While this maxim no doubt rings true in many aspects of life, it is particularly valid with regards to income tax planning concerning the sale of shares of private corporations. Taxpayers who carefully arrange their affairs to ensure they comply with all of the necessary requirements under the Income Tax Act (Canada) (the “Act”)[1] before ‘leaping’ or triggering a disposition can often benefit from various provisions, such as the $750,000 capital gains exemption set out by section 110.6, which greatly reduce their tax owing.
Caution and care are required because the Act contains numerous deeming provisions, oft described as “trap[s] for the unwary”[2], which can result in painful consequences where the proper tax planning has not been implemented. Section 84.1 and the recent Tax Court of Canada decision Emory v. R. offer an instructive example of this principle in action.
In Emory, the taxpayer and another individual were the shareholders of two corporations: Sona Computers Inc. (“Sona”) and Ontario Inc. The taxpayer and the other individual both sold their shares of Sona to Ontario Inc. The taxpayer received $400,000 as consideration for her shares of Sona.[3]
The taxpayer reported the gain from the sale of her shares as a capital gain which was eligible for the capital gains exemption provided by section 110.6. However, due to the operation of section 84.1, what would have been a tax-free capital gain was transformed into a taxable dividend and a hefty tax bill ensued.
What is Section 84.1 and why did it apply?
Section 84.1 applies where an individual taxpayer (resident in Canada) disposes of shares of a “subject corporation” to a “purchaser corporation” that does not deal at arm's length with the taxpayer and, immediately after the disposition, the subject corporation is connected with the purchaser corporation within the meaning of subsection 186(4). This provision provides for connected status where control is held directly or where a company controls more than 10% of the votes and value of another.
The Court in Emory concluded that section 84.1 applied (i.e. the taxpayer and Ontario Inc. did not deal at arm’s length) due to the operation of the deeming provisions of paragraphs 84.1(2)(b) and (2.2)(b), (c) and (d). Were it not for these deeming provisions, the Court would have found that the taxpayer was at arm’s length with Ontario Inc. and section 84.1 would not apply.
As a result of the application of these provisions, the taxpayer and the other individual were considered to be in a group that (1) controlled Sona immediately before the disposition and (2) controlled Ontario Inc. immediately after the disposition, and therefore, the requirements of section 84.1 were met.
While the Court commiserated with the taxpayer’s plight, finding that the taxpayer’s ownership of a small number of shares of Ontario Inc. “unfortunately resulted in the application of section [84.1]”, it was unwilling to reconsider the object and spirit of the legislation.[4]
Instead, the Court affirmed the application of section 84.1 as a valid anti-avoidance provision with a wide reaching effect, as this was clearly intended by Parliament. The Court also set out a warning (or perhaps, a plea) to tax practitioners, business owners, and shareholders. The Court stated: “it is perhaps worth mentioning that section 84.1 would not have applied to the disposition by the [taxpayer] of the shares of Sona if the [taxpayer] had not owned any shares in Ontario Inc.”. Thus, the proper tax planning could have avoided the application of section 84.1 (and the subsequent transformation of a tax-free capital gain into a taxable dividend) had the taxpayer been made aware of the rocks before she leapt.
Colin Green is an Associate with BrazeauSeller.LLP. Colin practices in the areas of tax & estate planning, wills and corporate & commercial law. Colin can be reached at 613-237-4000 ext. 227 or cgreen@brazeauseller.com.
[1] R.S.C. 1985, c. 1 (5th Supp.), all statutory references herein are to the Act.
[2] Emory v. R. 2010 D.T.C. 1074, (“Emory”) at para. 32.
[3] Technically, a third corporation was involved, but it has been omitted from this discussion.
[4] Emory, at para. 41.
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