Issue 420, August 2016

In a June 14, 2016 French Tax Court of Canada case (Poulin et al. vs. H.M.Q., 2013-2554(IT)G, 2013-2555(IT)G), at issue was whether the taxpayers, P and T, who disposed of their shares in the Corporation, were acting at arm’s length such that the proceeds of sale would constitute a deemed dividend under Section 84.1 rather than a capital gain.

The sales were in the context of a reorganization to implement the departure of P and the integration of H into the company. Simply,

  • P sold his shares to TCo (owned by T);
  • T sold his shares to HCo (owned by H); and,
  • both P and T claimed the Capital Gains Exemption (CGE).

different treatment of two sales within the same reorganization

The Minister took the position the P and TCo, and T and HCo acted in concert and, therefore, were deemed not to have been acting at arm’s length (Paragraph 251(1)(c)). As such, they were subject to a deemed dividend under Section 84.1.

Taxpayer P wins
The Court found that P and TCo did not act in concert, but were acting at arm’s length. In this case there was a major conflict between P and T; it was in the interest of the Corporation that one of them leave. P and T reached an agreement after difficult negotiations. P wanted to sell his shares for the best price and terms.

structuring a sale to access CGE does not automatically mean parties do not act at arm’s length

The Court also noted, however, that the fact that P and T organized the transaction so that P could benefit from CGE does not in and of itself demonstrate that the parties did not act at arm’s length.

non-commercial transactions of convenience indicate parties do not act at arm’s length

Taxpayer T loses
On the other hand, the Court found that T and HCo acted in concert without separate interests. The transaction was undertaken to provide a tax benefit for T, with HCo simply accommodating T’s wishes. The transaction did not reflect normal commercial relations between parties acting in their own interest. For example, contrary to the P and TCo transaction, the sale agreement did not provide for repayment terms, and, nine years later, there was still a balance on the sale price.

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