investment business or a personal services business and includes an ANT. (Therefore, in order to know what
ABI is you need to know what PSB income is)

"Personal Service Business" Is defined at s.125(7) as a corporation providing services where an individual who
performs services on behalf of the company (or any individual
related to that individual) is a specified shareholder, and but for the
existence of the company the individual would be considered an
employee of the customer.

"Specified Shareholder" Owns at least 10% of a class of shares in that corporation.

- Essentially, there are three essential ingredients required for income to qualify as being from a PSB:
a) There must be an incorporated employee;
- this is simply an individual who performs services on behalf of the corporation.
b) the incorporated employee must be a specified shareholder or related to a specified shareholder;

15
(c) Abut for the existence of the corporation(a) the services provided by the incorporated employee in fact are
such that he would reasonably be regarded as an officer or employee of the person or partnership(a) receiving the
services.

eg. Billy works for Dickee Dee ice-cream and frozen yogurt as a "test licker." Billy is paid 25 cents per lick,
which is not a bad salary since Billy is by far the faster licker west of Toronto. One day Billy quits Dickee Dee
and creates a corporation named "Just the Way You Lick It". Billy is the sole shareholder of "Just the Way" as
well as being the sole employee. Billy approached Dickee Dee and offers to sell them the services of a licker who
they employ (namely Billy). Dickee Dee agrees. This means that Dickee Dee now pays "Just the Way" for Billy's
services, and Billy receives a salary from "Just the Way". Voila, Billy is suddenly in a much lower tax bracket
since he can fool around with the salary amount, dividends paid etc. However, RC is much too smart to let this
go, so they created the Personal Service Business. So, this means that Billy doesn't get all the tax breaks since,
but for the existence of "Just the Way", he would be an employee of Dickee Dee.

- Because PSB’s are charged at 45%, it will result in the individual paying 17% more tax when he or she receives
the income from the corp through a dividend. As a result, it is not very attractive to make a PSB anymore.

EXCEPTIONS:
a) Even if you fall within all of s.125(7), if the corporation has more than 5 full time employees throughout the
year, this section would not apply (note: it doesn’t make a difference if these five individuals are specified
shareholders). To be safe to fall in this exception you should make sure that the five full time are involved full
time with the business. Also should be employed throughout the year.
IE: A receptionist might not count as they would probably not be seen as involved full time in the business.

Q. What about the difference between an employee and an independent contractor?

A. I'm glad you asked. It is important to remember that even without the corporation there,
in some instances "Billy" would still only be an indep. contractor and not an employee.
To make this determination, do the old Weibe Door stuff to see if the individual would qualify as an employee
anyway.

Tests to determine the nature of the relationship

(I) Control Test

$ What is the nature and degree of control which the employer exercises over the worker?

$ The more control (e.g., of working hours, job description, pattern of remuneration, location of work [facility of
employer?], how much direction is given to employees), the more likely the worker is to be an employee.
Performing Right Society v. Mitchell and Booker (1924, K.B.)

$ This test is not that helpful today, since many bona fide employees work at home or without much contact with
their employers.

(ii) Part and Parcel (Organization) Test (also referred to as the integration test)

$ To what extent is the worker integrated into the employer’s system of business? Is he an integral part of the
business or an accessory to it - Stevenson Hordan and Harrison Ltd. v MacDonald and Evans (1952).

- In McFarlane v MNR, a C.A. who was engaged by a university to teach one four-month course was found to
be an independent contractor after the court noted that he chose the time and day when the course was taught,

16
selected the textbook for the course, was probably not required to provide the university with a course outline,
did not provide an ongoing need to the university, etc.

In Wiebe Door Services Ltd. v. M.N.R. (1987, Fed. C.A.), the court held that the test must be applied from the
employee’s perspective and not the employer’s, as the answer in the latter situation would nearly always be that if
the employees were gone, the business would fail. The test is a mater of circumstance and fact.

(iii) Economic Reality Test

$ If the worker has no real financial interest in the success or failure of the task he is performing (i.e., no risk
associated with failure), he will generally be considered an employee. Note that this refers to financial interest in
the worker’s task, not in the employer business! - Montreal v. Montreal Locomotive Works Ltd. (1947, SC(C)
Conversely, if the person has a significant monetary interest in the success of the company, this points to this
being business, not employment income.

Another important part of this test is if someone has to incur out of pocket expenses for tools etc. When someone
has to do this, this points to someone being an independent contractor as opposed to an employee.

This is a significant test today, but not foolproof, since some employees work for commission or incentives, etc.

(iv) Freedom to Delegate Test

Based on the presumption that an employee’s contract of service seldom contemplates the performance of work
by someone other than the employee, if the choice exists of whether to perform the work oneself or delegate the
responsibility, the worker is often an independent contractor.
A contract for services does not usually require the work to be done personally - Alexander v MNR
Not foolproof, though, because some contractors cannot delegate because of the nature of their work (e.g.,
graphic artist), while some managers with power of delegation are still employees.
(v) Specified Result Test

Was the worker hired for a general labour function (usually for an indeterminate period), or was he hired to
perform a specific, defined task? The former will usually be an employee, while the latter will often be an
independent contractor. - Alexander v MNR (Exch. Ct.)

(vi) Entrepreneur Test

In Wiebe Door, supra, the court held that no one test is sufficient, that all the tests must be considered together
as a four-in-one process, with no one test dominant over the others. The answer will always be a question of fact,
based largely on the results of the tests.

Finally, note that in applying the different tests or criteria, it is clear that it is always the substance of the
relationship which governs and not its form. - Fergusion v John Dawson and Partners (Contractors) Ltd.
(1976, Eng. CA)

NOTE: If you call something a contract of employment, this is insignificant for tax purposes. We are always
looking at the substance, not the form.

Office Holding: Certain people are deemed to be employees by the Act as a result of the office they hold:
S.248(1) - Office
means the position of an individual entitling the individual to a fixed or ascertainable stipend or remuneration and
includes a judicial office, the office of a minister of the Crown, the office of a member of the Senate or House of
Commons of Canada, a member of a legislative assembly or a member of a legislative or executive council and
any other office also includes the position of a corporate director.

17
This is really an override of common law principles as these people would probably be considered independent
contractors under the common law test.

Gagne v. M.N.R. (1983, T.R.B.)

The taxpayer was a lawyer who was retained by a law firm. He was compensated by way of a share of the firm’s
gross income. He argued that he was either a partner or an independent contractor, and that either way he was
entitled to claim business deductions.
Held, he was an employee and could not claim such deductions. All the tests were considered, and it was found
that:
(1) He was not a partner in the firm, as he had no capital investment in it;
(2) There were no risks associated with his employment, as the firm indemnified him for all potential
liability; and
(3) The firm retained a high degree of control over his work.
NOTE: Revenue generally allows associates to report themselves as independent contractors so they can have the
expense deductions which are available to independent contractors but not to employees.

Wiebe Door Services Ltd. v. M.N.R. (Supra)

W installed and repaired overhead doors and employed workers on the understanding that they were independent
contractors, responsible for running their own businesses and paying their own taxes and any contributions for
workers compensation, UIC, and CPP. M.N.R. assessed W the UIC and CPP premiums payable for the workers
as employees..
Held, the workers were independent contractors. The court employed the entrepreneur test, a combination of all
the traditional tests, and found that such factors as control, organization, risk, ownership of tools all pointed to
the workers’ being independent contractors. The answer is always a question of fact.
- The court notes that the entrepreneur test is not a fourfold test but, rather, is a four-in- one test with
emphasis on the combined force of the whole scheme of the operations.
NOTE: The court states that the agreement between W and the workers as independent contractors did not in
itself make the workers independent contractors. The court must carefully examine the facts to come to its own
conclusion.

Marotta v. The Queen (1986, Fed. Ct. T.D.)

M was a doctor who was appointed to a position as physician in chief and given a professorship at a teaching
hospital. His duties included teaching and administrative tasks, and was supplied with an office and staff by the
university. M was responsible to the chairman of the university’s Department of Medicine for the quality of
teaching of medical students at the hospital. His salary was paid directly to him by the university. The university
withheld source deductions and M participated in the university’s registered pension plan and in its group life and
long term disability plan. With respect to carrying out of his duties, M was given great latitude and freedom. He
entered into a partnership with other doctors for the provision of medical services to the hospital, and included his
university salary as partnership (business) income.
Held, this was actually employment income. Despite a large degree of autonomy, M was still an employee of the
university. The following factors were considered:
a) the business in which M was principally engaged was the university’s and not his own (his work in
private practice was to be limited to a maximum of $15,000;
b) the work done was fully integrated within the teaching organization of the university; and
c) the work was not defined by or limited to a specified task or specified objective in any contractual
sense.

NOTE: The problem in applying these tests for PSB’s is not only do you have to determine if someone is an
employee or an independent contractor but also you need to pretend away a corporation to make the
determination.

Background for PSB’s

Sazio v. MNR (1969)

18
- S resigns as coach, and then offers his services through Sazio Inc. RC taxes S on the full salary and disregards
the existence of Sazio Inc.

COURT: It is o.k. for S to do this. RC should look at who can sue for the salary. In this case, the contract is
between S Inc. and the team, S himself has no legal claim. Furthermore, there is nothing wrong with a
corporation coaching a football team.

MNR v. Leon (post-Sazio)

- Same idea, a group of brothers incorporated themselves and then sell the services back to the original company
through the newly formed corporations.
COURT: Accepted an argument from RC that the corporations in such situations are actually "shams" without
any real business purpose. Therefore, tax individuals.
- This was a bizarre case and threw the law into disarray

Stubart Investments (post-Leon)

COURT: Leon was wrongly decided. One shouldn't look for a legitimate business purpose. Such a requirement
would allow RC to ignore tons o'stuff in the Act which is aimed solely at tax advantages, not business purposes.

SO, RC DECIDED TO....

Create a statutory bar to this whole situation with the Personal Service Business definition.
Put a catch-all anti-avoidance clause at s.245.
This section prohibits a taxpayer taking advantage of the tax benefits of any transaction that was
designed to avoid paying tax.

NOTE: Cy says there is a bias in the court system against finding PSB’s, perhaps because of the large penalties
which the T may face. Not that the court has said that it is salting their thinking, but Cy just sees this as a trend.

Of course, there are some situations where the court found that a Personal Service Business did not in fact exist....

David T. McDonald Company Limited v MNR (TaxCt, 1992)

Facts: All preferred shares of DM Comp were owned by David McDonald and all common shares owned by his
wife and children. DM therefore was a specified shareholder within the meaning of s.125(7) of the Act. DM
entered into an agreement with S. Corp. Under the terms of this agreement, DM was appointed as S Corp.’s sole
and exclusive sales and marketing manager for its footwear products in Canada. The Corp was paid directly by S.
Corp. for DM’s services and the Corp in turn remunerated DM. The Minister reassessed claiming the Corp was a
PSB.
Issue: Whether DM could reasonably be regarded, within the meaning of s.125(7) as an officer or employee of S.
Corp. Abut for the existence of(a) the corp taxpayer.

Held: The Corp’s appeal was allowed. During the time in issue, DM kept his own schedule including spending
winters away, he was not integrated into any administrative organization of S. Corp., he did not report to its
president or any senior officers, and he did not participate in its pension or medical plan. Therefore, he was an
independent contractor and not an employee pursuant to the Wiebe Door test.
NOTE: Cy states that the fact that DM had not been employed by S Corp prior to DM Corp being hired was very
important to the courts determination that he was in fact an independent contractor
NOTE: DM was a director of the company. This allowed him to sign certain documents on behalf of S. Corp.
The court and counsel for MNR agreed that this fact is of little significance.

Societe de Projets ETPA Inc. v. MNR (TaxCt, 1992)

Facts: Fact situation is the same as Sazio etc. except that the individual in this case had a long term business
relationship with the client. The individual is arguing that he was an independent contractor with the client for
many years, so even with a corporation present the situation is not a P.S.B. Here the individual argued that he
was completely independent, devoted half of his time to this supposed employer and half of his time to managing

19
income properties comprising some thirty units. These properties are owned by another company of which he is
also the sole shareholder and director.
Issue: Whether or not T corp could reasonably be regarded as an officer or employee of the corp for which the
specified shareholder was providing work to through the T corp.
Held: Applies the Weibe Door criteria, focusing on control over the individual by the client, and finds that the
situation is not a P.S.B. The specified shareholder was completely independent in his projects, for which he was
to bear the risk and cost; and there was no fringe benefits of any nature. Taking responsibility for costs, including
rent, and expenses relating to designing or developing projects, including the travel expenses required in order to
meet customers, both outside the province and outside the country, indicates Independent contractor status. There
was also no guarantee of payment. There was no express exclusivity relating to business between the parties. He
even paid rent for the office he held at the supposed employer. But for the corporation, the individual would not
be an employee of the client.
EXAM: A previous business relationship existed between the specified shareholder and the corp receiving
the services. Where a previous business relationship existed, a good indicator of employment rather than an
independent contractor is how plans (medical, pension) were applied to the individual. If the person was covered
by the companies medical plan etc. it is probably the case that he was an employee. Therefore, the creation of a
corporation causes a P.S.B. situation.
However, in Societe the individual had resigned from the pension plan, and stayed in the health plan but repaid
the company premium. This sorta balances out the tendency to lean towards a P.S.B. where the individual was
covered by company plans. Also even when there was no corp and the specified shareholder did work for the
supposed employer, the T was completely independent in his projects for which he bore the risk and the cost if
things did not materialize.
NOTE: Cy does not understand why he was not found to be an employee.

ANOTHER FIEN POINT: Judges may be reluctant to find a P.S.B. because of the huge costs to the taxpayer
upon such a ruling.

Factors which may help in determining a P.S.B.

1. As mentioned above, check out whether the company plans had applied to the individual,
and perhaps even if they continue to apply notwithstanding the corporation. If plans are
applicable, it's leaning towards a P.S.B.

2. See how many clients the corporation is dealing with. If there's only one client, once again it seems to hint at a
P.S.B. (This idea can also help in determining employee vs. indep. contractor, if an individual is dealing with
more than one "client", she's probably not strictly an employee). If you think there is a chance of a PSB and you
want to assist your client in avoiding this trap, have them provide services to more than one entity.
NOTE: Unless you are over the five full time employee mark, the fact that you are providing services to
more then one entity does not mean that you are not a PSB on its own.

3. How many full time employees does the corporation have (this is discussed below).
Is it greater than 5?

4. What exactly does the corporation provide to the client? The definition of a P.S.B.
requires that the corporation provide services to the client. Perhaps it is a good that is
actually being provided. (eg. corporation hired to do research, but payment isn't made
until a report is handed over, arguable that the corporation is providing a good (report)
as opposed to a service (research)).

NOW BACK TO THE P.S.B. DEFINITION AT SECTION 125(7).... (pg. 1007)

20
"....is a specified shareholder" Luckily for us, "specified shareholder" is defined at s.248(1) as an individual
owning directly or indirectly

"....or of another related company" This is just put in to prevent the creation of a whole bunch
of corporations to avoid the P.S.B. section.
(you know, a long line of corporations)

s.248(1) definition of specified shareholder (responsible for preamble and s.(a) + (d))
A specified shareholder of a corporation in a taxation year means a taxpayer who owns, directly or indirectly, at
any time in the year, not less than 10% of the issued shares of any class of the capital stock of the corporation or
of any other corporation that is related to the corporation and, for the purposes of this definition:

(a) a taxpayer shall be deemed to own each share of the capital stock of a corporation owned at that time
by a person with whom the T does not deal at arm’s length.
(d) you will be deemed to be a specified shareholder of a corporation if you or a related person to you
has the option to buy shares in the corp.

The effect of all this is to avoid related individuals setting up holding companies to set up PSB’s. It is also
important to realize that in the case of a situation where the individual, or a person related to that
individual holds an option to purchase shares of the corporation, RC will consider the individual to be in
possession of these shares. Therefore, even if the individual has no holding in the corporation at this
time, the existence of an option to purchase at least 10% of a specific share will result in the situation
being a P.S.B. (as long as the employee criteria is also satisfied).

This definition in effect makes it very hard to plan from the shareholder’s side of things, therefore, it is necessary
to plan for the service side of things to protect your client.

THE 5 FULL TIME EMPLOYEE EXCEPTION....

S.125(7)(c) defines an exception to a P.S.B. where "the corporation employs in the business throughout the year
more than 5 full time employees".

LOGIC: This takes a situation outside of a P.S.B. because RC assumes that a company which employs more than
5 full time employees serves some real purpose, and isn't just a Sazio attempt to avoid taxes.

Hughes & Co. Holdings Ltd v MNR (TaxCt, 1989)

Facts: This is actually a specified investment business case, but right now we only care about the >5 employees
exception. The section dealing with SIBs contains the identical exception for PSBs in s.125(7). This case deals
primarily with the exception. H's company had 4 full time individuals, and a few part time employees.
ISSUES: 1. Would H qualify as the 5th full time employee? He actually practiced law full
time, but stated that he was available to the company 24 hours a day, 7 days a
week. He visited Brandon from time to time.
2. Would the part-timers be included in calculating the >5 employee exception?
TJ: Found that although H was only paid $8000/yr, and carried on a full time legal career, he was actively
involved in the management of the corporation and could be considered a full time employee. The court also
found that the part-timers would satisfy the >5 exception. Once the threshold of full time employees is met, part-
time employees can be used to meet the over 5 requirements.

CA: Held that H was not a full time employee. The court looked at the fact that he only spent

796 minutes/yr on the phone re: company business. This time period amounted to a shade under 11 hours for the
year. With incoming calls and outgoing calls taken together, as well as other incidentals, the most that could be

21
said arbitrarily was 28 hours. Additionally, the annual honorarium of $8250 paid to Mr. H. For his services falls
far below full time remuneration.
As well, the court held that the >5 exception wasn't satisfied by the part-time employees. It needs to be full time.

Q. So what the heck is full time?

A. It would appear that a full time employee is someone who works the normal or
regularly scheduled hours for an employee of that class.

As far as RC goes, they have stated that if two employees share a full time position where the individuals
alternate days (eg. Mon., Wed., Fri.,) then for the purposes of the Act, they will constitute one full time
employee. However, this doesn't apply where the employees alternate mornings and afternoons etc. (Why? I don't
have a clue).
IE: Secretary working Monday, Wednesday, Friday, with another working Tuesday and Thursday would equal a
full time employee. However, two secretaries who worked everyday, one in the mornings and one in the
afternoon would not equal a full time employee.

Also notice that the exception in s.125(7)(c) requires that the employees be employed "throughout the year".
Interpretation Bulletin 73R5 (para 15) stated that vacancies caused by termination will not disqualify a
corporation from the exception as long as there aren't any undue delays in filling the position.
IE: If someone quits on Dec.28 of the year, it does not mean that you do not qualify provided that there is no
undue delay in filling the position.

NOTE: It has to be more than 5 full time employees in the business. If the employees are working for the corp in
other capacities, but not in the business, the exception will not be met. This is question of fact.

ONE FINAL THOUGHT FOR PERSONAL SERVICE BUSINESSES....

S.18(1)(p)
an outlay or expense to the extent that is was made or incurred by a corporation in a taxation year for the purpose
of gaining or producing income from a PSB, other than the salary, benefits for employees and fees for collecting
overdue accounts is not deductible.

This states that a company which is found to be part of a P.S.B. situation (eg. Sazio Inc.) can't take an income tax
deduction except for the salaries and allowances paid to the incorporated employee. This means that rent, CCA,
and all that fun stuff can't be deducted. So, if RC finds that it's a P.S.B., the taxpayer gets screwed again since a
ton of deductions are lost.

ACTIVE BUSINESS IN CANADA (by a C.C.P.C.)

Definition: S.125(7) defines active business as any business .... other than a specified investment business,
investment or a personal services business and includes an adventure in the nature of trade.

As Well: Income from an Active Business is deemed to include any income from the year
which is pertaining to or incident to that business. s.125(7)

SO HERE'S HOW THE TAXING OF ACTIVE BUSINESS INCOME WORKS....

FIRST $200,000 38% tax from s.123(1)(a)

17% tax from s.7(1) of the Manitoba Act
10% credit from s.124(1)

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 16% credit from s.125(1)
8% credit from s.7(3) of the Manitoba Act

21% Tax on First $200,000 of A.B.I.

OVER $200,000 38% tax from s.123(1)(a)

17% tax from s.7(1) of the Manitoba Act

45% Tax on A.B.I. above $200,000

Example
CCPC earns $225,000 ABI

Tax = 21% x $200,000 = $42,000

= 45% x $25,000 = $11,250
$53,250.00

S.125(1) provides for a 16% reduction in federal tax on the first $200,000 of A.B.I. earned by a corporation. This
is called a small business deduction. Cy has helpfully pointed out that this name is very misleading. It is not a
deduction, it's a tax credit. As well, this is not really limited to small business as any business with less then 15
million taxable capital can claim it,

SECTION 125(1) EXPLAINED ....

- The Federal tax of a corporation that is a CCPC throughout the year is reduced by 16% of the least of

(a) (i) All income from active business carried on in Canada other than fr. a partnership;
(this applies for the simple corporation situation, probably not our exam)

PLUS

(ii) The specified partnership income of the corporation.

"Specified Partnership Income" is defined for us at s.125(7) as being the lesser of the following, for each
partnership which the corporation is a member of.

(a) The corporations share of all active business income in Canada of the P'ship;
or
(b) Corp.'s share of all A.B.I. in Canada of the P'ship x $200,000
All A.B.I. in Canada of the P'ship

This formula determines the amount of the $200,000 deduction which is actually
applicable to the corporation itself. The purpose of this pro-ration is to limit total to $200,000 for low
rate. Remember, it wouldn't be fair if all the partner
corporations could each use a $200,000 deduction. So....

