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The capital gains taxation of corporations and shareholders in the United Kingdom and Canada 1973

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THE CAPITAL GAINS TAXATION OF CORPORATIONS AND SHAREHOLDERS IN THE UNITED KINGDOM AND CANADA by NICHOLAS CHARLES ATTEWELL LL.B., U n i v e r s i t y of London, 1969 A THESIS SUBMITTED IN PARTIAL FULFILMENT OF THE REQUIREMENTS FOR THE DEGREE OF MASTER OF LAWS i n the Department 6 f LAW 'We accept t h i s t h e s i s as conforming to the r e q u i r e d s tandard. THE UNIVERSITY" OF BRITISH October 1973 COLUMBIA In presenting this thesis in partial fulfilment of the requirements for an advanced degree at the University of British Columbia, I agree that the Library shall make i t freely available for reference and study. I further agree that permission for extensive copying of this thesis for scholarly purposes may be granted by the Head of my Department or by his representatives. It is understood that copying or publication of this thesis for financial gain shall not be allowed without my written permission.' Department of L-AW The University of British Columbia Vancouver 8, Canada i i THE CAPITAL GAINS TAXATION OF CORPORATIONS AND SHAREHOLDERS IN THE UNITED KINGDOM AND CANADA NICHOLAS CHARLES ATTEWELL The s u b j e c t of t h i s t h e s i s i s a comparison of the tax consequences i n the UK and Canada of c a p i t a l gains and l o s s e s r e a l i s e d by c o r p o r a t i o n s , and by shareholders on t h e i r shares. The comparison i s made w i t h r e f e r e n c e to c e r t a i n p r i n c i p l e s d e r i v e d from the recent r e p o r t i n Canada of the Royal Commission on Ta x a t i o n . One of the b a s i c axioms under- l y i n g the Commission's reccommendations was that the form i n which a busi n e s s i s c a r r i e d on or property i s h e l d should be n e u t r a l i n i t s tax consequences. Two p r i n c i p l e s are e x t r a c t e d from t h i s axiom, upon which the d i s c u s s i o n s i n t h i s t h e s i s are based. The f i r s t p r i n c i p l e r e q u i r e s that the t a x a t i o n of c o r p o r a t i o n s and t h e i r shareholders be i n t e g r a t e d , so that no more taxes are p a i d on c a p i t a l gains or other income a c c r u i n g to a c o r p o r a t i o n than would have been p a i d had they accrued d i r e c t l y to an i n d i v i d u a l . In f a c t , d i s c u s s i o n of the d i v i d e n d tax c r e d i t g i v e n to i n d i v i d u a l shareholders and the r i g h t g i v e n to c o r p o r a t i o n s to deduct c e r t a i n d i v i d e n d s r e c e i v e d from t h e i r income r e v e a l s a general p o s i t i o n i n both systems of p a r t i a l i n t e g r a t i o n only, w i t h a f u l l e r degree of i i i i n t e g r a t i o n b e i ng given by v i r t u e of s p e c i a l p r o v i s i o n s to p r i v a t e c o r p o r a t i o n s i n Canada and to c e r t a i n investment companies i n both systems. However, both systems are d i s t o r t e d by c e r t a i n f a c t o r s . On the one hand, the f l a t r a t e of tax paid by c o r p o r a t i o n s induces i n d i v i d u a l , shareholders paying higher p e r s o n a l r a t e s of Income Tax to cause the c o r p o r a t i o n to accumulate, r a t h e r than to d i s t r i b u t e , i t s earnings. On the other hand, the lower r a t e of tax paid by a l l taxpayers on c a p i t a l gains as opposed to other income causes the same shareholders to o b t a i n t h e i r share of such accumulations i n a manner which r e s u l t s i n a c a p i t a l g a i n i n t h e i r hands and not o r d i n a r y income. T h i s may be done e i t h e r by v i r t u e of a s a l e of the members* shares or by o b t a i n i n g a d i s t r i b u t i o n from the c o r p o r a t i o n i n c a p i t a l form. Both systems have numerous p r o v i s i o n s to discourage c o r p o r a t i o n s from accumulating income and to con- v e r t what would otherwise be c a p i t a l r e c e i p t s i n shareholders* hands i n t o income r e c e i p t s . The r e s u l t i s to s e v e r e l y c u r t a i l the o p p o r t u n i t i e s f o r tax avoidance through m a n i p u l a t i n g the form i n which c o r p o r a t e s u r p l u s e s are d i s t r i b u t e d . The second p r i n c i p l e holds that there should be no tax payable on a c a p i t a l g a i n when i t r e s u l t s from a d i s p o s a l which has only made a change i n the l e g a l form i n which an a s s e t i s h e l d and has made no change i n i t s u n d e r l y i n g i v b e n e f i c i a l ownership. This p r i n c i p l e i s recognised i n both systems by many p r o v i s i o n s which grant a d e f e r r a l of tax on c a p i t a l gains where an i n d i v i d u a l t r a n s f e r s a s s e t s to a c o r p o r a t i o n i n r e t u r n f o r shares, where a c o r p o r a t i o n t r a n s f e r s a s s e t s to another c o r p o r a t i o n which i s c o n t r o l l e d by i t or d i r e c t l y or i n d i r e c t l y by another c o r p o r a t i o n which a l s o c o n t r o l s the t r a n s f e r o r (whether the t r a n s f e r accompanies a c o r p o r a t e amalgamation or r e c o n s t r u c t i o n or not) or where a shareholder's h o l d i n g i n a company i s converted i n t o another h o l d i n g as the r e s u l t of a co r p o r a t e r e c o n s t r u c t i o n or amalgamation or a c o n v e r s i o n r i g h t attached to the shares. However, some e q u a l l y obvious s i t u a t i o n s are not recognized i n the same way, e.g. t r a n s f e r of a s s e t s by a c o r p o r a t i o n to i t s c o n t r o l l i n g i n d i v i d u a l shareholder, so that i t must be concluded that the s t a t u t e s are somewhat s e l e c t i v e i n t h e i r a p p l i c a t i o n of t h i s p r i n c i p l e . Although t h i s t h e s i s i s p r i m a r i l y concerned w i t h c o r p o r a t i o n s and t h e i r s h a reholders, i t a l s o d e a l s w i t h mutual fund t r u s t s and u n i t t r u s t s and t h e i r u n i t h o l d e r s i n the same f a s h i o n . The j u s t i f i c a t i o n f o r t h i s i s the s i m i l a r i t y of the f u n c t i o n and tax treatment of these t r u s t s to c e r t a i n investment companies found i n both systems. V TABLE OF CONTENTS PAGE INTRODUCTION 1 CHAPTER I - T r a n s f e r of Assets by I n d i v i d u a l s to Corporations 6 Part 1. General r u l e s 7 Part 2. Anti-avoidance p r o v i s i o n s 13 Part 3 . P r o v i s i o n s r e l i e v i n g from tax 19 Footnotes 32J CHAPTER I I - Taxation of C a p i t a l Gains A c c r u i n g to Corporations and Shareholders 37 Part 1. L i a b i l i t y to tax k2 (A) L i a b i l i t y of r e s i d e n t s kj ( i ) Gains a r i s i n g i n the U.K. or Canada kj ( i i ) Gains a r i s i n g abroad kk (B) L i a b i l i t y of non-residents k6 (C) L i a b i l i t y of shareholders f o r c o r p o r a t e taxes 50 Part 2. Computation of c a p i t a l gains and l o s s e s 5k (A) The gen e r a l r u l e s of computation 56 (B) The t r a n s i t i o n a l p r o v i s i o n s 58 (C) The i d e n t i f i c a t i o n r u l e s 63 (D) V a l u a t i o n of shares and debentures 66 v i PAGE Part 3. Treatment of c a p i t a l gains and l o s s e s 71 (A) C a p i t a l l o s s e s 73 ( i ) Deduction of c a p i t a l l o s s e s from c a p i t a l gains and other income 73 ( i i ) The di s a l l o w a n c e of c a p i t a l l o s s e s 76 (B) The set o f f of n o n - c a p i t a l l o s s e s a g a i n s t c a p i t a l gains 77 (C) Exemptions 79 (D) Rates of tax 82 Part k. P a r t i c u l a r c o r p o r a t e d i s p o s i t i o n s 90 (A) Dealings by c o r p o r a t i o n s w i t h t h e i r own shares 91 (B) D i s p o s i t i o n s to a s s o c i a t e d persons 95 ( i ) A nti-avoidance p r o v i s i o n s 95 (a) General p r o v i s i o n s 95 (b) P r o v i s i o n s a f f e c t i n g d i s p o s - i t i o n s to s h a r e h o l d e r s . 97 ( i i ) Tax r e l i e v i n g p r o v i s i o n s 10̂ - (a) Inter—group t r a n s f e r s 106 (b) T r a n s f e r s of a s s e t s to non- r e s i d e n t companies l l * * P art 5' S p e c i a l C o r p o r a t i o n s 118 (A) Non-resident owned investment c o r p o r a t i o n s 120 (B) Investment c o r p o r a t i o n s and t r u s t s 122 v i i PAGE (C) Mutual fund c o r p o r a t i o n s 125 (D) Unit t r u s t s 126 (E) Mutual fund t r u s t s 135 (F) Mortgage investment c o r p o r a t i o n s 137 \ (G) Insurance c o r p o r a t i o n s 138 Part 6. Con c l u s i o n 1**5 Footnotes 1^8 CHAPTER I I I - Corporate D i s t r i b u t i o n s and C a p i t a l Gains 172 Part 1. Rules a p p l i c a b l e to a l l c o r p o r a t i o n s 176 (A) T a x a t i o n of income d i s t r i b u t i o n s i n the hands of i n d i v i d u a l s 176 (B) T a x a t i o n of income d i s t r i b u t i o n s i n the hands of c o r p o r a t i o n s 180 (C) What i s an income d i s t r i b u t i o n ? 18k (D) C a p i t a l d i s t r i b u t i o n s 198 (E) 1971 C a p i t a l surplus on hand 205 Part 2. The r u l e s a p p l i c a b l e to p r i v a t e c o r p o r a t i o n s 210 (A) C a p i t a l d i v i d e n d s 211 (B) Refundable d i v i d e n d tax 213 Part 3. Investment i n s t i t u t i o n s 2l6 (A) Non-resident owned investment c o r p o r - a t i o n s 218 (B) Mutual fund c o r p o r a t i o n s 221 (C) Investment c o r p o r a t i o n s and t r u s t s 227 v i i i PAGE (D) Unit t r u s t s 232 (E) Mutual fund t r u s t s 2*4-1 (F) Mortgage investment c o r p o r a t i o n s 2 V} (G) Insurance c o r p o r a t i o n s 2bk Part k. C o n c l u s i o n 2^8 Footnotes 2 5 3 CHAPTER IV - C a p i t a l Gains and Corporate Accumulations 2 7 9 Part 1. P r o v i s i o n s encouraging c o r p o r a t e d i s t r i - b u t i o n s to shareholders 28*4- (A) The c l o s e company p r o v i s i o n s - U.K. 28*+ (B) Income and c a p i t a l gains a c c r u i n g to non-resident companies - U.K. 288 ( i ) T r a n s f e r s of a s s e t s to non-residents to a v o i d Income Tax 289 ( i i ) C a p i t a l gains a c c r u i n g to non- r e s i d e n t s companies 2 9 0 (C) Income and c a p i t a l gains a c c r u i n g to non-resident companies - Canada 2 9 3 (D) Income and c a p i t a l gains a c c r u i n g to non-resident u n i t t r u s t s 3 0 3 Part 2. P r o v i s i o n s designed to prevent the e x t r - a c t i o n of c o r p o r a t e s u r p l u s e s i n the form of c a p i t a l gains 308 (A) Canada 310 ( i ) Designated s u r p l u s 310 ( i i ) Other p r o v i s i o n s reducing l o s s e s a r i s i n g from the d i s p o s i t i o n of shares 3 1 ^ I X PAGE ( i i i ) General a n t i - a v o i d a n c e provisions 316 (B) United Kingdom 320 ( i ) P r o v i s i o n s reducing l o s s e s r e s u l t - i n g from a d i s p o s a l of shares 321 ( i i ) P r o v i s i o n s d e a l i n g w i t h short term purchases and s a l e s of shares designed to a v o i d tax 3 2 3 ( i i i ) General a n t i - a v o i d a n c e pro- v i s i o n s 327 Footnotes 33** CHAPTER V - Corporate Reorganizations 3^7 Part 1. Corporate amalgamations 3^9 (A) Canada 3^9 ( i ) T r a n s f e r of a s s e t s by the predec- essor c o r p o r a t i o n s to the new c o r p o r a t i o n s 350 ( i i ) C o n t i n u a t i o n of the tax p o s i t i o n of the predecessor companies i n t o the new companies 351 ( i i i ) Treatment of shareholders i n the predecessor c o r p o r a t i o n s 357 (B) U.K. 36l ( i ) T r a n s f e r of a s s e t s to the new c o r p o r a t i o n 361 ( i i ) The c o n t i n u a t i o n of the tax pos- i t i o n of the predecessor companies i n t o the new companies 362 ( i i i ) Treatment of shareholders 36** X PAGE Part 2. Reorganizations of c a p i t a l 373 (A) Reorganizations c a r r i e d out at the i n s t a n c e of the company 373 (B) Conversion of shares and debentures 380 (C) C l o s e l y c o n t r o l l e d companies - a n t i - avoidance p r o v i s i o n s 385 Part 3» Corporate L i q u i d a t i o n s 388 Part k. C o n c l u s i o n 393 Footnotes 396 CONCLUSION ^07 BIBLIOGRAPHY ^1^ TABLE OF ABBREVIATIONS **21 VITA INTRODUCTION B r i e f l y , the sub j e c t of t h i s t h e s i s i s a compar- i s o n of the tax consequences i n the U.K. and Canada a r i s i n g from c a p i t a l gains and l o s s e s r e a l i s e d by c o r p o r a t i o n s , and by shareholders on t h e i r shares. The comparison i s made by re f e r e n c e to c e r t a i n p r i n c i p l e s of t a x a t i o n which have been much d i s c u s s e d r e c e n t l y i n both c o u n t r i e s . The q u e s t i o n of i n t e g r a t i n g the t a x a t i o n of corpor- a t i o n s and shareholders became an i s s u e f o r p u b l i c debate i n Canada not long ago as a r e s u l t of the p u b l i c a t i o n of the Report of the Royal Commission on Taxation, otherwise known as the C a r t e r Report. The r e p o r t recommended setrongly that i n t e g r a t i o n be extended to a l l c o r p o r a t i o n s , on the b a s i s of the general p r i n - c i p l e u n d e r l y i n g many of i t s recommendations that the form i n which a bu s i n e s s i s c a r r i e d on or pr o p e r t y i s h e l d should be n e u t r a l i n i t s tax consequences. Thus the i n t e g r a t i o n of per- sonal and co r p o r a t e t a x a t i o n r e q u i r e s that a c a p i t a l g a i n or other income r e a l i s e d by a c o r p o r a t i o n , t a k i n g account of both the taxes paid by the c o r p o r a t i o n and by i t s shareholders when they r e c e i v e a d i s t r i b u t i o n of these amounts, should bear no more tax than i f i t had been earned d i r e c t l y by sh a r e h o l d e r s . Another aspect of the p r i n c i p l e of n e u t r a l i t y r e q u i r e s that no tax be pa i d on a c a p i t a l g a i n and no r e c o g n i t i o n be made of a c a p i t a l l o s s , when they r e s u l t from a d i s p o s i t i o n of p r o p e r t y which causes only a change i n the l e g a l form i n which the prop e r t y i s h e l d and no u n d e r l y i n g change i n i t s 2 b e n e f i c i a l ownership. I t i s i n the l i g h t of these two aspects of the p r i n - c i p l e of n e u t r a l i t y that the s t a t u t o r y p r o v i s i o n s of the two l e g a l systems are e x p l a i n e d and compared. However, the order i n which the v a r i o u s t o p i c s are d e a l t w i t h i s roughly the order i n time i n which they would a r i s e f o r c o n s i d e r a t i o n i n p r a c t i c e . Thus, i n chapter one, the t h e s i s begins w i t h an account of the t r a n s f e r of a s s e t s by an i n d i v i d u a l to a c o r p o r a t i o n . Where the t r a n s f e r i s f o r money, then no s p e c i a l problems a r i s e , but i f the t r a n s f e r o r r e c e i v e s shares i n c o n s i d e r a t i o n f o r h i s a s s e t s , then i t c o u l d be s a i d that he i s only changing the l e g a l form i n which he holds these a s s e t s . On the hand, he may have no v o i c e i n the running of the c o r p o r a t i o n . T h i s chapter d i s - cusses the s i t u a t i o n s i n which the s t a t u t e s r e c o g n i z e the p r i n - c i p l e of n e u t r a l i t y and allow the d e f e r r a l of taxes on c a p i t a l gains accrued to a s s e t s t r a n s f e r r e d to a c o r p o r a t i o n i n r e t u r n f o r shares. In r e c o g n i z i n g that a t r a n s f e r of a s s e t s to a c o r p o r a - t i o n i n v o l v e s a change i n the l e g a l form of ownership only, the Law accepts the e s s e n t i a l i d e n t i t y of the c o r p o r a t i o n and the t r a n s f e r o r . However, t h i s e s s e n t i a l i d e n t i t y of two p e r s o n a l i t - i e s which are l e g a l l y separate may be e x p l o i t e d f o r tax a v o i d - ance reasons. The p r o v i s i o n s which reco g n i z e t h i s aspect are a l s o d i s c u s s e d i n t h i s chapter. The t a x a t i o n of c a p i t a l gains r e a l i s e d on a s s e t s , once 3 they are in the hands of a corporation, i s considered i n chapter two. By comparing this tax treatment with that accorded to c a p i t a l gains re a l i s e d by individuals personally, many of the disadvantages or advantages of the corporate form are revealed. Further, by using this form, the taxpayer becomes a shareholder as opposed to the direc t owner of the assets which he has transferred to the corporation or which the corporation has purchased with his money. Thus the taxation of c a p i t a l gains re a l i s e d on such shares, as compared with the taxation of c a p i t a l gains re a l i s e d on the corporation's assets, i s also s i g n i f i c a n t and i s considered i n this chapter. When the corporation's gains are derived from disposals of assets to i t s shareholders or to other corporations which are d i r e c t l y or i n d i r e c t l y controlled by the same shareholders as control i t , the disposal may result in a change i n the legal form i n which the assets are held only and the same questions and problems arise as i n chapter one. The integration of personal and corporate taxation i s dealt with i n chapter three, which discusses the tax consequ- ences to both corporations and shareholders of corporate d i s - t r i b u t i o n s . The important issues here are the degree of tax cre d i t given to individual shareholders f o r corporate taxes, the p o s s i b i l i t y of passing d i s t r i b u t i o n s through intermediary corporations without additional tax l i a b i l i t y and the extent to which a shareholder can reduce his tax l i a b i l i t y on a d i s t r i - bution by obtaining i t i n a form which results i n i t s being treated as a c a p i t a l gain i n his hands and not ordinary income. I* Further, there are special provisions applicable to c e r t a i n types of corporations, i . e . private corporations i n Canada and various investment companies i n both systems, which permit a much greater degree of integration. Tax avoidance opportunities occur f o r individuals by virtue of the d i f f e r i n g rates of tax payable by individuals and corporations and by virtue of the lower rates of tax payable by a l l taxpayers on c a p i t a l gains,, which involve a corporation accumulating, rather than d i s t r i b u t i n g , i t s income and c a p i t a l gains. Both systems have provisions to discourage this sort of avoidance, which are considered i n chapter four. These provis- ions discourage the accumulation of corporate earnings and attack schemes whereby the shareholder s e l l s his shares, i n order to r e a l i s e his aliquot portion of a corporation's accumulated sur- plus as a c a p i t a l gain, the purchaser being i n a p o s i t i o n to receive a corporate d i s t r i b u t i o n without grave tax consequences. From the discussions i n chapters three and four of the extent to which a shareholder can obtain his share of arxorpora- tiorfs surplus as c a p i t a l gain i n his hands, there are revealed situations i n which the form i n which the shareholder obtains these amounts has a s i g n i f i c a n t effect on the amount of tax he pays. In the course of i t s operations, a corporation may wish to amalgamate with another corporation or reorganize i t s e l f . This may involve technical disposals by shareholders of t h e i r 5 shares or by corporations of t h e i r assets, when there i s no change i n the underlying economic ownership of those assets and only a change i n the legal form i n which they are held. The extent to which the p r i n c i p l e of neutrality i s recognised i n r e l a t i o n to corporate reorganizations and amalgamations i s discussed i n chapter f i v e . The discussion w i l l revolve around si m i l a r ideas to those found i n the f i r s t chapter on transfers of assets to a corporation. Although this thesis i s primarily concerned with the corporation and i t s shareholders* i t w i l l also deal with the c a p i t a l gains taxation of unit and mutual! funds trusts and t h e i r unit holders i n a s i m i l a r fashion. The j u s t i f i c a t i o n f o r this l i e s i n $he s i m i l a r i t y i n function of these trusts to c e r t a i n investment companies which are also discussed. Further, such trusts are to a large extent treated i n a s i m i l a r fashion to companies and, i n the U.K., w i l l usually be deemed to be companies f o r tax purposes. 6 CHAPTER I TRANSFER OF ASSETS BY INDIVIDUALS TO CORPORATIONS A corporation i s a separate l e g a l person, so^that any transfer of assets by an in d i v i d u a l to i t (whether the ind i v i d u a l i s a shareholder or not) w i l l constitute a charge- able event, i n consequence of which a c a p i t a l gain or loss w i l l be calculated according to the ordinary rules of compu- tat i o n . This i s the case, whether the transaction consists of a sale to the company by an individual who has no connection with the corporation f o r cash or of a transfer of business assets or investments to a corporation by an in d i v i d u a l proprietor i n return f o r shares. On the other hand, i t i s not possible to ignore e n t i r e l y the close r e l a t i o n which may exist between a corpor- ation and i t s shareholders and the effect this may have on bargains between them. In the f i r s t place, there are avoidance problems, because the two parties can get together to f i x an a r t i f i c i a l l y high or low price or time disposals to best advan- tage, so that gains are minimized and losses maximized. In the second place, there i s the opposite, but related, problem that i f a person transfers assets to a corporation which he then controls, so that, i n r e a l i t y , there i s no s i g n i f i c a n t a l t e r a t i o n In t h e x o n t r o l of or b e n e f i c i a l interests i n those assets, i t w i l l be regarded as very unfair to impose a tax penalty on such a transfer. 7 The problem f o r a tax law i s to draw the l i n e between s i t u a t i o n s where no tax should be imposed, s i t u a t i o n s where p r o v i s i o n s should be imposed to prevent tax avoidance and s i t u a t i o n s where no s p e c i a l i n t e r f e r e n c e i s necessary. The l i n e s drawn w i l l be discussed i n t h i s chapter i n r r e l a t i o n to the Canadian and U.K. tax laws. There w i l l now be considered the p a r t i c u l a r r u l e s enacted i n both c o u n t r i e s , by examining i n Part 1 the general r u l e s a p p l i c a b l e i n a l l cases, by examining i n Part 2 the anti-avoidance p r o v i s i o n s designed to counteract c o l l u s i v e t r a n s a c t i o n s and i n Part 3 the p r o v i s i o n s which defer a c a p i t a l gain when the t r a n s f e r of assets to c o r p o r a t i o n s leads to no more than a change i n the l e g a l form of h o l d i n g the a s s e t s . Part 1 - General Rules These are the r u l e s which apply whenever one tax- payer t r a n s f e r s assets to another taxpayer and the p a r t i e s deal at arms l e n g t h . 1 In the U.K., the Finance Act 1 9 6 5 imposes a charge to C a p i t a l Gains Tax on c a p i t a l gains r e s u l t i n g from a 2 " d i s p o s a l of a s s e t s " , whereas the Canadian Act includes i n a taxpayer's income "taxable c a p i t a l gains""' a r i s i n g from a 3 " d i s p o s i t i o n of property". I t i s thus c l e a r t h a t a t r a n s f e r of assets by an i n d i v i d u a l to a company w i l l be a d i s p o s a l or d i s p o s i t i o n of these a s s e t s , w i t h i n the normal meaning of these 8 terms. I n o r d e r to compute the a c t u a l g a i n o r l o s s . I t i s n e c e s s a r y t o know the proceeds of d i s p o s i t i o n o f the t r a n s - f e r o r . G e n e r a l l y t h e s e w i l l be the amount of money r e c e i v e d o r the v a l u e o f any non-monetary c o n s i d e r a t i o n , the o n l y p o s s i b l e problem b e i n g the v a l u e to be a s s i g n e d t o any c o n s i d - e r a t i o n r e c e i v e d i n the form of s h a r e s . I t c o u l d be argued t h a t the v a l u e of such c o n s i d e r a t i o n was i t s p a r v a l u e , but i t has been h e l d t h a t the v a l u e to be t a k e n i s the market v a l u e o f li- t he s h a r e s . T h i s may, o f c o u r s e , e q u a l the p a r v a l u e , p a r t i c - u l a r l y where the c o r p o r a t i o n i s s e t up f o r the purpose o f r e c e i v i n g a t r a n s f e r o f the a s s e t s . Where the t r a n s f e r e e r e - c e i v e s no c o n s i d e r a t i o n f o r the ; t r a n s f e r , t h e r e w i l l be a deemed d i s p o s a l of the a s s e t s f o r proceeds e q u a l to market v a l u e by v i r t u e of the t r a n s f e r b e i n g a g i f t . - * I t s h o u l d be noted t h a t where the t r a n s a c t i o n t a k e s p l a c e a t arms l e n g t h and the t r a n s - f e r o r s proceeds of d i s p o s i t i o n e q u a l the v a l u e of p r o p e r t y r e - c e i v e d , i t i s p o s s i b l e f o r him to a v o i d any l i a b i l i t y t o tax on any c a p i t a l g a i n w h i c h has a c c r u e d to the p r o p e r t y b e i n g t r a n s f e r r e d , by t r a n s f e r r i n g i t f o r c o n s i d e r a t i o n e q u a l i n v a l u e t o what the a s s e t c o s t him.^ The a c q u i s i t i o n c o s t t o the c o r p o r a t i o n o f the p r o p e r t y t r a n s f e r r e d to i t w i l l e q u a l the amount of any money and the v a l u e o f any p r o p e r t y g i v e n by i t i n r e t u r n , ' ' u n l e s s the t r a n s - f e r amounts to a g i f t , when the a c q u i s i t i o n c o s t w i l l e q u a l the 9 g market value of the p r o p e r t y . As to the c o s t of the prop- e r t y to the c o r p o r a t i o n which has been a c q u i r e d i n r e t u r n f o r an i s s u e of shares, the q u e s t i o n i s more d i f f i c u l t . I t has 9 been h e l d i n s e v e r a l E n g l i s h and Canadian cases, t h a t , prima f a c i e , the c o s t of such p r o p e r t y w i l l equal the par value of the shares i s s u e d , i n s p i t e of the f a c t that the a c t u a l value of the shares i s d i f f e r e n t . I t i s not c l e a r how f a r these cases, which, i n f a c t , d e a l t w i t h the a c q u i s i t i o n of i n v e n t o r y , are a p p l i c a b l e f o r the purpose of computing c a p i t a l g a i n s , 1 0 but i t would c l e a r l y be u n f a i r to have the t r a n s f e r o r ' s pro- ceeds of d i s p o s i t i o n e q u a l l i n g the a c t u a l value of the shares and theocompany*s c o s t e q u a l l i n g only t h e i r par v a l u e . More- over, i f the c o r p o r a t i o n attempts to a v o i d t h i s problem by i s s u i n g shares of par value equal to the value of the p r o p e r t y , but the market value of which exceeds that v a l u e , the d i f f e r - ence i n value may be i n c l u d e d i n the t r a n s f e r o r ' s income under the p r o v i s i o n s d i s c u s s e d below. The a c q u i s i t i o n c o s t to the t r a n s f e r o r of any pro- p e r t y , i n c l u d i n g shares, r e c e i v e d from the c o r p o r a t i o n i n con- s i d e r a t i o n f o r the t r a n s f e r w i l l equal the value of the p r o p e r t y t r a n s f e r r e d , as b e i n g the a c t u a l c o s t o f . t h e p r o p e r t y . 1 1 The r e a l i s a t i o n by the c o r p o r a t i o n of a c a p i t a l g a i n , as the r e s u l t of the i s s u e of shares or the t r a n s f e r of other p r o p e r t y to the shareholder, w i l l be d i s c u s s e d i n t h e r f o l l o w i n g 12 c h a p t e r . 10 Both systems have provisions which include i n a taxpayer's income the amount by which the value of consider- ation given by a corporation exceeds the value of consideration given by a shareholder, transferring assets to i t . In Canada, there are two relevant provisions. By section 8k(l) there i s deemed to be a dividend paid by the corporation to the extent that an increase i n i t s paid up c a p i t a l exceeds any increase i n the value of i t s assets. 1-' This w i l l apply where the value of property transferred to a corporation i s exceeded by the paid lb up c a p i t a l of the shares issued i n return f o r i t . The d i v i d - end i s deemed to be paid to a l l the holders of the classes of shares i n question, so that not only the transferor, but other shareholders, w i l l be l i a b l e f o r t h e i r proportion of the d i v i d * end. To the extent that there i s no deemed dividend, section 15 may apply, which includes i n a shareholder's income the amount of any benefit conferred on him by a corporation. The amount of the benefit i n the case of a transfer of assets to a corp- oration would be the amount by which the market value of the assets transferred i s exceeded by the value of the consideration received from the corporation. Although i t i s cle a r that -the section does not apply where the transferor receiving the benefit i s not a shareholder, i t i s not so c l e a r what i s the posi t i o n where the corporation issues shares i n return f o r the property transferred and the transferor only becomes a share- holder of the company by virtue of that issue. It could plausibly be argued that the recipient of the benefit i s not 11 a shareholder when he receives the benefit, but only becomes a shareholder by virtue of the b e n e f i t . 1 ^ However, there i s no authority to support this argument. Where an issue of shares at a reduced consideration, i . e . at a discount, results i n the shares being only partly paid up, there w i l l be no deemed dividend under section 8^(1), since the increase i n paid up c a p i t a l w i l l be equalled by an increase i n the corpor- ation's assets, and there w i l l be no benefit conferred on the shareholder, since he w i l l remain l i a b l e tocpay the balance.*** 17 As w i l l be seen l a t e r , the U.K. Act includes i n a shareholder's income any " d i s t r i b u t i o n out of the assets of 18 the;companyn and the amount by which a benefit received by a member from a company exceeds the value of consideration given by the member, on a "transfer of assets" by the company to the 19 member or by the member to the company. * These provisions w i l l c l e a r l y include i n a member's income the amount by which the value of the assets transferred by him to the company i s ex- ceeded by the value of the consideration given by the company. This, however, i s subject to the same provisos as attach to section 15 of the Canadian Act, where the shareholder only becomes a shareholder by virtue of the benefit conferred and where the shares, are partly paid. The i n c l u s i o n of part of the property given by the corporation i n the shareholder's income means that any c a p i t a l gain to this extent w i l l not also be taxed as s u c h . 