2019-0813021E5 TOSI and excluded shares

Principal Issues: 1. Whether the shares held by specified individuals in the capital stock of corporations that are members of a partnership will constitute excluded shares? 2. Would the answer in 1) change if the specified individuals were related?

Position: 1. Yes; 2. No.

Reasons: See comments.

Author: Bilodeau, Patrick
Section: 120.4(1); 120.4(1.1)

XXXXXXXXXX                                                                                                                                               2019-081302
                                                                                                                                                                        Patrick Bilodeau
August 9, 2019

Dear XXXXXXXXXX:

Re:  Request for Technical Interpretation re: TOSI rules and the “excluded shares” exception

This is in reply to your letter of June 6, 2019 wherein you requested clarification on the application of paragraph (c) of the definition of “excluded shares” in subsection 120.4(1) of the Income Tax Act (Canada) (the “Act”) in the context of the hypothetical scenario described below.

Scenario

1.    A partnership (“Partnership AB”) carries on an active business in Canada.  The income from the business carried on by Partnership AB does not include income from the provision of services.

2.    Partnerco A and Partnerco B (collectively the “Partnercos”) are corporations that are not professional corporations.  The Partnercos each own a 50% interest in Partnership AB.

3.    Each of the Partnercos do not earn income other than the business income that arises in connection with their ownership in Partnership AB.

4.    The shareholders of Partnerco A are Holdco A and Mrs. A.  Holdco A and Mrs. A own 90% and 10%, respectively, of the votes that can be cast at an annual meeting of the shareholders and fair market value of all of the issued and outstanding shares of the capital stock of Partnerco A.  Mr. A and Mrs. A own 90% and 10% of the issued and outstanding shares of the capital stock of Holdco A, respectively.

5.    The shareholders of Partnerco B are Holdco B and Mrs. B.  Holdco B and Mrs. B own 90% and 10%, respectively, of the votes that can be cast at an annual meeting of the shareholders and fair market value of all of the issued and outstanding shares of the capital stock of Partnerco B.  Mr. B and Mrs. B own 90% and 10% of the issued and outstanding shares of the capital stock of Holdco B, respectively.

6.    Mr. A is the spouse of Mrs. A and Mr. B is the spouse of Mrs. B.  Mr. A and Mrs. A are not related to Mr. B and Mrs. B.  Each of Mr. A, Mrs. A, Mr. B and Mrs. B is over 25 years old.

Your questions

An individual's income from, or a taxable capital gain from the disposition of, excluded shares is excluded from split income pursuant to subparagraph (g)(i) of the "excluded amount" definition in subsection 120.4(1).  The definition of “excluded shares” is set out in subsection 120.4(1) (hereafter the “excluded shares definition”).  In general, shares of the capital stock of a corporation owned by a specified individual will be excluded shares if the conditions included in paragraphs (a) to (c) of the excluded shares definition are satisfied.

1.    Under the assumption that the conditions included in paragraphs (a) and (b) of the excluded shares definition are satisfied, can the CRA confirm that, in relation to the above scenario, paragraph (c) of the excluded shares definition will also be satisfied such that the shares held by Mrs. A in Partnerco A and the shares held by Mrs. B in Partnerco B will constitute “excluded shares”?

2.    Would the answer to question 1) change if Mr. A and Mr. B were siblings?

Our comments

This response provides general comments about the provisions of the Act.  It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination. The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70‑6R9, Advance Income Tax Rulings and Technical Interpretations.  All statutory references herein are to the provisions of the Act.

Response to question 1

For paragraph (c) of the excluded shares definition to be satisfied, all or substantially all of the income of the corporation for the relevant taxation year must constitute income that is not derived, directly or indirectly, from one or more related businesses in respect of the specified individual other than a business of the corporation.

By virtue of clause 120.4(1.1)(d)(i)(B), the income of the Partnercos that arises in connection with the ownership of the Partnerco’s interests in Partnership AB will be considered to be derived directly or indirectly from the business of Partnership AB. In addition, the business of Partnership AB will constitute a related business in respect of both Mrs. A and Mrs. B by virtue of paragraph (b) of the “related business” definition in subsection 120.4(1).  This is so considering that Mr. A, a source individual in respect of Mrs. A, and Mr. B, a source individual in respect of Mrs. B, will each have an indirect interest at any time in the year in Partnership AB.  Consequently, it will be the case that all or substantially all of the income of the Partnercos will be income derived, directly or indirectly, from a related business, being the business of Partnership AB, in respect of Mrs. A and Mrs. B.

Notwithstanding the above, the requirement under paragraph (c) of the excluded shares definition will nonetheless be satisfied since the related business (i.e. the business carried on by Partnership AB) will also constitute the business of the Partnercos.  Where the jurisdictional law regarding partnerships provides that a partnership is an agreement among the partners to carry on business in common, each partner will be considered to be carrying on the business of the partnership.  Consequently, the income of the Partnercos will constitute income that is not derived, directly or indirectly, from one or more other related businesses in respect of both Mrs. A and Mrs. B other than a business of the Partnercos.

Based on the foregoing, the condition set out in paragraph (c) of the excluded shares definition will be satisfied.  Under the assumption that the conditions in paragraphs (a) and (b) of the excluded shares definition are also satisfied, the shares held by Mrs. A in Partnerco A and the shares held by Mrs. B in Partnerco B will accordingly constitute excluded shares.

Response to question 2

Our answer to question 1 would not be different if Mr. A and Mr. B were siblings.

We trust these comments will be of assistance to you.

Yours truly,

David Palamar
for Division Director
Reorganizations Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

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