Eg. Three corporations form a partnership. Before the formula was put into place, (s.125(1)(a)(ii)) each
corporation would use a $200,000 deduction. So effectively, the first
$600,000 would be taxed at 21%. This is avoided by the formula. So if the Partnership earned

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$300,000, and each corporation was a 1/3 partner. Then each corporation could claim a 21% rate on the lesser of:
$100,000 x $200,000 = $66,667
$300,000

or $100,000 (Corporations share of P'ships A.B.I. in Canada)

HERE, therefore, $66,667

EXCEEDS (minus iii and iv - ignore example above for purposes of formula)

(iii) All losses from active business carried on in Canada other than from a P'ship.

PLUS

(iv) The specified partnership loss of the corporation.

"Specified Partnership Loss" is defined at s.125(7) as, for each P'ship that the corporation is a member of, the
corporation's share of P'ship loss, if any, from active business in Canada.

(b) Ignore this subsection, it is evil.

NOTE: If the corporation has less than a 365 day fiscal year. (first or last year of business) Then s.125(5)(b)
states that the $200,000 deduction is to be pro rated according to X/365. IE:

Number of days in corporate year x 200,000

365

(c) The corporation’s business limit for the year. S.125(3) defines this to be $200,000 unless the corp is
associated with another CCPC in which case the $200,000 must be allocated amongst all associated corps.
IE: $200,000 = max ABI subject to the low rate annually.
NOTE: Associated companies will be covered later on. However, briefly, associated companies would be two
corps owned by the same person. IE: two shoe stores owned by same person under different corps.

PRACTICAL APPLICATIONS: This 21% tax rate allows the theory of integration to occur. This means that
we can make use of the fact that dividends are not required to be paid out. By having the corporation hold onto
the money, and not declare a dividend, the taxpayer is deferring the second tax which is usually paid by the
shareholders. This idea dies for >$200,000 since the 45% tax rate removes any chance of integration. As well,
RC is very generous in the $200,000 limit. RC will not question a corporation which pays out bonuses in order to
get under the $200,000 limit. Therefore, always try and get the corporation have less than $200,000 A.B.I. and
get the low, low tax rate of 21%.

NOTE: s.125(1)(a)(ii) refers only to partnerships, not joint ventures. Is it possible for multiple corps to
participate in a joint venture and thus exceed the $200,000 limit? This begs the question as to whether or not
there can be a joint venture which is not a partnership? Generally, a joint venture is thought of as a single venture
entered into for a single purpose of relatively short duration, for instance, development of one real estate project.
There appears to be great technical difficulty in distinguishing why such a venture is not also a partnership -
perhaps the answer is that a single venture does not constitute a business - but this is a very debatable point. The
courts have provided very little help. In most situations it is very difficult to distinguish a joint venture from a
partnership which is a relationship between two or more persons carrying on a business in common with a view
to a profit.

*SEE EXAMPLES ON S.125, SMALL BUSINESS DEDUCTION, PAGE 42*

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 BACK TO SOME SECTION 125(7) STUFF AGAIN....

The definition of A.B.I. requires that the source must be a business which is not a SIB or PSB. So, it seems that
the income cannot arise from a property source.

S.129(4) defines a property source as including an SIB,

- Threfore an SIB will be taxed as a property source, not as a business source.
- s.129(4) however does not help us to distinguish between business and property sources.
- It is necessary, therefore, to go back to the common law in trying to determine whether you have a business or
property source.

Q. SO WHY DO WE CARE ABOUT BUSINESS vs. PROPERTY INCOME?

Corporate property income is taxed as investment income. This means that such income is subject to a different
tax rate that business income.

RECALL: Walsh apartment case which discussed the active nature of business vs. property.
Walsh and Micay v. M.N.R. (1965, Excheq.)
$ Two lawyers purchased a couple of apartment buildings and a shopping centre late in 1960 and attempted to
claim the maximum full annual CCA on these properties. CCA can be taken for the full year; but if its a business,
s.11(3) says that the CCA must be pro-rated and therefore, only 1/6 of CCA could be claimed. They argued that
Reg. 1100(3), which requires the pro-rating of CCA, only applies to business sources and not to property sources,
as only a business can have a short tax year. In property source income, the full calendar year is used. SO...were
the rents collected by the taxpayers business or property source income? (Don’t worry about the section numbers)
$ Held, this was a property source, as only minimal janitorial and snow removal services were provided, not more
involved and elaborate amenities such as breakfast, maid or laundry service (court’s examples of what might
indicate a business source). Rent can be classed as either a property or business source. The court focuses on the
degree of labour in determining that the labour provided here was more passive then active and thus making this
a property source as opposed to a business source where the pro-rating CCA would apply. The types of services
provided are what a landlord of a property source would normally provide.
NOTE: The court states that prima facie, the perception of rent as land owner is not the conduct of business. It is
a question of fact as to what point mere ownership of real property and the letting thereof has passed into
commercial enterprise and administration.

In Elm Ridge Country Club Inc v The Queen (TC(C) the court stated on page 723:
The issue is whether the interest income constitutes income from property. The
term property is defined very broadly in subsection 248(1) but this definition is
not very helpful in defining income from property. Since the Act does not define
this expression, it must therefore be given its ordinary meaning. This expression
is generally regarded as signifying the return on invested capital where little or no

time, labour, or attention is devoted to producing the return. No one would dispute
that income from property would normally include dividends, interest, rents, and
royalties.

However, such receipts might constitute income from business if sufficient time and
effort is expended in earning them or if the property is employed and risked in a
business.

CY: For a corporation, there is a presumption that is rebuttable that the activity of a corporate taxpayer is a
business source rather than property source. (See article by John Durnford 1991 Can Tax Journal 1139).

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NOTE: Most of the cases we will look at in this area are pre-1990. Since then the wording and the numbering of
the ITA has changed. Therefore, only read these cases for there general ideas.
Burri v. Q. (FCTD, 1985)
Facts: Corporation owns an apartment building. The apartments were rented unfurnished except for stoves and
refrigerators. A coin-operated laundry was operated by a concessionaire with rentals being paid to B. The tenants
were provided with parking, television cable service and the right to use a swimming pool which was shared with
other adjacent apartment buildings. The property was managed by a property manager. Revenue assessed saying
this was not investment income from a property source but rather ABI.
Issue: Is this a business or property source?
Held: Refers to the Walsh decision and attached importance to the nature and amount of
services provided by the corporation. However, it is a question of fact in each case. Here, the services provided
by the T to the tenants were of a very limited nature and typical of what any owner of a modern apartment
building would expect to have to provide. These services were incidental to the making of revenue from property
through the earning of rent.
- The court also mentioned that possibly there is a rebuttable presumption that corporate income is from a
business source. However, if there is such a presumption, they say it has been rebutted here. Furthermore, they
went on to say that it is usually a question of fact, so don't put too much weight on the presumption.

Etoile Immobiliere v. MNR (1992, TaxCt Can.)

Facts: Corporation owned 158 townhouses which they operated much like a private village and from which they
received rental income. The corp. provided such services as a swimming pool, lots of staff, an elaborate security
system, amusement parks, and large underground parking area. There was security personnel, maintenance
personnel, contract security with dogs, lifeguard, accountant
Issues: Is this business or property source?

Held: There are enough services present to make this a business source. The complex was a large well organized
enterprise. ABI. All of the services involved a great deal more than what would be involved in operating a simple
apartment building. The court would have come to this conclusion whether or not there is a presumption.
NOTE: The court notes the presumption (albeit rebuttable) that income derived from a corporation is business
income.

NOTE: In MRT Inv, the fact that you hire a property manager to manage the property, as opposed to your own
employee is probably not relevant to the determination of business v. property.

Canadian Marconi v. R. (SCC, 1986)

Facts: In this situation the corporation owned a broadcasting division and sold them for 18 million dollars. The
money was invested in short term interest bearing securities and earned interest while the company was looking
for a business to invest the funds. The process of investing this cash involved a bunch of people moving the
money around etc. About 20% of the working hours of the senior company officer placed in charge of
investments was taken up by taking care of the above mentioned investments. Furthermore, at any one time there
were as many as twelve employees involved in the management of the investments. The extent of the activity of
this staff in managing the investments and their vigilance in earning a maximum return from the funds is
evidenced from their numerous purchases completed each year, the variation in the lengths of terms of deposits
made and securities purchased according to the trend of market interest rates and the fact that seldom would the
staff invest interest made in the same investment. Finally, the funds available for investment represented 1/2 of
total assets of the corporation during period in question.
Issue: Is the interest being earned income from a business?
CA: It's property source.
SCC: Wrong, it's a business source. The court mentions the existence of a presumption, and indicates that courts
should examine the activity involved in the income source. The commercial reality was that the T, perhaps
unwillingly and contrary to its business strategy, had been compelled to enter into an investment business

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NOTE: The court states the presumption is an eminently logical one to draw when a company derives income
from a business activity in which it is expressly empowered to engage. However, it must be recognized that the
presumption is rebuttable.
NOTE: This is a question of fact in every case?

NOTE: The same day as the Marconi case decision, the SCC released another decision (Ensite) which stated that
no such presumption existed. Oh well, just mention both on the exam and then use a facts based argument to
decide on property or business. (The Ensite decision will be discussed later in the outline)

Ben Barbary Company Limited v MNR

Facts: Corporation owned a restaurant, bar, convenience store etc. They sold everything except the restaurant and
took a note from the purchase for payment + interest.
Issue: Is the interest due on the note actually income from a business source?

Held: That the activity present did not make it income from a business. Therefore, it's from a property source.
The court went on to discuss the presumption idea found in Marconi and Ensite and makes a valiant, but futile
attempt to reconcile the two decision.
NOTE: In this case the Judge attempted to reconcile Ensite and Marconi in terms of the question of presumption.
He says that the difference can be explained by the fact that M was a big company where E was a small company.
Cy says that this is incorrect and has not been followed at all. He also says that Marconi is the true statement of
the law, and there is a presumption.

Alexander Co. Ltd. v. MNR (90 DTC 1894)

This is a case very similar to Ben Barbary. Here three commercial shopping centers were sold. There was a mtg
back and interest was paid by the purchaser. The interest was found to be passive income from a property source.

ASSOCIATED COMPANIES

Section 125(2) and 125(3) creates an exception to the 21% $200,000 tax break. Where there exists a bunch of
associated companies doing business together, the $200,000 break must be allocated amongst the companies
themselves. This is the same as the partnership idea to prevent the $200,000 from being multiplied by each and
every corporation which is involved in the business.

RULES FOR ASSOCIATED CORPORATIONS S.256(1)(a-e)

Here you go, everything that you ever wanted to know about associated companies, but was afraid to
ask.....which begs the question, why do we need to know about associated companies. Well, according to Cy this
is important when calculating stuff like active business income etc.

Section 256(1) One corporation is associated with another if at any time during the tax year;

(a) one of the corporations controlled, directly or indirectly, in any matter whatever, the other;

(b) both of the corporations were controlled, directly or indirectly, in any matter whatever, by the same
person or group;
"Group" for this purpose is defined at s.256(1.2) as two or more persons who own shares
of the capital stock of the corporation. This is a really wide open definition.

(c) each of the corporations were controlled, directly or indirectly in any matter whatever, by a person
and that person who controlled one of the corporations was related to each member of the group who controlled
the other, and either of those persons owned, in each corporation, not less than 25% of the issued shares of any
class of shares (other than a specified class);
NOTE: This is stricter then related persons provision in general, as this cross-ownership is required.

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 (d) one of the corporations was controlled, directly or indirectly, by a person and that
person was related to each member of a group that so controlled the other corp.,
and that person owned, in the other corporation, not less than 25% of any class (other than a
specified class);

(e) each of the corporations was controlled, directly or indirectly, by a related group
and each of its members of one of the related groups was related to all of the
members of the other related group, and one or more persons who were members
of both related groups, either alone or together, owned, in respect of each corp.,
not less than 25% of a class of shares (other than a specified class).

In addition to these sections, the Act also includes a ton of deeming sections which address the issue of
association.

S.256(2) States that two corporations are associated if they are associated to the same corp.
NOTE: If the middle company elects not to claim any part of the small business deduction, this
will break the association of the two other corps.

S.256(2.1) Gives the MNR the discretion to deem 2 corporations to be associated if one
of the main reasons for having two companies is to avoid/reduce taxes.
The onus here is on the taxpayer to rebut this assertion by showing that the two
companies are held for business purposes. This is tough since how many
companies were created without tax benefits being at least one of the factors
considered?
NOTE: Cy says that this plays a large preventative role. If the businesses are of different sorts and do not violate
any technical rules, however, Revenue tends to leave you alone.

NOTE: By virtue of s.251(2)(d), an adopted child has the status of a natural child. This is consistent with the
common law.
*SEE AND DO QUESTIONS ON PAGE 44(a) - 44(c) IN EXTRA MATERIALS*

NOW BACK TO THE RULES IN SECTION 256(1)(a-e)....

Under this area of tax law, there have been a lot of changes from the common law.

1. Group Common Law: Requires a common relation through blood or business.

S.256(1.2)(a): Any group of individuals which hold shares in a corp. are a group.
There is no common interest required

(a) Control Group Common Law: Requires some business link or shared interest. Act: Any combination of
shareholders w/>50% of shares

(b) Individual + Group Common Law: A control group can't contain an ind. with >50%.
S.256(1.2)(b)(i): Still a control group even with such an individual. Therefore,
even where one individual controls the company (IE: owns over 51%) that individual is still in a control group
with other shareholders of the corp.

(c) Multiple Control Groups Common Law: There can only be one control group/corp.
S.256(1.2)(b)(ii): There can be multiple control groups
IE: A owns 60% of company, B & C each own 20% of the company.
There are four possible control groups in this scenario, A; A&B; A&C; A&B&C.

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NOTE: There does not need to be a common interest between the parties, to be a group you can be enemies.

2. Control There are essentially four different types of control here:

(i) S.256(5.1) states that a person or group shall be considered to be in control where
that person holds direct or indirect influence over the corporation that, if exercised, would result
in control in fact; (the determination of this is a question of fact)

(ii) Where a person or group holds >50% of the shares of a corporation;

(iii) S.256(1.2)(c)(i) Where a person or group holds shares which amount to >50% of
the fair market value of the corporation (shares need not be voting);

(iv) s.256(1.2)(d) Where you have a corporate shareholder the shares owned by the corporate shareholder
are deemed to be owned by the shareholders proportionate to the value of its share ownership.

3. Share Ownership Common Law: Simply means owning shares of a corporation.

S.256(1.2)(d): States that when shares of a corporation (1) are
owned by another corporation (2), the shareholders
of corp.2 are deemed to own the shares of corp.1 in
proportion to their holdings of corp.2.

(a) Children S.256(1.3) stated that when a person who is under 18 yrs. old holds shares in a corporation, for the
purposes of determining whether the corporation is associated at the time with any other corporation that is
controlled directly or indirectly in any manner whatever by a parent of the child or by a group of persons of
which the parent is a member, both of their parents are deemed to own these shares unless it can, having regard
to all the circumstances, it can reasonably be considered that the child manages the business and affairs of the
corporation and does so without a significant degree of influence by the parent.
(** Notice that it says both of their parents, so this created two scenarios).

4. Contingent Interests S.256(1.4) where an individual holds a contingent right (eg. option) to purchase shares in
a corporation, they are deemed to own those shares. (This is except where the right is not exercisable at the time
because the exercise thereof is contingent on the death, bankruptcy, or permanent disability of an individual)
NOTE: This is important in the context of shareholders agreements as often in such agreements there is a right
for certain shareholders to acquire shares in the future. Therefore, if you draft with contingent rights, you might
end up with an associated company even though one was not intended.

5. Related to Yourself S.256(1.5) states that where a person owns shares in two corps.

they are considered to be related to themself.

AN IMPORTANT LAST NOTE....S.256(1.1) states that for the purposes of s.256(1)(a-e) when the analysis
focuses on holding 25% of a class of shares, if those shares are of a specified class, then ignore that
holding when determining association.

Specified Shares Are preferred, non-voting with cumulative dividends; non-convertible or exchangeable; and the
amount entitled to on redemption is not greater than FMV
POLICY: This permits many investments which have no control issue at all.

Hughes Homes Inc. and Her Majesty The Queen (Tax Ct, 1997)
Facts: HH was owned by both H and W, each owning 50% of the shares. W was responsible for the furnishing
and interior decorating of these show homes together with the colour coordination and finishing of the interior

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and exterior of all homes. W incorporated Lopa to provide these services to HH. She only provided these services
to HH. In 1990, W reduced her holding in HH to 10% from 50% (Cy says to avoid the cross-ownership
provisions)
Issue: Are Hughes Homes Ltd. and Lopa Enterprises Ltd. deemed associated corporations by virtue of subsection
256(2.1) of the ITA. IE: Was one of the main reasons for the seperate existence of Lopa to reduce the amount of
taxes that would otherwise be payable if the operations carried on by HH and Lopa were realized as one
corporation.
Held: None of the reasons for the incorporation of LOPA were for tax and therefore not under s.256(1.2). No
inference can be drawn that the tax savings that resulted from this incorporation and share reduction can
reasonably be considered to be one of the main or principal reasons for LOPA’s seperate existence. The onus is
on the H and W to show that none of the main reasons for the seperate existence of the two corporations was that
of reducing taxes. This is question of fact. Here the evidence showed that Lopa was incorporated without any tax
advice and that the T’s were not aware of the rules regarding associated companies. Furthermore, while the two
corp’s business complimented eachother, they were adequately seperate and distinct. Also, the court accepted H
and W’s assertion that the one of the main reasons for having two seperate corp’s was asset protection.
NOTE: Cy says that this is ridiculous and that there is no good reason for them to have done this other than tax
saving. He hopes that this will be appealed.

INVESTMENT INCOME BY A CCPC

- Why do we care? Because s.129(3)(a) provides that part of the 45% corporate tax rate
will be refunded if the money is aggregate investment income

DEFINITION: Section 129(4) defines Aggregate Investment Income (AII) as....

TAXABLE CAPITAL GAINS - ALLOWABLE CAPITAL LOSSES
PLUS
INCOME FROM PROPERTY SOURCES (other than dividends not includible in income by virtue
of s.112 which for our purposes is all dividends)
LESS
LOSSES FROM PROPERTY SOURCES

- It is very important to note that because of the definition of "income or loss" from a property source in
s.129(4.1), income and loss from a property source now includes those from a specified investment
business.

- The same definition also states that income from a property source does not include income from any
property that is incident to the active business.

SO HERE'S THE BIG BREAK....

Section 129(1,3) provides for a 26.67% tax refund when the AII flows from the corporation through dividends.
This means that AGI is essentially taxed at 25% which is damn near integration (about 3% off)! - this will be
gone into greater detail below.

Specified Investment Business is defined in s.125(7) as:

A business (other than ... a business of leasing personal property) the principal
purpose of which is to derive income from property (including interest, dividends,
rents or royalties) unless:
(i) the corporation employees in the business throughout the year more than five full time employees;

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(ii) in the course of carrying on an active business, any other corporation associated with it provides managerial,
administrative, financial, maintenance, or other similar services to the corporation in the year and the
corporation could reasonably be expected to require more than five full time employees if those services had not
been provided.

COMPONENTS OF AII....

1. Capital Gains and Losses: Remember that the difference between capital gains/losses and
business sources is the whole adventure in the nature of trade idea. If the RC thinks that
the source of the money is an A.N.T., it'll fall under Active Business Income not AII.
(See summary of capital gains from last year at the end of this section)

2. Property Source: Once again we must look back to stuff that we took earlier (meaning
earlier this year, and last year).

Here's a quick summary as to why it is important to determine if the income is coming from a property source.
As mentioned in the definition of AII, income earned from a specified investment business falls under the
definition of a property source. As income under AII, the amount of tax will be 25% eventually following
the dividends.

BUT, if the source is found to be ABI then it'll be taxed at 45% after the first
$200,000 which is taxed at 21%. So, in different situations the taxpayer will want to
argue different sources.
eg. Taxpayer gets $150,000 from a source. She'll want the court to find that the source
was incidental to business (ABI) and is taxed at the "small business" rate of 21%.
However, if the amount is in the millions, the taxpayer will want the source declared
property and taxed at an eventual 25%. RC will argue the opposite.

EXAM TIP: If possible, bonus out any ABI above $200,000 to take advantage of RC's lenient
position on such payments, and get the 21% tax rate.
NOTE: One thing it is necessary to remember about arguing how something should be characterized is that
businesses fluctuate. Therefore, it is necessary for a business to consider a long term view of there future income
to determine how they want income that could be an SIB or ABI to be characterized.

- The cases that concern themselves with SIB’s relate to situations where the company is carrying on a business,
but the company has cash out of the business in some way that gives rise to interest income by virtue of its
investment. Is this interest income ABI or is it SIB.

- Remember the definition of income of the corporation for the year from an active business from s.125(7) is the
corporation’s income for the year from an active business carried on by it including any income for the year
pertaining to or incident to the business other than income for the year from a source which is property.
- Therefore, any income which is incidental or pertaining to an active business is ABI.
- Furthermore, s.129(4) defines income or loss for a property source to include SIBs but not to include income or
loss from any property that is incident to or pertains to an active business.

Marconi pg. 35 of this outline

- Recall that this case was about interest that the company earned on an investment.

Issue: Is this income incidental to or pertaining to income, or is it a new property source?

Held: It's a business source, therefore ABI taxed at 45% (w/21% rate for first $200,000)

REALITY: If you really think about it, all companies have some sort of bank account that they use for everyday
business stuff. Of course, such an account will earn some amount of interest. This is clearly incidental to the

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business and would fall under ABI. BUT....if the money is clearly surplus cash, and not required for the everyday
operation of the business then any interest earned could more easily be considered to be coming from a property
source and therefore AII.