2 0 Further- 12 more, in Canada, the adjusted cost base of any share issued i s increased to the extent of any deemed dividend under section 8**(I) 2 1 and, by section 52(1), that part of the value of any property received that*is included i n income i s added to the cost to the recipient of that property. The result i s that, once excess consideration received by a shareholder from a corporation has been taxed as part of hisiincome, i t w i l l not be taxed again as a c a p i t a l gain, when he f i n a l l y comes to d i s - pose of the shares or other property comprised i n that consider- ation. There i s no equivalent provision i n the U.K. which i n - creases the a c q u i s i t i o n cost of property received i n respect of amounts included i n income. Property held at the beginning of the c a p i t a l gains systems i n both countries w i l l not r e t a i n that c h a r a c t e r i s t i c i n the hands of the transferee corporation, although the trans- 2*i i t i o n a l provisions J w i l l be u t i l i z e d to compute any c a p i t a l gain or loss of the transferor. There are two exceptions to this general rule i n Canada, which are found i n section 26(5) (dealing with non-depreciable property other than partnership interests) and section 20(1) (dealing with depreciable prop- erty) of the I.T.A.R. They are general rules which apply whenever property held on the 31st December 1971 i s trans- ferred by i t s owner to a person with whom he does not Ideal at arms length and t h e i r effect i s generally to put the trans- feree i n the:same position as the transferor as regards the 13 property, allowance being made f o r the actual consideration given by him. These provisions w i l l apply where the trans- feror of assets to a corporation does not deal with the corp- 2k oration at arms length. Part 2 - Anti-avoidance provisions The general effect of these provisions i s to deem the proceeds of d i s p o s i t i o n r e s u l t i n g from c e r t a i n transfers between clo s e l y related persons to be equal to the market value of the property transferred and to deem any loss r e s u l t i n g to be n i l . Section 69(1)(b) of the Canadian Act deems a taxpayer to have received proceeds equal to f a i r market value, where he disposes of property to a person, with whom he was not dealing at arms length, f o r no proceeds or f o r proceeds less than f a i r market value or to any person by way of g i f t i n t e r vivos. Whether persons deal with each other at arms length i s prira- 2 5 a r i l y a question of fa c t , J but the Actideems persons termed "related persons" not to deal with each other at arms length. 2** 2 7 The Act sets out a lengthy d e f i n i t i o n of "related persons" , but, f o r our purposes, a corporation i s related to a person who controls i t , to a person who i s a member of a related 2 8 group which controls i t or to any person related to those persons. Control i s not defined i n the Act, but the courts have upheld a general rule that control requires a 50% share- 2 9 holding plus one share. * Where the transferor of property to Ik the corporation receives no consideration from i t , the trans- f e r w i l l amount to a g i f t and f a l l within section 6 9 ( 1 )(b). In the U.K., the provisions are very s i m i l a r . Section 22(k)(a) of the F.A. 1965 deems a person's a c q u i s i t i o n of an asset and the disposal of i t to him to be f o r consider- ation equal to the market value of the asset, where he acquires i t s otherwise than by way of a bargain made at arms length and, i n p a r t i c u l a r , where he acquires i t by way of g i f t . The question whether a bargain i s at arms length i s determined much as i n Canada, with the difference that the term "connected person" i s used instead of "related person" and the. connected person re- l a t i o n s h i p i s extended to persons who are not r e l a t i v e s or corp- orations, f o r example, trustees, partners, and b e n e f i c i a r i e s 30 under t r u s t s . The word "control" i s extensively defined by . . t 31 statute. These anti-avoidance provisions w i l l apply i n a l l cases where an in d i v i d u a l incorporates a company and transfers assets to i t . They w i l l also apply i n the U.K., where a partnership incorporates a company and transfers i t s business to i t , as the company w i l l be controlled by persons connected with each other. In Canada, the transaction would probably f a l l under the general meaning of a bargain not at arms length. In situations where the shareholders or the shareholder and persons to whom he i s connected or related do not control the corporation, these rules w i l l not apply, unless i t : i s proved 15 that the parties are not i n fact dealing at arms length. The concept of arms length i s not defined, but i t "would appear to refer to some element of-connection or relationship between the parties which would lead to any bargain they might 32 make being governed by other than market considerations". It appears that i t would be d i f f i c u l t to j u s t i f y any trans- action at an undervalue, unless there were some bona f i d e commercial reason f o r i t . Whereas section 22(b) of the U.K. Act deals with the acq u i s i t i o n cost to the recipient of an asset from a person with whom he does not deal at arms length, i t i s apparent that section 69 (1 )(b) does not. This i s p a r t i a l l y remedied by section 6 9 ( l ) ( a ) of the Act, which deems a taxpayer to acquire property at a cost,equal to i t s market value where i t i s acquired from a person, with whom he does not deal at arms length, at an amount i n excess of i t s market value, and by section 6 9(I)(c) of the Act, which deems the ac q u i s i t i o n cost of property received i n a g i f t to equal i t s market value. Thus the s i t u a t i o n i s covered where the recipient gives excess con- sideration and where he gives no consideration f o r the acquired property, but not where he gives consideration which i s worth less than the property received. In the l a t t e r case, i t would appear that although the proceeds of di s p o s i t i o n of the d i s - 33 poser w i l l equal market value, the ac q u i s i t i o n cost of the recipient w i l l equal the actual cost to him of the property, 16 which w i l l be less than the value of that property. In this way the acquirer could, on a subsequent disposal, be taxed again on a gain i n respect of which the disposer has already been taxed. On the other hand, i t was decided i n A l l f i n e Bowlerama v. M.N.R., a decision which has been c r i t i c i s e d f o r apparently contradicting the express terms of the Act 3^, that i n such a case the acquirer i n fact takes an a c q u i s i t i o n cost equal to the amount deemed to be the proceeds of d i s p o s i t i o n to the d i s - poser. 35 This decision would appear to produce a f a i r e r r e s u l t . These considerations would be relevant to the transferor of assets to a company where the value of assets given by one party to the transaction was greater i n value than the consider- ation given by the other party. In addition, where the company gives the larger amount of consideration, the excess could also 36 be taxed as part of the transferor's income. EXAMPLE X transfers assets worth $1000 to company Y which transfers i n return assets worth $2000. X controls Y. Proceeds of X = 1000 (Section 69(1)(b)) Cost to Y = 1000 (Section 69(I)(aj) Proceeds of Y = 2000 (Section 69(1)(b)) Cost to X = 1000 (actual cost under section 5^(a) on a s t r i c t statu- tory interpretation) OR 2000 ( i f the A l l f i n e case i s correct) Amount included i n x's income = 1000 (Section 15) The position w i l l not be so serious i f the consideration given by the company comprises an issue of shares, as there i s no d i s p o s i t i o n of those shares by the company f o r c a p i t a l 37 gains purposes. A d i f f i c u l t y arises i n connection with section 22 (if) (a) of the U . K . Act, where the consideration given to the transferor by the company consists of an issue of shares. It seems that i n order f o r this section to operate, there must be both an a c q u i s i t i o n of an asset and a disposal of an asset, 3 8 so that as an issue of shares does not amount to a disposal, the section w i l l not be applicable to determine the a c q u i s i t i o n 39 costtto the transferor of shares issued to him by a company. The cost would then equal the value of the property transferred to the company i n return f o r which the shares were issued, as being the actual cost of those shares. F i n a l l y , both systems have anti-avoidance provisions r e s t r i c t i n g or denying c a p i t a l losses r e s u l t i n g from a trans- f e r of assets to a corporation. Section 85 CO of the Canadian Act provides that where a c a p i t a l loss i s incurred on a d i s - position of property to a corporation, which, immediately bo a f t e r the d i s p o s i t i o n , i s controlled d i r e c t l y or i n d i r e c t l y i n any manner whatever by the transferor, i t i s deemed to be n i l , but the transferor can increase the cost base of the common shares (or, i f none, preference shares) held by him i n 18 the company, to the extent of the loss, whether those shares are acquired as a result of the transfer or were held pre- viously. A somewhat wider rule i s found i n paragraph 17 schedule 7 of the F.A. 1 9 6 5 , which enacts that a l l c a p i t a l losses a r i s i n g out of disposals between connected persons are not allowable against other c a p i t a l gains, except i n the case of gains rea l i s e d on a disposal between the same parties while they are s t i l l connected. The U.K. provisions are both wider i n the range of persons to which they apply and the r e l i e f they allow would appear more uncertain than the r e l i e f given i n Canada. A person may not make a second disposal to another person, but he must dispose of his shares one day, even i f on death. F i n a l l y , reference should be made to section 55 of the Canadian Act, which applies when, as the result of one or more transactions of any kind, a taxpayer has disposed of property under circumstances such that he may reasonably be considered to h a v e a a r t i f i c i a l l y or unduly reduced the amount of a gain, created a loss or increased a los s . In this case, the taxpayer's gain or loss, as the case may be, i s the amount that i t would otherwise have been. This very wide provisions could apply to any attempt to transfer an asset to a corpora- tion without r e a l i s i n g any accrued gain, when the transfer was not covered by the tax r e l i e v i n g provisions to be d i s - cussed i n the next part of this chapter. 19 Part 3 - Provisions r e l i e v i n g from tax Both systems provide a procedure f o r individuals to transfer assets to a corporation i n return f o r shares i n that corporation, without incurring any l i a b i l i t y f o r tax on any c a p i t a l gains which would otherwise a r i s e . The aim and j u s t i f i c a t i o n of these provisions i s well summarised i n the Canadian Government's white paper "Proposals For Tax Reform" at page k2, where i t states, "If a taxpayer transfers someeof his assets to a corporation i n whichithe owns a l l of the shares, there i s a sale within the legal d e f i n i t i o n of that word, but there has been no change i n the underlying beneficialaowner- ship of the assets. The Government proposes that this fact be recognised by treating the transaction as though i t had been a sale at the cost to the taxpayer of the property transferred." As w i l l be seen, the U.K. provision goes even further than t h i s . Thus section 85 of the Canadian Act applies where a taxpayer disposes of c a p i t a l or e l i g i b l e c a p i t a l property of his to a Canadian Corporation and, immediately a f t e r the d i s - position, owns not less than 80% of the issued shares of each class of the corporation. The section allows the taxpayer and the corporation j o i n t l y to elect the amount of the proceeds of di s p o s i t i o n , so that i f the amount elected equals the adjusted cost base of the assets to the taxpayer, no c a p i t a l gain w i l l be r e a l i s e d . Moreover, the elected amount w i l l form the corp- orations a c q u i s i t i o n cost. 20 However, the Act contains r e s t r i c t i o n s on the amount that can be elected and, i n addition, there may be p r a c t i c a l considerations which w i l l a f f e c t the amount elected, other than the amount of tax which may be presently avoided. In the f i r s t place, there are three statutory provisions which place an upper and a lower}limit on the amount that can be elected. It {13 must not exceed the market value of the property transferred J and i t must not be less than the market value of any consider- ation (other than shares) received from the corporation'*'* (the f i r s t a l t e r n a t i v e taking precedence over the l a t t e r ) . There are minimum amounts set by the section f o r depreciable property and e l i g i b l e c a p i t a l property. In the second place, there are several p r a c t i c a l considerations which have to be borne i n mind when making an e l e c t i o n . The amount elected w i l l form the cost to the corp- oration of the assets transferred. Two consequences flow from t h i s . On thecone hand, a reduced cost base to the corporation means reduced depreciation deductions and e l i g i b l e c a p i t a l deductions from income. In p a r t i c u l a r , where the;^capital cost to the transferor of depreciable property i s greater than the amount elected, the corporation i s deemed to have a c a p i t a l cost equal to that of the transferor and to have received c a p i t a l cost allowances equal to the difference i n the two amounts. Thus the corporation faces a potential l i a b i l i t y f o r recapture of c a p i t a l cost allowances, of which the tra ns 21 feror had the benefit. Moreover, where the amount elected equals the cost base of the^property transferred, the c a p i t a l gain i s only deferred by the transferor and i t s t i l l may have to be re a l i s e d at some future date by the company. It may be preferred to pay the tax now, especially where there are minor- i t y shareholders i n the company, who might object to the company taking over the majority shareholder's l i a b i l i t y i n respect of the gain. Furthermore, to the extent that that the elected amount i s less than the value of the asset transferred and less than the paid up c a p i t a l of the shares issued by the corporation i n return f o r the transfer, there i s an increase i n the paid up c a p i t a l deficiency of the corporation . The probable result of this i s to diminish the amount that can be d i s t r i b u t e d by the corporation to i t s shareholders by way of a return of c a p i t a l as opposed to a taxable dividend. On the other;.hand, while there may be inducements for the parties to elect an amount which w i l l result i n a cap- i t a l gain, there w i l l usually be l i t t l e point i n electing an amount which w i l l result i n a c a p i t a l loss, as the loss w i l l simply be disallowed and added to the adjusted cost base of the 50 transferor's shares. Care should be taken i n determining the consider- ation to be given by the corporation i n return f o r the transfer. The provision which w i l l result i n a reduction of the corpora- 2 2 t i o n ' s p a i d up c a p i t a l d e f i c i e n c y , i f the p a i d up c a p i t a l of the shares i s s u e d exceeds the e l e c t e d amount, have j u s t been c o n s i d e r e d . In a d d i t i o n , there w i l l be a c a p i t a l g a i n to the t r a n s f e r o r i f the f a i r market value of any c o n s i d e r a t i o n other than shares r e c e i v e d from the company exceeds the a d j u s t - ed c o s t base of the prop e r t y t r a n s f e r r e d ^ * and s e c t i o n s 8^(1) and 15 may apply to i n c l u d e amounts r e c e i v e d i n the t r a n s - f e r o r ' s income to the same extent as d i s c u s s e d i n the f i r s t 5 2 p a r t of t h i s c h a pter. Thus, although the t r a n s f e r o r may av o i d r e a l i s i n g a c a p i t a l g a i n , he may s t i l l be taxed on amounts r e c e i v e d as p a r t of h i s o r d i n a r y income. Any c o n s i d e r a t i o n (other than shares) a c q u i r e d from the c o r p o r a t i o n i s deemed to be a c q u i r e d a t a c o s t equal to i t s f a i r market v a l u e , unless t h i s exceeds the p r o p o r t i o n of the f a i r market value of the pr o p e r t y t r a n s f e r r e d to the corp- o r a t i o n which t h i s amount bears to the f a i r market value of 53 a l l the c o n s i d e r a t i o n r e c e i v e d from the c o r p o r a t i o n . Any shares r e c e i v e d from the c o r p o r a t i o n are deemed to have a c o s t equal to the e l e c t e d amount l e s s the deemed c o s t of any non- share c o n s i d e r a t i o n r e c e i v e d . Where two types of share are r e c e i v e d , t h i s c o s t i s s p l i t between them, by a l l o c a t i n g to any p r e f e r r e d shares an amount equal to the l e s s e r of t h e i r market value and the whole amount a n d ^ to common shares any balance remaining a f t e r deducting the deemed c o s t of the p r e f e r r e d 56 shares. I f there are s e v e r a l c l a s s e s of common or: p r e f e r r e d 23 shares, the cost amount is allocated to each class according 57 to their f a i r market values immediately after the disposition. There is now revealed another reason for considering carefully before electing a low amount as the proceeds of sale of pro- perty disposed of to a corporation. Any shares received w i l l have an acquisition cost equal to the amount elected, less the value of any other consideration. Coupled with the fact that the corporation is receiving the assets at a low cost base, this leads to the possibility of capital gains, which have accrued to the asset prior to the transfer, being taxed once in the hands of the corporation and once again when the shares are disposed of. As regards assets held by the transferor on the 31st December 1971, the position is basically unchanged from that 58 described in the f i r s t part of this chapter. However, i t is expressly provided in section 20(1.2) of the I.T.A.R. that where depreciable property is acquired under section 85 by a corp- oration, the corporation is deemed to have acquired i t before 1972 and to have owned i t without interruption from December 31st 1971 until i t was disposed of. Having discussed the effect of the section, i t is now necessary to discuss the scope of i t s operation. In the f i r s t place, i t only applies to Canadian Corporations, which are defined in section 8 9 ( 1 ) ( a ) as 2k resident corporations which were either incorporated i n Canada or were resident i n Canada throughout the period commencing June 18th 1971 and ending at the date when the transfer i s made. The reason f o r r e s t r i c t i n g the scope of the provisions to Canadian Corporations was that otherwise, i f r e l i e f were given i n respect of transfers to foreign corporations, "gains might s l i d e right through the Canadian 59 tax net untouched." However, this d e f i n i t i o n excludes c e r t a i n resident corporations. Relief i s only given under this section where the property being transferred consists of c a p i t a l property ^° and e l i g i b l e c a p i t a l property. Therefore, a transfer of other assets^e.g. accounts receivable and inventory, w i l l be subject to the ordinary rules which apply when such assets are d i s - 6 1 posed of on the sale of a business. The transferor must immediately a f t e r the transfer own 80% of the shares of each class of the corporation. This e f f e c t i v e l y l i m i t s the benefit of the section to a trans- f e r by a single proprietor, unless section 85(2) of the Act applies. This permits a partnership transferring c a p i t a l or e l i g i b l e c a p i t a l property to a corporation to obtain the benefit of the section i f the partnership immediately a f t e r the d i s p o s i t i o n owns 80% of the issued shares of each class of the corporation and i f a l l the partners and the corporation j o i n t l y make the required e l e c t i o n . Section 85(3) goes 25 f u r t h e r and allows the p a r t n e r s to wind up the p a r t n e r - s h i p w i t h i n 60 days of the t r a n s f e r and d i s t r i b u t e the p r o p e r t y r e c e i v e d from the c o r p o r a t i o n without tax conseq- ueces. The e q u i v a l e n t U.K. p r o v i s i o n s are found i n para- graph 15 of schedule 19 of the F.A. 1969. These apply where a person, who i s not a company, t r a n s f e r s to a company a business as a going concern, together w i t h the whole of the a s s e t s of the business or the whole of those a s s e t s other than cash, and the t r a n s f e r i s wholly or p a r t l y i n exchange f o r shares i s s u e d by the company. The c a p i t a l g a i n or l o s s r e a l i s e d i s a c t u a l l y c a l c u l a t e d a c c o r d i n g to the r u l e s set out i n the f i r s t two p a r t s of t h i s chapter, whichever may be a p p l i c a b l e , and the r e l i e f g i v e n takes the form of a deduction from aggregate net 62 c a p i t a l gains of the p r o p o r t i o n of those gains which the cost to the d i s p o s e r of the shares r e c e i v e d from the c o r p o r a t i o n bears to the value of the whole c o n s i d e r a t i o n r e c e i v e d . ^ The obvious i n t e n t i o n of t h i s p r o v i s i o n i s that there be no c a p i t a l g a i n to the extent that the c o n s i d e r a t i o n g i v e n bybthe company c o n s i s t s of an i s s u e of shares. T h i s i s , i n f a c t , the r e s u l t i f the c o s t to the t r a n s f e r o r of those shares i s equal to t h e i r v a l u e , but i f that c o s t exceeds or i s l e s s than that value, the 6^ r e l i e f w i l l be c o r r e s p o n d i n g l y g r e a t e r or l e s s e r . The reduct- i o n of the g a i n i s not, however, a permanent exemption, as the c o s t base of the shares r e c e i v e d from the company i s reduced by the same amount. Thus the r e s u l t i s , as i n Canada, a d e f e r r a l of the g a i n , b u t a i s o > g e n e r a l l y apply on the s a l e of a 26 as i n Canada, this d e ferral does not prevent the difference between the value of the consideration given by the company and that given by the transferor shareholder being included i n the l a t t e r ' s income. The fact that the c a p i t a l gain i s actually c a l - culated and there i s a f u l l disposal of the assets transferred under the normal rules means that even though the gain accru- ing to the transferor i s deferred, the corporation receives:: the asset at a cost equal to what was actually paid f o r i t or i t s market value. This removes two d i f f i c u l t i e s found i n the Canadian system. F i r s t , the corporation i s not prevented from receiving f u l l depreciation allowances or p o t e n t i a l l y l i a b l e to recapture depreciation allowed to the transferor and, second, there i s no p o s s i b i l i t y of double taxation of any gain accruing p r i o r to the transfer because of the low cost base given to the assets i n the hands of the corporation and the shares i n the hands of the members. Although the section i s not, as i n Canada, e l e c t i v e , i t appears that most of the problems which might cause a Canadian taxpayer not to defer his gain cannot a r i s e i n the U.K. In any case, the provision could e a s i l y be avoided by s e l l i n g property to the corporation fo r cash and then issuing shares i n return f o r that cash. Any assets which were held by the transferor at the beginning of Capital Gains Tax system lose that c h a r a c t e r i s t i c i n the hands of the corporation. 2 7 As there i s no express requirement i n the U.K. Act that the company be resident i n the U.K., i t must be assumed that a transfer of assets to a non-resident company w i l l f a l l within the terms of the provision. This compares favourably with the po s i t i o n under section 85 of the Canadian Act, which only applies to Canadian Corporations. Turning now to the.type of assets which are covered, the r e s t r i c t i o n i n the paragraph which l i m i t s i t s operation to "assets of a business" would appear to rule out one use which i s available for section 85 of the Canadian Act. It seems cle a r that the l a t t e r provision w i l l apply to a simple transfer of investments to a company f o r estate planning 66 purposes. The business requirement i n the U.K. would appear to rule t h i s out, as f a r as paragraph 15 i s concerned. On the other hand, i t may be wondered how j u s t i f i a b l e i t i s to extend tax r e l i e f to transfers of investments to companies, when the usual motive of such transfers i s to avoid or reduce taxes. The same motives may exist f o r transferring a business to company, but, i n p r a c t i c a l terms, i t i s d i f f i c u l t to d i s t i n g u i s h s i t - uations where there are genuine business reasons f o r a transfer fromvthose where tax avoidance motives are predominant. It may be that some sort of business purpose test would be j u s t i f i a b l e here. Again, the U.K. provisions do not apply to non-capital assets, so that the rules dealing with the transfer of such assets as inventory and accounts receivable are those which business. 2 8 67 The U.K. provision i s generally less l i m i t i n g to thevrange of persons to which i t applies, i n that there i s no requirement that the transferor obtain a p a r t i c u l a r percentage of the shares issued by the corporation. In ̂ particular, i t extends protection to a transferor of a business who rec eives i n return from the corporation a minority holding of shares. It may be doubted whetherithis i s j u s t i f i a b l e , i n view of the fact that such a transfer may be more akin to a sale of the 6 8 business and a reinvestment of the proceeds, rather than a transfer which only changes the form i n which the business i s held and not the underlying b e n e f i c i a l ownership. In this respect the l i m i t a t i o n i n section 8 5 of the Canadian Act may be j u s t i f i a b l e . On the other hand, the 80% shareholding requirement means that Section 8 5 w i l l be of no use i n the case of a transfer to a company of businesses by a number of persons who are not partners, whereas paragraph 1 5 of the U.K. Act would give r e l i e f to each transferor i n so f a r as he received shares from the company. These aforementioned r e s t r i c t i o n s i n the Canadian Act could be avoided by a combination of section 8 5 and section 8 7 oftthe Act, but this would make the oper- ation more complex and d i f f i c u l t and consequently more 6 9 expensive. In two respects the Canadian provision would appear to have the advantage over the U.K. provision. Although paragraph 15 of the U.K. Act covers j o i n t transfers by a number of independent persons, there i s no express reference to a transfer by a partnership, so that the position i s i n some doubt. On the one hand, the Interpretation Act 1889 70 lays down general rules to the eff e c t that, unless the con- trary i s shown, i n a l l Acts of Parliament the word"person"shall include i t s p l u r a l and any body of persons whether incorporated or not. There i s obviously a contrary intention i n respect of companies i n paragraph 15, but the statutory d e f i n i t i o n of 71 companies expressly excludes partnerships.' On the other hand, by virtue of section **5(7) of the F.A. 1965, any partnership dealings are to be treated as dealings of the partners and not of the firm as such and any tax on c a p i t a l gains re a l i s e d on a disposal of partnership assets i s to be assessed on the part- ners separately. Itvwould thus appear that a transfer by a partnership i s within the terms of the section, although any actual tax l i a b i l i t y a r i s i n g from i t would f a l l on the i n - dividual partners. The shares issued would become partner- ship assets and as there i s no provision, l i k e section 85(3) of the Canadian Act, which permits the partnership to d i s - tribute those shares without tax consequences, i t appears that any gain deferred by virtue of paragraph 15 would be taxed i f the partnership was wound up. 30 In the second place, the Canadian provision applies i n any s i t u a t i o n where the transferor holds the requisite shareholding immediately a f t e r the transfer. There i s no requirement, as there c l e a r l y i s i n the U.K., that the shares be issued as consideration f o r the property transferred, so that once a.taxpayer has a qu a l i f y i n g shareholding he can transfer as many assets as he wishes to the corporation under the umbrella of section 85, subject to the proviso that i f he receives i n exchange from the corporation property other than shares with a market value i n excess of the adjusted cost base of the assets transferred, there; w i l l be a c a p i t a l .gain. On the other hand, the provisions of section 85 which at t r i b u t e the elected proceeds to shares received as th e i r a c q u i s i t i o n cost do not apply to shares held before the transfer i s made, so that there w i l l be no increase i n the adjusted cost base of existing shares i n respect of assets l a t e r transferred to the corporation under section 85, unless the provisions of section 53(I)(c) apply. This section provides f o r the i n - crease i n the adjusted cost base of shares held by a member wjao makes a c a p i t a l contribution to the company. It would generally require that the adjusted cost base of the shares be increased by the increase i n the i r market value brought about by the contribution, but this would be inconsistent with the obvious aim of section 85 to transfer to the trans- feror's shares the adjusted cost base of the assets which he transfers to the corporation. The pos i t i o n i s thus some- what doubtful and the safe course would be f o r the transferor to take shares from the corporation. F i n a l l y , two omissions from both systems must be considered. Tax r e l i e f i s given when share c a p i t a l i s issued by%a company i n return for property, but not when debt c a p i t a l i s issued. In both systems, debt c a p i t a l i s deemed to be con- sideration other than shares and so l i a b l e to cause a c a p i t a l gain. This should be kept i n mind when the financing of a transfer of assets to a corporation i s being considered. Further, there i s no express provision f o r l i a b i l i t i e s taken over by the company, so that these also w i l l s t r i c t l y const- it u t e non-share consideration received. In practice, i n the U.K., the Revenue Authorities, as a concession, do not treat 72 such as- consideration given by the company and i t may be that the Canadian Authorities w i l l do the same. 32 NOTES 1 For the meaning of the terra "dealing at arms length" and -the provisions governing transactions between parties not dealing at arms length, see Part 2 of this chapter. 2 S. 1 9 ( 1 ) F.A. 1965 3 S. 3 8 and s. 3 k Murphy v Australian Machinery and Investment Co. Ltd. [l<j>4>8 I A.C. 1*59 and two Canadian cases Claude B e l l e - I s l e v M.N.R. |l96if_I C.T.C. kO and Plercy v M.N.R. ( 1 9 5 6 ) 15 Tax A.B.C. 217 5 S. 6 9 ( 1 ) (b) i n Canada and s. 22 (It) (a) F « A « 1 9 6 5 i n the U.K. 6 On the other hand such transactions might be stopped by s. 55 i n Canada - see Part 2 of this chapter (last paragraph) 7 S. 5 4(a) i n Canada and para, k sch. 6 F.A. 1965 i n the U.K. 8 S. 69( 1 ) (c) 9 In the U.K., Craddock v Zevo Finance Ltd. ( 1 9 ^ 3 ) 27 T.C. 2 6 7 , i n p a r t i c u l a r Lord Green M.R. at 2 7 8 , and Osborne v Steel Barrel Co. Ltd. ( 1 9 ^ 2 ) 2k T.C. 2 9 7 . In Canada, Tuxedo Holding Co. Ltd. v M.N.R. 59 D.T.C. 1 1 0 2 . 