Q. v. Marsh and McLennan (FCA, 1983)

Facts: M was a huge insurance firm which acted as a go-between for other insurance providers. The purchasers of
insurance would first pay their premiums to M, who would then remit the amount to the individual insurance
companies within 60 days. Of course, during that dead time M would hold between 15-22 million dollars and
invest same in short-term debt instruments. This makes a fair bit of interest.
M: Argued that the money was AII (this is probably because it was more than $200,000)
Issue: Was the income to be characterized as ABI or SIB.
Held: The funds which earned the interest are incidental to the business of M, therefore the interest earned is ABI
and taxed at the appropriate rate. The court used the terminology "temporary surplus required for ongoing
business". The investment transactions were incidental to the main business; there was no separate investment
business. The money was necessary to pay the insurance companies. This is a question of fact.
per LeDain: TEST is to ask whether the money fund was employed and at risk in the business. M required
this money to meet its everyday business obligations (IE: to pay the premiums)
- If you are investing capital that is clearly needed for the operation of the business it is going to be found to be
incidental and ABI.

Q. v. Brown Boveri Howden Inc. (FCA)

Facts:- B built turbo generating equipment. When B made a turbo generation agreement, it generally was a four
or five year agreement as this was how long it would take to build generally. Throughout the contract, the
customer is charged progress payments on a schedule. The money was necessary to be paid before B would
proceed to the next step in the process. Sometimes that money would be paid, but wouldn't be needed by B right
away and, you guessed it, they earned interest.
Issue: ABI or AGI?
Held: Followed Marsh and said that the money was used in carrying on business and the interest came from a
business source therefore ABI tax rate.
TEST: The funds were required by B to meet its business obligations, and were at risk in the business.

Ensite Ltd. v. Q (SC(C) (remember, this was the case that said there was no corporate business presumption)
Facts: E decided to finance the establishment of a manufacturing plant in the Philippines. The T decided that it
would commit up to five million dollars of its own money, while the rest of the capital requirements, up to forty
million dollars would be covered by loans. The loans were made available through swap arrangements between
the Central Bank of the Phillippines and the commercial banks which made the loans to the taxpayer’s Philippine
branch. The commercial banks obtained Philippine pesos from the Central Bank upon depositing U.S. dollars
with the Central Bank. The T made U.S. dollar deposits with the commercial banks, which then made the peso
loans in an equivalent amount to the T’s Philippine branch. The U.S. dollar deposits were made by the T out of
surplus cash retained from its operations. The T took the position that the interest earned on the deposits was
investment income.
Held: The proper test was whether the property was employed and risked in the business. The test emphasized
that the holding or using of the property must be linked to some definite obligation or liability of the business.
Risk means more than a remote risk. Elaborated on LeDain's test in Marsh and asked if the withdrawal of the 40
million would have a destabilizing affect on E's business. The court states that the threshold of the test is met
when the withdrawal of the property would have a decidedly destabilizing effect on the corporate operations
themselves. The answer is yes since w/o the cash, the plant wouldn't be built. Result = ABI tax rate.
NOTE: Employed and risked = would the business be destabilized
- This serves too narrow the Ledain test which this court felt was too broad as under the employed and risked test,
everything that a creditor could attack would be part of the business and this would cover most assets.
NOTES: 1. If corporate funds are put aside for immediate obligations to be met = ABI
2. If corporate funds are put aside to meet capital needs in the future = AII
(Cy doesn't think this distinction makes a lot of sense (exam?))

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NOTE: As to the SCC comments relating to the Ledain test, Cy says they are just probably trying to explain
Ledain’s test and that Ledain’s test is always applied. However, discuss both on exam; matter of semantics?

Q. What about the fact that Marconi and Ensite contradict each other about the idea
of a corporate presumption of business income?
A. per Cy: In Marconi the issue was a basic "property vs. business" source dilemma. In Ensite the issue was
whether the funds were "incident to" business, since the "property vs. business" conflict had already been
decided. So, maybe there is a rebuttable presumption that corporate income is from a business source when
addressing the fundamental issue of "property vs. business" but there is no such presumption for the later analysis
of "incidental to".
This, in Cy’s opinion is the most plausible analysis but has never been addressed by the courts.

A Potpourri of Elements In Computing Business Income by Brian Carr

-This articles examines the existence of a corporate presumption by analyzing the Marconi and Ensite cases.

-Nb to distinguish b/w prop and bus income b/c dft tax treatments and dft sections of the ITA apply to each.
-Each of the Ensite and Marconi decision is significant not simply b/c the ct drew a distinction b/w income from
a bus and income from prop in a specific factual situation, but b/c of the nature of the distinction which the ct
drew in each case and the reasoning that the Ct used to arrive at its decision.
-While the SCC affirmed the existence of the presumption in Marconi, by virtue of the decision in Ensite the ct
has thrown into doubt the meaning of the presumption and the circumstances in which it will apply.
-It is not obvious that the cases referred to by Madam Justice Wilson in Marconi should have been followed by
her in determining that there is a presumption that income earned by a corp is income from business as opposed
to income from property for purposes of the ITA.
-Ct in Marconi says that the presumption can be rebutted but never gives guidelines as to circumstances in which
the presumption could be rebutted but merely cites a few cases where it was rebutted. In addition, the ct is not
helpful in giving a framework (of facts) against which one can judge whether income is income from a bus or
income from a property.
-It is unfortunate that the SCC did not make a pronouncement as to whether the presumption applies under the
new legislation which do not require corps to have specific objects clauses. the author suggests that the
presumption should not just disappear in this case.
-The decision of the ct in Ensite raises the basic issue of the circumstances in which the presumption applies.
-If any meaning is to be given to the stmt of Wilson in Ensite that the presumption does not apply where to do so
would collapse the distinction b/w ABU and other sources of income which Parl clearly intended to preserve.
-If the presumption is merely one of evidence, and if one can prove all the relevant facts, the decision of the ct
will be the same whether or not the presumption applies (i.e. if the presumption applies just rebut it based on the
facts to show that prop income or not rebut it to show bus income). However, Wilson in Ensite implies that
where the presumption does not apply, the activities must be more substantial to support the conclusion that the
income is income from a bus and not income from property.
-The ct has not indicated the test to be applied in determining whether the income is property income where the
presumption does not apply.

Q. v. Irving (FCTD, 1992)

Facts: The T was engaged in the fur business, deriving its income from sales commissions, sales of raw skins,
and sales of manufactured fur coats. Held certificates of deposit which gained interest. Reported such interest as
business income qualifying for the small business deduction. Minister reassessed.

Held: The company had nothing but its certificates of deposit to give it continuity and stability. It had no fixed
assets, no work in hand, and little inventory. On the other hand, it would buy furs for resale and be at risk
therefore until paid by its purchasers. It’s collection rate from such purchases was high, however, and it was
inconceivable in any event, that all would default at once. Even if this were too happen, moreover, the furs
involved would remain in the T’s control and they could sell them (did not release furs until payment).
Therefore, it could not be said that the T’s income-producing certificates were all required as part of its working

33
capital or that they were all being employed Aat risk(a) in its business. Looked at the interest being earned,
and the fund of money which was generating the income, and decided that part of the fund was incidental
to business (needed to meet business obligations) and part wasn't. So, part of the interest was taxed at ABI
rates and part at AGI rates.

McCutcheon Farms Ltd. v. Q. (FCTD, 1990)

Facts: By way of reassessment, the Minister disallowed the T’s attempts to claim the small business deduction in
respect of interest income earned by it during its 1981, 1982, and 1983 taxation years on substantial term
deposits.
Held: The T’s appeal was dismissed. The T, which had operated a successful and profitable farming business for
many years, never need to resort to any substantial portion of the substantial term deposits (resorted to account at
times for current expenses) in issue in the carrying on of its business, and had not provided sufficient evidence
that, even in times of emergency, it would ever be required to do so. The interest income in question, therefore,
could not be characterized as incidental and thus ABI.

Newton Ready Mix Ltd. v. The MNR (Tax Ct, 1989)

Facts: The T was in the business of manufacturing or processing concrete. The Minister reduced the T’s AB
income available by excluding interest earned from a $400,000 term deposits. The T appealed arguing that the
money in the term deposit were surplus funds being put away for the purchase of capital assets.
Held: The evidence did not establish that the T relied on the term deposits as an integral part of its business
operations, nor was there any cogent proof as to the actual amount of the cash reserves which the T required on
an ongoing basis. There was no capital replacement policy. This was especially seen as the case as a substantial
portion of the term deposit was used by the T to purchase a farm for personal use.

Current Cases - Interest Income Whether Income From Active Business or Income From Property by
McDonnell and Thomas EM PG 149.
-Considerable jurisprudence exists in both Canada and England to the effect that there is a rebuttable presumption
that income received from or generated by an activity done in pursuit of an object set out in a corp’s constating
docs is income from a business.
-In Marconi Wilson said that such a presumption does exist but that such a presumption can be rebutted. It is a
question of fact in each case whether it is income from bus or property.
-Wilson’s judgment in Marconi seems to follow the trdtnl view of the judge’s role in interpreting tax legislation
=> judges ought to be reluctant to presume how Parl would have reacted to a particular set of circumstances if it
appears that those particular circumstances are not squarely w/in the relevant statutory provision i.e. it is the
judge’s role to interpret fairly the legislation relevant to the case; it is Parl’s role to legislate if, on a fair reading
of the leg, the particular case is not squarely w/in the relevant leg.

-In Ensite, Wilson says that the presumption does not apply as Ait would collapse the distinction b/w ABI and
other sources of income which Parl clearly intended to preserve in its amendment of s. 129(4) of the Act.(a) It is
not entirely clear what Wilson meant. In the Marconi case, she clearly made the point that the presumption was
rebuttable and that the determination of the character of the income was one to be made on all the facts of the
particular case. The authors of the article think it would be wrong, therefore, to read the stmt in Ensite as support
for the proposition that in any case involving a characterization of income for purposes of sections 129 and 125
the rebuttable presumption is to be ignored.
-Ensite does stand for the proposition that the Aat risk(a) in the business approach is one that will likely find
favour with the courts in future cases. However, will be a question of fact in those cases as to what the result will
be.

SPECIFIED INVESTMENT BUSINESS.

A specified investment business is defined at s.125(7):

34
specified investment business carried on by a corporation in a taxation year means a business (other than a
business carried on by a credit union or a business of leasing property other than real property) the principal
purpose of which is to derive income from property (including interest, dividends, rents, or royalties), unless
(a) the corporation employees in the business throughout the year more than five full time employees.

ROYALTY: Payment is made according to the amount of production made through use of property.
RENT: Payment is made according to the amount of time property was used.
- For distinction see St. John Ship Building

This S.I.B. definition was put in during the early 80's and was aimed at identifying and dealing with corporations
which had a low employee number and fell between easily identifiable business and property sources. If Marconi
and Bury were decided today, they wouldn't even make it to court since they fall smack into the S.I.B. definition
and therefore whether characterized as a property source or business source they would be taxed the same way.

S.I.B. income is treated the same as property source income.

Mayon Investments Inc. and Temax Investments Inc. v. MNR (Tax Ct, 1990)
Facts: T was in the business of mortgage brokerage, providing mortgage financing on the security of second,
third, and fourth mortgages. The major portion of T’s income from such mortgages was interest income. The
number of full time employees during the period in question did not exceed five. The T argued that the business
was akin to a bank as the risk involved with the mortgages required investigations and appraisals. Therefore,
argued specific goal is to derive income from business and that the business was providing services.
Issue: Is this an SIB or is the T entitled to the small business deduction.
Held: You're a S.I.B. since your principle purpose is to earn income from a property source. Here the appellants
are deriving income from a business as the level of activity clearly indicates a business. However, the principle
purpose of the business is to derive income from property; which is exactly the SIB definition. (There were not
enough services provided to take this out of the SIB definition).

Luigi Tiengo v MNR (TCC, 1990)

Facts: - T was an engineering firm which did design sketches for furniture manufacturers; advised at the various
phases of production, and assisted in the marketing of the product. The sketches that were done were at times
discarded, others evolved towards prototypes that were the property of T’s clients. The T would continue to assist
in developing and producing the final products, as to the choice of colors, upholstery, shapes, etc. Rather than
being paid for each service rendered, the T was paid a percentage of revenue from the sales of products which T
helped its client develop to market
Issue: ABI or SIB?
Held: The Court held that this was ABI based on a) this wasn’t a royalty; and b) the primary purpose for which
the company was earning income was by providing services.
A) Royalties- The company is in business, it's not a royalty. The reason it is not a royalty is that the furniture
companies were not using physical property of the corporation. The company was paid for consulting services,
not really for the design itself. This is despite the percentage method used to calculate revenues (which looks like
royalties) It's not a S.I.B. since the purpose wasn't to produce income from a property source. (this was a question
of fact!!)
Cy does not like this and thinks that it may have been decided wrong. Royalties are not limited to the use of
physical property because you certainly can obtain royalties for the use of intellectual property. Even if this was
not a royalty (which it may have been) the definition of a royalty should have been considered further). This is
especially the case, because the judge could have come to the same decision as even if a royalty was found, there
was still room for the services argument below.
B) Services - Here there was a real service component so it could not be said that the companies primary purpose
was to derive income from property.
Cy says that the court was probably right on this point.

Alamar Farms (TaxCt, 1992)

35
(Cy hates this case)
Facts: A received royalties from oil wells and mineral rights located on it's property. It also, during the material
time, received income from farming. RC calls the income as S.I.B. income.
Held: Sorry, it's ABI!?!?! Although the royalty income was prima facie income derived from property, thus
falling within the definition of income from a ASIB(a) it was incidental to the T’s principal activity of farming
(an ABI). It was also incidental to as well as it pertained to) the T’s active farming business due to the fact that it
was necessary thereto and it was risked therein. An overall appreciation of the facts supports the conclusion that
the royalty income was employed or risked in the farming business, that it was necessary to its operations or
working capital, that its withdrawal would have a decidedly destabilizing effect, and that it had been actually
used to fulfill a requirement which had to be met in order to do business.
NOTE: Here they appear to be applying the test of employed and risked in the business from Brown Boveri and
Marsh McLennan. However, when one considers the test from those cases, it appears that this court misapplied
the test. In those cases, the court was dealing with characterizing the underlying capital which was producing the
income. The test was whether the underlying capital was employed or risked in the business. If the capital was
risked, then the interest would be ABI. The courts in those cases did not consider how the interest was used that
was generated from the underlying capital. However, Alomar, the judge did not concentrate on underlying capital
but rather the use of the royalties - Seems to be a clear misapplication.

The closest thing that the judge did to relate the test correctly was by tying the royalties to the land where the
farming was. (IE: oil was taken from same land where the farming took place). Cy says that this is not really the
test and even this was an application of the test, probably a spurious argument.
If this case is to be applied, it would effectively mean that a farm corp receiving rents from an apartment building
could character same as ABI and use the small business deduction provided they employ and risk the income in
the business. It is doubtful that this is what was intended.

EXCEPTION: Just as the PSB exception, where the corporation has >5 full time employees, it'll fall outside of
the S.I.B. definition. Just apply the same case law Hughes and principles as mentioned above concerning the >5
PSB exception.

RDTOH
As mentioned above, as a CCPC a companies investment income is taxed initially at 51.57%. Part of this tax is
kept track of in the REFUNDABLE DIVIDEND TAX ON HAND ACCOUNT (RDTOH).

So Taxation of Aggregate Investment Income in a CCPC:

38% - s.123(1)(a) Fed. ITA
6.67% - s.123.3(a) Fed. ITA
- 10% - s.124(1) Fed. ITA
+ 17% - s.7(1) MB ITA
51.67%
- 26.67% ss.129(1) and (3) Fed ITA (this refund comes in only when retained earning are dividended out)
= 25% total tax rate for AII
- s.129(1) and (3) provide that of the $51.67 tax per $100 of Aggregate Investment Income, $26.67 is refundable.
s.129(3) establishes a Refundable Dividend Tax on Hand Account (ARDTOH(a)). In simplified terms refundable
dividend tax on hand of a CCPC at the end of the taxation year means the total of:

s.129(3)(a)(i)(A) - 26 2./3 % of the Aggregate Investment Income for the year

+ s.129(3)(b) - the part IV taxes payable for the year (will take later)
+ s.129(3)(c) - The RDTOH at end of the preceding year

- (LESS)
s.129(3)(d) - The dividend refund for the preceding year under s.129(1)

36
- s.129(1) provides for a divided refund of $1.00 of taxes out of the RDTOH Account at the end of the year for
every $3.00 of taxable dividends paid by the corporation in the year. When the RDTOH is exhausted there is
further refund of taxes triggered by the payment of dividends.

So this is essentially a moving account. You basically take the preceding years RDTOH balance, add this years
increase of 26 2/3% of the corporations investment income, and then subtract out the preceding years dividends.

NOTE: If provincial tax rates were charged at the theoretical levels, there would be perfect integration (here, after
$26.67 is repaid, integration is still about 3% off) and it would not be necessary to put out an additional $5/$100
to claim the RDTOH as with theoretical tax rates, you would only have to put out the money which you had.
*SEE CHARTS ON PAGE 47(A) AND 47(B) - ILLUSTRATES THAT SYSTEM DOES NOT WORK
EXACTLY CORRECTLY BECAUSE OF DIFFERENT PROVINCIAL TAX RATES*

Example:
Corporation earns $100 Aggregate Investment Income
It pays $51.67 tax
It has $48.33 left
Of the $51.67 tax, $26.67 goes into RDTOH

To get the $26.67 RDTOH back from the government, it will have to pay a dividend of $80 (ie it will use the
$48.33 left plus it will have to use $31.67 obtained from other sources.)

On paying out a dividend of $80, it will get a refund of 1/3 x $80 = $26.67

So net tax on the original $100 AII is $51.67 - $26.67 = $25.00 (this is close to integration, being thrown off
about 3%.)

The purpose of the RDTOH mechanism is to take more tax than necessary and then refund it; is to prevent the
deferral of tax on Investment Income. That is, if the corporation were taxed at 25% immediately, individuals in
tax brackets higher than that would tend to transfer their passive investments to a corporation, and as long as the
income earned was retained in the corporation, the second level of shareholder tax would be deferred. With the
RDTOH mechanism, individuals cannot defer taxes by transferring investment income to a corporation.

RDTOH Is not actually an account. It is just an amount of money that the government keeps
track of for tax paid by a corporation on investment income. Just like all the other tax, the government uses this
money in it's everyday business. This means that if the government went broke, the balance in a companies
RDTOH account would be worthless.

KEY: The corporation can only get s.129(1) refund as long as it has a credit in it's RDTOH account. So, if the
corp. has RDTOH of $100 and pays out $400 in taxable dividends, then the corporation only gets a dividend
refund of $100 instead of ($400/3) $133.

RESULT: There is no benefit for an individual to invest through a corporation!!!!

OF COURSE, THERE'S ALWAYS LOOPHOLES TO CLOSE BECAUSE....

What happened was the corporations ended up having a ton of RDTOH in it's account, but had no money to pay
out dividends and get that money! The reason for this is to get the $26.67/$100.00 you need $31.67. Many
companies do not have the extra $5.00 and no bank would lend $31.67 to get $25.00 back. So, other
corporations would come along and buy the corporation by paying the shareholders 10 - 20% of the RDTOH
amount. The new corporation would amalgamate with the other corporation, and would have enough money to
pay out dividends and get the RDTOH! To stop this action, RC put in s.129(1.2) which prevents an acquiring

37
corporation from getting the benefits of RDTOH from a corporation that it takes over. If the purpose of the share
purchase and amalgamation is to get the RDTOH, the RDTOH account is forfeited. This stopped the trafficking.

CY: Hey, but shouldn't the refund be refundable to anyone?

RC: Nope, only to the people that we want to get it.

INTEREST.
S.129(2.1)
Where a dividend refund for a taxation year is paid to, or applied to liability of a corporation, the Minister shall
pay or apply interest on the refund at the prescribed rate for the period beginning on the day that is the later of
(a) the day that is 120 days after the end of the year;
(b) the day on which the corporation’s return of income under this Part for the year was filed
and ending on the day on which the refund is paid or applied.

ANOTHER FIEN POINT: If a corporation earns both ABI and Investment income, when it pays out dividends it
is impossible to tell which money is going out. Therefore, since RDTOH comes back as soon as dividends are
paid, it is deemed that dividends are paid out of investment income. Because there is no ordering process,
implicitly the Act is saying that dividends come out of investment income.

Q. SO WHAT DO I TELL MY CLIENT?

A. If the taxpayer corporation is earning less than $200,000 then try and argue that the money is ABI since that
money would then be taxed at 21%. However, if it's earning more than $200,000, push for investment income
because there is no ceiling on the RDTOH refund.
- Remember, you can’t flip flop from year to year. Therefore, have a long term view or outlook in
attempting to characterize income.

NOTE: Remember that the reason for RDTOH is to discourage corp’s earning investment income from
incorporating. To do this, RDTOH is collected and not released to the company until the personal income tax is
paid on the dividend. However, this is much more rational then ABI which places you 17% over what you would
pay as a sole proprietor for amounts over $200,000.00.

Refresher On Capital Gains (This Is From Last Year’s Outline - Cy Says We Have To Know It - Pick A Few
Cases Out Of The Hundred)

1. DISTINGUISHING BETWEEN BUSINESS AND CAPITAL GAIN: ADVENTURES IN THE NATURE OF TRADE

(a) Capital gains: Generally

A capital gain requires a disposition of property, s. 40. Whether a disposition is a capital gain is determined by
whether the property disposed of falls into an appropriate subdivision, s. 39(1). Three-quarters of all capital gains
will be taxable, ss. 38 and 3(b).

s. 39(1)(a)
A capital gain is the taxpayer’s gain from the disposition of property to the extent that the gain would not be
caught by s. 3 if read without reference to capital gains. In other words, if a disposition is deductible anywhere
else, it cannot be a capital gain.

- s.39(1)(b)
Same section as above, but for losses.