10 D. Ward Tax Considerations Relating to the Purchase of Assets of a Business Corporate Management Tax Conference 1972 22 at k?. 11 See n. 7 supra 12 See Part k of Chapter Two. 13 See Part 1 of Chapter Three Section C (text at nn. 5 3 - 6 ) Ik R. Brown Capital Reorganizations Corporate Management Tax Conference 1972 Ilk at 12k, 33 15 This argument would not hold i n the case of 8k(l)f which e x p r e s s l y covers shareholders immediately a f t e r the i n c r e a s e i n paid-up c a p i t a l . 16 R.K. Fr a s e r v M.N.R. 196^ C.T.C. 1 17 See Part 1 of Chapter Three S e c t i o n C 18 S. 233(2)(b) I.C.T.A. 1970 - see Part 1 of Chapter Three S e c t i o n C (text at n. 67). 19 S. 233 (3 ) I.C.T.A. 1970 - see Part 1 of Chapter Three S e c t i o n C (text at n. 67). 20 S. 39 i n Canada and para. 2(1) sch. 6 F.A. 1965 i n the U.K. 21 S. 5 3 ( l ) ( b ) 22 31st December i n Canada and 6th A p r i l 1965 i n the U.K. 23 See Part 2 of Chapter Two S e c t i o n B 2k Mention of these p r o v i s i o n s d e a l i n g w i t h non-arms l e n g t h t r a n s a c t i o n s s t r i c t l y belongs to Part 2 of t h i s chapter but i s made here f o r the convenience. 25 S. 2 5 l ( l ) ( b ) 26 S. 251 (1) (a ) 27 S. 251(2) - (6) . These s e c t i o n s d e f i n e the v a r i o u s persons who are r e l a t e d to each other. 28 S. 251(4*) (a) d e f i n e s a " r e l a t e d groupV as a group of persons, each member of which i s r e l a t e d to every other m emb e r . 29 B r i t i s h American Tobacco Co. L t d . v C.I.R. 19^3 1 A.E. 13 i n the U.K. and B u c k e r f i e l d s L t d . v M.N.R. 1965 1 Ex. C.R. 299 i n Canada. See a l s o f o r d i s c u s s i o n s of the c o u r t s * approach to i n t e r p r e t i n g " c o n t r o l " W. Latimer Corporate C o n t r o l - Some Recent D e c i s i o n s lk Canadian Tax Jo u r n a l 120 (1966), J . Decore A s s o c i a t e d Corporations - Furth e r C o n s i d e r a t i o n s 10 Canadian Tax J o u r n a l **52 (1962 ) and D. Matheson Corporate C o n t r o l Concepts and Tax Reform 20 Canadian Tax Jo u r n a l k$ (1972 ) 3b 30 Para. 17 and 21 Sch. 7 F.A. 1965- 31 S. "+5(1) F.A. 1965 and s. 302 I.C.T.A. 1970 - see Part 1 of Chapter Four Section A (text at nn. 15-6) 32 G. Wheatcroft and A. Park Capital Gains Taxes para. 7-02 33 S. 6 9(l)(b) 3k Case comment on case c i t e d i n text at n. 35 i n f r a 21 Canadian Tax Journal 23 (1973) 35 26 D.T.C. 1502 36 S. 15 and s. 8"+(l) - see text at nn. 13-6 supra. The cost base of the asset to the shareholder would be increased to the extent, of any amount so included i n his income - s. 52(1) and s. 5 3(l)(b). 37 S. 5 ^ ( c ) ( v i i ) - see Part k of Chapter Two section A (text at nn. 191-3) 38 Id. 39 G. Wheatcrof and A. Park supra n. 32 at para. 11-11. ko For the meaning of ••control" see n. 29 supra and text. kl For the d e f i n i t i o n of "connected persons" see para. 21 sch. 7 F.A. 1065 and text at n. 30 supra. kZ E l i g i b l e c a p i t a l property includes goodwill and other intangibles - s. 5^(d) and s. 1**. k3 S. 85(1) (c) kk S. 8 5(l)(b) b5 S. 85(l)(d)-(e) kS S. 85(5) k7 Defined i n s. 8£)(l)(d). b8 S. 8 9 ( l ) ( d ) ( i v ) kS See Part 1 of Chapter Three Section C (text at nn. 58-60) 50 S. 8$(k) 3 5 5 1 S. 8 5 ( l ) ( b ) 5 2 See text at nn. 13-6 supra 5 3 S. 8 5 ( l ) ( f ) 5k S. 8 5 ( l ) ( g ) - ( h ) 5 5 S. 8 5 ( D ( g ) 5 6 S. 8 5 ( l ) ( h ) 5 7 See n. 51* supra 5 8 See text at nn. 22-k supra 5 9 Honourable E. Benson, Minister of Finance Proposals for Tax Reform para. 3 - ^ 7 / 6 0 Defined i n s. 5Mb) as depreciable and other property the d i s p o s i t i o n of which results i n a c a p i t a l gain or lo s s . 6 1 For an account of the tax consequences of the purchase and sale of inventory and accounts receivable see M. O'Brien Sale of Assets: The Vendor's Position Corpor- ate Management Tax Conference 1 9 7 2 1 at 5 - 8 and D. Ward, supra h". 1 0 at 2 6 - 6 . 6 ? This i s the aggregate of a l l the c a p i t a l gains from a l l the assets, less any losses - para. 1 5 ( 2 ) and ( 7 ) 6 3 Para. 1 5 ( 2 ) and (k) 6k The cost of these shares w i l l be determined by the rules discussed i n Parts 1 and 2 of this chapter. In p a r t i c u l a r , theproblem as to whether s. 2 2 ( k ) ( a ) F.A. 1 9 6 5 applies to determine the cost of issued shares i s important here - see text at nn. 3 8 - 9 supra. 6 5 Para. 1 5 ( 3 ) 6 6 For an account of the use of s. 8 5 f o r estate planning purposes see S. S i l v e r and S. Taube Estate Planning i n Canada 2 1 Canadian Tax Journal 3 5 ( 1 9 7 3 ) 6 7 S. 1 3 7 and s. k85 I.C.T.A. 1 9 7 0 and see P. Whiteman and G. Wheatcroft Income Tax and Surtax Chatper 9 . 36 68 Of course, t h i s would depend on the s i z e of the i n t e r e s t r e c e i v e d i n the company and the amount of c o n t r o l obtained. 69 S. 87 allows Canadian Co r p o r a t i o n s to amalgamate without tax consequences - see Part 1 of Chapter f i v e . Thus an i n d i v i d u a l c o u l d t r a n s f e r a s s e t s to a c o r p o r a t i o n i n which he h e l d 80% of the i s s u e d shares of each c l a s s and t h i s company c o u l d amalgamate wit h an e x i s t i n g l a r g e r company or other s i m i l a r companies set up i n the same way by other i n d i v i d u a l s - Canadian Bar A s s o c i a t i o n - B r i e f on Tax Reform B i l l C-259 Submitted to the M i n i s t e r of Finance 26~~. 70 S. 1 and s. 19 71 S. 6l(3) F.A. 1969 and s. ^5(1) F.A. 1965. 72 Simon's Taxes - V o l . E Para. E^.210. 37 TAXATION OF CAPITAL GAINS ACCRUING TO CORPORATIONS AND SHAREHOLDERS Capital gains and losses r e a l i s e d by an individual on a transfer of assets to a corporation were dealt with i n the preceding chapter, which also discussed the rules f o r determining the ac q u i s i t i o n cost to the corporation of those assets and the a c q u i s i t i o n cost to the transferor of any shares or other property received by him i n consideration fo r the transfer. The result of such a transfer i s the substitution fo r one taxpaying owner of the transferred assets of two separate taxpayers, both having interests i n this property - the company which owns the assets and the shareholder who 1 2 obtains an i n d i r e c t interest by virtue of his shares. The purpose of this chapter i s to consider the taxation of c a p i t a l gains and losses re a l i s e d by companies on the i r assets and 3 by shareholders on the i r shares. The taxation of companies can not be considered i n i s o l a t i o n from the taxation of in d i v i d u a l s . Rather they must be compared, since the intending investor i n or transferor of assets to»a corporation i s not so much interested i n the absolute l e v e l of corporate taxation as the increase or de- crease i n his tax l i a b i l i t y r e s u l t i n g from his action. This 38 i s p a r t i c u l a r l y the case where the corporation i s no more than a convenient form f o r an ind i v i d u a l or partnership to use i n the conduct of t h e i r business or the holding of the i r investments. In such a case the le g a l separateness of the personalities of the corporation and i t s members breaks down. It w i l l be seen that there are i n general no special r e l i e v i n g provisions i n the case of such corporations as to the impos- i t i o n of tax on income or c a p i t a l gains, although the si t u a t i o n i s quite d i f f e r e n t when i t comes to corporate d i s - tributions and accumulations which are covered i n the following two chapters. The i n d i v i d u a l who transfers assets to or invests i n a corporation is changing his pos i t i o n from that of i n - divi d u a l proprietor or d i r e c t property owner to that of a shareholder of a corporation. He i s thus concerned not merely with the d i f f e r i n g amounts of taxes paid by corporations and indi v i d u a l s , but also with the tax consequences to him of holding shares. In f a c t , shares are f o r the most part treated exactly l i k e any other type of property - that i s they are capable of being disposed of to r e a l i s e c a p i t a l gains or losses. However, the fact that a corporation may hold numer- ous types of property, e.g. depreciable property, goodwill, c a p i t a l property, inventory, each of which may be subject to d i f f e r e n t rules of taxation and which are a l l represented by 39 one type of asset i n the shareholders' hands, may lead to tax advantages or disadvantages f o r the taxpayer. Thus there are s p e c i a l p r o v i s i o n s governing c a p i t a l gains and loss e s r e a l i s e d on shares, which i n some areas attempt to equal i s e the p o s i t i o n of shares and the assets they repres- ent. The most important p r o v i s i o n s of t h i s type are those which prevent corporations d i s t r i b u t i n g t h e i r earnings i n the form of c a p i t a l d i s t r i b u t i o n s and those which prevent shareholders r e a l i s i n g accumulated corporate earnings as a c a p i t a l gain on a sa l e of t h e i r shares. Although these w i l l be discussed i n the f o l l o w i n g two chapters, other p r o v i s i o n s of a s i m i l a r type w i l l be r e f e r r e d to throughout t h i s chapter. In a d d i t i o n , there are various s p e c i a l r u l e s governing the computation of c a p i t a l gains and losses r e a l i s e d on shares. The p r o v i s i o n s discussed i n t h i s chapter apply-to gains and loss e s a r i s i n g from shares as much as they apply to other a s s e t s , unless some statement to the contrary i s made. This chapter w i l l a l s o deal w i t h the d i s t i n c t i o n drawn i n both systems between c a p i t a l gains and other income and the b e n e f i c i a l treatment accorded to the l a t t e r . This d i s t i n c t i o n i s s i g n i f i c a n t both f o r t h i s chapter and the problem of d i s t r i b u t i n g and accumulating corporate surpluses discussed i n the f o l l o w i n g two chapters. Immediately f o l l o w i n g t h i s i n t r o d u c t i o n i n Part 1, 1*0 there w i l l be a d i s c u s s i o n of the g e n e r a l l i a b i l i t y of c o r p o r a t i o n s and i n d i v i d u a l taxpayers to pay tax on c a p i t a l gains and, i n p a r t i c u l a r , the extent to which r e s i d e n t tax- payers are l i a b l e f o r c a p i t a l gains abroad and non-resident taxpayers are l i a b l e f o r gains r e a l i s e d i n the U.K. or .Canada. In P a r t 2, there i s examined the computation of c a p i t a l gains r e a l i s e d by c o r p o r a t i o n s and i n d i v i d u a l s . In P a r t 3, the tax treatment of c a p i t a l gains and l o s s e s i s d e a l t w i t h . In p a r t i c u l a r t h i s i n v o l v e s d i s c u s s i o n of the a v a i l a b i l i t y f o r s e t - o f f of c a p i t a l and n o n - c a p i t a l l o s s e s , exemptions granted from tax payable on c a p i t a l ..gains and the r a t e s of tax payable by the- d i f f e r e n t taxpayers. In P a r t k, there i s d i s c u s s e d the r u l e s a f f e c t i n g c e r t a i n c o r p o r a t e d i s p o s i t i o n s . T h i s covers the tax treatment of share i s s u e s and r e a c q u i s i t i o n s by c o r p o r a t i o n s and d i s - p o s i t i o n s made by one company to another company, which i n - volve a change i n the l e g a l ownership of the a s s e t t r a n s - f e r r e d , but, i n substance, no change i n the u n d e r l y i n g bene- f i c i a l ownership, e.g. t r a n s f e r s between members of the same group of companies. L a s t l y , i n Part 5, there i s a d e s c r i p t i o n of c e r t a i n s p e c i a l types of company found i n both systems and the way i n which the r u l e s d i s c u s s e d i n the r e s t of the chapter are kl modified i n r e l a t i o n to them. Most of these companies are i n s t i t u t i o n s which serve as a medium through which members of the general public are enabled to invest small sums without "putting a l l t h e i r eggs i n one basket."^ The general policy of both Governments towards such i n s t i t u t i o n s i s to treat them simply as conduits between the investor and the investment. In f a c t , most of the provisions which do this involve corpor- ate d i s t r i b u t i o n s and are discussed more f u l l y i n the next chapter, so that i n some cases a reference to a company i n this chapter w i l l simply introduce i t f o r moreffull discussion then. Also included i n this category are unit trusts and mutual fund trusts, which serve a s i m i l a r function and are to a large extent treated as or i n a si m i l a r fashion to companies. k2 Part 1 - L i a b i l i t y to Tax This part . raises the question of the extent of the l i a b i l i t y of a corporation to pay tax on c a p i t a l gains, as compared with the l i a b i l i t y of in d i v i d u a l s . In answering this question a clea r d i s t i n c t i o n must be drawn between gains made by taxpayers resident i n the U.K. or Canada and those made by taxpayers not so resident. In the former case, there must be considered the separate situations of gains r e a l i s e d in the country of residence and gains r e a l i s e d outside i t . Lastly, there i s considered to what extent the shareholder i s i d e n t i f i e d with the corporation, so as to be made l i a b l e f o r u n s a t i s f i e d corporate tax assessments However, these d i s t i n c t i o n s are not relevant for the purposes of determining the period with reference to which assessments to tax on c a p i t a l gains are made. The period f o r individuals i s , i n Canada, the taxation year ( i . e . January 1st - December 31st) and, i n the U.K., the g year of assessment ( i . e . 6th A p r i l - 5th A p r i l ) . This i s not changed for income other than c a p i t a l gains, although the income which- i s taxed i n that period may have actually arisen i n the pr i o r year^ or p a r t i a l l y i n the year and part- i 0 i a l l y outside i t . A s i t f o r corporations, the po s i t i o n i s sim i l a r i n both systems. The assessment to tax both on c a p i t a l gains and other income i s made i n respect of the 43 p e r i o d s f o r which the c o r p o r a t i o n makes up i t s accounts,** 12 which, i n Canada, i s termed the f i s c a l p e r i o d and, i n the 13 U.K., the accounting p e r i o d and which g e n e r a l l y l a s t s f o r 12 months. A. L i a b i l i t y of Residents (I) Grains a r i s i n g i n the U.K. or Canada Although both c o u n t r i e s make i n d i v i d u a l s and corp- o r a t i o n s f u l l y l i a b l e f o r c a p i t a l gains r e a l i s e d by them e i t h e r i n the U.K. or Canada (as the case may b e ) , there i s some d i s p a r i t y i n the methods used to achieve t h i s . Whereas, i n Canada, there i s one tax » Income Tax - payable by l4 i n d i v i d u a l s and c o r p o r a t i o n s a l i k e on"taxable income", which i s d e f i n e d i n s e c t i o n 3 of the Act to i n c l u d e the amount by which the "taxable c a p i t a l g a i n s " f o r the year of the taxpayersexceed h i s "allowable c a p i t a l l o s s e s " f o r the year, i n the U.K., i n d i v i d u a l s pay C a p i t a l Gains Tax on 15 c a p i t a l gains and Income Tax on other income and c o r p o r - a t i o n s pay C o r p o r a t i o n Tax on " p r o f i t s " , * * * which are d e f i n e d 17 to mean "income and chargeable g a i n s " . However, the v a r i o u s forms of t a x a t i o n found i n the U.K. are not so d i f f e r e n t as they might at f i r s t s i g h t seem, i n l i g h t of the f a c t that the chargeable gains p o r t i o n of a c o r p o r a t i o n ' s p r o f i t s i s •I Q computed i n accordance w i t h C a p i t a l Gains Tax r u l e s and the 19 balance a c c o r d i n g to Income Tax Rules. kk (II) Capital gains arising abroad The position just described in relation to capital gains arising in the U.K. or Canada applies equally to capital gains arising abroad, in that none of the charging sections in either of the two systems limit the l i a b i l i t y of taxpayers to gains arising in their country of residence. In one case only is there an exception to this rule. This is found in the U.K. in section 2 0 ( 7 ) of the F . i f . A . 1 9 6 5 , which applies to 2 0 individuals who are resident or ordinarily resident, but not domiciled, in the U.K. at the time that assets situated outside the U.K. are disposed of. In such a case the in- dividual is not charged to Capital Gains Tax in respect of any gain arising, but tax "is charged on the amounts (if any) received in the U.K. in respect of those chargeable gains, any such amounts being treated as gains accruing when they are received in the U.K.". There are various anti-avoidance provisions designed to ensure that the proceeds of dispos- 21 i t i o n are not remitted in non-taxable form. This provision is obviously intended as a relieving provision for taxpayers whose permanent home is situated in a foreign country, but who are temporarily resident in the U.K., in regard to their foreign assets, and as such- is not really appropriate for corporations. It has both advantages and dis- advantages. On the one hand, losses arising from a disposal of h5 assets situate outside the U.K. are not allowable to a person within the section, although presumably such losses can i n practice be set off against gains a r i s i n g from a disposal of such assets. On the other hand, i t i s d i f f - i c u l t to see how the deemed disposal, rules can operate on foreign assets, seeing as there are no proceeds to remit to the U.K.22 One possible way of avoiding tax on foreign gains would be to incorporate a foreign company and transfer 23 foreign assets to i t . However, the opportunities for avoidance i n this area are limited i n the two systems by provisions which at t r i b u t e c a p i t a l gains accruing to c e r t a i n Zk foreign companies to resident shareholders. Both systems provide a foreign tax c r e d i t to resident taxpayers who are l i a b l e to pay tax on a gain a r i s i n g from the disposal of an asset situated abroad, when 2 5 the gain i s also taxable i n the foreign j u r i s d i c t i o n . There i s some doubt as to the scope of the Canadian c r e d i t . Section 126(1) of the Act gives c r e d i t f o r "non-business- 2 income tax" paid to a foreign gdvernment and this i s defined as any "income or p r o f i t s tax" paid by the taxpayer. The question which arises i s whether this d e f i n i t i o n would cover the Capital Gains Tax found i n the U.K., although i t would undoubtedly cover Corporation Tax levied on c a p i t a l gains, as this i s expressly described as a tax on p r o f i t s . This incon- sistency, i f correct, would c l e a r l y be u n j u s t i f i a b l e . 2 7 1*6 B. L i a b i l i t y of Non-residents Except where otherwise provided, the general rule i s that non-residents are not l i a b l e f o r capital-gains r e a l i s e d by them, even where the asset disposed of i s s i t - uated i n the U.K. or Canada. In Canada, there are several exceptions to t h i s . A non-resident i s l i a b l e f o r taxable c a p i t a l gains a r i s i n g as the result of a d i s p o s i t i o n of taxable Canadian-property. 2 8 The l a t t e r term i s defined to include real property situated i n Canada and any other c a p i t a l property used i n carrying on a business i n Canada, together with the following items which are of p a r t i c u l a r relevance to this thesis: 2 9 (a) shares i n a resident non-public corporation p (b) shares i n any public corporation, i f at any time during such of the f i v e year period preceding the d i s p o s i t i o n as i s a f t e r 1971 not less than 25% of the issued shares belonged to the non-resident person or to persons with whom he did not deal at arms length or to both categories of persons. The i n c l u s i o n of shares within this d e f i n i t i o n means that a non-resident may often be taxed on a gain a r i s i n g on a d i s - p o s i t i o n of a share which i s att r i b u t a b l e to gains re a l i s e d by the corporation on a d i s p o s i t i o n of property which i s not taxable Canadian?property. To avoid this unnecessary 1*7 additional tax l i a b i l i t y , the non-resident should, i f prac- t i c a l , hold property other than taxable Canadian property personally and not through a resident corporation. 3 0 As has frequently been pointed out, the obvious way to avoid this l i a b i l i t y i n respect of taxable Canadian property i s to transfer such assets to a non-resident corp- oration and to dispose of the shares i n that corporation instead of the assets themselves. There i s a procedure set down i n section 1 1 6 of the Act f o r a non-resident vendor of taxable Canadian property to notify the Revenue Authorities i n respect of his d i s p o s i t i o n and to pay over 2 5 % of his c a p i t a l gain as a prepayment of tax, as a resu l t of which a c e r t i f i c a t e w i l l be issued to the vendor. This i s of importance to a purchaser of such property from a non-resident vendor, as he can be made l i a b l e f o r 1 5 % of the amount by which the actual price paid by him exceeds the amount set out i n the c e r t i f i c a t e or, i n the absence of 3 1 such a c e r t i f i c a t e , f o r 15%* of the whole purchase p r i c e . He can escape this l i a b i l i t y only i f , a f t e r reasonable enquiry, he had no reason to believe that the vendor was not resident 3 2 i n Canada. Thus a purchaser should take care when making a purchase of taxable Canadian property from a vendor who could be a non-resident, either by making sure that he i s not i n fact a non-resident or by withholding from the purchase price the 1*8 amount for which he could be personally l i a b l e . If a pur- chaser i s made l i a b l e under these provisions, he i s given a right to recover his loss from the vendor, but this may not be a sati s f a c t o r y remedy i f the vendor i s a non-reside\nt. None of the provisions found i n section 116 of the Act are applicable where the taxable Canadian property constitutes 33 "excluded property*!, which i s defined to include shares i n 34 a public corporation and bonds and debentures. A much narrower l i a b i l i t y i s imposed on non- residents by U.K. Law. By section 20(2) of the F.A. 1965, an i n d i v i d u a l who i s neither resident nor o r d i n a r i l y resident i n the U.K., but who c a r r i e s on a trade i n the U.K. through a branch or agency situated there, i s l i a b l e to Capital Gains Tax on gains a r i s i n g from a disposal of assets used f o r the purposes of that branch or agency. Non-resident companies are 35 s i m i l a r l y charged, the only possible difference being that the assets must be situated i n the U.K., whereas i t appears to be enough forr.the purposes of section 20(2) i f the assets are acquired f o r the purposes of the trade, although never actually brought to the U.K.3^ It should be noted i n p a r t i c - ular, with reference to the above Canadian provisions, that no l i a b i l i t y i s imposed on non-residents i n respect of gains r e a l i s e d on shares of a resident corporation. The rules just described governing the l i a b i l i t y of *9 non-residents are subject to the terms of any tax treaties entered into with other countries. For example, the terms of the Canada - U.K. Income Tax Agreement provide, as a general rule, that only the country of a taxpayer's residence 37 i s e n t i t l e d to tax him on c a p i t a l gains. Exceptions are 38 made i n the case of immovable property and movable property forming part of the business property of a permanent estab- lishment i n one country or pertaining to a fixed base i n one country from which a profession i s ca r r i e d on, gains on which may be taxed i n the country i n which'they are situated. There i s no c o n f l i c t between this agreement and the U.K. provisions, but an obvious one between i t and the Canadian provisions. It would seem that u n t i l the agreement i s renegotiated, U.K. residents w i l l continue to escape l i a b i l i t y f o r Canadian tax on c a p i t a l gains r e a l i s e d on shares i n companies resident i n Canada. Moreover, this pattern i s repeated i n many of the international tax agreements entered into by Canada."^ In the tax l i a b i l i t y of non-residents f o r c a p i t a l gains i s found the f i r s t example of a d i f f e r e n t treatment of shares and the underlying corporate assets which they re- present. While the non-resident shareholder i n a company resident i n the U.K. i s not l i a b l e on his shareholdings, the company w i l l be l i a b l e i n respect of a l l i t s c a p i t a l assets. The shareholder suffers no disadvantage as long as those assets are used in a trade carried on in the U.K., but i t would be unwise for him to hold investments or other business assets through a U.K. resident company. On the other hand, the corporation w i l l not have to pay any tax, i f , instead of realising i t s assets, the non-resident* shareholder disposes of his shares. In Canada a similar problem may arise, but the same solution is not always possible when the non-residents' shares constitute taxable Canadian property. C L i a b i l i t y of shareholders for corporate taxes As a general rule, of course, a shareholder is not liable in respect of any of his corporation's l i a b i l i t i e s , including tax l i a b i l i t i e s , except perhaps when the corporation is wound up, when he may be liable to the extent of any amounts not paid up in respect of his shares. However, there are several U.K. provisions which make shareholders liable for what is primarily a tax l i a b i l i t y of a corporation. They are designed to prevent shareholders stripping corporations of assets and leaving them nothing with which to satisfy out- standing tax l i a b i l i t i e s . Section 266 of the I.C.T.A. 1970 provides that where 1+2 a shareholder receives a capital distribution from a company 43 otherwise than on a reduction of capital and the capital so distributed derives from a disposal of assets in respect of 51 which a c a p i t a l gain was real i s e d or the d i s t r i b u t i o n i t s e l f constitutes!such a disposal of assets, he i s l i a b l e to pay a proportion of any Corporation Tax l i a b i l i t y incurred by the corporation i n respect of that disposal and not paid by i t within 6 months of i t s becoming payable. This section does not af f e c t any personal l i a b i l i t y attaching to the shareholder as a result of a disposal of his shares caused by the d i s t r i b u - th *5 kk t i o n . Further, the section gives the shareholder the right to recover the tax from the company. The above provision i s obviously directed at d i s t r i - butions made i n the course of winding up accompany. However, a more general provision i s found i n paragraph 19 of the 7 t h schedule of the F.A. 1965• This operates where a chargeable gain i s re a l i s e d by any person as the resu l t of a disposal kS of an asset by way of g i f t and the tax assessed on the donor in respect of the gain i s not paid within 12 months. In thi s case the donee i s l i a b l e f o r the tax, but can recover the amount from the donor. This could cover d i s t r i b u t i o n s of c a p i t a l assets i n specie made by a corporation, f o r which the share- holder gives no consideration or consideration less than market value, whether made i n course of winding up or at any other time. Just as the U.K. Acts recognize the group of companies as one entity f o r the purposes of giving tax r e l i e f on i n t e r - 52 group transfers and the like, i t also recognises i t as one entity for tax collection purposes. Thus by section 277 of the I.C.T.A. 1970, where a member of a group of companies**9 is assessed to Corporation Tax on a capital gain and f a i l s to pay within 6 months of the date when i t was due-for payment, then the tax can be recovered from the principal member of the group or any other member of the group who owned the asset in question in the two year period before the gain was realised. This prevents the group members transferring an asset, just before i t is sold outside the group, to a group member which has no assets with which to pay any tax assessed to i t . Any company incurring l i a b i l i t y under this; section is given a right of recovery from the company which incurred the gain, and, in certain circumstances, certain members of the group. Group members are also liable to be assessed to tax for which other members or ex-members are primarily liable under similar provisions, where tax is imposed through a member leaving the group with an asset which i t acquired from another group member under the group transfer provisions and where tax is charged on a group member in respect of 52 shares in a company which has l e f t the group. None of the above provisions have their Canadian equivalent, so that there remains the basic position that a shareholder is not liable for a company's tax assessments, 53 except to the extent of unpaid c a p i t a l on his shares, which may be payable i f the company goes into l i q u i d a t i o n . o 5>+ Part 2 - Computation of Capital Gains and Losses There i s i n substance l i t t l e difference between the rules f o r computing c a p i t a l gains and losses, as between the U.K. and the Canadian systems and as between individuals and corporations within each system. On the.