ORDER:
1) See if gain/loss from bus source

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2) If yes ... no capital gain
3) If no ... falls in capital gain/capital loss source

PROBLEM: A disposition of property may also comprise business income. So the first course of action is to
determine whether a disposition affects business income and then whether it is a capital gain or loss. If it is a
disposition of property as business income, the gain is taxable at 100% where if the disposition results in a capital
gain, only charged 75% tax.

THE TEST:
1. Is there a business source? (If not, stop here.)
2. If so, is the property disposed of best classified as the fruit of the tree or as the tree itself?
Fruit is how the business earns its income, year after year (i.e., inventory, stock in trade). It is a recurring
or temporary asset purchased for resale. Sale of fruit will be business income.
The tree is the capital structure or capital property of the business. It is purchased for the long term, to
give rise to the fruit. Sale of the tree will result in a capital gain or loss.

Terminology:
The term "investment" or "capital asset" generally means an asset which:

1. is used in a business; or
2. produces an annual flow of income from property; or
3. provides pride in possession or aesthetic pleasure to its owner; or
4. It is used for daily living purposes
- Fien suggests an asset purchased for purposes of appreciation alone generally is not considered investment but rather is
inventory - Wood v MNR (SC(C)
- Inventory has been defined as items of property which are held for sale in the ordinary course of business(a) - [Bailey v
MNR (TC(C)]
- The subject property of an ANT is also referred to as inventory - [Friesen v The Queen (SC(C) and Factory Carpet Ltd
v The Queen (FCTD)]

(b) Intention

s.9(3) - If you dispose of a property source itself, then that is a capitol gain and not income from a property source. Note:
there is no such provision for a business source, but the case law has held the same way as s.9(3).
The common law helps us to determine how to categorize gains.
The common law distinction between business income and capital gain often turns on intention at the time the property
was acquired.
1. INVESTMENT INTENTION: Long-term; property is intended to enable you to produce the fruit (annual
return of income).(a) This will denote capital property and usually includes buildings, equipment. This gives rise
to a capital gain.
2. TRADING INTENTION: Short-term; intention is to flip the property quickly. It is the fruit itself, the
inventory, the sale of which will produce business income.
3. PERSONAL USE INTENTION: Acquired for aesthetic value, consumption (e.g., car, clothing, house) or
hobby. Generally depreciate in value. Give rise to a capital gain.
- The Common law, in determining whether something is a business source or a capitol gain, will look at subjective
intention in the determining the reason for the pchse of the property. The test is the intention of which is you bought the
property with, not how long you have held the property.
- Thus unless, in simplistic form, you bought assets to resell, you have capital property.

(c) Adventures in the Nature of Trade

s. 248(1)

39
Business includes profession, trade, undertaking...and adventures in the nature of trade. This definition includes any
undertaking. An undertaking is a broad term which probably includes any enterprising efforts.

An A.N.T. is in the nature of business but not otherwise a business. It refers to certain isolated dispositions of property
which might otherwise appear to be capital gains. Income from an A.N.T. is taxed as business income and not as a capital
gain. Dispositions which on their face would fall into the capital gains circle instead get considered as business income.

The concept of ANT is not restricted to the purchase and resale of an asset. Any scheme engaged in with the
intention of making a profit will be an adventure in the nature of trade: [Perkins v The Queen (FCTD)]. In the
Queen v Manley, the Federal Court of Appeal held that transactions involving the provision of services may be
an adventure in the nature of trade.

- Incentive for taxpayers to try not to have their dispositions classified as adventures in the nature of trade so that
they can avoid full taxation on the disposition.
- As we already know, a key element in a business is recurrence of income: adventures in the nature of trade do
not recur, but the government feels that they are situations analogous to business income and therefore should be
taxed as such.

The determination of whether a disposition is a capital gain or an A.N.T. is a question of fact. Two competing
approaches:
1. CY HATES THIS APPROACH: Look at all the circumstances of the transaction, including the subjective
intention of the taxpayer.
2. Look only at the SUBJECTIVE intention with which the taxpayer acquired the property. For example, if the
intention was to resell the property, it will probably be an A.N.T., but if the intention was to rent it out, it
will be a capital gain.
NOTE: Objective criteria will be employed to determine the subjective intention (i.e., look to the
circumstances of the case.
- Contrast this to the objective test used to distinguish a hobby from a business.

(d) The Cy Fien approach to distinguishing capital property from adventures in the nature of trade

TWO COMPONENTS:
(1) Intention
(2) Type of property

(I) Intention

- The initial motive or intention of the taxpayer is the most important test.
Generally, an intention to resell the property will mean it is an A.N.T., while intention to hold for the purpose of
generating income will indicate capital property.
- Intention to resell = inventory
- Intention to hold for purpose of earning annual income therefrom = capital property

- Intention is to be analyzed at the time when the purchaser becomes firmly committed to the essential terms of
the purchase [Western Wholesale Drug Ltd. v. The Queen (FCTD)] or to put in another way intention is to be
looked at when the purchase agreement becomes legally binding [Warnford Court (Canada) Ltd. v. MNR (Exch.
Ct.)]

- The acquisition of an asset with the hope of a rise in asset value or with the expectation of a rise in asset value is
not sufficient in itself to constitute the intention necessary for an ANT. What is necessary for there to be ANT is
either than the prospect of such a sale was an operating motivation in the acquisition of the asset, ie simply
stated, there was an intention to resell (Crystal Glass Canada Ltd v The Queen (FCA)]

40
In Friesen v The Queen (SC(C), the Supreme Court of Canada made it clear that it is the taxpayer’s intention at
the time of purchase which is the relevant intention.

The key elements to look at when considering a taxpayer's intention according to Mr. Justice Heald in
Kensington Land Developments Ltd. v. The Queen (FCA) were:
1. what were the relevant facts at the time of purchase
2. what happened subsequent to the purchase
3. what statements did the taxpayer make
- On the basis of this evidence Heald suggests one consider "whether or not the only possibility motivating the
acquisition was the ultimate creation and retention of a substantial capital investment"
Fien suggests that when dealing with a syndicate or partnership, intention is to be ascertained by looking at the
persons who in fact controlled its operation and decisions

Where taxpayer is a member of syndicate or partnership:

The intention of each taxpayer in a syndicate or partnership which has purchased an asset will generally
be determined by ascertaining the intention of those in the group who in fact controlled the operation and
decisions: [Wright v MNR (TC(C)]
However, given the right circumstances, it is possible for one member of a syndicate to have a capital
gain while the profits of the other members are trading income: [Mohawk Horning Ltd v The Queen]

Where the taxpayer loses, it is generally because the court does not believe the taxpayers stated intention.

The intention of a closely held corporation garnered from its shareholders; see Program Properties Ltd. v The
Queen (FCTD), Birmount Holdings Ltd. v. The Queen (FCA), Hummel Corporation of Quebec Ltd. v. The
Queen (FCTD)

THE DOCTRINE OF SECONDARY INTENTION:

It is clear that even if the taxpayer’s primary intention or motivation in acquiring the asset was to purchase it for
investment, if one of the other or secondary operating motivations for the purchase was to resell at a profit, this
will result in an ANT (this is known as the secondary intention test).

Crystal Glass v. The Queen, 89 D.T.C. 5143 (Fed. C.A.)

The test for an A.N.T. is whether the taxpayer acquired the property with any operative intention (it is not enough
that there is the thought of sale; it must be an operating motivation) to resell it. The operative motivation may not
be singular, though. If any one of the motivating factors at acquisition is an intention to resell, it will be an
A.N.T. Thus, the onus is on the taxpayer to establish that his sole intention was to use the property for investment
or personal use.

A CLUE TO DUAL INTENTION: Would the taxpayer have gone ahead with the venture had he known of one
potential use only?
Hope that the asset would rise in value is not enough

Regal Heights Ltd v. The Queen (1960, S.C.C.)

- Taxpayer wanted to build shopping center in Calgary near Trains-Canada highway. Property was purchased and
development started. Two years later a large company decided to build another center just two miles away. The
taxpayer backtracked from the shopping center idea and sold the land at a profit.
- Held: This is an ANT. The taxpayer had two intentions: 1) to operate a shopping center or 2) to sell the land at a
profit. The venture by the taxpayer was speculative, there was always a chance they would not be able to get
tenants for the mall. The establishment of this shopping center was always dependent upon the negotiation of a
lease with a major department store. If they failed they knew the property was valuable and they could resell it. If
any of the intentions / operating motivations were to resell the property at a profit, it’s an adventure in the nature
of trade. But for their secondary intention to resell, they wouldn’t have entered into the deal to buy the property.
The venture was entirely speculative. Therefore, there is an adventure in the nature of trade.

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NOTE: A secondary intention is not necessarily less of an intention then a primary intention, they can be equal.
NOTE: Regal Heights argued that there intention of building a shopping center was frustrated and thus they sold
the land. However, the court did not believe this argument.

Snell Farms Ltd. v. The Queen (1990, Fed. Ct. T.D.)

Taxpayer bought farmland with the intention of transferring it to his son, but the son did not want to farm the
land and the taxpayer eventually sold it at a profit. Was this an A.N.T. or a capital gain?
Held, that this was a capital gain as the taxpayer, at the time the land was purchased, had no intention at all to
resell it at a profit.
- The Court applied the test of Crystal Glass: secondary intention requires:
1. The thought of sale at a profit at the time of purchase, and
2. The prospects of the sale must be an operating motivation(a) in the acquisition of the property.
- In this case it would be difficult to suggest that the prospect of sale of the land was an operating motivation for
the taxpayer’s purchase of the land.
- Largely an issue of credibility. The court believed the taxpayer’s reason for selling the land.
NOTE: This is a case of the court accepting the taxpayer’s argument of frustrated intention.

Racine, Demers, and Nolin v MNR (Exch. Ct.)

- Mr. Justice Noel stated the following:
To give a transaction which involves the acquisition of capital the double
character of also being at the same time an adventure in the nature of trade,
the purchaser must have had in his mind, at the moment of the purchase,
the possibility of reselling as an operating motivation for the acquisition;
that is to say that he must have in mind that upon a certain type of
circumstances arising he had hopes of being able to resell it at a profit
instead of using the thing purchases for purposes of capital.
NOTE: The court accepts that there is always the possibility that a resale may occur. However, it is only when
resale is a motivating intention in buying the property that a trading intention arises.

EXCEPTION TO THE SECONDARY INTENTION DOCTRINE: SHARES ARE PRIMA FACIE

INVESTMENTS
Irrigation Industries v. M.N.R. (1962, S.C.C.)
- 2 years after the decision in Regal Heights
The taxpayer purchased shares in a mining company and sold the shares a few months later. The shares were
purchased with a bank overdraft, as the company couldn’t really afford them. There was no expectation of
dividends for quite some time. (Normally, shares can be an investment because dividends can be expected).
Held, this was not an A.N.T. Just because there was an intention to sell at a profit doesn’t necessarily mean it was
an A.N.T., in the absence of other indicators (i.e., type of property). Seemingly, there is an exception if the
property in question is shares, as they are something the purchase of which constitutes an investment.
CY SAYS: This is odd, as the S.C.C. has now created an automatic exception. Generally, it seems that anything
that is capable of being an investment ought also to be capable of being inventory if the intention is to resell, but
the S.C.C. apparently disagrees.
RATIO: The one exception to the doctrine of secondary intention is the purchase of shares is a well known
investment transaction and not deemed the be an ANT. The purchase of shares is generally regarded as a capital
transaction.
NOTE: The SCC made their decision based on an English case which was widely known as the wrongly decided
case in English law.

Factory Carpet Ltd. v. The Queen (FCTD)

The taxpayer bought shares in a company which went bankrupt a year later; the taxpayer claimed he bought the
shares for business purposes in order to turn the company around, MNR said these were a capital loss.

42
Held: the taxpayer bought the shares as an adventure in the nature of trade and therefore he could deduct the
entire business loss; the court said at the time the taxpayer bought the shares his intention was to turn the
company around and then sell the shares
RATIO: Exception from Irrigation Industries, where in this case the court held this was an isolated incident
where shares are an ANT.
PROCEDURAL NOTE: In most cases, the taxpayer is trying to prove a capital gain in order to be able to pay
less tax than if the disposition was an A.N.T. However, if the venture loses money and the taxpayer has no capital
gains in the year, he will not be able to deduct the capital losses from income. Therefore, he would want to try a
secondary intention argument in order to be able to deduct the loss under s. 38 as a loss incurred from a business
source.

Pollock v. The Queen (1994, Fed. C.A.)

OBITER: Casts doubt on the general presumption in Irrigation Industries; perhaps shares may be capable of
being inventory after all, but this remains to be seen. The court stated in this case that there is no presumption,
one way or another as to the characterization of shares.
NOTE: Fien’s guess is that the court will shift away from Irrigation and eventually Revenue will bring this
matter to the attention of the SCC.

John Dunford in his article about Irrigation Industries suggests that the case does not preclude the possibility
that a sale of shares can be characterized as an adventure in the nature of trade
the key Dunford suggests is the taxpayer's conduct - if a taxpayer borrows heavily to buy,
trades shares heavily, buys the shares when there is an absence of dividends, holds them
for a short time, or buys speculative securities the court can still consider his intention to
be geared towards an adventure in the nature of trade
Dunford says Irrigation Industries only suggests that you cannot automatically assume that a taxpayer bought
shares to resell because the nature of the asset is so tradeable; if the taxpayer has an intention consistent with
treating the purchase of the shares as an adventure in the nature of trade the court can find an adventure even in
the case of shares

ARGUMENTS AGAINST SECONDARY INTENTION:

(1) Original intention was to develop, hold, etc., but that was frustrated by circumstances beyond the
taxpayer’s control and resell was the only option.
(2) Original intention was abandoned when an unexpected offer came up and was too good to refuse.

(ii) Type of property

1. Property which by nature doesn’t appear to be capital property. This is assets/property which indicate a
trading intention.
e.g., vacant land purchased with no intention to develop.
This will be an A.N.T., as it was not bought to bear fruit and is not used for personal enjoyment either; it
must have been bought with the intention to sell at a profit.
NOTE: This does not constitute an investment intention, as that refers only to the production of fruit.
This is bare capital property.
- eg: Taylor

2. Property which is capable of generating business income but is also capable of being bought solely for the
purpose of resale
e.g., apartment block.
This could be either the fruit or the tree, so the matter will turn on the taxpayer’s subjective intention at
the time of acquisition and, perhaps, on an examination of other surrounding circumstances:

(a) How long did the taxpayer hold the asset? The longer held, the more likely to be an investment.
Temporal Factor. However, the length of time of holding is only one factor and may be
overridden by other evidence to the contrary. Furthermore, if the asset is not used in a business or

43
 does not otherwise give rise to income (or is not used for personal living, or is not capable of
giving aesthetic pleasure) then no matter how long the holding period, the court will find a
trading intention

- In Friesen v The Queen (SC(C), the Supreme Court of Canada stated:

The land involved was undeveloped real estate which was suitable
for resale but unsuitable as an income producing investment or for
the personal enjoyment of the appellant or his associates.

I agree with Iacobucci J. that the appellant meets the tests which
have been established in the common law for an ANT. The
speculative venture in which the appellant was involved was
clearly an adventure of a business nature rather than an investment of a capital nature.
(At p. 5554)

- although this is not true of vacant land (Sorokin v. M.N.R., 1986, T.C.C. - the sale of vacant
land as a rule is considered ordinary business income no matter how long it is held [in this case for 25 years])
and it is possible to be an investment even if held for a very short time (Biffis and Cappuccitti v. The Queen,
1986, Fed. Ct. (T.D.), where property was held for five weeks and was still an investment and a capital gain.

(b) How was the property sold by the taxpayer? That is, was the sale the result of an unexpected offer or
was it the result of an active effort to sell? Sale Factor

- If the taxpayer’s operating motivation or intention at the time of the acquisition was a trading
intention, then whether the disposition of the asset is deliberate or made in an unplanned way (for example, if the
property is destroyed or expropriated and the taxpayer compensated as a result thereof) is not relevant - the gain
or loss in either case will be business revenue or loss: [Vaughan Construction Co v MNR (SC(C)]

- On the other hand, if the operating motivation or intention at the time of acquisition was one of
investment, realizing the capital asset in the most advantageous manner generally should not change the
character of the gain realized from being a capital gain
(c) Capitalisation: Taxpayer’s lack of capital might indicate intention to flip quickly (California
Copper, infra)

(d) Number and frequency of transactions

- The fact that a disposition is a single isolated incident does not mean it is not an ANT [MNR v
Freud (S.C.C.)]

(e) Relationship between disposition and taxpayer’s business.

If disposition is similar to taxpayers line of work very difficult for it be considered not a business.

(iii) Lots of fun case law on adventures in the nature of trade

Taylor v. M.N.R. (1956, Excheq.)

T was president of a subsidiary company whose parent wouldn’t give him the authority to have more than a 30
day supply on hand. T got around this himself by buying the lead himself (he had permission to do so) and then
resold it to the company at a substantial profit. He assumed any risk for a fluctuation in price. He was not
personally in the business of buying and selling lead, so was this an A.N.T.? He argued that the purpose of the
transaction was to impress his bosses, not to make a profit. MNR wanted to tax this as business income under
ANT.

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$ Held, that it was an A.N.T. The fact that the transaction was an isolated one doesn’t preclude it from being an
A.N.T. if the intention is to flip the property at a profit. The character of the property indicated that his
motivation was to resell it as it can hardly be argued that the lead was going to produce income. The element of
speculation is indicative of an ANT, and here there was definite lead speculation. Finally, the T intent to improve
his image with the company doesn’t negate the trading purpose.
NOTE: The court held that in this case that an intention to resell without profit, eg: the intention to resell merely
to recoup one’s capital - is enough to constitute a trading intention. In Friesen v The Queen, however, the court
that there must be an intention to resell at a profit to constitute a trading intention.

California Copper Syndicate v. Harris (1904, Scotland)

A copper mine was sold to another company shortly after being acquired. It was capable of being capital
property, but the company did not have enough capital to work the mine. What was its status?
Held, that it was an A.N.T. Since the company didn’t have the money to operate the mine itself, it must have had
a trading intention and must have seen the mine as inventory.

David McDonald v. The Queen, (1974, Fed. C.A.)

Taxpayer acquired a farm, with no intention to develop it. The annual income of the farm was historically very
little. However, the taxpayer expressed the subjective intention to hold it longer than he actually did. The land
was sold five years later at a substantial profit. The T considered the disposition to be a capital gain. The taxpayer
claimed that land was bought for a long term investment and was also an isolated transaction.
Held, it was an A.N.T. There was no realistic possibility of producing much income from the farm and since the
appellant’s was an investment outside the ordinary scope of his profession, it would be difficult to say that the
land was bought for investment purposes; so it must have been acquired with a trading intention. The passage of
time is not relevant.
NOTE: While this case uses the subjective approach, it also looks objectively at the surrounding circumstances to
determine the taxpayer’s intention.

Albrumac Oils Ltd v Her Majesty The Queen (1977, FCTD)

T, a company which searched for oil, acquired a large parcel of farm land in 1966. In the ensuing years, the
company turned down several unsolicited offers to sell the land. In the meantime, the land was yielding a rental
income. In 1969 an easement was granted on the land and in the same year the land was sold at a substantial
profit. The Minister treated the gains from the easement and the sale to be business income on the basis that the
transactions constituted an ANT. The company appealed contending that the land was acquired as a long term
investment and the gains constituted a capital accretion.
- HOLDING: This was an ANT. The fact that the company had to turn down so many unsolicited offers was an
indication that the land was situated in a speculative area. The land was not related to the business of the
company, and the company tendered no evidence to indicate what it intended to do with the land. Furthermore,
the small return that the company was receiving from rental was not proportional to money invested. Therefore,
only reason for purchase was for speculative and thus sale value. From the evidence, it was obvious that the land
was acquired for speculative purposes.

First Investors Corp. Ltd. v. The Queen, 87 D.T.C. 5176 (Fed. C.A.)
According to regulations, FI needed to maintain a certain mix of assets to keeps its license, so it purchased an
automobile speedway but had no intention to operate it. After three years or so, FI sold the speedway at a profit.
They argued that this was not an A.N.T., as they had purchased the land to maintain their licence and not to resell
it. The provincial law required the asset to be sold within seven years, and in fact provincial authorities pressured
the company to sell the land quickly. The land was sold, what was the intention of the T when he sold the land?
Held, that this was an A.N.T. as they never planned to do anything but to sell it. (Might also have tried the but-
for test, as no doubt FI would not have bought the speedway if they thought they could never sell it.)
RATIO: A taxpayer’s suggestion that land is bought not for the eventual making of profit, but just to satisfy a
provincial statute’s requirement to hold a certain amount of land, does not rebut the assumption that the taxpayer
bought the land with a trading intention. If there’s a unique reason to buy the property, but it has no potential for
annual income, it will be held that it was brought with a trading intention.

45
Dissent:
suggests that there was no secondary intention to sell the property because of the reasons
behind the purchase. The dissent took a much broader approach stating that you have to look beyond the nature of
the asset to determine intention. They note that this land was purchased to keep earning income in their business,
not from the land. There are six factors to analyze a situation:
1. Subject Matter of Asset - land most likely not investment
2. Length of period of ownership
3. Frequency of similar transactions by the same person
4 Improvements made to the Asset
5. Reasons for disposition
6 Motive/intention of Taxpayer
NOTE: - Fien likes the dissent in this case much better than the majority; more reasoned
NOTE: Furthermore, if property is incapable of producing income (therefore can’t be a fruit of a producing tree!)
then any intent of taxpayer will likely be ignored.

Snell Farms Ltd. v. The Queen (1990, Fed. Ct. T.D.)