-other hand, there i s some va r i a t i o n of treatment within both systems, but p a r t i c u l a r l y i n the U.K., as between shares and secur- i t i e s on the one hand and other assets on the other and, within the former category, between shares and s e c u r i t i e s which are p u b l i c l y traded and those which are not. The rules f i r s t discussed i n section A of this part of this chapter are those which apply to determine the amount of gains or losses r e s u l t i n g from disposals of a l l types of assets (shares and s e c u r i t i e s Included) and made by a l l types of taxpayers. These are very s t r a i t - forward and require l i t t l e comment. However, these general rules are wholly or p a r t l y excluded, where the assets disposed of were held by the taxpayer when the tax on c a p i t a l gains was f i r s t introduced into the two countries, i * e * 1st January 1972 i n Canada and the 6th A p r i l 1965 i n the U.K. For such assets there are special computation provisions discussed i n section B, which are primarily designed to ensure that the amount of any gain or loss i s the lesser of the amount computed under 55 the normal rules and the amount accruing a f t e r the date of commencement of the system. Furthermore, both systems provide d i f f e r i n g rules when the assets involved are pub l i c l y traded shares or s e c u r i t i e s . The d i s t i n c t i o n seems to rest on the easy a v a i l a b i l i t y of a f a i r market value of the l a t t e r at the commencement of the system. The i d e n t i c a l nature of shares and se c u r i t i e s of one class of any corporation leads to a requirement f o r provisions to determine the ac q u i s i t i o n cost of part of a holding of such property, when a part only i s disposed of and d i f f e r e n t parts of i t were acquired at d i f f e r e n t times at d i f f e r e n t p r i c e s . Not only do such provisions remove any d i f f i c u l t i e s i n determining the ac q u i s i t i o n cost of the pa r t i c u l a r shares disposed of, but they eliminate the p o s s i b i l i t y of a taxpayer a r t i f i c i a l l y reducing gains or increasing losses by c a r e f u l l y selecting the shares disposed of, so that the a c q u i s i t i o n cost i s the one which i s most b e n e f i c i a l to him. These i d e n t i f i c a t i o n rules, which are discussed i n section C, also apply to any other type of assets which are i d e n t i c a l with each other. F i n a l l y , the application of many of the above provisions, together with many other provisions of the Acts, requires the determination of the market value (in the U.K.) or f a i r market value (in Canada) of an asset. As a rule, 56 the Acts leave this to be determined, according to the facts of each case, by agreement between the Revenue Author- i t i e s and the taxpayer or i n the l a s t resort by the courts. However, the easy a v a i l a b i l i t y of valuations f o r quoted shares and s e c u r i t i e s leads to special rules to determine their value according to t h e i r quoted p r i c e . The valuation rules are dealt with i n Section D. A . The General Rules of Computation Section kO of the Canadian Act provides that "a taxpayer's gain for a taxation year from the d i s p o s i t i o n of any property i s the amount by which ... his proceeds of d i s p o s i t i o n exceed the aggregate of the adjusted cost base to him of the property immediately before the d i s p o s i t i o n and any outlays or expenses to the extent they were made or 53 incurred by him f o r the purpose of making the d i s p o s i t i o n * . The "adjusted cost base" means the cost to the taxpayer ad- 5 4 justed as provided in;:the Act. The U.K. Act refers to gains a r i s i n g on a "disposal of a s s e t s " . ^ The gain i s computed by deducting from "the consideration ... accruing to a person on the disposal of an asset... the amount or value of the consideration, i n money or moneys worth, given by him or on his behalf wholly and exclusively f o r the a c q u i s i t i o n of the asset, together with 57 the incidental cost to him of the a c q u i s i t i o n or, i f the asset was not acquired by him, any expenditure wholly and exclusively incurred by him i n providing the asset. "The taxpayer i s also allowed to deduct" incidental costs of making the disposal" and other expenditure incurred wholly and exclusively to enhance the value of the asset or to defend"title to it.''*' The U.K. statute i s much more sp e c i f i c on theaallowable deductions, but most ( i f not a l l ) of the deductions allowed i n the U.K. should also be allowed 57 in Canadacunder the ordinary meaning of the term "cost". Losses are calculated i n both systems i n the same manner 58 that gains are calculated. Once a c a p i t a l gain or loss has been computed, the question arises as to how much i s to be taxed. Under Canada ian Law only "taxable c a p i t a l gains" are included i n income and only "allowable c a p i t a l losses" are deductible from income. ^ The l a t t e r are defined to mean half of any c a p i t a l loss and the former half of any c a p i t a l gain.** 0 On the other hand, i n the U.K., the whole of any gain or loss i s taken into account except i n one case. As from the 1st A p r i l 1973 i n the case of companies, the amount of chargeable gains and allowable losses w i l l be reduced by an amount to be deter- mined by parliament.** 1 The effect of this i n reducing the tax payable by corporations i s obvious and w i l l be discussed more f u l l y i n connection with the rates of tax payable by 58 62 companies on c a p i t a l gains. In the U.K. corporations are given one s p e c i f i c statutory advantage, although a li m i t e d one. Section 269 I.C.T.A. permits a corporation to add to any expenditure, which i t incurs on the constr- uction of any building, structure or works and which w i l l be deductible from the proceeds when they are disposed of, any interest on any money which i t borrows to carry out such expenditure, butthe interest must be chargeable to c a p i t a l . On the other hand, i t may be that such interest i s i n any case deductible as part of the cost of the asset. B. The t r a n s i t i o n a l provisions The basic t r a n s i t i o n a l provision i n the Canadian system, which applies to a l l assets, save f o r depreciable property and interests i n partnerships, i s found i n section 26(3) I.T.A.R. This enacts that the adjusted cost base of an asset held on the 31st December 1971 i s to be the middle amount of i t s actual cost, i t s f a i r market value on valuation 63 6k day and i t s proceeds of d i s p o s i t i o n . . This rule i s excluded i f the taxpayer elects that the cost of his assets equal their f a i r market value on valuation day.^ However, the election must be made i n respect of a l l the taxpayer's assets and i s not available where the taxpayer i s a corp- oration. There are further provisions which apply to depreciable property and exclude from computation c a p i t a l 59 66 gains accruing before the commencement of the system and others designed to prevent tax avoidance by means of 67 transfers between persons not dealing at arras length. Only i n two minor respects are there modifications of these Canadian rules as they a f f e c t shares and s e c u r i t i e s . In the f i r s t place, i n operating section 26(3) i n r e l a t i o n to obligations,** 8 the amortized** 9 cost of the obligation i s used instead of the actual cost. In the second place, the valuation day prescribed f o r pub l i c l y t r a d e d s e c u r - 70 i t i e s i s d i f f e r e n t from that prescribed for other property.' In the U.K., d i f f e r e n t rules are applied according to the types of asset involved andtthe Act provides f o r three types of asset - land with development value, shares and s e c u r i t i e s quoted on a recognized stock exchange i n the U.K. and other assets (including a l l other shares and s e c u r i t i e s ) . The ruleswwhich apply to land with development value w i l l not be discussed i n this thesis, as not being immediately relevant to i t s subject, but they are sub- s t a n t i a l l y s i m i l a r to the rules next described which govern dispositions of quoted shares and s e c u r i t i e s , without the benefit of an election l i k e the one given i n the F.A. 1 9 6 8 . 7 1 6o In regard to shares and s e c u r i t i e s which are quoted on a recognised stock exchange i n the U.K., the general rule i s j l a i d down 7 2 thatrsuch shares and secur- i t i e s are deemed to have been disposed of and reacquired at th e i r market value on the 6th of A p r i l 1965. On the other hand, where the operation of this rule would cause a greater gainoor loss than would result i f the ordinary computation rules were followed, i . e . , the a c q u i s i t i o n cost of the asset were deducted from the proceeds of sale, then the gain or loss derived from following the l a t t e r rules i s taken as 73 the taxable amount and where these t r a n s i t i o n a l rules would substitute a gain f o r a loss or a loss f o r a gain, the d i s p o s i t i o n i n question i s deemed to be for such proceeds 7k as would cause neither a gain nor a loss . In f a c t , these provisions are simply a more complicated way of achieving the same result achieved by section 26(3) of the Canadian I.T.A.R. Further, the equivalent of section 26(7) of the Canadian I.T.A.R. i s found i n schedule 11 of the F.A. 1968, which gives the taxpayer the right to elect that the acqu- i s i t i o n cost of quoted shares and s e c u r i t i e s equal their 7 5 market value on the 6th A p r i l 1965. However, i t i s more b e n e f i c i a l than section 26(7) i n allowing a separate election to be made i n respect of fixed interest s e c u r i t i e s and preference shares on the one hand and a l l other shares and se c u r i t i e s on the other hand 7 ^ and i n applying to a l l 77 taxpayers. ' 61 Where, following a company reorganization under 78 paragraphs k-7 of schedule 7 of the F.A. 1965, a share or debenture holder has received a new holding of shares or se c u r i t i e s i n return f o r his old holding, any election made p r i o r to the reorganization under the F.A. 1968 i n respect of one of the two types of shares and s e c u r i t i e s w i l l only operate i n respect of the new holding, i f i t comprises shares or se c u r i t i e s of that type, regardless of 79 whether the old holding was covered by the el e c t i o n . Moreover, such an elec t i o n made by the p r i n c i p a l member of 80 a group of companies also binds the other members of the same group, unless, p r i o r to entering the group, the member personally made an elec t i o n or f a i l e d to make i t within the re q u i s i t e time.® 1 The rules applying to shares and se c u r i t i e s not covered by the above provisions are those which apply to a l l other types of asset and are found i n paragraph 2k of schedule 6 of the F.A. 1965. Any c a p i t a l gain or loss i s calculated according to the ordinary rules, by deducting from the proceeds of d i s p o s i t i o n the a c q u i s i t i o n cost, and the r e s u l t i n g gain or loss i s then evenly apportioned over the period i n which i t accrued. That part which accrued a f t e r the 6th A p r i l 1965 i s the amount which i s taxed as a c a p i t a l gain or allowed as a c a p i t a l l o s s . As an al t e r n a t i v e , paragraph 25 of the same schedule allows the taxpayer to 62 elect that there be a deemed disposal and reac q u i s i t i o n of the assets f o r proceeds equal to th e i r market value on the 6th A p r i l 1965 and this election may be made or not made i n respect of each separate disposal. However the elec t i o n i s not available i f i t would result i n a loss or greater loss being produced and i f the elec t i o n would substitute a gain f o r a lo s s , the asset i s deemed to have been disposed of for such proceeds as would produce neither a gain nor a loss . The time apportionment rule described above i s s i g n i f i c a n t l y d i f f e r e n t from any of the t r a n s i t i o n a l rules found i n the Canadian system. The alternative e l e c t i o n follows the more general pattern set by the Canadian provisions and the other U.K. provisions, but this e l e c t i o n right i s not, as i s apparently the case with the elec t i o n right given by section 26(7) of the Canadian I.T.A.R., permitted where i t s use would increase a loss or turn a gain into a l o s s . One provision of the F.A. 1965, which prevents use being made of the corporate form and the above time appor- tionment rule to avoid taxes, should now be referred to. The device i n question i s a transfer of assets to a cl o s e l y controlled company by one of the co n t r o l l e r s or persons connected with him, where the shares i n that company were held on the 6th A p r i l 1965 by such c o n t r o l l e r and are subject to the time apportionment rule when disposed of. But f o r t h i provision, c a p i t a l gains r e a l i s e d on such a disposal would be 63 spread over the whole period of ownership of the shares under the time apportionment rule, even though a part of this gain was attributable to c a p i t a l gains accrued to assets transferred to the company since the shares were acquired. This i s prevented by spreading so much of the gain as i s a t t r i b u t a b l e to gains on such assets over a period beginning with the transfer of the asset to the corporation. Such pro- visions are unnecessary i n Canada, as there i s no time appor- tionment rule f o r computing gains and losses. In e f f e c t , this U.K. provision equalises the tax p o s i t i o n of the shares and the underlying assets of the corporation, to prevent the shareholder gaining an unwarranted advantage from t h e i r d i f f - erence. C. I d e n t i f i c a t i o n rules The basic Canadian rule i s set out i n section k7 of the Act which concerns, not just the properties now being discussed, but a l l i d e n t i c a l properties. It provides that where a person acquires one or more properties which are 8 i d e n t i c a l to property already owned by him, then he i s deemed to have disposed of his formerly acquired properties f o r proceeds equal to t h e i r adjusted cost base and to have acquired those properties, together with the new property, at a combined cost equalling the adjusted cost base of the old property plus the actual cost of the new property. The cost of each i n d i v i d u a l property i s obtained by d i v i d i n g the 6k t o t a l cost by the number of properties involved or, i n the 86 case of obligations, by d i v i d i n g the t o t a l cost by a f r a c - t i o n equal to the f r a c t i o n which the p r i n c i p a l amount of each obliga t i o n i s of the t o t a l p r i n c i p a l amounts of a l l such obligations. The equivalent U.K. rule i s s i m i l a r i n e f f e c t , although quite d i f f e r e n t i n form, and i s found i n paragraph 2 of schedule 7 of the F.A. 1965. This provides that " a l l 88 shares of the same class held by one person i n one capacity s h a l l ... be regarded as indistinguishable parts of a single asset ... growing or diminishing on the occasions on which additional shares of the class i n question are acquired or 89 some of the shares of the class i n question are disposed of." A disposal of some of the shares i n that holding i s treated as 90 a part disposal of a whole asset. Where the shares are held by a person to whom they were issued as an employee of a company or of any other person on terms which r e s t r i c t the right to dispose of them, they form a separate pool as long as 9 1 the r e s t r i c t i o n i s i n force and where a shareholder also has shares of the same class which are not within this l a t t e r provision, i t i s a question of f a c t whether a subsequent disposal comprises shares of the l a t t e r type or the former 92 type. Both systems have special provisions concerning 65 identicail assets held at the beginning of the c a p i t a l gains system. In Canada, by virtue of section 26(8) of the I.T.A.R., fo r the purpose of applying the t r a n s i t i o n a l provisions which determine the adjusted cost base of a l l assets held at this 9 3 time, the actual cost and market value on valuation day of each i d e n t i c a l asset i s calculated by d i v i d i n g the t o t a l a c q u i s i t i o n cost and market value on valuation day of a l l the i d e n t i c a l assets by the number of such assets and, i n the case of obligations, by the f r a c t i o n which the principal amount of each asset bears to the t o t a l p r i n c i p a l amounts of a l l the assets. To d i s t i n g u i s h such assets from assets acquired a f t e r the beginning of the system and asssets acquired and sold before the beginning of the system, the rule i s that the assets are deemed to be disposed of i n the same order i n which they were acquired. Thus, i f the taxpayer has i d e n t i c a l assets, some of which were acquired before and some a f t e r 1971, the 9k former w i l l be deemed to be disposed of before the l a t t e r . 95 As f o r the U.K. and shares held on the 6th A p r i l 1965, the rule i s quite simple. Both f o r the purpose of distinguishing such shares from shares acquired a f t e r that date and from shares disposed of p r i o r to that date, shares 9 6 are deemed to be disposed of f i r s t which were acquired f i r s t . There are no pooling provisions f o r such shares. In the absence of statutory provisions to the con- trary, a new holding of shares or debentures received by 66 virtue of a reorganization under the provisions discussed in c hapter f i v e i n exchange f o r an old holding i n the same or a d i f f e r e n t company w i l l not be subject to the trans- i t i o n a l provisions just described, even i f the holding f o r which they were exchanged was subject to those provisions. In f a c t , the U.K. provisions, i . e . paragraphs k-7 of schedule 7 of the F.A. 1965,̂ 7 do provide that the new holding i s to be treated as acquired at the same time and f o r the same price as the old holding, but,; i n Canada, this i s not generally the case, except where section 87 of the Act applies on an 98 amalgamation. 0. Valuation of shares and debentures The only d e f i n i t i o n of market value or f u l l market 99 value found i n either system i s contained i n section kk of the F.A. 1965. This defines the expression "market value" i n r e l a t i o n to any assets as meaning the price which that asset might reasonably be expected to fetch on a sale i n the open market and further provides that, i n estimating the market value of any assets, no reduction s h a l l be made in the estimate on account of i t s being made on the assump- tion that the whole of the assets are to be placed on the market at one and the same time. This d e f i n i t i o n i s amplified by the same s e c t i o n 1 0 0 ' i n the case of quoted shares and s e c u r i t i e s . It i s provided that shares and s e c u r i t i e s quoted on the London Stock 6 7 Exchange are to be valued according to their quoted prices, unless the quoted price does not represent a proper measure 101 of t h e i r market value or some other stock exchange i n the U.K. affords a more active market. This rule i s modified s l i g h t l y when applied to the valuation of shares and secur- i t i e s on the 6th A p r i l 1965 for the purpose of the trans- i t i o n a l provisions for computing gains and losses realised 102 from disposals of assets held on that date. In Canada, the only statutory provisions concern- ing the valuation of shares and se c u r i t i e s are found i n the t r a n s i t i o n a l rules. As already mentioned, the valuation day prescribed for pu b l i c l y traded shares and s e c u r i t i e s i s d i f f - erent from that prescribed for other a s s e t s . I n addition, i t i s l a i d down i n section 26(11) of the I.T.A.R. that "the f a i r market value on valuation day of any property prescribed to be a p u b l i c l y traded share or security s h a l l be deemed to be the greater of the amount, i f any, prescribed i n respect of that property and the f a i r market value of that property otherwise determined" on that day. This to some extent leaves the question of f a i r market value open, but the Government has indicated that the prescribed values w i l l be accepted by the Revenue Authorities, unless the tax- 10k payer can esta b l i s h some other value. This w i l l mean that i t w i l l be up to the taxpayer to show that the ordinary market price i s not the correct value, because of some 68 factor peculiar to him, e.g. he holds a c o n t r o l l i n g block of shares. Where the above provisions do not apply or are excluded because (in the U.K.) another market than the London Stock Exchange forms a more active market f o r the property i n question or the quoted price i s not a proper valuation or (in Canada) because the taxpayers can prove a f a i r market value d i f f e r i n g from the prescribed figure or no. value i s prescribed, then i t i s necessary to look to the general meaning of the terms " f a i r market value" and "market value". There have been many decisions on the meaning of such terms as these, of which one of the most 105 noted i s Gold Coast Selection Trust v Humphrey. In this 106 case, Viscount Simon defined f a i r market value "as the highest price obtainable i n an open and unrestricted market between parties acting at arms length". The U.K. d e f i n i t i o n of market value as the amount which an asset might be expected to fetch on the open market appears to be no more than a/reformulation of the d e f i n i t i o n s adopted by the courts, so that the old p r i n c i p l e s l a i d down by the courts f o r ascertaining market or f a i r market value w i l l apply to the c a p i t a l gains provisions found i n both the 107 U.K. and Canada. On the other hand, i t i s not so cl e a r that the U.K. provision which excludes a reduction in a 69 valuation through the valuation being based on the assump- tion that the whole asset involved i s put on the market at the same time i s also a mere reformulation of common law p r i n c i p l e s . Although there i s authority supporting such a p r i n c i p l e , 1 0 8 i t i s submitted that i t would probably depend on the facts of each case as to whether such a p r i n c i p l e should operate. It i s not intended to describe i n d e t a i l the p r i n c i p l e s developed by the courts to be followed i n 109 making valuations, but merely to describe i n a general way how they apply to shares and l i k e assets. The valuation of shares and s e c u r i t i e s which have their prices quoted, but yet are not covered by or are 110 excluded from the provisions described above, w i l l prima 111 f a c i e be determined by that figure which i s quoted. However, this w i l l c l e a r l y not be the case where the reason for the assets i n question being excluded from those pro- visions i s precisely because this price i s not a proper valuation or, i n any other case, where other factors make the quoted price an Incorrect valuation. In p a r t i c u l a r , this w i l l be the case where the shares i n question carry 112 with them the right to control the company, but even i n these situations, the quoted price w i l l be a s t a r t i n g figure 113 which can be raised or reduced accordingly. The most d i f f i c u l t valuation problem arises i n connection with shares and s e c u r i t i e s the prices of which are not jquoted. I t ; i s i n this s i t u a t i o n that rules of law or practice concerning the estimation of the value of an asset are the most unhelpful. L i t t l e more can be done than to l i s t the numerous factors which might be relevant i n assessing the value of such assets, leaving the valuer to assess t h e i r importance i n the individual case i n front of 114 him and to make his valuation accordingly. However, the most important of these factors are, perhaps, the earning potential of the company i n which the share i s held, the value of i t s assets and the degree of control which i s given by the shares over the company i n question.**'* 7 1 Part 3 - Treatment of Capital Gains and Losses The l i a b i l i t y of a taxpayer to pay tax on a c a p i t a l gain having been established and the amount of the gain having been computed, the treatment of such a gain in the hands of that taxpayer must be considered. It i s i n this area that there i s revealed the most s i g n i f i c a n t d i f f - erences i n the tax l i a b i l i t y of corporations and individuals, which should weigh heavily on a person's mind when he i s considering investing i n or transfearring a business or other assets to a corporation. As a general rule, where a c a p i t a l gain re a l i s e d i n c e r t a i n circumstances would be taxable, a c a p i t a l loss r e a l i s e d i n the same circumstances w i l l be deductible against c a p i t a l gains of the same taxpayer and possibly against other income. This right of set-off may extend beyond gains and income of the same year i n which the loss i s i n - curred to gains or income of future or past years. On the other hand, f o r various policy reasons, c a p i t a l losses r e a l i s e d on ce r t a i n types of assets are disallowed complete- l y . As this disallowance does not extend to shares of corporations holding such assets, the p o s s i b i l i t y arises of avoiding i t by transferring such assets to corporations and taking the loss on shares i n that corporation. The set- of f of c a p i t a l losses and the p o s s i b i l i t y of avoiding loss 72 disallowances by the use of corporations i s dealt with i n this part of this chapter i n section A. Secondly, the question i s discussed i n section B as to how f a r i t i s possible to set off non-capital losses, e.g. trading losses, against c a p i t a l gains of the same or other years. It w i l l be seen that the answer to this question seems to depend on the way i n which c a p i t a l gains are taxed. I f , as i n Canada fo r a l l taxpayers and i n the U.K. f o r corporations, c a p i t a l gains are regarded as ordin- ary income, such set off i s possible, but i f , as in.the U.K. taxation of c a p i t a l gains r e a l i s e d by individuals, c a p i t a l gains are taxed separately, then i t i s not possible. Thirdly, i s considered i n section C the existence of any exemptions from taxes on c a p i t a l gains available to individuals and corporations. Lastly and most importantly, there are described i n section D the rates of tax payable by taxpayers on c a p i t a l gains. The d i f f e r e n t rates payable by individuals and corp- orations are one of the most s i g n i f i c a n t factors to be examined when considering the tax advantages or disadvantages of corporations. 73 A . Capital Losses 1) Deductions of c a p i t a l losses from c a p i t a l gains and other income In the f i r s t place, c a p i t a l losses f o r the accounting period, year of assessment or taxation year (as the case may be) are set off against c a p i t a l gains accruing i n the same period. 1 1** Further, i n so f a r as the losses exceed the gains of the same period, they are carr i e d f o r - ward (and termed "net-capital losses" i n Canada) and set 117 off against any c a p i t a l gains a r i s i n g i n future years. This i s the general rule which i s subject to c e r t a i n var- iations and modifications within the two systems. While the right to carry forward c a p i t a l losses i n the U.K. takes precedence over the statutory right to set off non-capital losses and other deductions again* the 118 chargeable gains portion of " p r o f i t s " , i n Canada the 119 reverse i s true. On the: other hand, before carrying "net-capital losses" forward to future years, Canadian Law gives the additional right to set off such losses 120 against gains of the immediately preceding year. In two respects, Canadian individuals are i n a more advantageous position i n regard to the set-off of c a p i t a l losses. In the f i r s t place, i n d i v i d u a l s , but not corporations, are permitted to set off c a p i t a l losses of 74 the current year and then "net-capital losses" against up to one thousand do l l a r s of other income i n each taxation year,,in so f a r as such amount of income i s available i N a f t e r deducting other losses of the current year and "non- 121 c a p i t a l losses". There seems no reason i n p r i n c i p l e for not allowing corporations the benefit of this provision* . Rather i t seems to be the case of the Act giving r e l i e f to the in d i v i d u a l where small amounts are involved, on the basis that corporations are not so much i n need of such r e l i e f . In the:second place, corporations are disadvantaged by 122 section 111(4 ) , which provides that where "control of 123 the corporation has been acquired by a person who did not, the end of the preceding year, control the corporation", "net-capital losses" accruing i n any year p r i o r to the year in which control i s obtained cease to be deductible from the corporation's income, either i n the year when control i s obtained or any l a t e r year. This i s analogous to the rule found i n section 111 (5 ) , which forbids the carry-forward of non-capital losses on a change of control of the corporation, but, i n f a c t , i t extends the policy followed by this section, i n that that section also requires a change i n the corpor- ation's business. It i s notable that although the U.K. Act 124 contains a provision which has a sim i l a r effect to section 111(5 ) , i t has no provision equivalent to section 111(4 ) , so that there i s no cessation of the carry forward 75 of c a p i t a l losses on the change i n control.of a corporation. It has been suggested that i t i s i l l o g i c a l and 125 harsh to allow (where this i s allowed) the deduction of trading and other non-capital losses from c a p i t a l gains, but not the deduction of c a p i t a l losses from trading and other 12 6 non c a p i t a l income. The argument against allowing this i s that i t i s much easier for a taxpayer to manipulate his disposals so as to r e a l i s e c a p i t a l losses than i t i s to a r t - 127 i f i c i a l l y create trading losses. ' It would appear that this 12 R i s true and the question becomes one of balancing the p r a c t i c a l necessity to r e s t r i c t losses against fairness to the taxpayer. It may be that accompromise solution, f a i r e r than the present absolute p r o h i b i t i o n / would be to extend the limited rights of deduction given to individuals to deduct c a p i t a l losses from one thousand d o l l a r s of non-capital income. There i s one further d i f f i c u l t y which would have to be overcome i f c a p i t a l losses are to be deductible from non- c a p i t a l income. As individuals under U.K. Law pay a lower 129 rate of tax on c a p i t a l gains than on other (income, they would gain an unmerited advantage from being able to set off c a p i t a l losses against income on which the higher rate of tax i s payable. 76 (II) The disallowance of c a p i t a l losses There are several provisions found i n both systems which disallow c a p i t a l losses r e a l i s e d on certain types of 130 assets, e.g. personal use property and depreciable pro- perty 1-* 1 i n Canada and, i n the U.K., motor vehicles and depreciable property.1-'-' However, there i s only one express provision disallowing c a p i t a l losses r e a l i s e d on shares i n a corporation which are caused by the depreciation of such assets held by the corporation. This i s section 4 6 ( 4 ) of the Canadian Act, which provides that where i t may reasonably be regarded that, by reason of a decrease i n the f a i r market value of any personal usejproperty of a corporation, any c a p i t a l gain from the d i s p o s i t i o n of a share i n the corpor- ation has been reduced or become a loss or any such loss has become greater, the amount of the gain or loss i s deemed to be the amount i t would have been but f o r the decrease. Apart from this provision, there i s no express provision to prevent the exploitation by the taxpayer of this unequal treatment of shares and the assets they represent. It could be, how- ever, that, i n Canada, the provisions of section 55 of the 134 Act, which generally prevent a taxpayer a r t i f i c i a l l y reducing a gain or increasing a loss, w i l l be applied i n this s i t u a t i o n . 77 B. Set o f f of non-capital losses against c a p i t a l gains It has already been shown how, i n Canada, both f o r individuals and corporations, taxable c a p i t a l gains and allowable c a p i t a l losses are included when computing ordin- ary income. Invrthis respect c a p i t a l gains are regarded as a separate source of income, along with income from business, property and employment, and may be reduced by any deductions allowed by the Actvwhich are not expressly referable to any of the other sources. Further, i n so f a r as income from those other sources i s not s u f f i c i e n t to absorb available deductions which are exclusive to them, there w i l l be losses which can be deducted from any excess remaining when "taxable c a p i t a l gains" f o r the year have been reduced by any "allow- able c a p i t a l losses" f o r the year.*-*-* In so f a r as the losses from those other sources exceed the taxpayer's income f o r the year, they are termed "non-capital losses" and may be set off f i r s t against the p r i o r year's income and then against the income of the f i v e following years, i n the same manner as they are set against 13 6 income of the current year. The right of carry-back and carry-forward i s l o s t i n the case of business losses accru- ing to a corporation, i f there i s a change of control of the corporation accompanying a change i n the business of the 137 corporation. 78 Turning to the U.K., one finds the f i r s t sign- i f i c a n t consequence a r i s i n g from the fact of individual taxpayers being subjected to two d i f f e r e n t taxes — Capital Gains Tax on c a p i t a l gains and Income Tax on other income. In only one very limited s i t u a t i o n i s the i n d i v i d - ual allowed to treat c a p i t a l gains as income fo r the purpose of making deductions there from. This i s when the a l t e r - 138 native rate of tax i s applied. The position of corpor- ations i s more similar to that of t h e i r Canadian counterpart Several important provisions of the I.C.T.A. 1970 allow ded- uctions f o r the purposes of Corporation Tax from the " p r o f i t of an accounting period. It has already been noted that the 139 term " p r o f i t s " includes chargeable gains. In p a r t i c u l a r , there i s section 177(2), which allows trading losses i n a current accounting period to be set against " p r o f i t s " of the same or preceding accounting period and section 2k8 pro- vides for the deduction of charges on income paid by a company i n an accounting period to be deducted from the " t o t a l p r o f i t s " of that accounting period. "Charges on income" are defined to exclude payments otherwise deductible lko i n computing p r o f i t s , c a p i t a l payments, d i s t r i b u t i o n s and payments made otherwise than f o r valuable consider- ation (except f o r c e r t a i n charitable covenants), but does include interest and annuities, payments f o r r o y a l t i e s , 1 kl patents and mining rents and r o y a l t i e s . It i s d i f f i c u l t to see why corporations only and 7 9 not individuals should get the benefit of these r i g h t s . On the other hand i t might be argued that individuals pay a reduced rate of tax on c a p i t a l gains and they might in any case be reluctant to use up losses derived from other income sources against this lower rate income. C. Exemptions Both systems provide exemptions for individuals, which are not available to corporations and t r u s t s . In Canada there are two relevant provisions. In the f i r s t place, section 3 9 ( 2 ) deducts from the aggregate c a p i t a l gains and losses f o r a year from disposing of foreign currency the sum of 200 d o l l a r s . This section i s expressed to apply to individuals, which c l e a r l y excludes corporations, but would appear to include trusts i n view of section 104(2), which provides that trusts are to be taxed as i f they were ind i v i d u a l s . In the second place, where an in d i v i d u a l ceases to be resident i n Canada, so that there i s a deemed disposal of his assets f o r proceeds equal to t h e i r market value under section 48, he i s only charged on c a p i t a l gains to the extent they exceed 5000 d o l l a r s . A corporation and 142 a trust i n a s i m i l a r s i t u a t i o n w i l l be deemed to dispose of a l l t h e i r property, but a l l their c a p i t a l gains w i l l be taken into a c c o u n t . ^ Otherwise, except i n one c a s e , . there are no 80 exemptions either f o r corporations or fo r individuals where only a small amount of gains are re a l i s e d i n a taxation year. In the U.K. there are two provisions which grant exemptions to individuals exclusively where small amounts are involved. Thus, by section 57 of the F.A. 1971, an indiv i d u a l i s not charged to Capital Gains Tax i f the aggregateaamount or value of.consideration received f o r a l l disposals of assets i n a year of assessment does not exceed f i v e hundred pounds, although any losses r e a l i s e d i n a year must be set off against any gains f o r that year, even i f no tax i s payable on them under this section. Further, by section 27(2) of the F.A. 1965, a gain accruing to an i n - dividual on a disposal by way of a g i f t of an asset, the market value of which does not exceed one hundred pounds, i s deemed not to be a chargeable gain, but there i s no exemption when the t o t a l value of several g i f t s made i n a year exceeds one hundred pounds. These two provisions are useful, i n that they avoid the administrative inconvenience and expense of c a l c u l a t i n g gains of small amount where only afsmall amount of tax would i n fact be payable. They are possibly a further legacy of the separate taxation of c a p i t a l gains and other income i n the case of in d i v i d u a l s . F i n a l l y , reference i s made to a U.K. exemption 81 for which there i s no Canadian equivalent. Although this applies to individuals only, i t i s obviously inappropriate fo r corporations and i s included here as an example of equality of treatment accorded to a taxpayer, whether he car r i e s on his business as an ind i v i d u a l proprietorship or through a c l o s e l y controlled corporation. By section 34 of the F.A. 19^5, where an i n d i v i d - ual who has attained the age of 60 years disposes of the whole or part of a business which he has owned for ten years, then any c a p i t a l gain i s reduced by the amount of 10,000 pounds i f he has attained the age of 65 years and this figure i s reduced by 2000 pounds f o r every year by which his age f a l l s below t h i s . This r e l i e f only applies to gains r e a l i s e d on assets used i n the business, which include good- 145 w i l l , but not investments. The r e l i e f also covers the si t u a t i o n where a taxpayer disposes of shares i n a family 146 trading company, where he has i n the l a s t ten years been l47 a f u l l lime working dire c t o r of the company. In this case, the part of the gain available f o r r e l i e f i s that proportion that the value of the assets used i n the company's 148 149 business bears to the value of a l l i t s assets. A disposal of shares caused by the l i q u i d a t i o n of the company i s also within the provision, except to the extent that i t s business assets are d i s t r i b u t e d i n specie. 1-* 0 The ten year requirement i s s a t i s f i e d i f f o r part of the period the 82 business was owned d i r e c t l y and f o r the balance by the family company.1^ 1 Thus the businessman's r e l i e f i s not affected, whether he c a r r i e s on business personally or through the medium of a company. D. Rates of Tax The d i f f e r i n g rates of tax payable by individuals and corporations are one of the most s i g n i f i c a n t factors i n considering the advantages or disadvantages of holding assets through a corporation. A taxpayer's conduct may be governed by whether the corporate rate i s greater or lesser than his personal rate. There are found i n both systems s i g n i f i c a n t variations i n the rates applied to individuals and the rates applied to corporations. Taking the Canadian system f i r s t , i t has already been noted that only half of any c a p i t a l gain or loss i s 152 included i n income. J The obvious effect of this i s that c a p i t a l gains are taxed at only half the rate that i s applied to other income. Moreover, the same rates are not payable by both individuals and corporations. The former pay pro- gressive r a t e s 1 ^ ranging from 17% on the f i r s t f i v e hundred do l l a r s of taxable income to "+7% on amounts above sixty thousand d o l l a r s for the year 1972 (the 17% figure being reduced gradually to 6% i n 1976) and, i n addition, a pro- v i n c i a l tax i n the region of 30%, ^ calculated as a percent- 83 age of the federal tax. The maximum personal rate w i l l 155 thus be i n the region of 6l%. On the other hand, corporations pay a f l a t rate of 50% 1^ 6 for 1972 which i s reduced by lO^. 1^ 7 of the corporation's taxable income earned i n a year i n a province(but not the North West T e r r i t o r i e s or 158 the Yukon T e r r i t o r i e s ) . This i s not the f i n a l story, however, as half of the tax paid by private corporations on taxable c a p i t a l gains and investment income i s refundable 159 when these amounts are di s t r i b u t e d . In the U.K., individuals also pay tax at a di f f e r e n t rate from that paid by corporations, but c a p i t a l gains are not, as i n Canada, subject to the progressive tax rates which apply to other income. They are charged to a f l a t rate of 3 0 % . l 6 ° Even sc^for the purposes of comparison i t w i l l be useful to outline b r i e f l y the progressive Income Tax system found i n the U.K. A l l income i s charged at a standard rate of 38 .75% 1 6 1 (30% f o r the year 1973 - 1974, when i t i s termed the"basic rate). 1** 2 In addition, i f the to t a l income of the indi v i d u a l exceeds a prescribed amount, a higher set l63 of Surtax (after 6th A p r i l 1973 simply termed "the higher rate or r a t e s " ) 1 ^ rates are applied and i f (after 6th A p r i l 1973) investment income exceeds a prescribed amount, there 165 i s an Investment Surcharge payable. The surtax rates 8k f o r 1972-3 (which are paid i n addition to the standard rate) have not been fixe d , but for 1971-2 they began at 10% on the f i r s t f i v e hundred pounds of the amount by which t o t a l income exceeds two thousand pounds and ended at 50% on t o t a l income i n excess of f i f t e e n thousand pounds,1**** and the higher rates of tax set f o r the year 1973-** begin at k0% on the f i r s t one thousand pounds of the amount by which t o t a l income exceeds f i v e thousand pounds and end at 167 75% of t o t a l income i n excess of twenty thousand pounds. The basic rate i s not payable when the higher rates are 1 go payable, but the Investment Surcharge, which i s fixed at 15% f o r the same year, i s payable i n addition to the 169 higher rates. Thus the maximum rate payable on invest-m ent income i n the year 1973-7^ w i l l be 90%. There i s one exception to the rule that c a p i t a l gains accruing to individuals are not brought within the progressive Income Tax system, although this i s more i n the way of r e l i e v i n g provision f o r low income taxpayers. Under section 21 of the F.A. 1965 an indi v i d u a l resident or or d i n a r i l y resident i n the U.K. can, i f the result would be a reduction i n tax payable on c a p i t a l gains, pay Income Tax and Surtax (or the higher rates and the Investment Surcharge f o r the year 1973-7**) on an amount equal to half the net c a p i t a l gains r e a l i s e d i n a year i f the to t a l amount 85 of such gains does not exceed f i v e thousand pounds and, i n any other case, on an amount equal to two thousand f i v e hundred pounds plus the excess of gains over f i v e thousand pounds. These amounts are treated as the highest part of income, but the individual can set off most personal 170 allowances against them(but not losses). The alte r n a t i v e rate i s not available i n connection with the disposal of an asset which the ind i v i d u a l acquired (otherwise than as a legatee) within the two years p r i o r to the disposal from a person who was connected with him.*''1 The result of this provision i s that an individual paying only standard or basic rate Income Tax w i l l pay i n year 1972-73 a rate of 19.375% on c a p i t a l gains and i n the year 1973-7^ a rate of 15%, but as the individual's income increases, so that he i s paying Surtax or the higher rate or rates and the Investment Surcharge, the advantages w i l l cease. However, i n no case w i l l the rate payable exceed 30%. U.K. corporations pay a standard rate of Corpor- 172 ation Tax on the i r "profits'*. This rate i s set by P a r l i a - ment for each f i n a n c i a l year (April 1st - March 31st) i n the Finance Act following such year1''-' and the rate set f o r 1971- 72171* i s 40%. As from A p r i l 1st 1973, as already mentioned, 1 7 5 a f r a c t i o n of c a p i t a l gains accruing to corporations w i l l not be included i n " p r o f i t s " f or Corporation Tax purposes. In view of the fact that the Government has announced i t s 86 intention to make this f r a c t i o n for the f i r s t year two- 176 f i f t h s and the corporate rate 50%, corporations w i l l pay an e f f e c t i v e rate of 30% on gains, i . e . the same as the standard rate for i n d i v i d u a l s . The position of individuals under both systems i s very similar, although this would not seem to be the case at f i r s t sight. Whereas i n Canada half of any c a p i t a l gain i s included i n income subject to progressive rates of tax, giving an ef f e c t i v e maximum rate of 30-1%, the same result i s achieved i n the U.K. by virtue of a maximum rate of 30% coupled with the alternative basis, which allows the application of progressive rates up to the maximum rate. On the other hand, the taxation of corporate gains i s more generous i n Canada, though less so a f t e r 1st A p r i l 1973* Several consequences flow from the d i f f e r i n g rates payable by corporations and individuals on the one hand and from the d i f f e r i n g rates payable by both corpor- ations and individuals i n respect of c a p i t a l gains and other income on the other hand. In regard to the former, whether an in d i v i d u a l w i l l transfer an asset to a corporation w i l l to some extent depend on whether the corporate tax rate exceeds his own. If i t i s higher, i t may be advisable to hold assets outside a corporation, but i f i t i s lower, the 177 opposite i s true. However, the answer to this question 87 cannot depend solely on d i f f e r i n g rates payable. It may be desired to d i s t r i b u t e to shareholders c a p i t a l gains r e a l i s e d by the corporation, i n which case the tax treat- ment of corporate d i s t r i b u t i o n s w i l l have to be consider- ed. The tax, treatment of a d i s t r i b u t i o n may n u l l i f y the benefit gained from a low corporate r a t e . 1 7 8 Regarding the d i f f e r i n g rates referable to c a p i t a l gains and other income found i n both systems, there iss an obvious inducement f o r taxpayers to have the i r receipts treated as c a p i t a l gains as opposed to ordinary income. This i s more f u l l y discussed i n the relevant chap** t e r s . 1 7 9 However, the general effect i s that shareholders may aim to r e a l i s e corporate surpluses as c a p i t a l gains, e.g. by means of a c a p i t a l d i s t r i b u t i o n from the company or by disposing of shares i n the market, instead of receiv- ing dividends from the corporation, which are taxable as ordinary income. On the whole, non-resident?taxpayers pay the same rates of tax as residents, so the general p o s i t i o n outlined above i s equally applicable. However, there are some d i f f e r - ences. The limited nature of the l i a b i l i t y of non-resident taxpayers to pay tax on c a p i t a l gains and the confinement of the U.K. a l t e r n a t i v e rate of tax to resident individuals has already been mentioned, but there i s , i n addition, a 88 18 0 Canadian provision which imposes an extra tax of 25% on every corporation (other than one that was throughout v 181 the year a Canadian corporation) that c a r r i e s on bus- 182 iness i n Canada i n respect of i t s taxable income or taxable income earned i n Canada, as the case may be. The purpose of this tax i s to equalise the pos i t i o n of non- resident companies which carry on business i n Canada through branches or agencies with that of those companies which 184 have incorporated Canadian subsidiary companies. Whereas 185 the non-resident withholding tax Is paid i n respect of di s t r i b u t i o n s made by such subsidiaries, i t i s not paid on remittances of p r o f i t s by a Canadian branch o f f i c e to i t s owners. Thus the additional rate of tax i s made to equal 186 that of the non-resident withholding tax and cer t a i n ded- uctions are allowed from the taxable amount, so that the actual sum taxed approximates the income that would be earned by a subsidiary and dis t r i b u t e d by i t to the parent. 1 In p a r t i c u l a r , any corporation which i s a non-resident throughout the year can deduct the amount of any taxable c a p i t a l gains a r i s i n g from dispositions of taxable Canadian 188 property which are not used i n carrying on the business. The application of the section to a l l non-Canadian corporations means that not just non-resident corporations, 189 but a few resident corporations, w i l l be paying the tax. 89 F u r t h e r , s u c h companies w i l l pay t h e tax on a l l t h e c a p i t a l g a i n s f o r w h i c h t h e y a r e l i a b l e , n o t m e r e l y t h o s e 190 a r i s i n g on a s s e t s u s e d i n t h e i r b u s i n e s s . T h i s seems somewhat anomalous i n view o f t h e p u r p o s e o f t h e s e c t i o n . 9b Part 4 - Par t i c u l a r Corporate Dispositions As a general rule, the same events w i l l con- s t i t u t e disposals or dispositions and the effect of such disposals or dispositions w i l l be the same for the purpose of taxing c a p i t a l gains, whether a corporation or an indiv- idual i s involved. However, i n two areas special rules must be considered which arise from the special nature of corporations. In the f i r s t place, there i s the effect of corporations issuing and dealing i n t h e i r own shares or sec u r i t i e s and, i n the second place, the effect of a d i s - posal of assets by a corporation to a person or corporation to which i t i s c l o s e l y related, whether by virtue of control, shareholdings, being the member of the same group of com- panies or otherwise. In regard to the l a t t e r , i t i s necessary to return to remarks i n the introduction to chapter one concerning the necessity f o r the Law to consider the dual aspect of the separate legal personality of a corporation as against i t s shareholders and the possible close connection between them, with r e s u l t i n g necessity for anti-avoidance provis- ions and tax r e l i e v i n g provisions. The same factors are important here. The closeness of the corporation to i t s members or other persons with which i t i s cl o s e l y related gives opportunity to avoid tax by disposing of assets at excessive or low consideration or by manipulating the timing 91 of disposals. On the other hand, the disposal may be to another corporation which i s controlled by the same persons as control the transferor, so that there i s no real change i n ownership of the assets. There i s no need to consider the general rules applicable which are the same as described i n chapter one, but i t i s necessary to consider the special anti-avoidance and r e l i e v i n g provisions r e l a t i n g to corporate disposals. A. Dealings by a corporation with i t s own shares The nature of a share issue, from a tax point of view, depends to a large extent on the point of view taken of the nature of a corporation. Looking at the corporation as a separate legal entity from i t s shareholders, one would perhaps say that the issue of shares i s a disposal of assets i n return f o r a c a p i t a l sum and that this sum i s taxable as a c a p i t a l gain. On the other hand, i f the corpor- ation i s considered as a form through which individuals can make jo i n t investments, then the share i s no more than a receipt or acknowledgement by the corporation of the share- holder's investment i n i t and i s not an asset of the corpor- ation which i t can acquire and dispose of just l i k e i t s 191 business assets. In practice, the l a t t e r view has been adopted i n the Canadian and U.K. systems. This i s provided f o r i n Canada by section 5 ^ ( c ) ( v i ) - ( v i i ) of the Act, which 92 defines the term "d i s p o s i t i o n " so as to exclude the issue by a corporation of any bond, debenture, share or s i m i l a r i n t e r e s t i n a corporation. Although there i s no such express statutory provision i n the U.K., i t i s generally recognized that the issue of shares does not give r i s e to a 192 disposal of them. Apart from the theoretical consider- ations, i n practice, i t would seem to be c l e a r l y undesirable to have the f u l l amounts received by a corporation on an 193 issue of shares taxed i n i t s hands as a c a p i t a l gain;*- The position i s less c l e a r , when i t comes to the a c q u i s i t i o n and reissue by a corporation of i t s own shares. There i s l i t t l e problem i n the U.K., as the a c q u i s i t i o n by a corporation of i t s own shares i s i l l e g a l and u l t r a v i r e s , but, i n Canada, the question i s a s i g n i f i c a n t one, as the trend appears to be f o r Corporation Statutes to give this 194 power to corporations incorporated under them. ^ As w i l l 195 be shown i n the next chapter, a corporation w i l l not be able to use this power to d i s t r i b u t e i t s accumulated surpluses i n the form of the purchase price of shares, on which the shareholders pay tax at c a p i t a l gains rates only. This i s the result of section 84 of the Act which deems a l l the a c q u i s i t i o n price to be a dividend i n the shareholder's hands, except i n so f a r as i t constitutes a return of paid up c a p i t a l and except when the a c q u i s i t i o n i s i n the open market, when section 181 of the Act imposes a special tax on the corporation i n respect of the same amount. However, i f the corporation's own shares are transferred to i t i n consideration of property sold by the corporation to the shareholder or i n settlement of obligations or debts owed by the shareholder to the corporation, the question also a r i s e s , as to whether a receipt by the corporation of an amount comprising i t s own shares w i l l be treated i n the same way as a receipt of cash or other property. It i s submitted that this i s the case. Not only i s there no statutory provision excluding such consideration from the computation of c a p i t a l gains or income accruing to the corporation, but the exclusion of such amounts would open up opportunities f o r tax avoidance. Further, i t does not appear that the same arguments which j u s t i f y an issue of shares not being a d i s p o s i t i o n would be applicable here. The corporation i s receiving a valuable asset which i t can r e a l i s e by r e i s s u - ing. Thus the sale by a corporation of property to a share- holder i n return for some of i t s own shares would, i f the parties were dealing at arms length, re s u l t i n a d i s p o s i t i o n of that property f o r proceeds of d i s p o s i t i o n equal to the 196 value of those shares. It seems cle a r that an a c q u i s i t i o n of i t s own shares by a corporation w i l l cause a d i s p o s i t i o n of those shares by the shareholder. 1^ 7 The same arguments which were used to j u s t i f y not treating as a d i s p o s i t i o n of property an issue of shares by a corporation might also be used to j u s t i f y the same treatment of a reissue of shares previously acquired by the corporation from i t s own members. However, the argument would be somewhat weaker, p a r t i c u l a r l y i n the case where the corporation makes a habit of dealing i n i t s own shares. The shares have bieen issued once and are acquired as an asset with value at a d e f i n i t e cost, so that the c a p i t a l gain accruing during the corporation's holding of the share can be measured. However, i t would seem that the same section of 199 the Canadian Act, which prevented an i n i t i a l issue of shares being a d i s p o s i t i o n would also apply to a reissue of i t s own shares. The section not only expressly excludes from the meaning of d i s p o s i t i o n an issue of shares, but "any other transaction that, but f o r this subparagraph, would be a d i s - p o s i t i o n by a corporation of a share i n i t s c a p i t a l stock". F i n a l l y , there i s the question of the a c q u i s i t i o n cost to the shareholder of shares issued to him by the cor- poration. This w i l l be governed by the rules discussed i n the f i r s t chapter. Thus the a c q u i s i t i o n cost w i l l be the 200 actual cost to the shareholder of acquiring the shares, unless the corporation does not deal with him at arms length, 2 or the special provisions apply which allow a taxpayer to transfer assets to a corporation without being taxed on any c a p i t a l gains accrued to those a s s e t s . 2 0 2 Even where the parties do not deal at arms length, as has already been noted, i t may be that section 22(4) of the F.A. 1965 does not apply to determine the a c q u i s i t i o n cost to a shareholder of shares issuedvto him by a corporation, i n view of the fact that the section appears to require that the asset i n question be both disposed of and acquired and i t would appear that the shares have not been disposed of by the corporation 2 03 when i t issues them. Special rules apply where shares are issued i n the course of a reorganization, amalgamation or reconstruction 206 204 of a company and where shares are issued as bonus or rights issues (in the U.K.J20-* or stock dividends (in Canada)' B. Disposals or'dispositions to associated persons As mentioned i n the introduction to this part of this chapter, there are two types of provisions which w i l l be considered i n order - anti-avoidance and r e l i e v i n g provisions. 1) Anti-avoidance provisions There must here be distinguished two types of a n t i - avoidance provisions. There are the rules already discussed i n chapter one, which apply equally to disposals by corpor- ations and there are special rules r e l a t i n g to disposals to shareholders. a) General provisions As noted above, section 69 of the Canadian Act and s e c t i o n 2 2 ( 4 ) of the U.K. Act apply e q u a l l y to d i s p o s a l s by c o r p o r a t i o n s as they do to d i s p o s a l s by i n d i v i d u a l s . However, i n regard to d i s p o s a l s by corporations there must be con- s i d e r e d f u r t h e r the s t a t u t o r y d e f i n i t i o n of " r e l a t e d person" and "connected person". Both s e c t i o n 251 of the Canadian Act and paragraph 21 schedule 7 of the F.A. 1965 d e f i n e circum- stances when two corporations are " r e l a t e d " or "connected" to each other. Generally t h i s w i l l be where the corporations are c o n t r o l l e d by the same persons or by persons who are them- selves " r e l a t e d " or "connected". Otherwise, a c o r p o r a t i o n i s " r e l a t e d " or "connected" to a c o r p o r a t i o n or an i n d i v i d u a l i n the same circumstances that an i n d i v i d u a l would be "connected" 2 or " r e l a t e d " to a corporation, e.g. i f one c o n t r o l s the other. The Canadian and U.K. r e s t r i c t i o n s on losses con- tained i n s e c t i o n 8 5 ( 4 ) of the Canadian Act and paragraph 17 2 schedule 7 F.A. 1965 a l s o apply to d i s p o s a l s by c o r p o r a t i o n s . In a d d i t i o n , i n Canada, by s e c t i o n 4 0 ( 2)(e) a c a p i t a l l o s s i s deemed to be n i l i f i t r e s u l t s from a d i s p o s i t i o n of property by a c o r p o r a t i o n to a person c o n t r o l l i n g i t or to a corpor- a t i o n c o n t r o l l e d by the same person as c o n t r o l s i t . This sub- s e c t i o n i s somewhat harsher than s e c t i o n 8 5 ( 4 ) , i n that at l e a s t under the l a t t e r subsection there i s some compensating r e l i e f from the adjustment of the cost base of the shares. This enactment of s e c t i o n 40 ( 2)(e) b r i n g s the Canadian r u l e s roughly i n t o l i n e w i t h the U.K. r u l e s , as paragraph 17 already covers the s i t u a t i o n covered by t h i s s u b s e c t i o n . On the other hand, the U.K. p r o v i s i o n does not completely n u l l i f y the l o s s as does the Canadian p r o v i s i o n . b) P r o v i s i o n s a f f e c t i n g d i s p o s i t i o n s to shareholders Both systems have p r o v i s i o n s s p e c i f i c a l l y d i r e c t e d at d i s p o s i t i o n s to s h a r e h o l d e r s , which determine the proceeds of d i s p o s i t i o n of the c o r p o r a t i o n and the a c q u i s i t i o n c o s t of the a s s e t s d i s p o s e d of to the s h a r e h o l d e r . Where the c o r p o r a t i o n d i s t r i b u t e s p r o p e r t y to a shareholder as a d i v i d e n d i n k i n d , i t i s deemed to dispose of that p r o p e r t y f o r proceeds equal to market valu e , by v i r t u e of s e c t i o n 52(1) of the Canadian A c t , which amount i s deemed to form the shareholders a c q u i s i t i o n c o s t . In any other case, where p r o p e r t y of a c o r p o r a t i o n has been a p p r o p r i a t e d i n any manner whatever f o r the b e n e f i t of a shareholder, e i t h e r f o r no c o n s i d e r a t i o n or f o r c o n s i d - e r a t i o n l e s s than market valu e , then, by s e c t i o n 69(k) of the Act, i f the s a l e of that p r o p e r t y at f a i r market value would have i n c r e a s e d the c o r p o r a t i o n ' s income f o r the year, f o r the purposes of determining the c o r p o r a t i o n s income f o r the year, i t s h a l l be deemed to have s o l d the p r o p e r t y f o r i t s f a i r market v a l u e . S e c t i o n 69(5) of the Act a p p l i e s an i d e n t i c a l 98 provision to appropriations made by the corporation on i t s winding up, save that i t applies even where the share- holder!; has given f u l l consideration. There i s no l i m i t i n either section 52(1) or i n sections 69(4)-(5) as to the type of property to which they apply. Several questions a r i s e i n connection with the provisions of sections 69(k)-(5) which to some extent are derived from the fact that they are a di r e c t transposition from the old act to the new act of provisions which were directed at preventing a corporation avoiding r e a l i s i n g income on a disposal of i t s trading stock, by disposing i t to shareholders outside the ordinary course of business to r e a l i s e a c a p i t a l gain. In the f i r s t place, section 69(h) does not apply where i t receives consideration equal to or more than the market value of property appropriated. In this s i t u a t i o n , presumably, the proceeds of d i s p o s i t i o n of the corporation w i l l be the actual proceeds received and the actual cost to 211 the shareholder w i l l form his a c q u i s i t i o n cost. The con- tinued a p p l i c a t i o n of section 69(5), in: spite of such consid- eration being given by the shareholder, prevents the corpora- t i o n arguing that the cancella t i o n of the member's shares i s f u l l consideration for the property d i s t r i b u t e d . 