Taxpayer bought farmland with the intention of transferring it to his son, but the son did not want to farm the
land and the taxpayer eventually sold it at a profit. Was this an A.N.T. or a capital gain?
Held, that this was a capital gain as the taxpayer, at the time the land was purchased, had no intention at all to
resell it at a profit.
- The Court applied the test of Crystal Glass: secondary intention requires:
1. The thought of sale at a profit at the time of purchase, and
2. The prospects of the sale must be an operating motivation in the acquisition of the property.
- In this case it would be difficult to suggest that the prospect of sale of the land was an operating motivation for
the taxpayer’s purchase of the land.
- Largely an issue of credibility. The court believed the taxpayer’s reason for selling the land.
NOTE: This is a case of the court accepting the taxpayer’s argument of frustrated intention.
Les Placement Richard Martineau Ltée v. M.N.R. (1991, T.C.C.)
Taxpayer was buying apartment buildings and selling them in record time. He argued that this was inadvertent;
he intended to buy them as long-term investments but was forced to sell them because of problems that kept
arising. Problems included structural problems with the buildings and major tenant problems. The apartment
building was sold for large gains. The taxpayer says frustrated intention.
Held, the explanation was reasonable and the income was a capital gain and not business income. Resale was not
a motivating factor. The court noted that the apartment buildings had the potential of being a long term
investment and that the way they were financed was more compatible with the approach of an investor then a
speculator.

Di Ioia v. R (T.C.C.)
Di Ioia made $800,000 profit selling a property eight months after he bought it. It was allowed as a capital gain
because he convinced the court that he was in for the long haul, and someone, out the blue offered to buy it.
Remember, the intention is at the time purchases. The result is seen as a Afrustrated intention.(a)

Arya v. The Queen (1994, T.C.C.)

Taxpayer purchased bare land and turned it around three years later, still undeveloped, at a profit of nearly
$500,000. He argued that he had intended to develop the land but found that he didn’t have enough money to do
so his intentions were frustrated and he had to sell.
- Issue: What was the T’s intention when the property was acquired and whether the t’s stated intention at the
time of acquisition was followed by a secondary motivating intention.

Held, OK, fine it’s a capital gain. You were stupid and didn’t know what it takes. The taxpayer’s conduct did not
indicate any action motivating secondary intention to sell the land if their motel project failed. The primary
intention in the acquisition of this property was to own, build, and operate a motel. The court also notes that the

46
T’s had no prior real estate history other than home purchases. Also, the appellants had no prior business or loan
history.
NOTE: Contrast this with California Copper - the T didn’t have enough money, but they knew what they were
doing. Still the two cases are pretty hard to reconcile. Fien says that this case is probably decided wrong and that
this case is a good illustration of how court’s are unpredictable.

Leasehold Const Corp

- T was in the commercial and industrial construction business. In December, 1973, the T purchased land,
constructed a shopping mall thereon and, some five years later, sold the mall at a profit pursuant to an unsolicited
offer. Revenue characterized this as an ANT.
- Held, this is a capital gain. The court says that you look at the ordinary business of the taxpayer to see if it is
connected somehow. Although the T business involved constructing and selling buildings, it did hold them on
occasion as investments (5 out of 58 in a 23 year period). In this case, moreover, the t has built the mall in issue
with long-term financing and top-quality long term tenants in place, thus assuring itself of a high rental cash flow
and a return on investment (27%). It also continued to manage the building for 3.5 years after having sold it. The
court takes into consideration all of these factors and determines that an investment intention existed and
therefore the sale was a capital gain.
Factors to be considered:
A) Financing - long or short term
B) Length of holding;
(C) Circumstances around building
D) Possible return on investment
E) Nature of business
F) Circumstances surrounding sale
G) Pattern of transactions
H) Similar transactions of the same business
I) Work expended on the property
J) The stated intention of the taxpayer
NOTE: Fien states that normally the greater the amount and length of financing, the less likely that a trading
intention will be found.
NOTE: The court notes again that it is the intention of the taxpayer at the moment when the asset is purchased or
created that it is determinative.

Shares and Intention An Anomaly

Remember in Irrigation Industries Ltd., the S.C.C. found that all shares were Capital Property. This case has
been widely criticized.
In the more recent decision of Pollock at the FCA, however, the court says that there should not be a presumption
that shares are capital property, and suggests that Irrigation is wrongly decided.. It is notable that in the dissent
in Irrigation, Judson, said the majority was going against the decision in Regal Heights, a decision Judson
wrote.
- As a result of Pollock v The Queen, there may be more cases of shares in the Nature of Trade Area. Fien thinks
that real estate and shares will be equivalent within 20 years.

Summary
- You look at 2 issues to address ANT:
1. Taxpayer’s Intention - especially whether or not the Doctrine of Secondary Intention applies;
2. Nature of the Asset - Can the asset produce fruit? Temporal factor of holding, capitalization, etc.
- If unusually fast resale, normally ANT but might not be if:
1. Development intent was frustrated; or
2. Unexpected offer to sell at a price taxpayer couldn’t refuse.
- When you profit, you have a capital gain, but when you lose money you want a business loss. Revenue Canada
wants profit to be a business or property source and capitol loss if the T loses money.

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NOTE: There are very few cases which deal with personal use intention. When you buy something for a personal
use intention and you sell them, you are going to have a capital gain.

PART IV TAX

KEY: Remember that dividends go between companies tax free pursuant to section 82 and 112. Therefore, is it
possible for a company with a RDTOH account to dividend out money’s to another company, receive its tax
credit, with the other recipient company not paying any tax. If this was allowed, this would be a great tax
avoidance scheme as it would effectively allow corporations with RDTOH to set up holding companies to receive
dividends - then claim the RDTOH - while still deferring the second level of tax. To avoid this, there is Part IV
Tax. The Part IV tax is a refundable tax.
- Part IV tax is only levied on private corporations (whether a CCPC or not) receiving dividends in certain
situations. (Don’t worry about the subject corporation part of the definition)

Connected Corporations:
Is defined at s.186(4) for the purposes of Part IV tax stating that where dividends go from a payer corporation to a
recipient corporation, the corporations are connected:
(a) the payer corp. controls the receipt. corp. at the time the dividends are received;
(b) the recipient corp. owns more than 10% of full voting shares under all circumstances and the
shares must have a fair market value of more than 10% of the fair market value of all the issued shares of the
capital stock of the payer corporation.
How do you define control for the purposes of s.186(4)(a).
- For this section, there is a special definition for control and therefore it is not necessary to refer to the common
law. This is a deeming section.

s.186(2)
For the purposes of this Part, one corporation is controlled by another corporation if more than 50% of its issued
share capital (having full voting rights under all circumstances) belongs to the other corporation, to persons with
whom the other corporation does not deal at arm’s length, or to the other corporation and persons with whom the
other corporation does not deal at arm’s length.

eg. Ms. R. owns 45% of the payor corporation and also owns the recipient corporation which owns 6% of the
payor corporation. By virtue of s.186(2), the recipient corporation would be considered to be in control and thus
connected to the payor corporation.

eg. So, under s.186(4)(a) where the receipt. corp. owns 51% of the payer corp. they are connected. Under
s.186(4)(b) if the receipt. corp. owns 11% of voting shares and 11% of shares by value of the payer corp. they are
connected. As well, under s.186(2) if Jim were to own 100% of the receipt. corp., the receipt. corp. owns 5% of
the payer corp., and X owns 95% of the payer corporation, then the corp. would be connected since X is non-
arms length to the receipt. corp.
NOTE: For the example to make sense, X must be Jim’s brother.

NOTE: For the purposes of s.186(4)(a), clearly if you have 11% of the votes you have enough votes to be
connected. However, just because you own 11% of all voting shares does not mean that you own 11% of the Fair
Market Value of the company. Rater the 11% of the shares may be worth 9 or 10%. A minority discount arises
because of a lack of liquidity for smaller share holdings. Conversely if you own 50% of the shares, you would
probably be able to sell your shares at a premium because you are selling control. Since the market is not as
strong for minority interests, it may be necessary to sell at a discount. Therefore, if you are close to 10% of
voting shares, you cannot assume that you have 10% of FMV. It is necessary for a business valuator to determine
your position. Cy says discounts for minority share holdings usually run 10-20%.

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SO NOW THAT WE KNOW THE CORP'S ARE CONNECTED....

S.186(1) has two types of Part IV tax. Cy said we'll look at (b) first.

Before Part IV was put in a corporation could devise a scheme to get the RDTOH back without paying out a
dividend to the shareholder. This would be beneficial because remember that once the shareholder gets a
dividend, they must pay the personal tax to finish the theoretical integration process. So, what was done was to
pay out a dividend to a shell corporation. This way the dividends could pass between the corporations without
any tax being paid pursuant to s.82 and s.112. Once the shell corporation got the dividend, it could hold or use
the money without the shareholder having to pay any personal tax. Also, the original company would get it's
RDTOH credit! Of course RC decided to put an end to this....

- Where a corporation receives a refund of tax under section 129 out of RDTOH in respect of a dividend it has
paid to a connected corporation, the receiving corporation must pay as a refundable tax under s.186(1)(b) an
amount equal to its share of any tax refunded to the payor corporation as a result of the dividend. This prevents
corporations in a connected group from retrieving RDTOH back regarding Aggregate Investment Income which
has been earned.

SO IF THE PAYER AND RECIPIENT CORPORATIONS ARE CONNECTED....

- S.186(1)provides that every corporation that is at any time in a tax year a private corporation (ignore subject
corporation part), shall, on or before the last day of the third month after the end of the year, pay a tax under this
Part for the year equal to the amount, if any, by which the total of...
(b) for connected corporations ...
S.129(1)(a) DIVIDEND REFUND AMOUNT OF "ASSESSABLE DIVIDEND" REC'D BY RECEIPT.
REC'D BY PAYER CORP. X AMOUNT OF TAXABLE DIVIDENDS PAID BY THE PAYER
FOR THE YEAR IN THAT YEAR

"Assessable Dividend" is defined at

s.186(3)
as the taxable dividend deductible by the receipt. corp. under s.112.

- The tax that the recipient pays out as a result of receiving a dividend from a connected company goes into the
recipient companies RDTOH by virtue of:
s.129(3)(b)
refundable dividend tax on hand of a corporation at the end of a taxation year means the amount, if any, by which
the total of:

(b) the total of the taxes under Part IV payable by the corporation for the year, exceeds:

(d) the corporation’s dividend refund for its preceding taxation year.

eg. So, if the payer company pays dividends, and gets back RDTOH of $100, and the receipt. company receives
15% of the dividends, then the recipient corporation will pay a tax of $15.
$100 x $15/$100 = $15
So as the payer corporation gets dividend refunds back, any connected companies who get dividends will pay
tax to the government under Part IV. Note however that when the connected receipt. corp. pays part IV
tax, that money goes into it's RDTOH account! This means that when the receipt. corp. pays out it's own
dividends it will receive the RDTOH back. Only the final shareholder at the top of the connection will
not pay part IV tax, but it doesn't matter because he pays the personal tax on the dividends!

Another example:
- Assume A. Co. owns 100% of corp. B. Co., and B. Co. earns $100 AII:

49
- B. Co. earns $100 AII
- It pays $51.67 tax
- It has $48.33 left
- Of the $51.67 tax, $26.67 goes into the RDTOH of B. Co.
- To get the $26.67 RDTOH back from the government, B.Co. Could pay a dividend of $80 to A Co. (ie it will
use the $48.33 II retained earnings left plus it will have to use $31.67 obtained from other sources).
- On paying out a dividend of $80, B. Co. will get a refund of 1/3 x $80 = $26.67.

- That is, if B. Co pays A Co. a dividend of $80, B. Co. Receives back its dividend refund out of RDTOH of
$26.67 (1/3 of dividend). If it were not for s.186(1)(b), A Co. would not pay any tax on the dividend from B. Co.
This would defeat the purpose of Section 129 RDTOH regarding AII since a holding company like A. Co. could
easily be incorporated to hold the shares of an investment corporation like B. Co., which does the actual
investing.
- s.186(1)(b) prevents such an escape from the Section 129 RDTOH by taxing A. Co. under Part IV on the $80
dividend received from B. Co. A Co. must pay a tax equal to the amount of the dividend refund which B. Co.
receives out of its RDTOH on payment of the dividend multiplied by the proportion of the dividend that A Co.
received. The $26.67 tax which A. Co. pays goes into the RDTOH of A. Co. under s.129(3)(b) which A Co. can
retrieve on it in turn paying out a dividend under s.129(1).
- (Had A Co. owned only 51% of B.Co. subject to a refund of B. Co., i.e. $13.60 Part IV tax ($26.67 x 51%).

*SEE PAGE 49(a) FOR A CHART AND EXAMPLE*

NOW S.186(1)(a) TAX...

The purpose of this section is to deal with non-connected companies. This is targeted at something not related to
investment income but it uses the same RDTOH account. The reason for this is that the RDTOH account is set up
in a manner appropriate to deal with a situation when a recipient corporation receives a dividend from a payor
corporation that is not connected.

The term portfolio dividends is not used in the ITA. The term is used in practice to mean dividends from
corporations in which the recipient has a relatively small ownership interest, namely 10% or less, and hence, has
only a portfolio or investment interest in the shares.

eg. Let's say that Steve has a small share holding in corporation X. In tax law, this is referred to as a portfolio
holding which generally amounts to less than 10% of a class. As an individual, Steve would pay about 36.33%
(30% federal rate plus surtaxes) tax on any dividends paid out by the corporation. Before s.186(1)(a) was out,
Steve could have put the small amount of shares that he owns into a holding co. (let's call it Hold Co.) of which
he would own 100%. So, Hold Co. could take the dividends from X Co. tax free (s.112 etc.) and Steve wouldn't
have to pay any of the individual tax until Hold Co. pays out dividends. Basically, if Steve wanted to use the
money for investments etc. he could still make use of the money through Hold Co.! But, RC caught on....

When a private corporation receives an assessable dividend (see definition on p.75) from a portfolio investment
in shares, a 33.33% refundable tax must be paid on the dividend under s.186(1)(a). This Part IV tax also goes
into the recipient corporation’s RDTOH under s.129(3)(b) and its fully refundable to the corporation when the
dividend income is passed on to its shareholders under s.129(1).
- As already illustrated, this part of the Part IV mechanism is designed to discourage individuals who have
portfolio investments in corporations - i.e. 10% or less - to defer tax on receiving portfolio dividends by placing
their holdings in a corporation that would otherwise receive the portfolio dividends without tax by virtue of s.82
and 121.

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THEORY: This 33 1/3% is pretty damn close to what the individual (Steve) would pay if Hold Co. wasn't used.
(By putting in a holding company you may defer about 3%-depending on surcharges) This means that much of
the incentive for using Hold Co. is removed.

One big difference from the s.186(1)(b) tax is that, although the company still only receives the RDTOH back
at a $1 - $3 ratio of dividends, the 33 1/3% tax being paid means that the calculations will work out
perfectly. In other words, the corporation will not have to borrow money to make a dividend payment
large enough to get the full amount of the RDTOH account back.

*SEE PAGE 50(a) FOR AN EXAMPLE*

Q. Won't a receipt. corp. always end up paying Part IV tax?

A. No, because a connected receipt. corp. will not pay Part IV tax where the payer corp. doesn't receive RDTOH.
(eg. like where the payer corp. has no investment income to trigger the refund of RDTOH). Part IV tax always
applies to dividends except where the companies are connected and the payor companies receives no tax credit
out of RDTOH.

SUMMARY

IF THE CORPORATIONS ARE CONNECTED....

S.186(1)(b) - If the payer gets an RDTOH refund, then the receipt. must pay
Part IV tax.
- If the payer doesn't receive RDTOH refund, then the receipt
doesn't have to pay Part IV tax.

IF THE CORPORATIONS ARE NOT CONNECTED....

S.186(1)(a) - Receipt. always pays the Part IV 33 1/3% tax.

Can the recipient company use the dividend money to offset non-capital losses instead of paying Part IV
taxes?
Pursuant to s.186(1)(c-d) where a receipt. corp. has Part IV tax to pay, and also has a non-capital loss which is
available for use that year (carried from -7 or +3 years), the corporation can apply that loss against any dividends
which were received. This effectively reduces the amount of Part IV tax which ultimately must be paid.
CY: This option is rarely taken by knowledgeable tax lawyers. Such non-capital losses are better used to offset
gains from other sources. However, if you non-capital losses against refundable Part IV tax the non capital losses
are gone by virtue of s.111(3). Remember that the Part IV tax is refundable while the tax levied on other sources
is not. It makes more sense to use the non-capital loss in a situation where non-refundable tax will be offset. Cy
says that don’t do this unless you have a situation where non-capital losses are expiring. You never want to use
refundable tax to wipe out losses; you want to use permanent tax against these losses.

*SEE PROBLEM ON PAGE 51 FOR ANOTHER EXAMPLE*

- NOTE: For this problem, if you calculate the total Part IV tax payable; it is actually more than is being
refunded out of RDTOH accounts. This is because Part IV tax collected under s.186(1)(a) need not be as a result
of credits out of RDTOH.

CORPORATE DISTRIBUTION

There are four ways that a corporation’s assets reach the hands of its shareholders:

1. Declared Dividends

51
 2. Winding up the Corporation
3. Redemption and Purchase Back of Shares (R and PB)
4. Shareholder Appropriations and Loans.

KEY: No matter how the money comes out of the corporation (1-4), there is the same tax affect.

Don't forget that some things do come out of a corporation tax free:

1. Capital Dividend Account Dividends

2. Paid Up Capital (PU(C) - this is simply the money put into the treasury for the original
acquisition of shares.

SO WHILE WE'RE HERE, LET'S LOOK AT THE TAX FREE STUFF....

1. CAPITAL DIVIDENDS
Types of Dividends:
a) Taxable Dividends
b) Capital Dividends

S.89(1)
defines >taxable dividends’ as any dividend that does not result from a s.83(2) election is a taxable dividend.

s.248
defines a dividend to include a stock dividend.
- A stock dividend is when a dividend is paid in stock as opposed to in cash. If this is the case, assets remain the
same, retained earnings are reduced by the amount that the dividend was issued and paid up capital is increased
by the amount of the dividend. If dividend was paid in cash, assets and retained earnings would be reduced and
paid up capital would stay the same. (NOTE: Assets are to be valued at their original cost on balance sheets).

s.52(3)
A shareholder is given a cost base for the stock received in the form of the dividend equal to the amount of their
share of retained earnings that is reduced by virtue of the dividend being declared.

NOTE: Even more rare than a stock dividend is when a company pays out a dividend with assets in specie.
s.52(2) states that the shareholder is given a cost base equal to the value of the dividend in specie at FMV.

S.83(2)(a)
states that before payment of a dividend (or on the day of the dividend per Cy), a company can elect, on the full
amount of the dividend, to make it a Capital Dividend. The elected dividend can only be up to the amount of the
companies capital dividend account.
NOTE: This must be in the full amount of the dividend. If you have only $100,000 in your CDA but you
have $120,000 which you want to dividend out, you must declare two separate dividends. As you can only use
CDA account if the account represents the entire dividend. To be safe, Cy usually does this in two separate days,.

- When the corporation files an election sheet with RC, along with a statement of their capital account, s.83(2)(b)
allows the receiving taxpayer to take the dividend tax free.

Capital Dividend Account

S.89(1) defines the account as the net of the following calculation....

1/4 CAPITAL (capital gains - capital losses)

(PLUS) ALL DIVIDENDS RECEIVED FROM ANOTHER CORP'S CDA
(PLUS) 1/4 OF THE NET E.C.E FIGURE*

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(PLUS) LIFE INSURANCE PROCEEDS MINUS THE A.C.B. OF THE POLICY

* The E.C.E. figure refers to 1/4 of the proceeds rec. from sale of intangible cap. ppty. minus 1/4 the eligible
capital expenditures of the corporation.
- intangible capital property is essentially goodwill and franchise and patent rights which have an
unlimited term.
POLICY: Notice that the amounts are basically those which would be tax free if claimed by an individual. For
example, if an individual were to make a $100 capital gain, she would only be taxed on 3/4 or $75 of that. So, as
a corporation that makes a $100 capital gain, 1/4 or $25 would go into the capital account and remain tax free.
Same idea works with the ECE as ECE is reported at a 3/4 rate with the other 1/4 being non-taxable. Attempts to
create no disadvantage by earning income through a corp versus a sole proprietorship.
NOTE: s.89(1) effectively allows CDA dividends to flow through corporations until they get to an individual, in
order to make sure that the individual receives the tax benefit.
NOTE: Very often a company will hold life insurance on a key shareholder. Life Insurance is not taxable because
it does not come from a source. IE: It is not anticipated or recurring. Therefore, it should not be included in the
corp’s income as it would not be included in the individuals income.
NOTE: As well, using such figures works at preserving near integration in the system. EXAMPLE:

Tax on $1000 capital gain

Assume:
- Corp is a CCPC
- Corp’s tax rate is 51.67% (25% after allowing for refund of 26.67% RDTOH)
- Individual’s Tax Rate = 29% (this is the highest federal marginal tax bracket)

TAX ON $1000 CAPITAL GAIN THROUGH INDIVIDUAL:

Individual’s income = $750.00
Federal Tax = 29% x $750.00 = $217.50

Prov. Tax. = 52% x $217.50 = $113.10

Individuals Total Tax = $330.60 (217.50 + 113.10)
(Ignore surtaxes)
Individual retains:
$1000 - 330.60 = $669.40

TAX ON $1000 CAPITAL GAIN FLOWED THROUGH CORPORATION

A) Corp. Income = $750.00
Add to capital dividend account = $250.00
Corporate Tax = 25% x $750.00 = $187.50
Tax Div. Paid = $750.00 - $187.50 = $562.50
Cap. Div. Paid To Individual = $250.00 (add in on individual side)
B) Individual’s Income =
$562.50 + (25% x $562.50) = $703.13
Fed. Tax = 29% x $703.13 = $203.91
Fed. Tax Credit = 16.67% x $562.50 = $93.75
Net Fed. Tax = $203.91 - $93.75 = $110.16
Prov. Tax = 52% x $110.16 = $57.28
Individuals Total Tax = 110.16 + 57.28 = 167.44

Individual retains:
562.50 tax dividend
- 167.44 personal tax
+ 250.00 capital dividend
$645.06

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- The extra tax in interposing a corporation equals $24.34 which is the 3.25% loss on flowing Aggregate
Investment Income through a corporation (ie 3.25% of 750 = 24.34).
- However, it must be realized that some RDTOH remains. The $750 of corporation income generates 26.67% x
$750.00 which equals $200.00 RDTOH. But the $562.50 dividend paid out only generates 33 1/3% x $562.50
which equals $187.31. So there is still left $12.69 RDTOH (200-187.31).