99 I n the second p l a c e , they do not o p e r a t e when the s a l e would d e c r e a s e the c o r p o r a t i o n ' s income, i . e . produce a l o s s . When c o n s i d e r i n g whether the s a l e o f a c o r p o r a t i o n ' s p r o p e r t y a p p r o p r i a t e d t t o s h a r e h o l d e r s . on a winding up would d e c r e a s e o r i n c r e a s e the c o r p o r a t e income, one commentator 212 has suggested t h a t the s e c t i o n i s ambiguous as to whether you s h o u l d l o o k a t each i t e m o f p r o p e r t y i n t u r n or c o n s i d e r the whole of the c o r p o r a t i o n ' s p r o p e r t y w h i c h i s caught by the s e c t i o n ( i . e . to see i f t h e r e i s an o v e r a l l net g a i n or l o s s ) and t h a t the l a t t e r a l t e r n a t i v e i s p r e f e r r e d as b e i n g f a i r e r t o the company. I t would seem t h a t t h i s can o n l y be t r u e i n so f a r as i t r e f e r s to a l l the c o r p o r a t i o n ' s p r o p e r t y d i s t r i b u t e d t o each s h a r e h o l d e r , as the s e c t i o n uses the words " p r o p e r t y ... a p p r o p r i a t e d ... to .. a .. s h a r e h o l d e r " . I f the s e c t i o n does not a p p l y because the s a l e of the a s s e t s i n q u e s t i o n would produce a l o s s , t h e r e w i l l be a d i s p o s i t i o n o f those a s s e t s under normal r u l e s f o r the a c t u a l proceeds r e c e i v e d , u n l e s s the p a r t i e s do not d e a l a t arms l e n g t h , when s e c t i o n 69(1) w i l l a p p l y . Moreover the l o s s may be d i s a l l o w e d under s e c t i o n 4 o ( 2 ) ( e ) . 2 1 3 I n the t h i r d p l a c e , even where s e c t i o n s 69(4) and 69(5) do a p p l y they do not d e t e r m i n e the a c q u i s i t i o n c o s t t o the r e c i p i e n t . Thus t h i s c o s t w i l l be the a c t u a l c o n s i d e r a t i o n g i v e n , u n l e s s the d i s p o s i t i o n amounts to a g i f t , when s e c t i o n 69(1)(c) w i l l deem the a c q u i s i t i o n c o s t to be e q u a l 100 2 l k to the f a i r market value of the property received. It would seem reasonable that the acquisition cost to share- holders of property appropriated to them in a winding up would be the value of the property which they give up to receive such property, i.e. the value of their shares in the corporation which are cancelled in the winding up. However, there is some doubt as to whether this is the correct position in view of the position taken by the Revenue Author- i t i e s undertthe old Act that depreciable property received by shareholders in the same circumstances had an acquisition cost 215 to them of n i l . To the extent that the amount distributed 216 constitutes a deemed dividend, under section 8 k of the Act, there is no problem, since, by reason of section 5 2 ( 1 ) of the Act, where a taxpayer has acquired property and an amount in respect of its value has been included in computing fois income, that amount is added to the cost base of that property. However, this leaves open the question of the acquisition cost of property received which is not a deemed dividend, but 217 a return of paid up capital. Lastly, there is the problem concerning the inter- relation of section 52(2) and section 6 9 ( 5 ) . The general effect of section 8 k of the Act is that, on a winding up of the corporation, a l l payments made to shareholders are deemed to be dividends, except in so far as they merely return sub- 218 scribed capital. If these deemed dividends consist of 101 distributions in kind, do they constitute dividends in kind within the meaning of section $Z ( 2 f l ? 2 1 9 This would be of advantage to the shareholders, in that i t would give them an acquisition cost equal to market value and to the company in that i t would allow i t to realise losses, but i t would leave l i t t l e scope for the operation of section 6 9 ( 5 ) . It has been suggested by one commentator that section 52(2) only applies to dividends paid in the ordinary course of the corporation's business and that section 69(5) applies to distributions made on a winding up by virtue of the rule of statatory inter- pretation that a particular enactment w i l l overrule a general 220 enactment. However, the matter is not free from doubt, as on the clear words of section 8k and section 52, there seems no reason why the dividend deemed by section 8k should not be considered dividend in kind within the meaning of section 52. The way to avoid the d i f f i c u l t i e s surrounding sections 69(4) and 69(5) is to dispose of the assets in question prior to the winding up to the shareholders for pro- ceeds equal tothe f a i r market value of the assets. This w i l l ensure that the shareholders receive a cost base in the assets equal to f a i r market value and that the corporation w i l l realize any l o s s e s . 2 2 1 In the U.K., there is no distinction drawn between dividends in kind and other distributions made to shareholders. 1 0 2 S e c t i o n 22(k)(a) of the F.A. 1 9 6 5 , which has a l r e a d y been r e f e r r e d to i n co n n e c t i o n w i t h non arms l e n g t h d i s p o s i t i o n s , a l s o makes express p r o v i s i o n f o r d i s p o s i t i o n s by c o r p o r a t i o n s to s h a r e h o l d e r s . I t deems a person's a c q u i s i t i o n of an a s s e t and the d i s p o s a l of i t to him to be f o r proceeds equal to market value of the a s s e t "where he a c q u i r e s the a s s e t otherwise than by way of a b a r g a i n a t arms l e n g t h and i n p a r t i c u l a r where he a c q u i r e s i t by way of g i f t or by way of d i s t r i b u t i o n from a company i n r e s p e c t of shares i n the c ompa ny." There are s e v e r a l p o i n t s to be made i n connec t i o n w i t h t h i s s e c t i o n and f o r purposes of comparison w i t h the Canadian p r o v i s i o n s . In the f i r s t p l a c e , there are none of the d i f f i c - u l t i e s found i n co n n e c t i o n w i t h the Canadian p r o v i s i o n s as to the shareholder's a c q u i s i t i o n c o s t and where the d i s p o s a l of the p r o p e r t y f o r proceeds equal to market value would produce a l o s s , although such l o s s c o u l d be d i s a l l o w e d under the p r o v i s i o n s d i s c u s s e d a t the begi n n i n g of t h i s s e c t i o n . In the second p l a c e , the s e c t i o n a p p l i e s to d i s - t r i b u t i o n s . S e c t i o n 233 I.C.T.A. 1 9 7 0 2 2 2 sets out an ex t e n s i v e d e f i n i t i o n of the term " d i s t r i b u t i o n " f o r the purpose of Income and C o r p o r a t i o n Tax, but there i s no 103 s e c t i o n w h i c h a p p l i e s s e c t i o n 233 f o r the purposes o f s e c t i o n 22, so t h a t the term must be g i v e n i t s normal meaning* T h i s i s i m p o r t a n t because a l t h o u g h the d e f i n i t i o n i n s e c t i o n 233 i s wide enough t o c o v e r almost any d i s p o s a l o f p r o p e r t y t o s h a r e h o l d e r s , i t s p e c i f i c a l l y e x c l u d e s d d i s t r i b u t i o n s made on a w i n d i n g up. Thus the s e c t i o n w i l l a p p l y b o t h w h i l e the company i s a g o i n g c o n c e r n and when i t i s b e i n g wound up and i t would seem t h a t the term " d i s t r i b u t i o n " i s wide enough to c o v e r b o t h d i v i d e n d s i n k i n d and a p p r o p r i a t i o n s o f a s s e t s to i n d i v i d u a l s h a r e h o l d e r s . Moreover, not o n l y do the U.K. p r o v i s i o n s p r e v e n t the c o r p o r a t i o n a v o i d i n g tax by t r a n s f e r r i n g a s s e t s i n a r t i f i c i a l t r a n s a c t i o n s t o t h e i r members, but they p r e v e n t 223 c l o s e companies a s s i s t i n g t h e i r s h a r e h o l d e r s to reduce p o t e n t i a l g a i n s on t h e i r s h a r e s by t r a n s f e r r i n g a s s e t s to them a t a low c o n s i d e r a t i o n . Thus, by p a r a . 18 sched. 7 F.A. 1965, i f a c l o s e company t r a n s f e r s a s s e t s to any p e r s o n by way of b a r g a i n not made a t arms l e n g t h and f o r c o n s i d e r a t i o n l e s s t han the market v a l u e o f those a s s e t s , t h e d i f f e r e n c e between those two amounts i s a p p o r t i o n e d among a l l the s h a r e s h e l d i n the company and the amount a p p o r t i o n e d t o each share goes t o reduce i t s c o s t t o i t s h o l d e r . A l t h o u g h , on the f a c e o f i t , t h i s p r o v i s i o n c o n t i n u e s t o a p p l y when the amount a p p o r t i o n e d 224 i s t a x e d as p a r t o f i t s r e c i p i e n t ' s income, the Revenue have i n d i c a t e d t h a t they w i l l not e n f o r c e i t i n such a 10 4 s i t u a t i o n . 2 2 ^ I t thus appears t h a t the p r o v i s i o n w i l l not haveca wide scope o f o p e r a t i o n , i n view o f the v e r y compre- h e n s i v e p r o v i s i o n s i n c l u d i n g c o r p o r a t e d i s t r i b u t i o n s i n s h a r e - h o l d e r s ? income. i i ) Tax R e l i e v i n g P r o v i s i o n s Here a r e c o n s i d e r e d v a r i o u s p r o v i s i o n s w h i c h have e f f e c t when a c o r p o r a t i o n t r a n s f e r s a s s e t s t o a n o t h e r c o r p o r - a t i o n w i t h the r e s u l t t h a t t h e r e i s no change i n the under- l y i n g b e n e f i c i a l o wnership of tho s e a s s e t s , except f o r a change i n the l e g a l form o f t h e h h o l d i n g . I n s o t h e r words, they a p p l y where the t r a n s f e r e e c o r p o r a t i o n i s c o n t r o l l e d d i r e c t l y o r i n d i r e c t l y ( i . e . t h r o u g h o t h e r c o r p o r a t i o n s ) by the same s h a r e h o l d e r s as c o n t r o l the t r a n s f e r o r c o r p o r a t i o n . The t r a n s f e r o f a s s e t s may a l s o i n v o l v e , i n connec- t i o n w i t h the r e o r g a n i z a t i o n of one o r more c o r p o r a t i o n s , an exchange by s h a r e h o l d e r s o f t h e i r s h a r e s f o r s h a r e s i n the new company o r an e x t i n g u i s h i n g o f th o s e s h a r e s consequent upon the l i q u i d a t i o n o f the company. The p r o v i s i o n s w h i c h a l l o w a t a x f r e e t r a n s f e r o f a s s e t s t o a n o t h e r c o r p o r a t i o n i n such s i t u a t i o n s w i l l be d i s c u s s e d i n c h a p t e r f i v e . Of the two s e t s o f p r o v i s i o n s now t o be d i s c u s s e d n e i t h e r has an e x a c t e q u i v a l e n t i n the Canadian A c t , so t h a t i n b o t h c a s e s the U.K. p o s i t i o n w i l l be s e t out and be 1055 followed by a discussion of to what extent ( i f any) Canadian Law provides r e l i e f i n the same si t u a t i o n . F i r s t w i l l be set out the provisions which permit corporations to transfer assets to corporations within the same group of companies at no tax cost and then the rules which permit a tax free trans- f e r of foreign business assets to foreign corporations. (a) Inter Group Transfers Having considered the anti-avoidance provisions in this and the previous chapter, i t can be seen that a dispos- i t i o n by a company to a company which i t controls, which controls i t , or which i s controlled by another company, which also (whether d i r e c t l y or i n d i r e c t l y ) controls i t , w i l l not only generally result i n the proceeds of sale being deemed to equal the market value of the asset disposed of, but there w i l l be some sort of l i m i t a t i o n on the d e d u c t i b i l i t y of losses i n - curred. On the other hand, where there i s a group of two or more companies which i s under the control of one parent cor- poration, i t i s also clear that a transfer between the members of the group i s not a d i s p o s i t i o n where there i s a real change in ownership of the assets transferred. Rather the whole group should be likened to one large corporation which i s a l l o c a t i n g and r e a l l o c a t i n g assets between i t s various branches. Thus, U.K. law treats groups of resident companies as one entity and ignores transfers between group members, 106 so t h a t the a c q u i s i t i o n c o s t o f the member who a c t u a l l y a c q u i r e s an a s s e t from an o u t s i d e r forms the a c q u i s i t i o n c o s t o f the whole group and i n p a r t i c u l a r f o r the group member who f i n a l l y d i s p o s e s o f the a s s e t t o an o u t s i d e r * F i r s t must be c o n s i d e r e d the d e f i n i t i o n o f a "group o f companies" f o r the purpose o f t h e s e p r o v i s i o n s . 2 2 6 A p r e c i s e d e f i n i t i o n i s s e t out i n the I.C.T.A. 1 9 7 0 , b u t the g e n e r a l e f f e c t i s t h a t a "group o f companies" c o m p r i s e s a p r i n c i p a l company and any company o r companies i n w h i c h i t h o l d s , as b e n e f i c i a l owner d i r e c t l y o r i n d i r e c t l y , 227 228 l y , 75% o f the i s s u e d s h are c a p i t a l and i f a p r i n c i p a l company i s i t s e l f a member of a group under the above d e f - 229 i n i t i o n , then i t s own s u b s i d i a r i e s a r e a l s o members o f 230 t h a t group. J Thus the same pe r s o n s w i l l u l t i m a t e l y c o n t r o l t h r o u g h the p r i n c i p a l c o r p o r a t i o n o f each group a t l e a s t 75% 231 o f the i s s u e d s h are c a p i t a l o f a l l i t s s u b s i d i a r i e s . S e c t i o n 2 7 3 ( 1 ) o f the I.C.T.A. 1970 p r o v i d e s t h a t i f a member o f a group d i s p o s e s o f a s s e t s t o a n o t h e r member of the same group, the a s s e t i s deemed t o be d i s p o s e d o f f o r p roceeds o f such amount as w i l l g i v e r i s e t o n e i t h e r a c a p i t a l g a i n o r l o s s . The a c q u i r e r t a k e s over the d i s - poser's a c q u i s i t i o n d a t e when the a s s e t was a c q u i r e d p r i o r 232 to the 6 t h A p r i l 1965* C e r t a i n t r a n s a c t i o n s a r e excepted from the above r u l e , w h i c h a r e as f o l l o w s 1 107 (a) Transactions Involving trading stock. The effect of such a transaction depends on whether the asset i s trading stock i n the hands of both the acquiring and disposing company or i s a c a p i t a l asset i n the hands of one and trading stock i n the hands of the other. In the former case, the rule has 233 no application and, i n the l a t t e r case, the act lays down special rules which, as a rule, result i n the asset being deemed to be disposed of f o r proceeds equal to market value and acquired at a cost equal to this amount. 2^ (b) The disposal of a debt by one group member which i s 235 effected by s a t i s f y i n g the debt or any part of i t . It should be noted that generally a disposaloofaaddebt by the o r i g i n a l c r e d i t o r w i l l not give r i s e to a chargeable gain or allowable loss, 2"**' but this does not apply to any "debt on 23 7 a security", which i s defined to include loan stock (whether secured or unsecured) of any company. Thus the redemption of debentures of one group member held by another group member may give r i s e to a c a p i t a l gain or lo s s . (c) The disposal of redeemable shares on the occasion 238 of t h e i r redemption. (d) The disposal of shares r e s u l t i n g from a "c a p i t a l 239 d i s t r i b u t i o n " made by one group member to another. The general p r i n c i p l e behind these exceptions i s that the rule 108 i n s e c t i o n 273 s h o u l d o n l y a p p l y where t h e r e i s an a c t u a l p h y s i c a l t r a n s f e r o f non t r a d i n g a s s e t s and not where the d i s p o s a l i n q u e s t i o n i s a d i s p o s a l o f s h a r e s o r d ebentures by t h e i r h o l d e r when the company makes a r e t u r n o f c a p i t a l . However, i n s p i t e o f the f a c t t h a t the above e x c e p t i o n s p r e c l u d e the d i s p o s e r s o f s h a r e s o r d e b e n t u r e s from o b t a i n i n g the d e f e r r a l o f a c a p i t a l g a i n , i t i s not c l e a r whether they a l s o p r e c l u d e the c o r p o r a t i o n r e t u r n i n g c a p i t a l from d o i n g s o , i f t h a t r e t u r n o f c a p i t a l i s by way o f a t r a n s f e r 240 o f a s s e t s i n s p e c i e . R e f e r e n c e has a l r e a d y been made t o s e c t i o n 33 o f 2 4 l the F.A. 1 9 6 5 , w h i c h p e r m i t s any t a x p a y e r to d e f e r a c a p i t a l g a i n a r i s i n g on the d i s p o s a l o f an a s s e t used i n a b u s i n e s s , i f the proceeds a r e used t o a c q u i r e a new a s s e t t o 242 be used i n the b u s i n e s s . S e c t i o n 276 o f the I.C.T.A. 1970 p r o v i d e s t h a t f o r the purposes of t h i s r u l e " a l l the t r a d e s c a r r i e d on by members o f a group of companies s h a l l be t r e a t e d as a s i n g l e t r a d e " . The r e s u l t o f t h i s i s t o t r e a t a l l the members o f a group as one e n t i t y f o r the purposes o f t h i s r u l e , so t h a t i t w i l l a p p l y where one member d i s p o s e s o f an a s s e t , b u t a d i f f e r e n t member of the group a c q u i r e s the new a s s e t and the c o n d i t i o n t h a t the a s s e t s be used i n the b u s i n e s s o f the t a x p a y e r i s s a t i s f i e d i f the a s s e t s a r e 2 43 used i n any b u s i n e s s c a r r i e d on by any group member. 109 The above rules, which allow the tax free trans- fer of assets between group members, were open to abuse by corporations for tax avoidance purposes, with the result that various anti-avoidance provisions have been enacted, which are recounted below. (i) Assets held by a company leaving a group. As above mentioned, a charge to corporation tax may arise when an asset is disposed of outside the group. To avoid this, i t was easy to transfer the asset to be sold outside the group to a company within the group specially formed for this purpose and then to s e l l the shares in this company to an outsider. This procedure is met by section 278, which deems the company whose shares are sold outside the group to have disposed of and reacquired any asset, which i t acquired within the last six years from a fellow group member, at the date of actual acquisition for proceeds equal to market value at that date. The section also applies when the company leaving the group owns an asset, to which a char- geable gain has been carried forward on a replacement of a business asset under section 33 of the F.A. 1 9 6 5 . ^ ^ The section does not apply in three situations in which there can be no tax avoidance intention. These are as follows t 110 (a) When the asset was acquired from another group member, which leavestthe group at the same time, and the two 2 4 5 companies themselves form a group. (b) Where the corporation leaves the group as a result of being wound up or as a resu l t of some other company being 246 wound up* (c) By section 278 A, where the companylleaves the group as the result of a p a r t i c u l a r type of merger, effected by exchanging shares or debentures i n the company f o r shares or debentures i n a company outside the group. ( i i ) Shares i n a subsidiary leaving the group Section 279 was enacted to avoid a s p e c i f i c s i t u a t i o n , which arises when a corporation owns shares i n a subsidiary which have appreciated i n value. To r e a l i s e this gain tax free, i t was possible to incorporate a company out- side the group and then to dispose of the shares i n the sub- s i d i a r y to this company i n return f o r an issue of shares. This couldbbe done at no tax cost to the parent company be- 2 47 cause of para* 6 sched. 7 of the F.A. 1965 and the new company received the shares at market value, so that i t could dispose of them at no tax cost. This i s avoided by deeming the parent company to have disposed of and reacquired the o r i g i n a l shares i n i t s subsidiary f o r proceeds of sale equal 248 to t h e i r market value just before the reorganization. i n ( i i i ) Depreciatory transactions It has been seen that, by virtue of section 2 7 3 , assets can be transferred from one group member to another without any c a p i t a l gain being r e a l i s e d . As i t stands, this would allow group members to s t r i p a subsidiary member of i t s assets at no tax cost and then to dispose of the shares held by the group members and r e a l i z e a c a p i t a l l o s s . To counter t h i s , section 280 of the I.C.T.A. 1970 provides that any loss r e s u l t i n g from the disposal by one group member of shares or se c u r i t i e s i n another group member must be reduced by the amount that appears to the Inspector of Taxes to be just and reasonable having regard to any "depreciatory transactions". The l a t t e r term i s defined as "any disposal of assets at other than market value by one member of a group of companies to another" or any other transaction to which at leastttwo group members were parties, one of whom must be the company whose shares are disposed of at a lo s s . * In assessing the amount by which the loss i s to be reduced, the Inspector must make the decision on the footing that the loss should not r e f l e c t arreduction i n the value of the company's assets caused by a "depreciatory transaction", i n so f a r as the transaction increased the assets value of any other 250 member. On the other hand, on a disposal of shares or se c u r i t i e s of any other company which was a party to a depreciatory transaction by reference to which a loss 112 reduction was made.wwithin six years of such transaction. the Inspector must reduce any gain by such amount as seems just and reasonable having regard to the effect of the trans- 251 action on those shares of s e c u r i t i e s . Thus the section, i n e f f e c t , prevents the d e f e r r a l of tax on accrued gains on corporate assets. Turning to the Canadian system i n our search f o r tax r e l i e v i n g provisions f o r inter-group transfers, one?3smust stop at section 85 which was described i n the previous 2 52 chapter. J This applies to transfers to corporations by corporations, as i t applies to transfers by i n d i v i d u a l s , and, i n this case, i s subject to the same l i m i t a t i o n s . It hardly needs to be pointed out how d e f i c i e n t this i s as compared with the U.K. provisions. It w i l l cover one s i t u a t i o n only that i s covered by the U.K. provisions, i . e . the transfer of assets to a subsidiary corporation and then only to the extent that consideration i s received i n the form of shares. It w i l l not apply to transfers to parent companies or to fellow sub- s i d i a r i e s within the same group of companies. In view of the fact that section 69(1)(b) w i l l deem the proceeds of a trans- f e r to equal market value where assets are transferred to a c o n t r o l l i n g corporation or to a corporation controlled by the same persons as control the transferor or (where section 85 does not apply) to a subsidiary corporation and that sections 4o(2)(e) and 85(4) w i l l , i n the case of the f i r s t , 113 n u l l i f y and, i n the case of the l a t t e r , r e s t r i c t the 2 53 d e d u c t i b i l i t y of any losses, the absence of group r e l i e f 2 54 i n Canada has been much c r i t i c i z e d . The tax avoidance pro- visions i n this area are very e f f e c t i v e , but there i s no recognition of the other side of the corporate s i t u a t i o n , i . e . that the group of companies controlled by one company i s i n substance one large corporation organized into several branches. Tax avoidance provisions of equal force exist i n the U.K., but these are countered by the provisions of section 273, as limited by the other provisions just described. Three defects i n the U.K. system just described should be noted which, a f o r t i o r i , also exist i n the Canadian system. In the f i r s t place, although sections 258-264 of the I.C.T.A. 1970 set out a procedure f o r one group member to u t i l i z e the trading losses and other r e l i e f s of another group member, there i s no such procedure i n connection with c a p i t a l 255 losses and this has been c r i t i c i z e d . In practice, i t i s possible to get round this by arranging that a l l disposals fif assets within a group to outsiders are made by.only one group member. 2^ The second defect i s that although an ind i v i d u a l i s allowed by both systems to transfer assets to a corporation 257 controlled by him without recognition of any gain or loss, i f a corporation transfers assets to a shareholder who i s an ind i v i d u a l there i s no tax r e l i e f , even where the shareholder controls the corporation, so that there i s no real change i n the 114 substantial ownership of the asset. F i n a l l y , i n so f a r as non-resident companies are l i a b l e to pay tax on c a p i t a l gains, they w i l l be subject to a l l the anti-avoidance provisions which have just been des- cribed i n this chapter, but w i l l obtain the benefit of none of the complementary tax r e l i e v i n g provisions. (b) Transfers of assets to non-resident companies Section 268 of the I.C.T.A. 1970 applies when a company resident i n the U.K., which c a r r i e s on a trade out- side the U.K. through a branch of agency, transfers the trade c a r r i e d on there, together with i t s assets (or assets other than cash), to a company not resident i n the U.K. and the business i s transferred wholly or partly f o r shares or f o r shares and loan stock, but so that the shares held by the transferor amount to at least 25% of the ordinary share c a p i t a l of the transferee company. Any c a p i t a l gain i s ac t u a l l y calculated i n respect of each asset and apportioned between the shares and loan stock received on the one hand and the other consideration on the other hand according to market value at the date of t r a n s f e r . 2 ^ 8 Tax must be paid on the amountapportioned to the l a t t e r , but i s deferred on the amount apportioned to the former, u n t i l the happening of 2 59 c e r t a i n s p e c i f i e d events. u s The p r o v i s i o n i s s i m i l a r to the one w h i c h p e r m i t s i n d i v i d u a l s t o d e f e r c a p i t a l g a i n s a r i s i n g when they t r a n s - 2 6 0 f e r a s s e t s c o m p r i s e d i n a b u s i n e s s t o a c o r p o r a t i o n , but d i f f e r s i n some r e s p e c t s . I n the f i r s t p l a c e , the d e f e r r a l extends t o the p r o p o r t i o n of any g a i n a t t r i b u t a b l e t o l o a n s t o c k , u n l i k e the f o r m e r p r o v i s i o n s . I n the second p l a c e , t h e d e f e r r a l o n l y endures f o r a p e r i o d e x t e n d i n g up t o the 26l f i r s t of the s p e c i f i e d events t o ta k e p l a c e . I t may v e r y w e l l be t h a t t h i s would be the d i s p o s a l o f t h e s h a r e s o r l o a n s t o c k r e c e i v e d from the t r a n s f e r e e company, b u t t h e r e would s t i l l be the d i f f e r e n c e t h a t a mere p a r t i a l d i s p o s a l o f such s h a r e s o r l o a n s t o c k w i l l make the whole g a i n i m m e d i a t e l y t a x a b l e . I t was noted i n c o n n e c t i o n w i t h p a r a . 15 sched. 19 o f the F.A. 1969 t h a t t h e r e was no e x p r e s s l i m i t a t i o n i n the s e c t i o n to companies r e s i d e n t i n the U.K. I t would thus appear t h a t an i n d i v i d u a l can t r a n s f e r a s s e t s to a f o r e i g n c o r p o r a t i o n and g e t t h e b e n e f i t o f t h i s p r o v i s i o n . Whereas t h i s p r o v i s i o n a p p l i e s t o b o t h f o r e i g n and n o n - f o r e i g n a s s e t s , ssection 268 o n l y a p p l i e s t o f o r e i g n a s s e t s . Regard s h o u l d a l s o be had to the p r o v i s i o n s w h i c h exempt an i n d i v i d u a l who i s r e s i d e n t o r o r d i n a r i l y r e s i d e n t i n , b u t not d o m i c i l e d i n , the U.K. from t a x on g a i n s a r i s i n g on f o r e i g n a s s e t s , u n t i l 2 62 they a r e r e m i t t e d t o the U.K. 116 L a s t l y , i t s h o u l d be noted t h a t t h e r e i s no Canadian p r o v i s i o n w h i c h d e f e r s a c a p i t a l g a i n on a t r a n s f e r o f a s s e t s t o a f o r e i g n c o r p o r a t i o n . The r e a s o n f o r t h i s was s t a t e d i n the G o v e r n m e n t s White Paper, " P r o p o s a l s For Tax Reform", to be t h a t i f a t a x f r e e " r o l l - o v e r " i n t o f o r e i g n c o r p o r a t i o n s were p e r m i t t e d , g a i n s m i g h t " s l i d e t h r o u g h the 2 63 Canadian ta x net untouched" and i t does seem t h a t t h e r e c o uldbbe a t a x a v o i d a n c e o r e v a s i o n problem i f a t a x p a y e r w e r e a a l l o w e d to " r o l l - o v e r " a s s e t s s i t u a t e d i n Canada i n t o a f o r e i g n c o r p o r a t i o n i n r e t u r n f o r s h a r e s . However, the same r e a s o n i n g would not a p p l y i n the c a s e o f a t r a n s f e r o f f o r e i g n a s s e t s t o a f o r e i g n c o r p o r a t i o n . Moreover, a c o r p o r a t i o n r e s i d e n t i n Canada, j u s t l i k e any o t h e r r e s i d e n t t a x p a y e r , i s deemed t o d i s p o s e o f a l l i t s p r o p e r t y o t h e r t h a n t a x a b l e Canadian p r o p e r t y f o r proceeds e q u a l t o i t s f a i r market v a l u e i f i t c e a s e s t o be 264 r e s i d e n t i n Canada. I t can a v o i d t h i s , i f i t i s a 265 Canadian C o r p o r a t i o n , by making an e l e c t i o n and g i v i n g the M i n i s t e r s e c u r i t y f o r the t a x i t would o t h e r w i s e have b 267 266 p a i d . I n t h i s c a s e the p r o p e r t y , i n r e s p e c t o f w h i c h the e l e c t i o n i s made, i s t r e a t e d as t a x a b l e Canadian p r o p e r t y , i . e . i f d i s p o s e d o f by i t w h i l e n o n - r e s i d e n t , t h e r e may be t a x a b l e c a p i t a l g a i n s o r a l l o w a b l e c a p i t a l l o s s e s . The e l e c t i o n i s a l s o a v a i l a b l e f o r i n d i v i d u a l s , b u t not f o r 2 68 t r u s t s . When a t a x p a y e r becomes r e s i d e n t i n Canada, he i s 117 deemed to a c q u i r e a l l h i s p r o p e r t y , except taxable Canadian p r o p e r t y and p r o p e r t y i n r e s p e c t of which the 2 e l e c t i o n was made, a t a c o s t equal to i t s market v a l u e . Thus the taxpayer i s o n l y l i a b l e f o r gains a r i s i n g w h i l e he r e s i d e s i n Canada. 118 P a r t 5 - S p e c i a l C o r p o r a t i o n s The r u l e s a l r e a d y d i s c u s s e d i n t h i s c h a p t e r a r e g e n e r a l l y applicable t o the c o r p o r a t i o n s now to be mentioned, b u t a r e m o d i f i e d i n many p a r t i c u l a r r e s p e c t s . The b a s i c o b j e c t o f most o f thes e c o r p o r a t i o n s i s to combine the i n v e s t - ment funds o f numerous i n d i v i d u a l i n v e s t o r s i n t o one common f u n d , so t h a t the c o r p o r a t i o n becomes the d i r e c t h o l d e r o f the i n v e s t m e n t s and the i n d i v i d u a l i n v e s t o r o b t a i n s s h a r e s i n the c o r p o r a t i o n . The s p e c i a l t r e a t m e n t o f t h e s e c o r p o r - a t i o n s i s founded on a g e n e r a l p o l i c y w h i c h aims a t t r e a t i n g them as a c o n d u i t o n l y between the a c t u a l i n v e s t m e n t s and t h e i r s h a r e h o l d e r s . I n t h i s c h a p t e r i s d i s c u s s e d the d e f i n - i t i o n and n a t u r e o f such i n s t i t u t i o n s and the t a x a t i o n o f income and c a p i t a l g a i n s i n t h e i r hands as i t i s r e a l i s e d , a l t h o u g h , i n f a c t , many o f the most i m p o r t a n t p r o v i s i o n s w h i c h g i v e n them t h e i r c h a r a c t e r i s t i c c o n d u i t n a t u r e a r e found i n the f o l l o w i n g c h a p t e r on d i s t r i b u t i o n s . The degree o f i n t e g r a t i o n o f p e r s o n a l and c o r p o r a t e t a x a t i o n a c h i e v e d and the methods used t o a c h i e v e i t v a r y from one c o r p o r a t i o n t o a n o t h e r . A l s o i n c l u d e d under t h i s head a r e i n s t i t u t i o n s w h i c h do not f a l l so e a s i l y i n t o the above p a r a g r a p h . U n i t and mutual f u n d t r u s t s a r e not c o r p o r a t i o n s , b u t they do s e r v e s i m i l a r f u n c t i o n s t o thos e o f the in v e s t m e n t i n s t i t u t i o n s 1 1 9 t h e r e d e s c r i b e d , and not o n l y a r e they t o a g r e a t e x t e n t g i v e n the c o n d u i t t r e a t m e n t , b u t they a r e i n many ar e a s e i t h e r t r e a t e d a s , o r i n a s i m i l a r f a s h i o n t o , c o r p o r a t i o n s . On the o t h e r hand, i n s u r a n c e companies a r e c o r p o r a t i o n s , b u t o n l y p a r t o f t h e i r f u n c t i o n i i n v o l v e s t h e i i n v e s t m e n t o f t h e i r i n v e s t o r s ' money. They conduct a p r o f i t a b l e b u s i n e s s f o r t h e i r s h a r e h o l d e r s , b u t a l s o , i n the c a s e o f l i f e i n s u r - ance companies, a c t as i n v e s t m e n t v e h i c l e s f o r t h e i r p o l i c y - h o l d e r s . T h e r e f o r e they a r e d e a l t w i t h h e r e , b u t from t h e i r p o l i c y h o l d e r s ' p o i n t o f view and not t h a t o f t h e i r s h a r e h o l d e r s . The h o l d e r s o f s h a r e s o r u n i t s i n t h e s e i n s t i t u t - i o n s a r e g e n e r a l l y t a x a b l e on c a p i t a l g a i n s r e a l i s e d when they d i s p o s e o f them as i n the case o f any o t h e r a s s e t s . The s p e c i a l r u l e s a p p l i c a b l e t o s h a r e s , w h i c h were d e s c r i b e d e a r l i e r i n t h i s c h a p t e r , a l s o a p p l y t o s h a r e s i n such o f t h e s e i n s t i t u t i o n s as a r e c o r p o r a t i o n s . E v e n u u n i t s i n u n i t and mutual f u n d t r u s t s w i l l o f t e n be t r e a t e d s i m i l a r l y t o s h a r e s . 2 70 Thus the i d e n t i f i c a t i o n r u l e s w i l l a p p l y t o them. F u r t h e r , t h e r e a r e e x p r e s s p r o v i s i o n s i n b o t h systems w h i c h t e n d t o put them i n the same p o s i t i o n as s h a r e s . I n Canada, c e r t a i n u n i t s a r e i n c l u d e d i n the d e f i n i t i o n o f t a x a b l e Canadian p r o p e r t y and, i n the U.K., c e r t a i n u n i t s a r e equated w i t h q u o t e d s h a r e s and s e c u r i t i e s f o r the purpose of the computation rules. 120 A. Non-resident Owned Investment Corporations The purpose of this corporation i s to allow non- residents to pool t h e i r resources and put t h e i r money into Canadian investments through the means of a corporation, without suffering any greater tax burden than i f the invest- 271 ment had been made d i r e c t l y . The q u a l i f y i n g conditions for such a corporation, which must be complied with through- 272 out the period following incorporation up to the end of the tax year i n question, require that a l l the issued shares 271 274 and debentures , J be owned by non-residents or other non- resident owned investment corporations and generally r e s t r i c t the main business of the corporation to that of holding and making investments. The corporation must make an el e c t i o n within 90 days of the commencement of i t s f i r s t tax year commencing a f t e r 1971 2 7 ^ and once i t s status i s l o s t through f a i l i n g to comply with the conditions, i t cannot be regained. The d e f i n i t i o n thus excludes corporations carrying on an 2 76 active business and generally corporations with res- ident shareholders. In regard to c a p i t a l gains accruing to such a corporation the tax treatment i s favourable i n two ways. In the f i r s t place, just as non-resident persons are only l i a b l e f o r c a p i t a l gains a r i s i n g from dispositions of 22 7 "taxable Canadian property" ' so are non-resident owned 121 investment corporations. 278 In the second place, the rate of tax payable i s only 25%, 279 although the effect of this advantage i s n u l l i f i e d by the fact that the whole amount of c a p i t a l gains and losses are included i n income (and not just h a l f ) . As, however, the act provides a method fo r d i s t r i b u t i n g such c a p i t a l gains at no tax cost to the member holder w i l l be i n no worse po s i t i o n through r e a l i s i n g the gain through the corporation than i f he had r e a l i s e d i t personally, unless his personal rate of income tax i s less than 50%. Moreover he w i l l be better off i f his personal rate exceeds 50%. A s i m i l a r position exists i n regard to Income other than taxable c a p i t a l gains which accrues to the non-resident owned investment copporation. The Act contains provisions which ensure that the only tax paid on income a r i s i n g from investments held by the corporation i s the withholding tax 2 81 paid when thi s income i s d i s t r i b u t e d to i t s members. Shares i n these corporations are not expressly included i n the Act's d e f i n i t i o n of taxable Canadian pro- perty, but i n view of the fact that i t i s unlike l y that 2 82 such a corporation would ever be a public corporation, i t appears that they w i l l usually be such by virtue of being shares i n a non-public corporation resident i n Canada. 2 8- 5 Thus the non-resident taxpayer w i l l be taxable on c a p i t a l gains re a l i s e d on t h e i r disposal. i n receipt of the d i s t r i b u t i o n , 280 a non-resident share- 122 There a r e no s p e c i a l p r o v i s i o n s i n the U.K. f o r n o n - r e s i d e n t s making i n v e s t m e n t s i n the c o u n t r y t h r o u g h the means o f a c o r p o r a t i o n . T h e r e f o r e , except i n r e g a r d to 284 a s s e t s used i n a t r a d e o r b u s i n e s s c a r r i e d on i n the U.K., the n o n - r e s i d e n t w i l l be c l e a r l y worse o f f t o h o l d a s s e t s t h r o u g h a c o r p o r a t i o n s i t u a t e i n the U.K. Such a c o r p o r a t i o n w i l l pay c o r p o r a t i o n tax a t normal r a t e s t o the same e x t e n t as any o t h e r r e s i d e n t c o r p o r a t i o n , even though a non-res- i d e n t p e r s o n i n the same s i t u a t i o n would pay no t a x . B, Investment C o r p o r a t i o n s and T r u s t s B o t h systems p r o v i d e f o r a type of c o r p o r a t i o n w h i c h from a t a x p o i n t o f view a c t s s i m p l y as a c o n d u i t between i t s s h a r e h o l d e r s and i t s i n v e s t m e n t s i n c o n n e c t i o n w i t h c a p i t a l g a i n s a c c r u i n g t o i t . I n Canada, they a r e termed " i n v e s t m e n t c o r p o r a t i o n s " and, i n the U.K., " i n v e s t - ment t r u s t s " . The c o n d i t i o n s o f q u a l i f i c a t i o n r e q u i r e t h a t the s h a r e s i n the c o r p o r a t i o n be w i d e l y s p r e a d among the 285 p u b l i c and t h a t the main b u s i n e s s o f the c o r p o r a t i o n be the making and h o l d i n g of i n v e s t m e n t s . Thus the U.K. a c t r e q u i r e s t h a t "the company's income i s d e r i v e d w h o l l y o r 2 86 m a i n l y from s h a r e s o r s e c u r i t i e s " and the Canadian A c t r e q u i r e s t h a t a t l e a s t 80% o f the c o r p o r a t i o n ' s p r o p e r t y throughout the y e a r c o n s i s t o f " s h a r e s , bonds, m a r k e t a b l e 2 87 s e c u r i t i e s , o r c a s h " , ' and t h a t "not l e s s t h a n 95% o f i t s 12 3 income fo r the year was derived from, sor dispositions of, 2 88 "these investments. It w i l l be noted that the reference to "income" i n the U.K. condition does not include a refer- ence to c a p i t a l gains, whereas the Canadian provision c l e a r l y does so. The conditions further require that a c e r t a i n amount 289 of the corporation's yearly income be d i s t r i b u t e d , but this amount i s calculated without reference to c a p i t a l gains accru- ing i n the year and, i n f a c t , the investment trust's a r t i c l e s of association or memorandum of association are required to p r o h i b i t " the d i s t r i b u t i o n as dividends of surpluses a r i s i n g 290 from the r e a l i z a t i o n of investmentsV. Both acts pplace l i m i t s on the size of individual investments that can be made 291 i n one company by the investment corporation or investment trust. In addition to the above conditions common to both systems, there are conditions peculiar to each system. Thus i n Canada, a minimum amount of i t s "gross revenue" must aris e 292 i n Canada and there i s a l i m i t on the size of one taxpayer's 293 holding i n the investment corporation ^ and, i n the U.K., the conditions recorded above are minimum conditions which must exist before the company can be approved by the Board of Trade. Taxable c a p i t a l gains are included i n the investment corporation's income and charged to Income Tax as are such gains accruing to other corporations; Double taxation i s avoided by the use of a tax refund available 12k 294 when the c o r p o r a t i o n d i s t r i b u t e s i t s c a p i t a l g a i n s . On the o t h e r hand, the p r o f i t s o f an i n v e s t m e n t t r u s t a r e computed by i n c l u d i n g o n l y a f r a c t i o n o f i t s c h a r g e a b l e g a i n s . These g a i n s a r e reduced by f i v e e i g h t h s o r such o t h e r f r a c t i o n i n f u t u r e y e a r s as P a r l i a m e n t may d e t e r m i n e . 2 9 ^ As the C o r p o r a t i o n Tax r a t e i s to be f i x e d a t k0% f o r the f i n a n c i a l y e a r 1972, such g a i n s w i l l be t a x e d a t an e f f e c t i v e r a t e o f 15%, I t w i l l be noted t h a t t h i s i s the same r a t e as w i l l be p a i d by i n d i v i d u a l s under the a l t e r n a t i v e r a t e 2 9 * * as from 6th A p r i l 1973 • Double t a x a t i o n o f g a i n s a c c r u i n g to i n v e s t m e n t t r u s t s i s a v o i d e d by a p r o - cedure w h i c h g i v e s the s h a r e h o l d e r a t a x c r e d i t i n r e s p e c t o f t a x p a y a b l e by him on any c a p i t a l g a i n r e a l i s e d on a d i s - p o s a l o f s h a r e s i n the c o m p a n y . 2 9 7 The above t r e a t m e n t o f c a p i t a l g a i n s a c c r u i n g to i n v e s t m e n t trusts and i n v e s t m e n t c o r p o r a t i o n s must be con- t r a s t e d w i t h the t a x a t i o n o f o t h e r income a c c r u i n g t o such c o r p o r a t i o n s . I n Canada, the c o r p o r a t i o n pays tax a t a r a t e o f 25% on such i n c o m e 2 9 8 and the s h a r e h o l d e r i s g i v e n f u l l creddlt f o r t h i s by v i r t u e o f the s t a n d a r d d i v i d e n d tax c r e d i t g i v e n i n r e s p e c t o f t a x a b l e d i v i d e n d s . 2 9 ' 9 On the o t h e r hand, i n the U.K., the c o r p o r a t i o n i s i n the same p o s i t i o n i n r e s p e c t o f such income as i s any o t h e r c o r p o r - a t i o n and d i s t r i b u t i o n s from i t a r e t r e a t e d as o r d i n a r y 125 d i s t r i b u t i o n s . Thus i n t h i s r e s p e c t the i n v e s t m e n t t r u s t i s somewhat d i s a d v a n t a g e o u s to i n v e s t o r s . C. M u t u a l Fund C o r p o r a t i o n s T h i s i s a c o r p o r a t i o n w h i c h i s v e r y s i m i l a r to t h e i n v e s t m e n t c o r p o r a t i o n , b u t w i t h o u t many o f the r e s - t r i c t i n g c o n d i t i o n s a t t a c h e d t o t h a t c o r p o r a t i o n . There a r e t h r e e b a s i c c o n d i t i o n s . I n the f i r s t p l a c e , i t must be a "Canadian C o r p o r a t i o n " 3 0 0 and a " p u b l i c c o r p o r a t i o n " ; 3 0 1 i n the second p l a c e , " i t s o n l y u n d e r t a k i n g was the i n v e s t - 302 i n g o f funds of the c o r p o r a t i o n " and, f i n a l l y , s h a r e s i s s u e d by the c o r p o r a t i o n amounting to 95% o f the f a i r mar- k e t v a l u e o f a l l i t s s h a r e s i s s u e d must e i t h e r have con- d i t i o n s a t t a c h e d to them " r e q u i r i n g the c o r p o r a t i o n t o a c c e p t , a t the demand of the h o l d e r t h e r e o f and a t the p r i c e d e t e r m i n e d and p a y a b l e i n a c c o r d a n c e w i t h the c o n d i t i o n s , the s u r r e n d e r o f the s h a r e s , o r f r a c t i o n s o r p a r t s t h e r e o f , t h a t a r e f u l l y p a i d " o r "be q u a l i f i e d i n a c c o r d a n c e w i t h the p r e s c r i b e d c o n d i t i o n s r e l a t i n g to the r e d emption of n 303 s h a r e s " . The t a x t r e a t m e n t of c a p i t a l g a i n s i n thehhands of m utual f u n d c o r p o r a t i o n s i s the same as f o r i n v e s t m e n t c o r p o r a t i o n s . F u r t h e r , t h e r e i s the same r i g h t t o a r e f u n d o f t a x p a i d on c a p i t a l g a i n s when such g a i n s a r e d i s t r i b u t e d and, i n a d d i t i o n , a s i m i l a r r i g h t when i t redeems i t s s h a r e s . 1 2 6 An investment corporation w i l l also q u a l i f y f o r the l a t t e r r i g h t i i f i t s a t i s f i e s the above three conditions necessary f o r i t to be a mutual fund corporation. Although the mutual fund corporation would thus appear to be a much more f l e x i b l e instrument, with equal tax benefits so f a r as c a p i t a l gains are concerned, i n fact there i s a great incentive to q u a l i f y as an investment corporation . The reason i s that such a corporation pays a rate of 2 5 % on i t s income other than c a p i t a l gains.-*0-' 0 . Unit Trusts Unit trusts are provided f o r i n the tax systems of both countries, although the provisions made are various i n th e i r methods and e f f e c t s . Generally such trusts are treated as ordinary trust s , unless statute provides otherwise, so that an account of the general law governing trusts i s required. On the other hand, i n many situations the rules applicable to trusts are excluded and the unit trust i s treated as a c ompa ny• F i r s t w i l l be considered the statutory d e f i n i t i o n s found of unit t r u s t s . In Canada, a unit trust i s defined under two alte r n a t i v e d e f i n i t i o n s either of which i s s u f f i c - i e n t , but i t must i n any case be "an i n t e r vivos trust *he interes t of each beneficiary under which was described by 12 7 3 07 reference to units of the t r u s t " . The f i r s t a l t e r n a t i v e i s simply a condition as to the redemption of trust units s i m i l a r to that found i n connection with shares i n a mutual fund corporation.-* 0 8 The other al t e r n a t i v e places r e s t r i c - tions on the a c t i v i t i e s of the trust and makes i t subject to "prescribed conditions r e l a t i n g to the number of i t s unit holders, dispersal of ownership of i t s units and public trading of i t s units",-* 0 9 but there are no redemption requirements. In fact the l i m i t a t i o n s are s i m i l a r to those Li 311 310 imposed on investment corporations — the only undertaking of the trust must be the "investing of ,funds of the trust";' 312 i t must be resident i n Canada; at least 80% of i t s pro- perty throughout the year must consist of shares, bonds, mortgages, marketable s e c u r i t i e s , cash and c e r t a i n rentals and r o y a l t i e s ; ^ 95% of i t s income must be derived from, or 3l4 dispositions of, i t s above investments; and there i s a l i m i t a t i o n on the size of any one investment held by the trust i n a single corporation.-*1-'' In the U.K., a d i s t i n c t i o n must be drawn between authorised and unauthorized unit t r u s t s . The former are 316 defined as "a unit trust scheme i n the case of which an order of the Board of Trade under section 17 of the Pre- vention of Frauds (Investments) Act 1958" or the equivalent Northern Ireland Act i s i n force.-* 1 7 A unit trust scheme i s defined as "any arrangement made f o r the purpose of, or 128 having the effect of, providing f a c i l i t i e s f o r the p a r t i c - ipation by persons as b e n e f i c i a r i e s under a trust i n the p r o f i t s or income a r i s i n g from the a c q u i s i t i o n , holding, management or disposal of s e c u r i t i e s or any other property 3 X *9 whatsoever". An unauthorized trust i s simply one which i s not authorised. The Prevention of Frauds (Investments) Act sets out the conditions on which the Board w i l l approve 319 an authorised unit t r u s t . * These conditions concern the type of trustee which i s acceptable and lay down minimum contents f o r the trust deed. In p a r t i c u l a r the trust deed must give the unit holder the right to require the manager of the trust to purchase his units, but there are no con- 3 2 0 d i t i o n s concerning the investment a c t i v i t i e s of the trust or the d i s t r i b u t i o n of i t s income. In Canada, unit trusts are taxed as ordinary trusts , which i n turn are taxed as i f they were individual 3 2 1 taxpayers. As a r e s u l t , c a p i t a l gains accruing to the unit trust are included i n the computation of the trust's income i n the sameaimanner as they are included i n an i n - dividual's income. However, the rate of tax w i l l generally be higher. Under Section 1 2 2 ( 1 ) , the rateof tax payable 3 2 2 by an i n t e r vivos trust (including a unit trust) on i t s 323 income i s the greater of 3 9 % and the rate payable by an 3 2 4 i n d i v i d u a l on the same income. This puts the trust i n a 12 9 s i m i l a r position to that of a company paying a fix e d cor- porate rate of 50% and means that the trust w i l l never pay less tax than an individual beneficiary would, but may pay more. A non-resident unit trust i s i n the same position as a non-resident i n d i v i d u a l . In p a r t i c u l a r , i t i s o n l y l l i a b l e f o r c a p i t a l gains a r i s i n g from dispositions of taxable 325 Canadian property. As i n the case of an ordinary tru s t , a unit trust makes a disposition of property when i t makes a "transfer of property of the trust to any beneficiary under the 326 t r u s t " . Further, the parties to such a transfer w i l l 327 possibly not be dealing at arms length, i n which case the 328 proceeds of d i s p o s i t i o n would be deemed to be market value. Two rules concerning dispositions of ordinary trusts do not apply i n the case of unit t r u s t s . In the f i r s t place, unit trusts are not deemed to dispose of t h e i r assets every 21 32 Q years f o r proceeds equal to the market value of those assets^ 7 an^>in the second place, the provisions which deem trustees to dispose of assets f o r proceeds equal to t h e i r Adjusted cost 330 base when the assets are being transferred to b e n e f i c i a r i e s i n t o t a l or p a r t i a l s a t i s f a c t i o n of the i r c a p i t a l interests i n the trust are not applicable to unit t r u s t s . The trustees of any tr u s t , whether resident or non- resident, can avoid paying tax on income a r i s i n g , i f that 1 3 Q income i s p a y a b l e 3 3 2 i n the year i t arises to i t s benefic- i a r i e s , i . e . i n the case of a unit trust i t s unit holders. 333 The amount so payable i s deducted from the trust's income 334 and included as part of the beneficiary's income. However, this procedure i s not available i f both trust and beneficiary are not resident i n Canada. 3 3^ This right of deduction not only ensures that the trustees are not taxed on income and c a p i t a l gains accruing to them, but that these amounts are taxed at the i n d i v i d u a l rates of the b e n e f i c i a r i e s who are e n t i t l e d to them. In the case of non-resident b e n e f i c i a r i e s e n t i t l e d to such income, the non-resident .withholding tax 336 i s payable, but only when the income i s d i s t r i b u t e d . Turning now to the taxation of U.K. unit trusts one can f a i r l y quickly dispose of authorised unit t r u s t s , which, by vi r t u e of section 35^(1) of the I.C.T.A. 1970 are treated as companies "resident i n the U.K., whose business consists mainly i n the making of investments and thepprincipal part of whoseiincome i s derived t herefrom". 3 3 7 S i m i l a r l y , i t s unit holders are treated as i f they are shareholders i n the 338 company. The consequence i s that, as regards income and c a p i t a l gains, the taxation of authorised unit trusts i s the same as the taxation of investment t r u s t s . 3 3 9 There Is, however, one provision which allows a reduction i n the chargeable gains accruing to authorised unit trusts when the trust i s contracting, i . e . when i t redeems more units i n a 13i y e a r than a r e p u r c h a s e d , and so i s f o r c e d t o d d i s p o s e o f 3 U 0 t r u s t a s s e t s t o meet the d i f f e r e n c e . - ' The o b j e c t i s t o p r e v e n t the d o u b l e t a x a t i o n o f c a p i t a l g a i n s a r i s i n g from the d i s p o s a l o f such assets" - once i n the hands of the t r u s t 3 4 l and once i n the hands of the u n i t h o l d e r - and t o p r o v i d e r e l i e f to the t r u s t * The t r e a t m e n t o f u n a u t h o r i s e d u n i t t r u s t s i s a l i t t l e more complex. A l t h o u g h , by v i r t u e o f s e c t i o n 45(8) o f the F.A. 1965, a u n i t t r u s t scheme i s t r e a t e d f o r C a p i t a l Gains Tax purposes as i f i t were a company and as i f the r i g h t s o f u n i t h o l d e r s were sh a r e s i n the company, the 342 u n a u t h o r i z e d u n i t t r u s t pays-' C a p i t a l Gains Tax on i t s c a p i t a l g a i n s and Income Tax on i t s o t h e r income. The e f f e c t of t r e a t i n g t h e t r u s t as a company i s to e x c l u d e the c o m p l i c a t e d r u l e s a p p l i c a b l e to t r u s t s w h i c h cause deemed d i s p o s a l s o f the t r u s t ' s a s s e t s on the happening of c e r t a i n 343 e v e n t s . ' •* On the o t h e r hand, i t a l s o e x c l u d e s the r u l e w h i c h t r e a t s c a p i t a l g a i n s r e a l i s e d by a t r u s t e e as c a p i t a l g a i n s o f a b e n e f i c i a r y who i s a b s o l u t e l y e n t i t l e d as a g a i n s t 344 the t r u s t e e t o t h e s e t t l e d p r o p e r t y . Thus the t r u s t i s s i m p l y t a x e d on i t s c a p i t a l g a i n s as i f i t were an i n d i v i d - u a l , b u t w i t h o u t the b e n e f i t o f the a l t e r n a t i v e r a t e a v a i l - 345 a b l e t o i n d i v i d u a l s . T h i s p o s i t i o n s h o u l d be c o n t r a s t e d w i t h t h a t i n r e s p e c t o f o t h e r income r e a l i s e d by a u n i t t r u s t , i n r e s p e c t 132 o f w h i c h the absence o f any e x p r e s s s t a t u t o r y p r o v i s i o n r e q u i r i n g the t r u s t t o be t r e a t e d as a company means t h a t the o r d i n a r y t r u s t r u l e s a p p l y . Thus, i f a u n i t h o l d e r has a v e s t e d r i g h t t o such income as i t a r i s e s , whether p a i d out i m m e d i a t e l y o r not, 3**** o r the income i s i n f a c t p a i d out to 347 t h e b e n e f i c i a r y as i t a r i s e s , then i t i s t r e a t e d as income of t h e b e n e f i c i a r y and t a x e d a t h i s p e r s o n a l r a t e s . I n any o t h e r c a s e , the t r u s t e e i s charg e d t o the s t a n d a r d o r b a s i c r a t e o f t a x (as the c a s e may b e ) , b u t not t o S u r t a x o r the 3 48 h i g h e r r a t e s . J The u n i t h o l d e r i n a u n i t t r u s t h o l d s a c a p i t a l a s s e t and w i l l be t a x e d on any c a p i t a l g a i n r e a l i s e d i n r e s p e c t o f i t , t he o n l y c o m p l i c a t i o n b e i n g t h a t by v i r t u e o f s e c t i o n s 4 5 ( 8 ) o f the F.A.1965 and 354 o f the I.C.T.A. 1970 the h o l d e r w i l l be t r e a t e d as d i s p o s i n g o f sh a r e s i n a 349 company and not u n i t s o f a t r u s t . As i n the c a s e o f s h a r e s , n o n - r e s i d e n t u n i t h o l d e r s i n u n i t t r u s t s r e s i d e n t i n the U.K. w i l l not be l i a b l e f o r c a p i t a l g a i n s a r i s i n g 350 when they d i s p o s e o f t h e i r u n i t s . The case i s d i f f e r e n t i n Canada, s i n c e u n i t s h e l d by n o n - r e s i d e n t s i n u n i t t r u s t s r e s i d e n t i n Canada a r e i n c l u d e d w i t h i n the d e f i n i t i o n o f t a x a b l e Canadian p r o p e r t y g i v e n i n s e c t i o n 1 1 5 ( 1 ) ( b ) o f 3 51 the A c t , ^ * so t h a t the h o l d e r w i l l be t a x e d on any g a i n r e a l i s e d on a d i s p o s a l . 133 E a r l i e r i n the c h a p t e r , i t was p o i n t e d out how i t would be p o s s i b l e f o r a n o n - r e s i d e n t t a x p a y e r t o a v o i d l i a b i l i t y i n r e s p e c t o f t a x a b l e Canadian p r o p e r t y , by t r a n s f e r r i n g such p r o p e r t y t o a n o n - r e s i d e n t c o r p o r a t i o n and d i s p o s i n g o f the s h a r e s i n t h a t c o r p o r a t i o n and not the p r o p e r t y . The A c t c o n t a i n s a p r o v i s i o n w h i c h appears t o be d e s i g n e d to c o u n t e r a t t e m p t s t o c a r r y out a s i m i l a r scheme u s i n g a n o n - r e s i d e n t u n i t t r u s t . S e c t i o n 5 3 ( 2 ) $ j ) a p p l i e s when a r e s i d e n t t a x p a y e r p u r chases a u n i t i n a non- r e s i d e n t u n i t t r u s t from a n o n - r e s i d e n t p e r s o n , a t a time when the f a i r market v a l u e o f a l l the t a x a b l e Canadian p r o p e r t y h e l d by the t r u s t exceeds i n v a l u e one h a l f o f a l l t he t r u s t ' s assets.-*-* 2 The s e c t i o n r e q u i r e s t h a t t h e r e be c a l c u l a t e d the c a p i t a l g a i n s J w h i c h have a c c r u e d to such t a x a b l e Canadian p r o p e r t y , b u t w h i c h have not y e t been r e a l i s e d , and t h a t the r e s i d e n t p u r c h a s e r deduct from the a d j u s t e d c o s t base o f the purchased u n i t s t h a t p a r t o f those c a p i t a l g a i n s w h i c h i s a t t r i b u t a b l e t o t h o s e u n i t s . T h i s p r e v e n t s the a v o i d a n c e o f t a x caused by a n o n - r e s i d e n t u n i t h o l d e r o f a n o n - r e s i d e n t u n i t t r u s t d i s p o s i n g o f h i s u n i t s i n t h a t t r u s t f o r a c a p i t a l g a i n , w h i c h r e f l e c t s c a p i t a l g a i n s a c c r u e d t o t a x a b l e Canadian p r o p e r t y h e l d by the t r u s t , i n s t e a d o f t h e t r u s t d i s p o s i n g o f t h a t p r o p e r t y d i r e c t l y add p a y i n g t a x on the r e a l i s e d g a i n s . I t does t h i s by t h r o w i n g on t o the r e s i d e n t p u r c h a s e r o f u n i t s i n the t r u s t the l i a b i l i t y f o r any o f those a c c r u e d g a i n s . 