Q. What if the companies capital account isn't big enough?

A. According to s.83(2)(a) a corporation can only make the capital election on the full amount of the dividend.
So where the amount of the proposed dividend is more than is in the capital account, the company must either
declare the full amount taxable, or make two separate dividends.
OTHERWISE LOOK OUT FOR:
s.184(2)(a)
which imposes a penalty where a corporation makes an election which is greater than the amount held in the
capital account. The penalty works out to 75% of the excess election.
NOTE: The shareholders receiving the excess dividend become jointly and severally liable for the penalty with
the corporation to the extent of their pro-rata shareholdings: s.184(3-5).
EXCEPTION:

S.184(3) allows a backdoor to the 75% penalty. Where all of the shareholders elect to treat the excess amount as a
separate, taxable dividend within 90 days of receiving RC's penalty assessment, the penalty is voided. However,
all shareholders must then take their proportionate share of the excess into their incomes as an ordinary taxable
dividend.
- When corp is penalized, however, the dividend received by the individual still remains tax free for the
individual.

- Remember that money only goes into the capital account where the income came through a capital gain. It is
possible that RC will view the capital gain as an adventure in the nature of trade! We have to go back to first
year and analyze the secondary intention etc. of the corporation. If it is an A.N.T., then the full amount is taxable
and nothing goes into the capital account. So if you realize this too late, your capital account will be less than you
actually think it is since you included the capital gain which was actually income from an A.N.T. So when a
dividend is declared, RC will find that you didn't have enough money in your capital account and the penalty
from s.184(2)(a) will apply.

NOTE: The relief offered under s.184(3) is very generous. However, it may be difficult to get all shareholders to
agree to have the dividend as a taxable For example, by the time Revenue determines that the tax free dividend
exceeds the CDA account, one or more of the shareholders who received the tax free dividend may have sold
their shares. It is unlikely that those former shareholders who no longer have an interest in the company will be
willing to have the dividend received before become taxable so that a corp of which they no longer own shares of
can avoid a penalty. Furthermore, if the shareholders do not get along, a minority shareholder with a small
interest in the company may not be willing to agree so that a majority shareholder will suffer the extreme effects
of the penalty.

NOTE: If the shareholders elect to void the penalty under s.184(3), interest will have accrued and be charged
against the individual T receiving the dividend from the time that the dividend was paid.

NOTE: The Capital Dividend Account (CDA) is calculated at a particular point in time. IE: If the company has a
capital gain in October and expects that they will have a capital loss of the same amount in November it is
necessary for them to declare the CDA dividend prior to the capital loss in November as once the capital loss
occurs, the CDA account will be wiped out. If a dividend is paid out before November, the tax free dividend
works and the CDA account after the capital loss will just be negative.

54
 - Cy says that if this scenario occurs and you don’t have the money to pay the dividend in October,
borrow the money from the bank and arrange with the shareholders to put the money back into the company, or
pay the dividend out by promissory note.

2. Winding Up a Corporation:
- Ss. 203 and 204 of the CBCA and MBCA provide for how corporations are to be dissolved.

Simply, winding up requires a special resolution of the shareholders of each class of shares which authorizes the
directors to distribute the property of the corp. and address the liabilities. The corporation must carry out these
tasks before it can file the Articles of Dissolution. Upon issuance of the Articles of Dissolution by the Director of
the Corporations Branch the corporation ceases to exist.

- On winding up the shareholder relinquishes his shares in return for the distribution of assets of the corporation
to him. There are tax consequences to both the corporation and the shareholder.

METHODS: A. CASH
B. IN SPECIE

A. This method involves the directors selling off all of the assets of the company. From these proceeds, the
directors pay off all liabilities, then declare a dividend which is equal to the remaining amount (retained
earnings). The shareholders then return their shares and receive their capital back.

B. This way is used when the directors/shareholders don't want to convert all of the assets.
(eg. want specific land back, bad time to sell bonds). The directors would convert enough assets to satisfy the
liabilities, and then distribute the assets in specie to the shareholders. In that case...

S.69(5)(a)
deems the corporation to have disposed of these assets at FMV.
s.69(5)(b)
And, for the shareholder is deemed to have acquired the assets at an ACB of FMV. (This ensures that double
taxation does not occur when the taxpayer sells the property).
- So in the eyes of RC, the corporation has been fully dissolved notwithstanding that some of the assets were
transferred in specie. Therefore the corporation must address all of those nasty capital gain/loss issues etc.
NOTE: When company is distributing assets on dissolution, you have the deemed disposition at FMV pursuant to
the above. There may, however, later be disputes about what is FMV. If Revenue disagrees and wins, the
directors would be liable on dissolution for taxes owing and the shareholders are liable also under corporate law
to any creditor that hasn’t been paid and this includes Revenue.

KEY: Using either A or B gives the same tax result for the corporation. But, for
THE SHAREHOLDER there are different ramifications

A. Where the corporation dissolves all of it's assets, then the shareholder will take the dividend the same as we've
been discussing for the last couple of eons. Ss. 82, 121, and 112. will apply with the theory of integration lurking
in the background.

B. BUT where the corporation gets into all of this deeming stuff the shareholder will be hit with either a deemed
dividend and a disposition of shares which may result in a capital gain/loss.

55
S.84(2) states that where assets are distributed on a wind-up, each class of shareholders are deemed to receive a
dividend equal to the value of the property received but less the amount by which the PUC is reduced. Simply,
the deemed dividend is equal to the amount that the worth of the property exceeds the PUC.

"Paid Up Capital" is not defined in the Act unless expressly stated. Therefore we must look to corporate law
which generally sees PUC as the amount which a corporation receives in consideration for its shares.. IE: Stated
capital (this is what it is called in corporate law pursuant to s.26 MBCA)

EXAMPLE: Kenny owns shares in a corporation which is winding up. He paid $1000 for the shares. Upon wind
up the corporation has....
Assets = $4300
Liabilities = $1100
PUC = $1000 1. Dealing with liabilities: $4300 - $1100 = $3200.00
RE = $2200 2. S.84(2) deemed dividend of

$3200 - $1000 = $2200

Notice that in this very simple example, Ken has the same tax ramifications as though he had received a dividend,
and then turned in his shares to get his PUC back tax free.

NOTE: On the deemed disposition of assets under s.69(5) there may be a capital gain. You may, as a result, have
a simultaneous CDA generated. Therefore, you are not robbed of your CDA in a deemed disposition as opposed
to a dissolution where all assets are sold prior to dissolution.

Q. What if the corporation has money in it's capital account, but the deemed dividend
will be more than that amount? Will the whole thing have to be taxable, and the
capital account will go to waste?
A. S.83(2) allows the corporation to elect to make the deemed dividend a capital tax free dividend. As well, to
make max. use of the amount in the capital account, s.88(2)(b)(i + iii) deem the dividend to be divided into
amounts which would fit the level of the capital account (IE: s.83(2)). So if there's only $100 in the capital
account, s.88(2)(b)(i + iii) will deem one dividend to be capital, tax free, and in the amount of $100.
NOTE: S.88(2)(b)(iv) deems each shareholder to receive a pro rata amount of the deemed split of capital and
taxable dividends. This means that one shareholder couldn't claim that all his dividends were capital, while all the
taxable dividends went to his ex-girlfriend.

BUT IT'S NOT OVER YET...

The shareholder must hand in her shares to the corporation to receive the portion of the wind up. Under the Act
definition of "disposition", s.54(b)(i), this is not a deemed disposition (it's an actual one). So, the taxpayer must
worry about possible capital gains and losses.
- This is weird because under s.84(2) the shareholder would have already included the taxable dividend on wind-
up as income. So, under s.54 para. (j) the proceeds from disposition on capital gains are reduced by the amount
of the s.84(2) deemed dividend.

EXAMPLES.....

1. Tony acquires shares for $1000. This means that the PUC is $1000.

On wind up Tony gets $2500 worth of property.

So the s.84(2) deemed dividend is $2500 - $1000 = $1500.
According to this, Tony received $2500 for the disposition of his shares.
So according to s.54(j) he subtracts the amount of the deemed dividend
$2500 - $1500 = $1000

56
 And looking back to the beginning he paid $1000 for his shares so the adjusted
cost base is $1000 and he shows no capital gains or losses.

2. Kristi buys 50 shares for $1000.

Al buys 50 shares for $500. This means total PUC is $1500.
At wind up, the shareholders as a group get $2500.
So the s.84(2) deemed dividend that they split pro rata (which happens to be 1/2)
is $2500 - $1500 (PU(C) = $1000.
Pro rated, Al and Kristi each get a $500 dividend.

Kristi wants to figure out if she has a capital gain or not. So she takes the amount which
she got for the disposition of her shares ($2500 for the whole class /2 = $1250)
and subtracts the amount of her deemed dividend ($500) leaving her with
$1250 - $500 = $750. Now her cost base is $1000 so she ends up with a net
capital loss of $250. Clear as mud n'est pas?

Al is mad that Kristi gets to figure out here capital gain/loss. So he takes the amount
which he got for the disposition of his shares ($2500/2 = $1250) and subtracts
the amount of his deemed dividend ($1000/2 = $500) leaving him with $750.
Now his cost base is $500 so he ends up with a capital gain of $250.

CY: There is no rhyme or reason as to who ends up with a capital gain or loss. The only sure fire way to keep
reconcile this stuff is that in the end (on a historical analysis) the capital gains and capital losses of all the
shareholders over time (IE: From the very beginning) will equal zero. This includes the shareholders that sold to
other shareholders not necessarily on disposition.

3. Shane buys shares for $1000.

Adam buys these shares from Shane for $1500.
Remember that the PUC in the corporation is still the original $1000 that Shane paid.
On wind up, Adam gets $2500 worth of property.
His s.84(2) deemed dividend is $2500 - $1000 (PU(C) = $1500
Now, Adam takes the amount which he got for the disposition of his shares ($2500)
and subtracts the amount of the deemed dividend ($1500) = $1000.
But, since his cost base was the $1500 that he paid to Shane for the shares,
Adam ends up with a resulting $1000 - $1500 = $500 capital loss.

CY: To get our net balance of zero, notice that Shane had a cost base of $1000 and sold them for $1500 so she
has a capital gain of $500. Balance this with Adam's loss and you get ZERO.

EXAM: Remember to advise the client to check out the amount of PUC in the corporation if she is buying shares
from a shareholder that already holds the shares. She could end up sustaining a huge capital gain/loss if she has
no clue as to the PUC that will be used in the deemed dividend calculation.

4. Tom buys 150 shares for $1500.

Dick buys 50 shares for $500. So the PUC is $2000.
Harry buys Dick's 50 shares for $2000.
On wind up, the whole class which now consists of Tom and Harry get $3000.
So the s.84(2) dividend to the class is $3000 - $2000 (PU(C) = $1000.
Pro rated, Tom gets 3/4 (since he holds 150 outa 200 shares) = $750
Harry gets 1/4 (since he holds 50 outa 200 shares) = $250.
To figure out Tom's capital gain/loss situation. He first must figure how much
he got for his shares. The class got $3000, and since he owned 3/4 of the
shares in the class he got $2250. So, the s.54(j) proceeds from disposition

57
 are $2250 - $750 (deemed dividend) = $1500. Since his cost base was
$1500 he ends up without any capital gain or loss.
To figure out Harry's capital gain/loss situation. He got $3000 x 1/4 for his shares
since he only owns 25% of the shares in the class = $750. So his proceeds
from disposition are $750 - $250 (deemed dividend) = $500. Since he paid
Dick $2000 for the shares, he ends up with a net $1500 capital loss.

CY: And to zero out the capital gains/losses, notice that Dick ended up with a cost base of $500 and sold them
for proceeds of $2000 so he had a $1500 capital gain which cancels out Harry's capital loss.

Remember that the deemed dividend will be the amount over and above the PUC which is already in the
corporation regardless of how many times the shares trade hands and for how much.

EXAM.......Guaranteed that there will be a situation where a deemed dividend is paid out to another
corporation. Just don't forget that this goes back to the RDTOH and Part IV tax stuff.

Problem
There are 100 issued common shares in S. Ltd. X owns 50 of them and the other 50 shares are owned by a person
at arm’s length to X. The paid up capital of all 100 common shares of S. Ltd. is $100,000.

X had originally purchased her shares in S. Ltd. from an arm’s length person for $100,000.

In anticipation of winding up, S. Ltd. has sold all its assets and converted them into cash. Using some of this case
it has paid off all its liabilities, including its Part I income tax for the year. It now has left $400,000 in cash.

S. Ltd. Has no refundable dividend tax on hand. The amount in its capital dividend account is $100,000.

What are the income tax ramifications to X when she returns her 50 shares for cancellation to S. Ltd. on its
winding up and receives one-half of S. Ltd.’s available cash.

Answer
S. Ltd. has $400,000 left to pay out on winding up to the two shareholders, $200,000 to X and $200,000 to the
other shareholder.

1. The class of shareholders receives a deemed dividend of (400,000 - 100,000) = 300,000 (remember the
PUC of the shares was 100,000). X’s deemed dividend = 1/2 x $300,000 = $150,000.

2. S Ltd. elects that the 100,000 in the CDA will be a capital dividend, one-half of which goes to X.
Therefore X receives a taxable dividend equal to 150,000 - 50,000 = 100,000. See s.84(2) and s.88(2).

3. X disposes of her shares for adjusted proceeds equal to 200,000 - 150,000 = 50,000 (note: the adjusted
proceeds are reduced under s.54 proceeds of disposition para(j) by the full deemed dividend to X, i.e. by both the
capital dividend of $50,000 and the $100,000 taxable dividend).

Therefore, X has a capital loss equal to $50,000 - 100,000 = ($50,000) loss (remember the ACB of the
shares to X was 100,000).

NOTE: If a dividend comes out of a CDA account, it must come out tax free and therefore it cannot be included
in your capital gain/loss calculation.

NOTE: On the wind up of a company, there are two circumstances where you may have to take Part IV taxes,
RDTOH, into account:

58
a) If there is a deemed dividend under s.84(2), you are actually receiving an actual dividend. If a company has an
RDTOH account, it will be entitled to a refund of $1 for every $3 dividended out to the extent of the account.
This RDTOH refund must be added to your proceeds in order that it can be dividended out as company is
winding up.
b) If you are a corporation who is receiving a deemed dividend on the wind up of a company, and part of the
dividend paid by the winding up company gives the winding up company an RDTOH refund, then the company
receiving the dividend will have the implications discussed under Part IV (IE: necessary to determine if
connected and what taxes are payable).
*THEREFORE, a deemed dividend needs to be scrutinized in the same manner as anyother dividend when the
dividend is being received by a corporate shareholder.

Exception to Wind Up (NOT EXAMINABLE)

S.88(1) states that if a corporation that is winding up is 90-100% owned by a parent company, then none of the
above applies. Instead, s.88(1)(a) generally provides for a tax free rollover (IE: at UCC or ACB depending if
depreciable or not) of the assets from the subsidiary to the parent and a tax free rollover of the shares from the
parent to the subsidiary. That is, the subsidiary is deemed to have disposed of the assets which go to the parent at
their ACB and the parent is deemed to have disposed of its shares in the subsidiary at the ACB of the shares.
S.88(1) also provides that s.84(2) does not apply so that there is no deemed dividend and that s.69(5) does not
apply so there is no disposition for capital gains purposes.
- This is in order to facilitate corporate reorganization.
NOTE: There is nothing in the Act, to prevent a parent corporation from buying up the shares of a subsidiary in
order to achieve 90% shareholdings and thus avoid deemed dividends. Cy says that this section also provides a
very effective way to squeeze out a minority (less than 10%) shareholder.

3. REDEMPTION AND PURCHASE BACK OF SHARES ("R and PB")

Redemption: Is where the shareholder rights permit the company or shareholder to unilaterally
cause the shares to be redeemed under a pre-determined shareholder rights
formula. Unilateral Act (usually preferred shares)

Purchase Back: Is where the shareholder and corporation reach a consensus whereby the
shareholder allows the company to buy back the shares for $X. This is a
bilateral agreement. Bilateral Act (usually common shares(

Solvency Test:
S.36 CBCA S.34 MBCA
- Subject to its Articles, a corporation may redeem any of its redeemable shares provided that it meets a solvency
test. The legislation provides that in order to redeem its shares a corporation must retain sufficient assets to the
corporation to be able to pay both its liabilities and the amount that would be required to be paid on a liquidation
to shareholders ranking ahead of or rateably with the shareholder whose shares are being redeemed.

S.34 CBCA S.32 MBCA

- Subject to its Articles, a corporation can purchase back shares issued by it provided that it meets a solvency test.
The legislation provides that in order to purchase back its shares a corporation must retain sufficient assets in the
corporation to be able to pay both its liabilities and the stated capital of all classes of shares issued by the
corporation.

Tax Consequences to Shareholder

On a redemption or purchase back of shares, the shareholder gives his or her shares back to the corporation.
S.39(6) of the CBCA and s.37(6) of the MBCA states that shares are redeemed or bought back by a corporation

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are canceled. There are two possible tax consequences to a shareholder when his or her shares are redeemed or
bought back by a corporation:

(i) a deemed dividend; and

(ii) a disposition of the shares which may give rise to a capital gain or capital loss.

Deemed Dividend
S.84(3) Under this section, where a shareholder has her shares R or PB by a corporation
the shareholder is deemed to have received a dividend which is equal to the
proceeds (amount paid by corporation to shH. for shares) less the PUC of those shares.

NOTE: The redemption or purchase back need not take place in respect to all of the shares of a particular class.

S.89(1) defines paid up capital of a share to be its prorata share of the paid up capital of the whole class.
Therefore, the paid up capital of shares that are being redeemed or purchased back is calculated as follows:

No of shares being redeemed or Paid up capital of whole class

purchased back x
Total No. Of Shares in the Class

NOTE: In this situation the PUC is calculated pro rata (IE: you use the PUC of the individual under s.84(3) as
compared to the deemed divided under s.84(2) we used the PUC for the whole class). For example, if 10 shares
are bought from treasury for $20, and then 10 are bought for $60, 5 shares will have a pro rata PUC of

5/20 x $80 = $20 .

- This is how an individuals PUC is calculated for the purposes of this section despite the fact that an individual
may have actually paid more or less for his shares then his pro-rated share of the PUC of his class.
NOTE: s.37 MBCA and s.39 CBCA, are the same as s.84(3) in providing for this pro-ration. These sections
provide that when shares of a class are redeemed or purchased back by a corporation, the stated capital of the
class is reduced by the same pro rata proration. Therefore, the calculation of the amount by which the stated
capital of the class of shares is reduced on cancellation of the shares is the same calculation as set forth above. A
deemed dividend on a redemption or purchase back may result in a dividend refund to the corporation under
s.129(1) if it has RDTOH, in the same way as an actual dividend may result in a dividend refund.

Disposition of Shares
- Under s.54 disposition, para (b)(i), and s.84(9) whenever a share is canceled as on a redemption or purchase
back of the share there is a disposition of the share for capital gains purposes. Normally the proceeds of
disposition would be the amount received by the shareholder for his or her shares on the redemption or purchase
back but as with the provisions under s.84(2) in respect of the winding up of a corporation, s.54 proceeds of
disposition para (j) provides that the proceeds of the disposition of shares on a redemption or purchase back of
the shares are reduced by the amount of any s.84(3) deemed dividend received by the shareholder.

EXAMPLE 1:
- SH1 and SH2 are individuals
- SH1 purchases 10 shares out of treasury for $10.
- SH2 purchases 10 shares out of treasury for $2
- Assume there are only 20 shares in the class
(A) Assume SH1's 10 shares are redeemed for $14:
- PUC of SH1's shares - 10/20 x $12 = $6
- Deemed dividend = $14-6 = $8
- Adjusted proceeds for capital gains = $14 - $8 = $6
- Capital Gain/Loss = adjusted proceeds - adjusted cost base

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 $6 - $10 = $4 (capital loss)
(B) Assume SH2's 10 shares are redeemed for $14:
- PUC = 10/20 x $12 = $6
- Deemed Dividend = $14 - $6 = $8
- Adjusted Proceeds = $14 - $8 = $6
- Capital Gain/Loss = $6 - $2 = $4 capital gain

Notice that although they each got the same amount back from the corporation, because SH1 paid more than SH2
into the treasury originally, they each have different tax ramifications.
EXAMPLE 2: Monty paid $7000 for 10 shares. In that class of shares there is $20,000 in PUC for 40 shares.
Monty gets $9500 on a R or PB. So
(a) PUC for the shares pro rata is 10/40 x $20,000 = $5000
(b) S.84(3) deemed dividend is $9500 - $5000 = $4500
(c) Proceeds from disposition are $9500 (actual proceeds) - $4500 = $5000
(d) So with his ACB Monty ends up with a capital loss of $2000.

EXAMPLE 3:
- SH1 buys 10 shares for $100,000
- SH2 buys 20 shares for $20,000
a) - Company redeems 10 of SH2's shares for $10,000
- SH2 pro rata share of PUC is $40,000 (ie: 10/30 x $120,000)
- SH2 distribution is 10,000; dividend calculation 10,000 - 40,000 = nil (When dividend calculation ends up in
the negative, there will be no deemed dividend)
- Capital Gains, proceeds (no adjustments since no dividend) - ACB
IE: $10,000 - $10,000 = no CG

EXAMPLE 4:
- SH1 buys treasury stock at 10 shares for $1000
- SH2 buys treasury stock at 10 shares for $3000
- Company redeems SH2's 10 shares for $5000
- Then company winds out and pays $10,000 to SH2
A)- SH2 Deemed Dividend = $5000 - $2000 (Pro-rata share of PU(C) = $3000

- Adjusted Proceeds: $5000 - $3000 = $2000

- ACB = $3000, Capital Gains $2000 - $3000 = $1000 Capital Loss

Wind Up:
B) - SH1 is the only one left
- $10000 distribution on wind up
- Only $2000 in PUC left
- SH1 Deemed dividend: $10,000 - $2,000 = $8,000
- Adjusted Proceeds = $10,000 - $8,000 = $2,000
- Capital Gain/Loss: $2,000 - $1,000 = $1,000 capital gain
NOTE: That SH1's gains net out SH2's losses.

EXAMPLE 5:
- SH1 subscribes for 20 shares for $20,000
- SH1 sells 10 shares to SH2 for $15,000
- Corp. redeems SH2 out entirely of all 10 shares for $30,000
- Corp winds up and pays SH1 $50,000

NOTE: When doing this type of answer, it is necessary to do it in order of transactions

A) SH1 (at time of sale of shares to SH2)

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- Capital Gain/Loss: $15,000 - $10,000 = $5,000

B) SH2:
- Deemed Dividend: $30,000 - $10,000 = $20,000
- Adjusted Proceeds: $30,000 - $20,000 = $10,000
- Capital Gain/Loss: $10,000 - $15,000 = ($5000) capital loss

(C) SH1 (on wind up):

- Deemed Dividend: $50,000 - $10,000 = $40,000
- Adjusted Proceeds: $50,000 - $40,000 = $10,000
- Capital Gain/Loss: $10,000 - $10,000 = $0

NOTE: The reason people pay different prices for shares, is that values of companies fluctuate. People pay more
or less depending on the value of the company.

NOTE: If you agree to have you shares purchased back with payment over time or there is a redemption which
allows for payment over time, you are still required to calculate your deemed dividend immediately and pay the
required taxes (IE: even if you haven’t received the money) The authority for this is: Gabezuelo 83 DTC 679.
This stems from the definition in s.248 of Amount which includes money rights. Therefore, while you may not
actually have the cash, the fact that you have a promissory note or an agreement which indicates that you are
owed the money is a thing of a value and thus you fall under this definition.

- Cy says to be very careful of this, as you could end up with a deemed dividend and thus taxes which are
greater then the cash which you have actually received due to the amount that is being paid at a later date.

NOTE: If the shareholders of a company wish to buy out a fellow shareholder, they have two options:
a) They can have the company redeem the shares (if those rights are available) or enter into a purchase agreement
with the shareholder; or
b) They can buy the shareholder out personally.
- If they choose to buy the shareholder out personally, they will have to cause the company to dividend out to
them the necessary money. However, as a result of this dividend, they will have to pay the associated tax. If the
corporation buys out the shareholder, all that it costs is the price owed to the shareholder and there will be no tax
payable.
- The only circumstance that the shareholders may want to buy out another individually is in order to bump up
their ACB for the capital gains calculation. IE: if they buy the shares personally, there ACB for the purchase of
their original shares will be bumped up (presuming they are paying more for the shares, then they paid for their
original shares).

EXAMPLE 5: In 1985 Nerrad Ltd. issued 20,000 shares out of treasury to its shareholders for a PUC of $240,000
($12 per share). In 1990, Nerrad Ltd. was not doing very well and the value of its shares had dropped by half. It
required some more working capital and it issued 10,000 additional shares for a PUC of $60,000 ($6 per share).
One of the new shareholders was Sylvester Ltd. Which bought 1000 shares for $6000. S Ltd. is not related to N
Ltd.

SUMMARY: PUC = $300,000

TOTAL SHARES = 30,000

By 1995, the financial position of N Ltd. had improved and it decided to enter into a purchase contract with S.
Ltd. to buy back its shares.

Sylvester Ltd. gets its shares (1000) PB for $12,000. So....

(a) PUC of the shares is 1000/30,000 x $300,000 = $10,000

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 (b) S.84(3) deemed dividend of $12,000 - $10,000 = $2000
(c) Proceeds from disposition are $12,000 - $2000 = $10,000
(d) So Sylvester Ltd. ends up with a $10,000 - $6000 (ACB) = $4000 capital gain.

Of course don't forget that Sylvester Ltd. is a corporation itself so all that Part IV and RDTOH stuff applies
(maybe). To begin with, s.112 and s.121 make the dividend between corporations tax free. But, if the
corporations are connected Sylvester will have to pay a Part IV tax depending upon the amount of RDTOH which
Nerrad Ltd. gets back (check to see if Nerrad has any investment income). If the corporations aren't connected
(like here since Sylvester owning 1/30 of the shares is not greater than 10% ownership) then Sylvester will pay
1/3 tax on the dividend into it's own RDTOH account. Also, 3/4 of the $4000 is a taxable capital gain and taxed
as investment income. Therefore, $3000 of that is taxed at 51.67% with the old investment income refund
bringing the rate down (eventually). See above for this investment refund.

Since the question says that the corporations are not connected, S. Ltd. will have to pay Part IV tax of 33.33% of
$2000 (s.186(1)(a)). This $666.67 Part IV tax will be refundable. S Ltd. will have a taxable gain of $3000 which
will be taxed as AII - i.e. at 51.67% with 26.67% going to RDTOH.

NOTE: For the exam mention that if an individual were in the place of Sylvester Ltd., the stuff we learned last
year about claiming 125% of the dividend and then receiving a credit would apply.

QUICK ADD-ON TO EXAMPLE 5: If Nerrad Ltd. had $5000 in it's RDTOH account and paid out the s.84(3)
deemed dividend of $2000 to Sylvester Ltd., it would have received back $1 for every $3 of dividend that it paid
out. (eg. 1/3 x $2000 = $666.67)

Possible Tax Risks to Purchaser....

WHEN PURCHASING FROM PRE-EXISTING SHAREHOLDER

(SEE ARTICLE ON PAGE 67(a)
If shareholders pay more for their shares then the PUC of their shares, they are going to suffer tax consequences
on wind up.
If the PUC per share that is sitting in the corporation is a lot less than the price for which the taxpayer is paying
in the outside market, there is gonna be tax ramifications upon R or PB. When the shares are R or PB it'll work
out that the majority of the money will be considered a capital loss. This cannot offset the taxable deemed
dividend that is being received!(IE: Capital losses can only be offset by capital gains) So, the taxpayer will have
used taxed money to purchase the shares on the outside market, and then the money will be taxed again when she
gets the deemed dividend upon R or PB. The best bet is for the taxpayer to sell these shares before any R or PB
since then, the price that she paid on the open market will be her ACB and a more accurate calculation of capital
+/- will occur. Also, there'll be no deemed taxable dividend.
IE: Shareholder purchases shares from treasury at $5.00. PUC per share is $4.00. On wind up, or purchase, or
redemption, the shareholder ends up with $1.00 deemed dividend, and a $1 capital loss. The deemed dividend
must be included in income but the capital loss can only be used to offset capital gains.

WHEN PURCHASING FROM TREASURY

In the situation where the taxpayer is purchasing shares from treasury but there are already shares in that class
being held, it is important to look at the PUC which is already in the corporation. If the purchase price being paid
by the taxpayer will water down the PUC per share (eg. At the start of the company 200 shares were sold for
$200, now the taxpayer is purchasing 100 shares for $200 dollars. The PUC per share has gone from $1 to $0.75.
Notice that the taxpayers own shares have an ACB of $2 per share but only the $0.75 per share PUC.) it is a good
idea to get the corporation to create a new class of shares.

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NOTE: The above situation will only have a negative impact for the taxpayer in a winding up, or R or PB
situation. Since if the taxpayer sells to an outside individual, then her ACB will determine the tax ramifications,
not the PUC in the corporation.

NOTE: Always consider Part IV and RDTOH in a purchase/wind up/redemption

NOTE: Remember that for a corp to be connected, you have to own a specified percentage of another corp.
S.84(3), reads literally that deemed dividends are to be calculated after the shares are gone (IE: percentage
holding would be diluted). To avoid this problem, Revenue in IT269R3, paragraph 10 says that you are
connected if you were connected before the redemption. This eliminates the literal reading of s.84(3).

PAID UP CAPITAL STUFF.... S.84

Since PUC comes out of the corporation tax free, RC wants to make sure that tax lawyers (such as we are all
gonna be) don't find ways to artificially increase the PUC for the classes of shares.

S.84(1) states that if the PUC is increased for a class of shares by illegitimate means, there
will be a deemed dividend to the holders of that class of shares in the amount that PUC is
increased illegitimately.

NON-PERMITTED INCREASES IN PUC ...

a) Moving retained earnings to PUC (IE: Without a stock dividend)
IE: Corp A has $200 retained earnings and $250 PUC. Corp decides to move $200 retained earnings to
PUC to make PUC $450.00. This results in a deemed divided to the shareholders of the class of which PUC was
increased of $200.00
b) Issuing shares our of treasury and increasing PUC by more than the real consideration paid for the shares.
IE: Corp issues $500 of shares out of treasury and shareholder pays by transferring $300 asset to
corporation. Corporation adds $500 to its PUC. S.84(1) will again deem a dividend of $200 to be received by the
shareholders of the class of shares that has had its PUC increased by the excess of $200. Note that the deemed
dividend is on the whole class of shares, not just to the one shareholder with whom the transaction was
consummated.
NOTE: A s.84(1) deemed dividend increases the cost base of the shares on which it is deemed, pursuant to
s.53(1)(b). This is due to the scenario being analogized to cash having been paid out as a taxable dividend and
recontributed to the corporation.

LEGITIMATE WAYS TO INCREASE PUC....

(1) Shares are issued out of treasury, and in consideration money is paid in by the shares
purchasers. This money is obviously PUC. S.84(1)(b)

(2) Stock Dividends, when used to increase PUC, do not cause s.84(1) to come into play.
S.84(1)(a)

DEF'N: Instead of giving out a cash dividend, the company may give take stocks from a different class out of
treasury and give them to the shareholders.
NOTE: under s.52(3), the shareholder is assigned a cost for the stock dividend equal to its Aamount.(a)
Therefore, the result of a stock dividend is exactly the same as if a cash dividend had been paid

eg. J.P. (who is too neo-post modern to take advanced tax) owns 10 common shares in Paws Ltd. for which he
paid $1000 into treasury. The company declares a stock dividend in which they give one $50 preferred share for
every common share. As a result, J.P. gets 10 preferred shares. As well, Paws Ltd. now has $1000 PUC for
common shares and $500 PUC for preferred shares.

THEORY: This actually allows the corporation to ensure that the shareholders will hold more stock in the
company. The process behind a stock dividend is as though the money was paid out to the shareholder, and the

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shareholder used the money to purchase the preferred shares. Except with a stock dividend the shareholder has no
option but to get the preferred shares. Pretty sneaky eh?
(3) Decreasing PUC for another class of shares and then increasing the PUC by the same amount for a different
class of shares is allowed. Chances are that this won't be used in normal corporations since one of the classes of
shareholders will be getting screwed. But, if there's only one shareholder it might be a method of tax planning
(but I don't really know so don't trust me).

(4) SHAREHOLDER BENEFITS AND LOANS Remember we're doing ways to get $ out of a corp.

Benefits
Under s.15(1) where a benefit is conferred on a shareholder or on a person in contemplation of becoming a
shareholder by corporation (other than through a regular corporation transaction, eg dividends, redemptions) the
value of that benefit is included in the shareholders income. It is considered ordinary income and not a dividend
so forget about any tax credits etc.

The common law has given a wide meaning to benefit and may include any advantage, gain, or privilege,
including use or appropriation of a corporate asset. This definition does not include dividends received, proceeds
on wind-up, or proceeds from R or PB.

The value of the benefit (unless a specific calculation is provided for in the ITA) is the amount the shareholder
would have to pay to purchase the benefit from an arm’s length party, i.e. fair market value - see Youngman v
The Queen and IT - 432R2, para.11

A couple of the usual benefits which fall under this section are:
(a) Appropriation of Corporation Assets
(b) Corporate Advantages
(a) This can occur where the shareholder just comes along and takes some money out of the corporations
accounts without there being a dividend declared, or anything like that. S.15(1) makes any money taken like this
to be the shareholders income. Since this is taxed as ordinary income, there is no dividend tax credit available so
you end up paying more tax. But there are more subtle ways of doing this....

It often occurs that the shareholder will purchase an asset from the corporation for less than the FMV. In this
situation RC deems that the value of the benefit will be the amount for which the shareholder would have had to
pay to purchase the benefit from an arm's length party. This is a matter of evidence.
The authority for this is: Youngman v. Q

S.69(4) deems the corporation to have disposed of the asset for FMV in such situations so there could be the
same tax consequences to the corporation as if the asset had been sold.

(b) Corporate advantages include such situations as where the shareholder lives in a house, with little or no rent
being paid, that is owned by the company. This less than FMV benefit is deemed to be included in the
shareholders income. Authority for this is Pauls Hauling Ltd. v MNR (79 DTC 167) It is generally a question of
fact as to whether the advantage to the shareholder is actually falling under s.15(1).

eg. Holidays vs. Business Trips Hart v. Q. (IE: Someone travels on company business but stays a few days after
for a vacation. The company pays for the whole thing).
- Cy says Revenue doesn’t care if you stay for one extra day. Rather, it is interested in extended lengthy,
and costly vacations.

Hart v The Queen (FCA, 1982)

Facts: The taxpayer was the principal shareholder in a farming operation. He went on a business trip and tour
arranged by a farmer’s association. This trip was paid for by his farm corp. The tour included visits to agricultural
operations for the purpose of gaining knowledge of the different methods and techniques used. It also included

65
site seeing and entertainment. The taxpayer put to profitable use certain of the acquired information. The Minister
assessed the taxpayer for a taxable benefit from the holiday value of the trip.
Held: A portion of the cost of the trip was a personal holiday and thus was a taxable benefit to the T. Given the
different parts of the tour, it is not possible to conclude that the tour was predominantly or even essentially a
business trip or that it had no value as a holiday and represented no economic benefit as a holiday trip received or
enjoyed by the appellant. Accepted the trial judge’s assessment of what percentage of the trip was a personal
benefit.

In some situations there are fixed formulas to calculate the amount of the benefit. This is because it is really
tough for RC and other tax type people to determine the amount which is a "benefit or advantage". RC found
themselves being taken to court all the time about this fact. So.....

S.15(5) Automobiles which are owned by the corporation but used by a shareholder will
fall under the same formula used in the employee situation s.6(1)(e) and s.6(2).

FORMULA: The benefit is = 2% per month of the original cost of the car. It doesn’t make a difference if the car
is new or used.

NOTE: If the corporation leases the car, the benefit which is tacked onto the shareholders income is equal to 2/3
of the monthly lease payment.

NOTE: If the shareholder is paying the company any rent for the car, the amount that the shareholder is paying
will be deducted from the above inclusion. - s.6(1)(b).

The shareholder will be exempt from s.15(1) application where she can demonstrate that 90% of the use of the
car is for business purposes and less than 12000 km of annual personal use is being put on the car. Then the
benefit will only be the normal benefit as calculated above times the amount of the 1000km allowed which is
being put on. If the shareholder falls within this exception the benefit is calculated as:

Benefit = Personal Use Kilometers x 2% of original cost (or 2/3 of lease cost)
12,000

NOTE: The result of this formula has been that over the last few years, there has been very few company cars
used for personal use. This is because the benefit necessary to be included in income is too large.

NOTE: This is not a dividend, and therefore there will not be a dividend tax credit. The money is just directly
included in income.

SHAREHOLDER LOANS....
This idea of interest free loans is addressed under s.80.4(2). It covers both loans made to a shareholder by the
corporation in which the shareholder owns shares or by a related corporation.

S.80.4(2)
Where a person or a partnership was:
(a) a shareholder of a corporation,
(b) connected (IE: not dealing at arm’s length) with a shareholder of a corporation, or
(c) a member of a partnership, or a beneficiary of a trust, that was a shareholder of a corporation;
and by virtue of such share holding that person or partnership received a loan from, or otherwise incurred a debt
to, that corporation, any other corporation related thereto or a partnership of which that corporation or any
corporation related thereto was a member, the person or partnership shall be deemed to have received a benefit in
a taxation year equal to the amount if any, by which
(d) all interest on all such loans and debts computed at the prescribed rate on each such loan and debt for
the period in the year during which it was outstanding

66
exceeds
(e) the amount of interest for the year paid on all such loans and debts not later than 30 days after the
later of the end of the year.

s.80.4(8) -Persons Connected with a Shareholder

For the purposes of subsection (2), a person is connected with a shareholder of a corporation if that person does
not deal at arm’s length.

s.15(9) - Deemed benefit to shareholders by corporation

Where an amount in respect of a loan or debt is deemed by section 80.4 to be a benefit received by a person or
partnership in a taxation year, the amount of the loan or debt shall be deemed to be a benefit conferred in the year
on a shareholder.

FORMULA: The s.15(91) benefit for the shareholder is the amount which;

The prescribed rate of interest under s.80.4(7)(b) and Reg.4301 EXCEEDS

The amount of interest paid no later than 30 days after the end of the year.

NOTE: Corporations who are shareholders do not fall under s.80.4 which allows them to borrow money from
other corporation in order to make their own dividends and get back RDTOH. S.80.4 only applies to
shareholders that are individuals
POLICY: Dividends can go from corporation to corporation tax free. Therefore, to be consistent, so can
loans.

S.80.4(3)(b) states that s.80.4 doesn't apply where the principle of the loan has been included in the shareholders
income pursuant to s.15(2).

S.80.5 provides an offsetting deduction to the imputed interest into income under s.15(9) when the shareholder
has borrowed money to use it in business such that he would get a deduction under s.20(1)(c). The individual
shareholder must include the interest as a benefit but then gets this offsetting deduction.
- Therefore, there is only a net effect under s.80.4(2) if the money borrowed by the shareholder as for personal
use and not for an income producing purpose.

NON-REPAYMENT OF SHAREHOLDER INDEBTEDNESS ...

- If a shareholder were permitted to owe the corporation monies on account of a loan or other indebtedness
forever, the shareholder could gain access to the corporation’s property without incurring dividend tax.

- s.15(2) is meant to preclude this tax free avenue to corporate property.

- s.15(2) only applies to shareholders who are individuals, not to corporations.

S.15(2)

This section will include as shareholder income the principal amount of the loan (Under s.80.4(2) we were only
talking about interest) unless the loan or indebtedness arose:

(a) in the ordinary course of the corp's business and in the case of a loan, lending of money was
part of its ordinary business (s.15(2.3));

(b) the debtor is an employee of the corp. but not a specified employee as
defined at s.248(1) (s.15(2.4));

(c) to acquire a dwelling where the debtor is also an employee of the corp.

67
 who received the loan or became indebted because of the employee's
employment (s.15(2.4));

(d) to acquire treasury shares or the corp. or a related corp. where the debtor
is also an employee of the corp. who received the loan or became indebted
because of the employee's employment (s.15(2.4));

(e) to acquire a car to be used in employment where the debtor is also an

employee of the corp. who received the loan or became indebted
because of the employee's employment (s.15(2.4));

AND bona fide arrangements are made at the start of the loan for
repayment in a reasonable time (Q. of Fact);

OR the loan is repaid within one year from the end of the corp's fiscal year in which the
loan arose, other than a repayment which is part of a series of loans and repayments (see s.15(2.6)).

A big tax implication is that this indebtedness is included for the taxpayer as ordinary income under s.15(2) and
not a dividend.

- As well, s.20(1)(j) provides that on repayment the loan will be a deduction for the taxpayer.
- While you do get the money back, depending on how high your other income is, when you include the loan
income, it will probably be taxes at the highest level but when you take it out your credit will be at a lower level
due to the deduction. Furthermore, even though you do get the refund, you are allowing .revenue to hold the
money while you are paying down the loan.
- The refund can be gradual if portions of the principal are paid down each year.

NOTE: By virtue of s.15(2).1 a connected individual is a person with whom the shareholder does not deal with at
arms-length.
NOTE: There is no imputed interest included in income under s.80.4(2) as once you include the principal in
income, revenue treats this money as if it is yours and only deducts it once you pay it back.

THEREFORE, it doesn’t pay to borrow from the corp unless you fall within one of the exceptions. If you do fall
within one of the exceptions it may be an advantage because the interest rate may be lower. *SEE CHART ON
PAGE 75 OF THE EM*

Section 85 Roll-Over

POLICY: This s.85 roll-over allows a taxpayer to dispose of property to a corp. and elect an amount (EA) that
will be deemed to be the taxpayer's proceeds of disposition (POD) and the corporations ACB. Simply put, the
corp. steps into the tax shoes of the transferor taxpayer (t'or). There is no deemed disposition at FMV.

Q. WHO CAN MAKE USE OF THE ROLL-OVER?

Any taxpayer (can be a corp, sole proprietor, or individual) regardless of residency who disposes of property to a
taxable Canadian corp.
Taxable Canadian Corporation is a Canadian corp. that is not exempt from tax under Part I as defined in s.89(1)
Canadian Corp. is a resident corp. that was either incorporated in Canada, or resident in Canada
throughout the period from June, 19/71 to the date of transfer of property.
(For the purposes of this course, these are the same thing)

Q. WHAT PROPERTY IS ELIGIBLE FOR THE ROLL-OVER?

S.85(1.1) defines eligible property for the purpose of s.85 as:

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(a) Capital Property (Depreciable + non-depreciable) (other than real property, or an interest in or an option in
respect of real property, owned by a non-resident person).;
(b) Capital Property that is real property or an interest in or an option in respect of real property, owned by a non-
resident insurer where that property and the property received as consideration for that property are property used
by it in the year in, or held by it in the year in the course of carrying on an insurance business in Canada.
(c) Canadian resource property
(d) Foreign Resource property
(e) Eligible Capital Property
(f) Inventory (except real property, an interest in real property, or an option to pchse real property)
(g) Accounts Receivable

Preconditions for s.85 to apply

1) The transferor can be an individual or corp, but the transferee must be a corporation;
2) The property must be eligibly property;
3) The parties must file a joint election on Form T2057;
4) The transferor must get back one share for each type of property transfer. One share is consideration;
5) There can also be non-share consideration paid as well;
6) The transferor must receive FMV. If paid more then FMV, will be a shareholder benefit under s.15(1). If paid
less then FMV, s.85(1)(e.2) may come into play.

S.85(1)(e.2)
Where parties are related, Revenue assumes that the intent of the corp in taking less is to benefit the related
shareholder and the deficiency in FMV will be taxed back to the transferor. The deficiency is added to the elected
amount.
- The result of this is double tax. This is really a punitive section. The transferor will have an elected
amount which is higher and as a result have to pay the gain right away. Furthermore, the gain will also later be
taxed by the common shareholder who receives the benefit of the underpayment. The reason it is the common
shareholder who receives the benefit of the underpayment as he or she has the right to share in assets upon
dissolution. When the common shareholder sells the asset, he too will have to pay tax.
NOTE: The addition to the elected amount under s.85(1)(e.2) applies to all calculations except for the s.85(1)(f)
(g)(h) calculations.
(See example on page 110)

- Basically, with a rollover, the transferor can divest himself of property without tax consequences. However, X
must still receive FMV consideration from the corp.

S.85(1)

The property must be disposed of to a taxable Canadian corporation

The consideration received by the t'or must include share of capital stock for each type of property received
The roll over EA must have been jointly elected

Timing for Filing of Election

- s.85(6) Any election shall be made on or before the day that is the earliest of the days on or before which any T
making the election is required to file a return of income pursuant to s.150 for the taxation year in which the
transaction to which the election relates occurred.

RULES FOR THE ROLL-OVER....

THE ELECTED AMOUNT

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- Even though FMV must be paid, the parties can deem an Elected amount at a lower level.
- Before getting into these sections, I will try to simplify the upper and lower limits for the elected amount.
- Boot is non-share consideration.
- The upper limit is always FMV.
- The lower limit is the ACB of the asset (for depreciable property it is the UC(C). When there is boot (IE:
non-share consideration), the following is the formula for the lower limit:
the greater of boot and tax base of the asset (ACB or UC(C)

- The lower limit is the minimum amount you can elect without penalty.
- The EA is what the transferor uses to calculate capital gains. The EA is the proceeds of disposition. Only if the
EA is at the lower limit without boot (or boot only up to the lower limit [ACB]), do you not have to worry about
a capital gain. Capital gain would be calculated as:
POD - ACB
- The EA is deemed to be the proceeds of disposition to the transferee.
- The reason you might want to pay BOOT, is if you want a capital gain to offset a capital loss that is expiring.

NOTE: Your upper limit must be higher then your lower limit. When they are reversed, you cannot fall under
s.85.
NOTE: With depreciable property, it is also necessary to consider such issues as recapture and terminal loss.

POD
S.85(1)(a) Deems the EA to be the proceeds of disposition for the t'or.

COST
S.85(1)(a) Deems the EA to be the t'ee corporation's cost of property.

EA < BOOT
S.85(1)(b) If the EA is less than the fmv of the non-share consideration (boot) received then
the EA is deemed to be equal to the fmv of the boot received.
EA can't be less than boot.
NOTE: This is still subject to s.85(1)(c) such that if the boot is greater than the fmv of
the property transferred, then the EA is only bumped up to the fmv since it cannot
be greater than the fmv.

EA > FMV
S.85(1)(c) If the EA is greater than the fmv of the transfer property, then the EA is deemed
to equal the fmv.

INVENTORY/CAPITAL PPTY.
S.85(1)(c.1) If the property is inventory or capital property and the EA is less than the lower
of fmv of the transfer property and cost amount of the property then the EA is
deemed to be the lesser of the two.
EA can't be lower than the lesser of FMV and ACB of the transferred ppty.

ELIGIBLE CAPITAL PROPERTY

s.85(1)(d) The EA for ECP cannot be lower than the lesser of: (a) 4/3 taxpayers CEC;
(b) cost of transfer ppty;
(c) fmv of transfer ppty.

And if lower than all three, then EA is deemed to be least of the three.

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 DEPRECIABLE PROPERTY
S.85(1)(e) The EA for depreciable property cannot be lower than the lease of:
(a) ucc;
(b) cost of the transferred property;
(c) fmv of the transferred property.
If lower than all three, EA is deemed to be the least of the three.

NOTE: This prevents the taxpayer from claiming artificial loss. You can only claim terminal loss when the fmv
is actually lower than the UCC.

Q. What happens if the t=or doesn’t take back enough consideration? I mean, what if the
shares (and boot) taken back is less than the fmv of the asset transferred?

Where the fmv of the property being transferred is more than the greater of the EA or the value of the
consideration and it is reasonable to infer that the portion of the excess was intended to be a benefit on a related
person then the EA is deemed to be equal to the amount elected by the parties originally plus the excess amount
that was intended to be a gift. S.85(1)(e.2)

TRANSLATION: If Tim transfers property whose to CyCo. with an EA of $100, and receives shares back worth
$50, and it turns out that Tim’s sister owns 75% of CyCo., then RC will deem Tim to receive EA + Excess ($50)
= $100. The deemed amount affects Tim’s proceeds of disposition and will give him a potential capital gain.

** Remember that s.85(1)(e.2) does not apply to ss85(1)(g-h) in calculating the cost to the t=or of the share
consideration.

Q. What happens if the t=or takes back too much consideration? I mean, what if the shares (and boot)
taken back are more than the fmv of the asset transferred?

S.15(1) states that if a benefit is conferred on a shareholder by a corporation then the amount of the benefit shall
be included in the shareholders income for the year. So the amount which the consideration exceeds the fmv of
the transferred asset will be deemed income and not a deemed dividend.

DETERMINING THE COST OF ASSETS

TO THE T=EE CORPORATION....

Generally

S.85(1)(a) states that the EA is deemed to be the corporations cost of the property

BUT

Depreciable Property
S.85(5) states that if the transfer involves depreciable property and the capital cost to the t=or
exceeds t=or proceeds from disposition (eg. EA is less than the t=or cost)
THEN the capital cost of the asset to the t=ee is deemed to be the amount that was the capital cost to the t=or.

TRANSLATION: When transferring depreciable property the EA may be the lower of UCC, capital cost or fmv.
This means that it’s o.k. for the EA to be less than capital cost. This means that unlike the general rule that the
EA is the corporations cost, s.85(5) kicks in and the cost would be that of the t=or. If this occurs, the corporation
is deemed to have claimed CCA in n amount equal to the difference between the capital cost and the elected
amount.

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 Eg. FMV 250
Cap. Cost 200
UCC 150
s.85(1)(e) EA 150
T=ee Cost as per s.85(5) = the t=or’s capital cost = 200

So, it’s like the corporation took the property as being worth 200 and then
instantly took 50 worth of CCA.

TO THE T=OR TAXPAYER

The following are the types of consideration that can be paid to the transferor:
a) Cash - FMV is the face value of the cash;
b) Debt - IE: Promissory note, the value of the debt can depend on the period when it is due. If it is not due for a
long time, it may have to be discounted to present value. To make sure that the promissory note is found to be at
FMV, make it due on demand. If it is not due on demand, it should carry a rate of interest that is at the going rate;
(c) Preferred Shares - these are shares under s.248 which do not have a right to share in assets upon dissolution.
To value these shares consider:
- if they are redeemable at any time, they are given there value at redemption;
- if they have cumulative dividends, provided cumulative dividends are paid at the going rate of interest,
the shares have their face value.
d) Common Shares - there value lies in the fact that shareholders are allowed to share in assets upon dissolution.
The value of these shares is determined by the value of the assets at the time of the rollover.

e) Assumed Liabilities - Consideration can take place through assuming liabilities of the transferor. NOTE:
assumption of liabilities is BOOT and will have to be counted as such (however, not counted in boot calculation
under s.85(1)(f)
f) Land - payment of FMV land. This is BOOT and the transferee corp will have to calculate capital gain/loss

NOTE: All of these values are determined at the time of the rollover. If things change immediately after, this has
no effect on value.

S.85(1)(f)(g)(h) are the sections that assign cost base to the consideration received by the transferor:
- The sections must be applied in the order listed:
(1) The Boot

S.85(1)(f) deems the cost base of a particular boot to be the lesser of:

(A) FMV of the particular boot property;

or
(B) FMV of asset A x FMV of the particular property rec=d by t=or for asset A
FMV of all boot properties received by transferor as consideration for asset
A

The usual result of this formula will be that the cost of the boot is the fmv. This is because in (B) the fmv of the
asset should always be greater than the EA (denominator) since if not, a s.15(1) shareholder benefit will occur. So
unless on the exam you recognize a shareholder benefit occurring, just go with the fmv as the cost of the boot to
the t=or.

Therefore, calculate cost base for boot as:

EA - boot FMV

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NOTE: This does not include assumed liabilities in boot.

(2) Preferred Shares

S.85(1)(g) deems the cost base of preferred shares of a particular class to be the lesser of:

(A) FMV of the particular class of shares received as consideration for Asset A;
or
(B) EA -*FMV of boot x FMV of particular class of pref. shares recvd as consid
FMV of all classes of pref. shares rec=d as consid.

If only one class of shares:, EA - FMV of boot (including assumed liabilities).

*The FMV of boot include any liabilities of the t=or assumed by the corporation.

KEY: The fractional part of (B) will only apply if the taxpayer receives more than one class of preferred shares as
consideration. In that case, all the fraction does is to allocate the value of each particular class of shares.

(3) Common Shares

S.85(1)(h) deems the cost of common shares to be EA - FMV of boot(including liabilities) - cost of pref. share
assigned by s.85(1)(g)

NOTE: If there are more than one class of common shares then just allocate the amount determined in s.85(1)(h)
pro rata amongst the shares. (Eg. 2 classes then divide in half)(see formula on page 77 EM)

NOTE: When there are no tax consequences, the T has not divested himself of the tax consequences. Rather, by
virtue of the rollover, he has just delayed them.

EXAMPLES:
ACB = $10 EA = $10, FMV = $100
a) The consideration paid is $10 in cash and $90 in preferred shares
- step 1: s.85(1)(f) - cost base of boot is $10
- step 2: s.85(1)(g) - cost base of preferreds is $10 - $10 = 0
- Therefore, the $10 is transferred cash free, and when the preferred shares are sold, if at current value, there will
be a capital gain of $90.00 ($90.00 - 0)
b) The consideration paid is $100 in preferred shares.
- step 1: s.85(1)(f) no cost base to assign to boot as there is no boot
- step 2: s.85(1)(g) - cost base of preferreds is $10 - 0 = $10.00
- Here, no money comes tax free as the tax consequences are spread over the entire $100 of preferred shares. To
get the $10 out as in A, there will be a $1 capital gain due to the fact that the cost base of the preferreds is $10.
Therefore, the type of payment in A, is much preferable.
(c) The consideration paid is $10 preferreds, $90 commons
- step 1: s.85(1)(f) - no cost base to assign to boot as there is no boot
- step 2: s.85(1)(g) - $10 - 0 = $10 cost base for preferreds;
- step 3: s.85(1)(h) - $10 - 0 - $10 = 0 cost base for commons.
Because two classes of shares were created, the preferred shares can be sold, and X can access the EA without
any tax consequences.
d) The consideration paid is $20 preferreds, $80 commons
- step 1: s.85(1)(f) - no cost base to assign to boot as there is no boot
- step 2: s.85(1)(g) - $10 - 0 = $10
- step 3: s.85(1)(h) - $10 - 0 - $10 = 0.

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This leaves an ACB for the commons of 0, and a $10 gain for the preferred when you sell them. Therefore, not as
good as situation (a) or (c).

Therefore, for the transferor to get back EA tax free:

a) Always pay cash for the EA amount;

b) Issue two classes of shares, with the preferred amount being the EA.

NOTE: Review Election Form on Page 79; Section 85 Agreement on Page 92 and Articles of Incorporation on
page 105.
- Regarding the agreement; to avoid circumstances where the parties are wrong about FMV, price adjustment
clauses are included in section 85 agreements. With this type of clause, if you later find that FMV is wrong
through your own review, through Revenue reassessment, or through court review, you can adjust the EA and file
a new election. Revenue generally accepts any adjustments as long as the parties have made a bona fide effort to
be correct in their first election.

FINALLY, PAID UP CAPITAL CONSIDERATIONS....

s.85(2.1)(a)

Where shares are issued on a s.85 rollover, normally the PUC of the shares issued will be equal to the value of
the consideration received for the shares pursuant to s.26(2) of The Corporations Act:
e.g. Asset = $100 FMV
$40 ACB or UCC
EA $40
Take back $100 common shares on s.85 rollover

Assets Liabilities
$100.00 $100 - PUC

However, s.85(2.1) for income tax purposes will deem the PUC to be something other than $100 that the PUC is
for corporate purposes. The purpose of this section is an anti-avoidance section which was placed in the ITA with
the introduction of the capital gains exemption in 195 which provided for $100,000 tax free capital gain for all
capital property and $500,000 capital gain for certain types of corporate shares. S.85(2.1) has been left in the Act
eventhough the $100,000 capital gain exemption was repealed in the February 22, 1994 Federal Budget.
Apparently, it was left in since the $500,000 exemption still remains for qualified small business corporate shares
and shares in family farm corporations.

In the above example, s.85(2.1) would reduce the PUC by $60,00, i.e. from $100 to $40 for tax purposes.

S.85(2.1)(a) sets out the formula for the PUC reduction).

Increase in total PUC through transfer - (EA - boot (incl liab assumed) X Increase of PUC in particular
class of shares
(All classes) Increase in PUC through transfer
A -B X C/A
NOTE: The fraction part of the formula will only apply if there is more than one class of shares in the
consideration from the corp. It has no application if only one class of shares is paid out.
NOTE: You must do a separate calculation for each class.

NOTE: If this calculation is negative, there is no PUC reduction

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Eg. Property is transferred to MyCo. Under s.85(1):

ACB $100
FMV $300

Consideration Rec=d
Boot $150
Shares $150 (PUC and FMV)

Deemed EA s.85(1)(b) EA = Boot = $150

ACB of common shares = Nil (Work it out)
So, without s.85(2.1) the taxpayer could redeem the common shares at their fmv ($150) for a potentially tax-
exempt capital gain of $150. There would be no deemed dividend because the amount paid would be equal to the
PUC of the shares ($150). But, we apply s.85(2.1) and....

Stated PUC for corporation $150

Less PUC Calculation

$150 (Total PUC of corp.) - $O (EA - Boot) X 150/150 (only one class so irrelevant)
= $150

So, PUC for tax purposes is NIL.

Now, when the taxpayer redeems the common shares at their FMV, the transferor is required to recognize a
deemed dividend instead of a capital gain s.84(3).

Redemption Price $150

PUC of shares NIL
Deemed dividend under s.84(3) $150

Actual cash received on disposition $150

Deemed Dividend $150
Deemed POD s.54(1) para.j NIL

As the end result, s.85(2.1) prevents the bump-up in the PUC of the shares and thereby prevents the t’or from
converting the potential deemed dividend upon redemption of the shares into a tax free capital gain.

NOTE: The corporation can use s.26(3) of The Corporations Act to make the PUC $40.00 instead of $100.00,
and then the rest of the $100.00 consideration received by the corporation for the shares would show up on the
balance sheet in an account called contributed surplus.

*INSERT PAGE 113(b) for SECTION 85 EXAMPLES and ANSWERS*

Remember:You can issue two classes of shares to isolate the gain in the common shares

To answer questions, always go through the following checklist:

a) Purchase Price;
b) Boot;
(c) EA;
d) Gain (EA is proceeds);
e) Cost of consideration received;

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f) what is the PUC of the shares received.

Q: T’or wants to transfer to corp:

Asset 1: Asset 2:
$10,000 - Capital Cost $8,000 - ACB
$5,000 - UCC $14,000 - FMV
$20,000 - FMV

Total FMV = $34,000

Ideal EA = $13,000

T’or wishes to take back $16,000 common shares and $18,000 in cash

EA = $18,000
CG to transferor $18,000 - $13,000 = $5,000

Each asset is elected separately. Therefore, it is necessary to consider where it is ideal to recognize the gain.

If elect $8,000 for asset 2, and $10,000 for asset 1, there will be $5000 recapture (10,000 - $5,000). However, if
$5000 is elected with respect to Asset 1, and $13,000 with respect to asset 2, there will be a $5000 capital gain on
asset 2. This is preferable given that capital gains are only included 3/4 in income whereas recapture is included
100% in income.

What is the PUC decrease: $16,000 - (18,000 - 18,000) = $16,000

Therefore PUC is reduced by $16,000 leaving PUC at 0.

What is the cost base for the common shares:

s.85(1)(f) = $18,000
s.85(1)(g) = 0 (no preferred shares)

s.85(1)(h) = $18,000 - $18,000 - 0 = 0

Therefore, when the common shares are sold, if at the same value, there will be an $18,000 CG.

Consider:
Dee transferred capital property to Dee Ltd. The capital property had an ACB of $5000 and FMV of $10,000.
Dee could receive any of the following packages of consideration:

A B C
Notes at FMV $5000 $2500 $2500
Preferred Shares $4500 $7500 -
Common Shares (PU(C) $500 - $2500

(a) Given an elected amount of $5000, which would be the cost of each item of consideration under each possible
package of consideration?
(b) What will be the P.U.C. for tax purposes under each possible package of consideration?

ACB = $5000 Assumed EA = $5000

FMV = $10,000 Ideal Purchase Price = $10,000

Scenario A:
s.85(1)(f) = $5000
s.85(1)(g) = $5000 - $5000 = 0

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s.85(1)(h) = $5000 - $5000 - 0 = 0
Preferred Shares
s.85(2.1) =
$5000 - (0) x 4500/5000 = $4500
PUC will be reduced by $4500 leaving it at 0. Notice that s.85(1)(g) assigns a cost base to Prefs of 0 as well.
Common Shares
s.85(2.1)
$5000 - (0) x $500/$5000 = $500
PUC will be reduced by $500 leaving it at 0. Notice that s.85(1)(h) assigns a cost base to commons of 0 as well.

Scenario B:
s.85(1)(f) = $2500
s.85(1)(g) = $5000 - $2500 = $2500
Preferred Shares
s.85(2.1) =
$7500 - 2500 = $5000
Therefore, PUC is reduced by $5000 to $2500 which is the cost base under s.85(1)(g)

Scenario C:
s.85(1)(f) = $2500
s.85(1)(g) = 0
s.85(1)(h) = $5000 - $2500 = $2500
s.85(1.2)(e) places EA at $10,000 as shareholder benefit
- Therefore, Transferor will have a $5000 capital gain

- since the transferor has already had a $5000 CG, by virtue of s.85(1)(e.2), the cost base for the assets will result
in no gain when they are sold in less they increase in value.
Common Shares
s.85(2.1)
$2500 - (5000 - 2500) = 0
Therefore PUC is not reduced at all, leaving PUC at $2500 so that no further gain will be suffered by the
transferor on the sale of the shares.

Remember that EA is also the cost base for the recipient corp as well. Therefore, the corp gets the bumped up
cost base.

Consider:
Transferor wants to transfer assets to a corporation in which her daughter owns all of the common shares. The
property being transferred is securities:

ACB = $100,000
FMV = $125,000

Consideration received by mother for transferring the shares:

Note = $100,000
Pref Share = $1000

- Remember the ideal consideration would have been $125,000, so we have a deficiency of $24,000.00. This
deficiency will be included under s.85(1)(e.2). This makes the EA $124,000.
- Since mother’s ACB is $100,000 and her deemed proceeds are $124,000, she will have a capital gain of
$24,000.00.

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Cost of assets:
s.85(1)(f) = $100,000
s.85(1)(g) = $100,000 - $100,000 = 0
Preferred Shares
s.85(2.1)
$1000 - ($124,000 - 100,000) = (23,000)
- When this calculation is negative, there will be no dividend reduction.
- Therefore, the cost base of the shares is $1000.00

- Under s.85(1)(e.2), the common shareholder receives the benefit that her mother has already been taxed on.
Common shareholders receive the benefit as they have the right to share in equity upon dissolution. Since the
daughter is the only common shareholder, she will receive the entire benefit. Since the daughter gets the shares
for nothing, her cost base isn’t increased, but her shares have just gone up in value $24,000. Double tax will
occur when the daughter gets out as the daughter will have a capital gain of this amount on sale of shares or on
wind up. While the corp gets the benefit of the increased EA, the common shareholder will get dinged with the
benefit when she gets out.

Consider:
FMV = $900,000 (therefore ideal consideration paid should be $900,000)
EA = $577,500 (this is ideal EA)

Consideration paid:
$247,500 (assumed mtg)
$330,000 (note)
$322,500 (common shares)
$900,000 (therefore proper consideration is paid)

s.85(1)(f) = $330,000
s.85(1)(g) = 0
s.85(1)(h) = $577,500 - 577,500 - 0 = 0

s.85(2.1) =
$322,500 - (577,500 - 577,500) = $322,500 PUC reduction, leaving PUC at 0.

What are the tax consequences to the t’or if the corp redeemed the debt issued by the corp for $330,000
and he sells his shares in the corp for $425,000?
- The debt has a cost base of $330,000 so there is no tax consequence for redeeming the debt. The cost base for
the shares is 0, so there will be a $425,000 CG.

What are the tax consequences to t’or if the corporation redeems the shares for $425,000?
- s.84(3) would be a deemed dividend of proceeds - PUC = $425,000 - 0 = $425,000 deemed dividend

NOTE: The effective tax rate for capital gains and dividends are very similar after the dividend tax credit.

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