134 Of c o u r s e , l t w i l l not work i n p r a c t i c e as l o n g as the u n i t s a r e t r a n s f e r r e d t o o t h e r n o n - r e s i d e n t s . Where the p r i c e s o f u n i t s i n a U.K. u n i t t r u s t a r e p u b l i s h e d d a i l y by the managers of the t r u s t , then f o r the purpose of a p p l y i n g t h e t r a n s i t i o n a l p r o v i s i o n s f o r com- 3 55 p u t i n g g a i n s on a s s e t s h e l d on the 6 t h A p r i l 1965 and the s t a t u t o r y r u l e s f o r d e t e r m i n i n g the market v a l u e of a s s e t s , 3 ^ they a r e t r e a t e d as i f they were s h a r e s o r s e c u r i t i e s quoted on a r e c o g n i z e d s t o c k exchange, except t h a t , i n the c a s e of the v a l u a t i o n p r o v i s i o n s , the v a l u e i s a s c e r t a i n e d w i t h r e f e r e n c e t o the b u y i n g p r i c e p u b l i s h e d , not t o any quoted p r i c e on a s t o c k exchange. A comparison o f Canadian and U.K. u n i t t r u s t s i s v e r y d i f f i c u l t i n view of the u n e q u i v o c a l t r e a t m e n t of the l a t t e r as c o r p o r a t i o n s and the a p p l i c a t i o n t o the f o r m e r of the o r d i n a r y t r u s t r u l e s s l i g h t l y m o d i f i e d . The u nauthor- i s e d u n i t t r u s t can be compared w i t h the Canadian u n i t t r u s t i n r e g a r d t o the t r e a t m e n t o f income o t h e r than c a p i t a l g a i n s , t h i s b e i n g the o n l y c a s e where a U.K. u n i t t r u s t i s t r e a t e d as a t r u s t . Here, i n f a c t , the p o s i t i o n o f b o t h systems i s v e r y s i m i l a r , the o n l y d i f f e r e n c e b e i n g t h a t i n the U.K. the u n i t h o l d e r need not be e n t i t l e d a c t u a l l y to r e c e i v e payment of income i n the y e a r i t a r i s e s . Even s o , i t i i s a p p a r e n t t h a t the U.K. u n i t t r u s t s shouldbbe compared 135 t o the Canadian i n v e s t m e n t c o r p o r a t i o n and m utual f u n d c o r p o r a t i o n . The u n a u t h o r i z e d u n i t t r u s t i s o b v i o u s l y i n an u n f a v o u r a b l e p o s i t i o n i n r e g a r d to c a p i t a l g a i n s r e a l i s e d by i t , b e i n g t a x e d as i f i t were a c o r p o r a t i o n w i t h none of t h e r e l i e f s a v a i l a b l e to t h e s e o t h e r i n s t i t u t i o n s , b u t t h e a u t h o r i s e d u n i t t r u s t i s s i m i l a r t o the mutual f u n d c o r p o r a t i o n i n the l a c k o f s p e c i a l t r e a t m e n t f o r income o t h e r than c a p i t a l g a i n s and t h e s p e c i a l r e f u n d s o r c r e d i t s g i v e n i n r e s p e c t o f tax p a i d on c a p i t a l g a i n s on a redemp- t i o n o f s h a r e s o r u n i t s . Even the Canadian u n i t t r u s t s r e v e a l a tendency t o be t r e a t e d as companies, w i t h the minimum 50% r a t e o f t a x , the e x c l u s i o n o f t h e r r u l e s deeming p e r i o d i c d i s p o s i t i o n s o f t h e i r a s s e t s and the t r e a t m e n t of t h e i r u n i t s as t a x a b l e Canadian p r o p e r t y . E. M u t u a l Fund T r u s t s A mutual f u n d t r u s t under Canadian Law must 357 s a t i s f y t h r e e c o n d i t i o n s . I n the f i r s t p l a c e , i t must be a u n i t t r u s t under e i t h e r o f the a l t e r n a t i v e s t a t u t o r y d e f i n i t i o n s w h i c h i s r e s i d e n t i n Canada. I n t h e second p l a c e , i t s o n l y u n d e r t a k i n g must be the i n v e s t i n g of funds o f the t r u s t and, l a s t l y , i t must comply w i t h " p r e s c r i b e d c o n d i t i o n s r e l a t i n g t o the number o f i t s u n i t h o l d e r s , the d i s p e r s a l o f ownership of i t s u n i t s and the p u b l i c t r a d i n g o f i t s u n i t s " . The mutual f u n d t r u s t i s thus r a t h e r s i m i l a r t o an u n i n c o r p o r a t e d v e r s i o n o f the mutual f u n d c o r p o r a t i o n 136 o r the in v e s t m e n t c o r p o r a t i o n depending on w h i c h a l t e r n - a t i v e d e f i n i t i o n o f u n i t t r u s t i s c o m p l i e d w i t h . Income a c c r u i n g t o a mutual f u n d t r u s t ( i n c l u d i n g c a p i t a l g a i n s ) i s t a x e d i n the same way as t h a t a c c r u i n g t o u n i t t r u s t s , 3 ' * 8 except t h a t the r a t e o f t a x p a y a b l e on t a x - a b l e c a p i t a l g a i n s i s i n a l l c a s e s a f l a t f e d e r a l r r a t e o f 359 39%, to w h i c h i s added the p r o v i n c i a l r a t e . I n a d d i t i o n t o the r i g h t o f the t r u s t e e s to deduct from income amounts p a y a b l e t o b e n e f i c i a r i e s i n the y e a r they a- r i s e , a mutual f u n d t r u s t i s a b l e to o b t a i n a r e f u n d of t a x p a i d by i t on c a p i t a l g a i n s when i t redeems i t s b e n e f i c - , 360 i a r i e s u n i t s . T h i s removes any element o f doub l e t a x - a t i o n a r i s i n g i n c o n n e c t i o n w i t h c a p i t a l g a i n s , w h i c h were not p a y a b l e i n the y e a r they a r o s e , b u t ac c u m u l a t e d , and g a i n s w h i c h a r e a c c r u e d , b u t not r e a l i s e d , a t the redemp- 361 t i o n d a t e . A u n i t of a mutual f u n d t r u s t h e l d by a non- r e s - i d e n t t a x p a y e r i s t a x a b l e Canadian p r o p e r t y , i f a t any time d u r i n g s u c h o f the p e r i o d o f 5 y e a r s i m m e d i a t e l y p r e c e d i n g i t s d i s p o s i t i o n as i s a f t e r 1971, not l e s s than 25% o f the i s s u e d u n i t s o f the t r u s t b e l o n g e d t o the t a x p a y e r , t o persons w i t h whom he d i d not d e a l a t arms l e n g t h o r t o b o t h t h e s e c a t e g o r i e s o f p e r s o n . I f a t a x p a y e r ' s u n i t s a r e t a x a b l e Canadian p r o p e r t y , t h e n he w i l l be l i a b l e f o r any c a p i t a l g a i n s r e s u l t i n g from t h e i r d i s p o s a l . I t w i l l be 13? noted t h a t the t e s t here a p p l i e d t o t h e s e u n i t s i s the 363 same as t h a t a p p l i e d t o s h a r e s i n p u b l i c c o r p o r a t i o n s , i n c l u d i n g , i n p a r t i c u l a r , m u tual fu n d and i n v e s t m e n t c o r p o r a t i o n s . The mutual f u n d t r u s t r e v e a l s the same t e n d e n c i e s t o be t r e a t e d as a c o r p o r a t i o n as the Canadian u n i t t r u s t I n f a c t , the i n d i c a t i o n s a r e even s t r o n g e r i n the c a s e of the mutual fu n d t r u s t , w i t h i t s f l a t r a t e a p p l i c a b l e to c a p i t a l g a i n s and the r i g h t t o o b t a i n a r e f u n d o f p a r t o f the t a x e s p a i d by i t on c a p i t a l g a i n s , w h i c h p u t s i t i n a s i m i l a r p o s i t i o n t o mutual f u n d c o r p o r a t i o n s i n p a r t i c u l a r . There i s no e q u i v a l e n t o f the mutual f u n d t r u s t i n the U.K. I t s f u n c t i o n i s performed by the u n i t t r u s t . F. Mortgage Investment C o r p o r a t i o n s The F e d e r a l Government of Canada has proposed t o amend the Income Tax A c t by a d d i n g s e c t i o n 130.1 to p r o v i d e f o r Mortgage Investment C o r p o r a t i o n s . A d e t a i l e d d e f i n i t i o i s proposed w h i c h w i l l l i m i t the scope of the p r o v i s i o n s to c o r p o r a t i o n s the b u l k o f t h e i i n v e s t m e n t s o f w h i c h c o n s i s t o f mortgages o v e r r e a l estate.3**** I n p a r t i c u l a r , i t must b a " p u b l i c c o r p o r a t i o n 1 * and a "Canadian C o r p o r a t i o n " " * 6 ^ and i t s o n l y u n d e r t a k i n g must be the " i n v e s t m e n t of i t s f u n d s " and i t must not "manage o r d e v e l o p any r e a l p r o p e r t y " " * 6 6 a n d i i t must have a t l e a s t 100 s h a r e h o l d e r s , n n o n e o f whom h o l d more than 25% o f i t s i s s u e d s h a r e s . 3 6 7 138 The c o r p o r a t i o n pays no Income Tax on c a p i t a l g a i n s a c c r u i n g t o i t i n a y e a r t o the e x t e n t t h a t they a r e p a i d out t o s h a r e h o l d e r s as c a p i t a l d i v i d e n d s w i t h i n the p e r i o d commencing 91 days a f t e r the b e g i n n i n g o f the y e a r and e n d i n g 90 a f t e r the end o f i t . There a r e s i m i l a r p r o v i s i o n s a l l o w i n g the c o r p o r a t i o n t o deduct from i t s income t a x a b l e d i v i d e n d s p a i d out o f income o t h e r than cap- i t a l g a i n s . " * 6 9 Thus, p r o v i d e d the c o r p o r a t i o n s d i s t r i b u t e s a l l i t s income and c a p i t a l g a i n s w i t h i n the r e q u i s i t e p e r i o d , o n l y the s h a r e h o l d e r s w i l l be t a x e d on the c o r p o r a t e e a r n i n g s . G. I n s u r a n c e Companies I n b o t h c o u n t r i e s i n s u r a n c e companies a r e l i a b l e f o r Income o r C o r p o r a t i o n Tax (as the case may b e ) , j u s t as a r e o t h e r companies. However, because o f the p e e u l i a r n a t u r e o f t h e i r b u s i n e s s and, i n p a r t i c u l a r , t h e i r d u a l r o l e s as i n s u r e r ^ w i t h i t s consequent l o n g term c o n t i n g e n t l i a b i l i t i e s , w h i c h must be p r o v i d e d f o r with s u f f i c i e n t r e s e r v e s ) and i n - vestment medium, s p e c i a l r u l e s a r e r e q u i r e d w h i c h must be c o n s i d e r e d . T h i s a p p l i e s c h i e f l y t o l i f e i n s u r a n c e c o r p o r - a t i o n s . S e c t i o n 138(1) of the Canadian A c t deems c e r t a i n 370 t y p e s o f i n s u r a n c e companies t o be c a r r y i n g on an i n s u r - ance b u s i n e s s f o r p r o f i t and p r o v i d e s t h a t t h e i r income from t h a t b u s i n e s s s h a l l be computed i n the same manner as f o r 139 o t h e r c o r p o r a t i o n s , except t h a t i t s income from such bus- i n e s s i s deemed t o i n c l u d e income from p r o p e r t y and t a x a b l e c a p i t a l g a i n s . T h i s g e n e r a l r u l e i s m o d i f i e d i n s e v e r a l r e s p e c t s i n c o n n e c t i o n w i t h l i f e i n s u r a n c e c o r p o r a t i o n s . I n the f i r s t p l a c e , the income of a l i f e i n s u r a n c e company c a r r y i n g on b u s i n e s s i n Canada i s l i m i t e d t o i t s income from c a r r y i n g on such b u s i n e s s and, i n p a r t i c u l a r , i t i n c l u d e s income and c a p i t a l g a i n s a r i s i n g from p r o p e r t y "used by i t i n the y e a r i n , o r h e l d by i t i n the y e a r i n the 371 c o u r s e o f , c a r r y i n g on" such b u s i n e s s " . Income from such b u s i n e s s c a r r i e d on abraad and income and c a p i t a l g a i n s a r i s i n g from p r o p e r t y used i n such b u s i n e s s i s e x c l u d e d . I n the second p l a c e , i n computing the c o r p o r a t i o n ' s income, t h e r e may be deducted v a r i o u s amounts s e t out i n the 372 A c t as r e s e r v e s i n c o n n e c t i o n w i t h i t s c u r r e n t p o l i c i e s . F i n a l l y , the f u l l amount o f g a i n s and l o s s e s a r i s i n g from the d i s p o s i t i o n of "Canada S e c u r i t i e s " a r e t a k e n account o f i n computing income of a l i f e i n s u r a n c e c o r p o r - 373 a t i o n . A "Canada S e c u r i t y i s d d e f i n e d i n s e c t i o n . 1 3 8 ( 1 2 ) (c) as a "bond, d e b e n t u r e , mortgage, hypothec o r agreement of s a l e t h a t i s non-segregated p r o p e r t y used by i t i n , o r h e l d by i t i n the c o u r s e o f c a r r y i n g on i t s l i f e i n s u r a n c e b u s i n e s s i n Canada". I n a d d i t i o n , theaamount o f any d i s - c o u n t r e c e i v e d o r premium p a i d on the purchase o f such a s e c u r i t y i s r e s p e c t i v e l y added to and d educted from i t s income a t the d a t e of purchase 3 7'*' and the p r i n c i p a l amount of the s e c u r i t y forms i t s c o s t f o r the purpose of computing 375 any g a i n o r l o s s on a subsequent s a l e . ^ The A c t g i v e s the l i f e i n s u r a n c e company the o p p o r t u n i t y t o compete w i t h the i n v e s t m e n t i n s t i t u t i o n s d e s c r i b e d p r e v i o u s l y 3 7 * * by p e r m i t t i n g them t o s e t a s i d e r e s e r v e s i n c o n n e c t i o n w i t h l i f e p o l i c i e s w h i c h " v a r y i n amount depending upon the f a i r market v a l u e o f a s p e c i f i e d group of a s s e t s " and such r e s e r v e s a r e termed " s e g r e g a t e d 377 funds". Any income o r c a p i t a l g a i n a c c r u i n g to t h e f u n d i s t r e a t e d as income o r c a p i t a l g a i n a c c r u i n g to the p o l i c y - h o l d e r , i f so a l l o c a t e d t o him by t h e c o r p o r a t i o n , and i s not i n c l u d e d i n the c o r p o r a t i o n ' s i n c o m e . 3 7 8 There i s no d o u b l e t a x a t i o n o f such income, as i t i s not i n c l u d e d i n the p o l i c y h o l d e r ' s income when i t i s a c t u a l l y p a i d o u t . 3 7 9 T h i s c o n t r a s t s w i t h the i n c l u s i o n i n the p o l i c y h o l d e r s ' income of payments made t o them by the c o r p o r a t i o n o t h e r w i s e t h a n out o f a s e g r e g a t e d f u n d to the e x t e n t such payments exceed the 3 80 c o s t t o the r e c i p i e n t o f the p o l i c y . However, even h e r e , to the e x t e n t t h a t such sums a r e p a y a b l e out o f p o l i c y r e s e r v e s o r c o n s i s t o f d i v i d e n d s , b o t h o f w h i c h a r e d e d u c t - i b l e i n computing the c o r p o r a t i o n ' s Income, t h e s e sums a l s o w i l l o n l y be t a x e d once i n t t h e hands of p o l i c y h o l d e r s . 3 8 1 I t was to c o u n t e r a c t the t a x d e f e r r a l advantage 141 o b t a i n e d from such payments o n l y b e i n g t a x a b l e when p a i d to p o l i c y h o l d e r s t h a t a 1 5 % t a x on " t a x a b l e Canadian l i f e i n v e s t m e n t income" o f a l i f e i n s u r a n c e c o r p o r a t i o n has been 382 imposed. T h i s o n l y a p p l i e s t o in v e s t m e n t income w h i c h has not borne normal Income Tax, i . e . i t w i l l a p p l y t o the amounts deducted from the c o r p o r a t i o n ' s income i n r e s p e c t of p o l i c y r e s e r v e s and d i v i d e n d s . However, the term " t a x a b l e Canadian l i f e i n v e s t m e n t Income" does not i n c l u d e c a p i t a l g a i n s , e xcept t h o s e a r i s i n g from the d i s p o s i t i o n o f Canada s e c u r i t i e s , b u t i s o b t a i n e d by d e d u c t i n g v a r i o u s amounts from the c o r p o r a t i o n ' s i n v e s t m e n t income and, i n p a r t i c u l a r , 384 such, income as i s a t t r i b u t a b l e t o s e g r e g a t e d funds and payments made to p o l i c y h o l d e r s i n r e s p e c t o f t h e i r p o l i c i e s i n so f a r as such payments a r e i n c l u d e d i n i n c o m e . 3 8 ^ The l a t t e r two d e d u c t i o n s f o l l o w from the purpose o f the s p e c i a l t a x t o a t t a c k o n l y t h a t income, i n r e s p e c t o f w h i c h t h e r e would o t h e r w i s e be a t a x d e f e r r a l . I n the U.K., t h e law aims a t the same p o l i c y o f a v o i d i n g the d o u b l e t a x a t i o n of c a p i t a l g a i n s a c c r u i n g t o the l i f e i n s u r a n c e c o r p o r a t i o n , b o t h i n the hands o f the c o r p o r a t i o n and i n the hands o f p o l i c y h o l d e r s , but whereas the Canadian law t o a l a r g e e x t e n t t a x e s the p o l i c y h o l d e r r a t h e r t h a n the c o r p o r a t i o n , i n the U.K. the c o r p o r a t i o n b e a r s the main burden. I n s u r a n c e companies g e n e r a l l y a r e s u b j e c t t o 1̂ 2 Corporation Tax as are other companies but. as i n Canada, there are special rules f o r l i f e insurance corporations. The Crown has the option to tax l i f e insurance corpor- ations either on the i r income from investments plus c a p i t a l 387 gains a f t e r deduction of management expenses, but with no deductions i n respect of policy l i a b i l i t i e s , or on t h e i r trading p r o f i t s as calculated under normal Income Tax rules, with f u l l deductions being allowed f o r policy reserves and with a deduction of so much of these p r o f i t s as "belongs or i s allocated to, or i s reserved f o r , or expended on behalf 388 of, policyholders'*. The crown w i l l i n most cases opt for the former a l t e r n a t i v e , on the grounds that the assessment on that basis i s usually larger and i s simpler to cal c u l a t e . Up to the 6th A p r i l 1973, where a company carrying on l i f e insurance business had c a p i t a l gains a r i s i n g from the disposal of "investments held i n connection with i t s l i f e insurance business" the tax payable on such part of those gains "belongs or i s allocated to, or i s reserved f o r , or expended on behalf of policyholders" was at a rate equal to that payable by indi v i d u a l s , i . e . at present 30%. 3 8 9 A sim i l a r right existed i n respect of other income which re- 390 duced the tax rate to 37.5%. As payments made to a p o l i c y holder i n respect of th e i r p o l i c i e s do not cause a disposal 391 of those p o l i c i e s f o r Capital Gains Tax purposes and are not otherwise included i n his income, no more tax w i l l i n \ general be paid on c a p i t a l gains and other income so d i s t r i b u t e d than i f i t had accrued to the policyholders d i r e c t . 3 9 2 As from the 6th A p r i l 1973 the reduced rate f o r c a p i t a l gains i s abolished, but i t continues f o r other income. However, because of the general provisions i n t r o - duced by the F.A. 1972, which reduce by a f r a c t i o n c a p i t a l gains accruing to a l l companies, 3 9 3 the e f f e c t i v e tax pos- i t i o n remains the same. The U.K. Act also relieves the l i f e insurance company from l i a b i l i t y i n respect of i t s income from carrying on i t s business-abroad. There i s exempted from Corporation Tax by section 315 of the I.C.T.A. 1970 a l l income and c a p i t a l gains a r i s i n g from assets which form i t s 3 9 k "foreign l i f e assurance funds", which i s the reserve of the company fo r i t s foreign l i f e assurance business. It may happen that a l i f e insurance company w i l l , under the terms of a l i f e insurance policy, transfer invest- ments or other assets to the p o l i c y holder instead of making a cash payment. In this case, there i s undoubtedly a d i s - position by the company of the assets transferred^ 9 5 a n < i the only question which arises i s as to the proceeds of dispos- i t i o n of the company and the a c q u i s i t i o n cost of the recip- ient policyholder. This problem i s solved i n the U.K. by section 321 of the I.C.T.A. 1970, which deems the company's disposal and the p o l i c y h o l d e r s a c q u i s i t i o n cost to equal the market value of the assets transferred. There i s no express Canadian provision, so that i t must be assumed that, 396 unless the parties do not deal at arms length, ' the pro- ceeds and the a c q u i s i t i o n cost w i l l equal the value of the right given up by the shareholder i n order to receive the assets i n specie, as being the actual cost of the p o l i c y - holder and the value of the benefit gained by the company. On the other hand, i f the value of the property received has been included i n the policyholder's income as proceeds 397 of d i s p o s i t i o n of his policy under section l 4 8(I)(a), then this value w i l l apparently form the a c q u i s i t i o n cost, by virtue of section 52(1) of the Act, which requires the addition to the cost of any asset of any part of i t s value included i n i t s owner's income. 1*5 P a r t 6 - C o n c l u s i o n The f i r s t two p a r t s of t h i s c h a p t e r e x p l o r e d the g e n e r a l l i a b i l i t y o f c o r p o r a t i o n s and s h a r e h o l d e r s i n r e s p e c t o f c a p i t a l g a i n s r e a l i s e d by them and the r u l e s f o r computing those g a i n s . They show t h a t t h e r e i s l i t t l e i n the way o f a s i g n i f i c a n t d i f f e r e n c e i n the t r e a t m e n t o f d i f f e r e n t t a x - payers and d i f f e r e n t a s s e t s . B o t h systems impose a l i g h t e r l i a b i l i t y on n o n - r e s i d e n t t a x p a y e r s , b u t t h i s i s e x p e c t e d . Indeed, the l i a b i l i t y imposed on n o n - r e s i d e n t s by the Can- a d i a n A c t i s much h e a v i e r than the c o r r e s p o n d i n g U.K. l i a b - i l i t y and has been the s u b j e c t o f much c r i t i c i s m . F u r t h e r , a l t h o u g h t h e r e a r e d i f f e r e n t c o m p u t a t i o n r u l e s i n b o t h systems f o r s h a r e s and s e c u r i t i e s , t h e s e d i f f e r e n c e s appear to be o f a more p r o c e d u r a l than s u b s t a n t i a l n a t u r e . Thus an i n d i v i d u a l w i l l g e n e r a l l y be l i a b l e t o tax i n the same c i r c u m s t a n c e s as a c o r p o r a t i o n would be and a member's shares a r e i n s u b s t a n c e t r e a t e d as o t h e r c a p i t a l a s s e t s . R e a l d i f f e r e n c e s a r e found i n t h e P a r t 3 d i s c u s s i o n o f the t r e a t m e n t of c a p i t a l g a i n s and l o s s e s . There a r e , to b e g i n w i t h , some d i f f e r e n c e s i n the r i g h t s g i v e n t o d i f f e r e n t t a x p a y e r s t o s e t o f f t h e i r l o s s e s , b u t more i m p o r t a n t i s the low r a t e o f t a x p a i d by a l l t a x p a y e r s on c a p i t a l g a i n s as compared w i t h o t h e r income and the f l a t r a t e o f c o r p o r a t e t a x , w h i c h may exceed o r be exceeded by the i n d i v i d u a l r a t e s o f s h a r e h o l d e r s . The l a t t e r may, depending on the s i t u a t i o n , 1 4 6 e i t h e r d i s c o u r a g e i n d i v i d u a l s from h o l d i n g a s s e t s v i t h i n a c o r p o r a t i o n o r encourage them to do so. The f o r m e r f a c t o r i n d u c e s t a x p a y e r s and p a r t i c u l a r l y s h a r e h o l d e r s t o o b t a i n t h e i r r e c e i p t s i n a form w h i c h w i l l produce a c a p i t a l g a i n and not o r d i n a r y income. These two f a c t o r s a r e o f prime i m p o r t a n c e f o r theppurposes o f the d i s c u s s i o n s i n the f o l l o w i n g two c h a p t e r s on c o r p o r a t e d i s t r i b u t i o n s and a c c u m u l a t i o n s . The p p o v i s i o n s d i s c u s s e d i n P a r t 4 r e v o l v e around the same problems and p r i n c i p l e s as those c o n s i d e r e d i n Chapter One. I n the l a t t e r c a s e , the c o n c e r n was f o r the a c q u i s i t i o n c o s t t o the s h a r e h o l d e r of shares and o t h e r pro- p e r t y r e c e i v e d fromaa c o r p o r a t i o n i n r e t u r n f o r a t r a n s f e r o f a s s e t s and the degree o f r e c o g n i t i o n o f c a p i t a l g a i n s r e s u l t i n g from the t r a n s f e r , w h i l e , i n the f o r m e r c a s e , i t i s the t a x p o s i t i o n o f a c o r p o r a t i o n i s s u i n g s h a r e s and t r a n s f e r r i n g a s s e t s t o a n o t h e r c o r p o r a t i o n o r i n d i v i d u a l , w i t h w h i c h o r whom i t i s c l o s e l y a s s o c i a t e d , t h a t i s d e a l t w i t h . There a r e i n each case a n t i - a v o i d a n c e p r o v i s i o n s and t a x r e l i e v i n g p r o v i s i o n s , w h i c h i n e f f e c t b r e a c h the c o r p o r - a t e v e i l and r e c o g n i z e the e s s e n t i a l i d e n t i t y o f t r a n s f e r o r and t r a n s f e r e e . I t has a l r e a d y been noted how the Canadian system, by s i m p l y a p p l y i n g the same p r o v i s i o n t o c o r p o r a t i o n s as a p p l i e s t o i n d i v i d u a l s , f a i l s , i n most s i t u a t i o n s , t o g i v e r e l i e f t o c o r p o r a t i o n s i n r e s p e c t o f g a i n s a r i s i n g from d i s - 1*7 p o s i t i o n s t o o t h e r c o r p o r a t i o n s w h i c h a r e under the same c o n t r o l as them and how b o t h systems f a i l t o r e l i e v e c o r p o r a t i o n s when t r a n s f e r i n g a s s e t s t o t h e i r c o n t r o l l i n g i n d i v i d u a l s h a r e h o l d e r s . The i n s t i t u t i o n s d e s c r i b e d i n the l a s t p a r t o f the c h a p t e r a r e c o r p o r a t i o n s and t r u s t s w h i c h , t o the e x t e n t t h a t s t a t u t e does not o t h e r w i s e p r o v i d e , a r e t r e a t e d as any o t h e r c o r p o r a t i o n s o r t r u s t s . However, by s a t i s f y i n g c e r t a i n con- d i t i o n s r e s t r i c t i n g t h e i r a c t i v i t i e s and powers and p r o - t e c t i n g t h e i r members, th e y q u a l i f y f o r s p e c i a l t a x advant- ages. A l t h o u g h most o f t h e s e o n l y t a k e e f f e c t when d i s - t r i b u t i o n s a r e made, so t h a t they come w i t h i n the scope of the next c h a p t e r , some, e.g. low r a t e s o f t a x p a i d on c a p i t a l g a i n s by U.K. i n v e s t m e n t t r u s t s and a u t h o r i s e d u n i t t r u s t s , a r e o f d i r e c t r e l e v a n c e t o t h i s c h a p t e r . Moreover, even a t t h i s s t a g e , i t can be seen how the U.K. t r e a t m e n t o f u n i t t r u s t s l e a v e s v e r y l i t t l e scope f o r the o p e r a t i o n of the o r d i n a r y t r u s t r u l e s , by t r e a t i n g them as c o r p o r a t i o n s f o r many p u r p o s e s . I n Canada, t h e r e i s no such e x p r e s s p r o v i s i o n , b u t the t r e a t m e n t o f t r u s t s g e n e r a l l y tends t o w a r d s t t h a t o f c o r p o r a t i o n s and t h i s i s s t i l l more pronounced i n the c a s e o f u n i t and m utual f u n d t r u s t s . 14 8 NOTES 1 T h i s i s s p e a k i n g l o o s e l y , as s t r i c t l y s p e a k i n g a s h a r e - h o l d e r has no l e g a l o r e q u i t a b l e i n t e r e s t i n c o r p o r a t e p r o p e r t y . 2 T h i s r e f e r s to s h a r e s o b t a i n e d by purchase o r sub- s c r i p t i o n f o r c a s h and t o s h a r e s o b t a i n e d i n r e t u r n f o r a t r a n s f e r o f p r o p e r t y . 3 I n f a c t , s h a r e s may a l s o form p a r t o f a c o r p o r a t i o n ' s a s s e t s . 4 There a r e , i n the U.K., c e r t a i n a n t i - a v o i d a n c e p r o v i s i o n s w h i c h can make s h a r e h o l d e r s l i a b l e f o r what i s t h e i r c o r p o r a t i o n ' s p r i m a r y l i a b i l i t y t o pay C o r p o r a t i o n Tax on c a p i t a l g a i n s - see t e x t a t nn. 42-52 i n f r a . 5 For i n s t a n c e , the d i s a l l o w a n c e o f c a p i t a l l o s s e s i n Canada r e s u l t i n g from a d e c l i n e i n the v a l u e o f p e r s o n a l use p r o p e r t y h e l d by the c o r p o r a t i o n - see t e x t a t nn. 130-134 i n f r a . 6 Examples o f thes e companies a r e in v e s t m e n t c o r p o r a t i o n s and t r u s t s and mutual f u n d c o r p o r a t i o n s . 7 S. 249(1) 8 S. 20(1) F.A. 1965 9 See s. 115(D-(2) I.C.T.A. 1970, as an example, w h i c h p r o v i d e s f o r t a x on b u s i n e s s income i n the U.K. b e i n g p a i d on income a r i s i n g i n the a c c o u n t i n g p e r i o d o f the b u s i n e s s e n d i n g i n the p r i o r y e a r o f assessment. 10 T h u s ? o i n Canada, b u s i n e s s income o f an i n d i v i d u a l i s ta x e d on the b a s i s o f income earned i n the f i s c a l p e r i o d ( f o r a d e f i n i t i o n o f t h i s see s. 248(1))ending i n each t a x a t i o n y e a r - S. 11(1) 11 S. 249(1) and s. 248(1) i n Canada and 247(1) I.C.T.A. 1970 i n the U.K. 12 See n. 11 supra 13 See n. 11 supra 14 S. 2(1) and s. 248(1) 15 S. 19(1) and s. 20(1) F.A. 1965 149 16 S. 238(1) and (3) I.C.T.A. 1970 17 S. 238(4) I.C.T.A. 1970 18 S. 265 I.C.T.A. 1970 19 S. 250 I.C.T.A. 1970 20 C o r p o r a t i o n s a r e e x p r e s s l y e x c l u d e d from the b e n e f i t of the s e c t i o n by s. 265(3) I.C.T.A. 1970 21 s . 45(6) F.A. 1965 22 For a d i s c u s s i o n of the problems s u r r o u n d i n g t h i s p r o - v i s i o n see G. W h e a t c r o f t and A. P a r k C a p i t a l G a i n s Taxes p a r a s . 4-08 & 9 and 22-08 t o 22-10. 23 I n the U.K., t h e r e may be a t a x f r e e r o l l - o v e r o f a s s e t s i n t o the c o r p o r a t i o n f o r an i n d i v i d u a l . I n Canada, i n no c a s e w i l l t h i s be so — see P a r t 3 o f Chapter One. 24 S. 4 l F.A. 1965 i n the U.K. and s. 91 i n Canada - see P a r t l l o f Chapter Four S e c t i o n s B and C. 25 S. 39(1) F.A. 1965, s. 498 I.C.T.A. 1970 and s. 100 F.A. 1972 i n the U.K. and s. 126 i n Canada. 26 S. 126(7)(c) 27 CCH Canadian L t d . E x p l a n a t i o n o f Canadian Tax Reform (1972) 327 2 8 S. 115(1 )tb$ 29 For the d e f i n i t i o n o f " p u b l i c c o r p o r a t i o n " see the C o n c l u s i o n t o Chapter Three ( t e x t a t nn. 281-92) 30 J . H a l l e y I n t e r n a t i o n a l Income - Canadian B a r Papers on Tax Reform 1971 243 a t 250. 31 S. 116(5) 32 There i s some d i f f i c u l t y i n d e t e r m i n i n g what c o n s t i t u t e s r e a s o n a b l e e n q u i r y under the s e c t i o n - P. Walker A c q u i s i t i o n s from N o n - r e s i d e n t s : S e c t i o n 116 ^20 C a n a d i a n Tax J o u r n a l 131 a t 135-6 (1972). See g e n e r a l l y the same a r t i c l e f o r a d i s c u s s i o n of o t h e r problems s u r r o u n d i n g the s e c t i o n . F or the Government's view as to what con- s t i t u t e s r e a s o n a b l e e n q u i r y and f o r an a c c o u n t o f the p r o - cedure t o be gone t h r o u g h under the s e c t i o n , see Inform- a t i o n C i r c u l a r 72-17 i s s u e d on the 10th J u l y 1972~ 1 150 33 S. Il6(6) was added by s. 38 (5 ) 1973 B i l l C-170. 34 The r e f e r e n c e t o bonds and d e b e n t u r e s i s odd, s e e i n g as thes e a r e not e x p r e s s l y i n c l u d e d i n the l i s t of t a x a b l e Canadian p r o p e r t y . 35 S. 246(2)(b) I.C.T.A. 1970 36 G. W h e a t c r o f t and A. Park supra n. 22 a t p a r a s . 22-03 &4 37 A r t i c l e 12(3) o f the Agreement 38 A r t i c l e s 12(1) and 12(2) o f the Agreement. Immoveable p r o p e r t y i s d e f i n e d i n a r t i c l e 5(2) and permanent e s t a b - l i s h m e n t i n a r t i c l e 4. E x c l u d e d from moveable p r o p e r t y a r e s h i p s , a i r c r a f t and moveable p r o p e r t y p e r t a i n i n g to them. 39 See a r t i c l e 8 o f the Canada - U.S.A. Agreement as a n o t h e r example. 40 Even i f the t a x p a y e r h e l d such a s s e t s p e r s o n a l l y , he would be t a x a b l e on any g a i n s - see p r e c e d i n g d i s c u s s i o n . 41 See t e x t a t nn. 29-30 s u p r a . 42 For the meaning of " c a p i t a l d i s t r i b u t i o n " see p a r a . 3 s c h - 7 F.A. 1965 and P a r t 1 o f Chapter Three S e c t i o n D ( t e x t a t nn. 98-9) - s. 266(5) I.CT . A . 1970. 43 I.e. on a w i n d i n g up. 44 S. 266(4) I.C.T.A. 1970 45 S. 266(3) I.C.T.A. 1970 46 P a r a . 19(4) p r o v i d e s t h a t r e f e r e n c e s t o a g i f t i n c l u d e r e f e r e n c e s t t o any t r a n s a c t i o n o t h e r w i s e than by way o f a b a r g a i n made a t arms l e n g t h so f a r as money o r money's w o r t h passes under the t r a n s a c t i o n w i t h o u t f u l l c o n s i d e r - a t i o n i n money o r money's w o r t h . F or the n a t u r e o f a non-arms l e n g t h b a r g a i n see P a r t 2 o f C h a p t e r One ( t e x t a t nn. 25-31) and t e x t a t n. 207 i n f r a . 47 See n. 46 s u p r a . 48 See P a r t 4 of t h i s c h a p t e r S e c t i o n B. 49 For the d e f i n i t i o n o f "group o f companies" see s. 272 and t e x t a t nn. 226-31 i n f r a . 15i 50 S. 277(2) I.C.T.A. 1970 51 S . 278(5) I.C.T.A. 1970 - see t e x t a t nn. 244-6 i n f r a . 52 S . 279{b) I.C.T.A. 1970 - see t e x t a t nn. 247-8 i n f r a . 53 " D i s p o s i t i o n " and "proceeds o f d i s p o s i t i o n " have t h e i r o r d i n a r y meaning, but a r e p a r t i a l l y d e f i n e d i n s. 54(c) and s. 54(h) r e s p e c t i v e l y . 54 " A d j u s t e d c o s t b a s e " i s d e f i n e d i n s. 5*Ma) and see s. 53 f o r a d j u s t m e n t s t o the a d j u s t e d c o s t base of non- d e p r e c i a b l e p r o p e r t y . 55 S. 19(1) F.A. 1965. " D i s p o s a l " has i t s o r d i n a r y meaning, but i s p a r t i a l l y d e f i n e d i n s. 22(2) of the same a c t . 56 P a r a . 4 s c h . 6 F.A. 1965. 57 M i n i s t r y o f N a t i o n a l Revenue Tax Reform and You - V a l u a t i o n Day 13 58 S . 40(1)(b) i n Canada and s. 23 F.A. 1965 i n the U.K. 59 S . 3(b) 60 S. 38 61 s . 93(2) F.A. 1972 62 See t e x t a t nn. 175-6 i n f r a . 63 " V a l u a t i o n day" i s d e f i n e d i n s. 24 I.T.A.R. The p r e - s c r i b e d days a r e 22nd December 1971 f o r p u b l i c l y t r a d e d s h a r e s and s e c u r i t i e s and 31st Decemberl.1971 f o r o t h e r a s s e t s - M i n i s t r y o f N a t i o n a l Revenue Tax Reform and Your- C a p i t a l G ains 9. 64 For an e x p l a n a t i o n o f the e f f e c t o f t h i s s e c t i o n and an example o f i t s a p p l i c a t i o n , see M i n i s t r y o f N a t i o n a l Revenue, supra n. 63 a t 9-10. 65 S . 26(7) I.T.A.R. 66 S . 20(1) I.T.A.R. 67 S. 26(5) I.T.A.R. 68 These w i l l i n c l u d e d e b e n t u r e s - s. 26(12 ) ( e ) I.T.A.R. 152 69 T h i s i s d e f i n e d i n s. 26(12) (a) I.T.A.R. as the p r i n - c i p a l amount o f the o b l i g a t i o n i f purchased a t a d i s - c ount o f l e s s t h a n 5%, the a c t u a l c o s t i f purchased a t a premium l e s s t h a n 5% o r , i n any o t h e r c a s e , the p r i n c i p a l amount p l u s the p r o p o r t i o n o f the d i s c o u n t o r minus the p r o p o r t i o n of the premium w h i c h i s appor- t i o n e d to the p e r i o d p r i o r to 1972 i f the d i s c o u n t o r premium i s s p r e a d e v e n l y o v e r the l i f e span of the o b l i g a t i o n . 70 S. 24 I.T.A.R. and see n. 63 s u p r a . 71 P a r a . 23 s c h . 6 F.A. I965. 72 P a r a . 22(2) Sch. 6 F.A. 1965. 73 P a r a . 22(4) s c h . 6 F.A. 1965. 7k OEd. 75 S. 32 F.A. 1968. 76 P a r a . 1(3) s c h . 11 F.A. 1968. 77 There i s no e x c l u s i o n o f companies, as f o r 26(7) I.T.A.R. 78 See Chapter F i v e 79 P a r a . 3 s c h . 11 F.A. 1968. 80 For the meaning of a "group o f companies" see s. 222 I.C.T.A. 1970 and t e x t a t nn. 226-31 i n f r a . 81 P a r a . 2 s c h . 11. The time l i m i t f o r making the e l e c t i o n i s two y e a r s from the end o f the y e a r o f assessment o r a c c o u n t i n g p e r i o d i n w h i c h the d i s p o s a l took p l a c e - p a r a . 1(6) s c h . 11. 82 For an example o f the a p p l i c a t i o n o f the time appor- tionment f o r m u l a see G. tfheatcroft and A. P a r k , supra n. 22 a t p a r a . 21-39* 83 T h i s assumes t h a t s. 55 o f the Canadian A c t does not p r e v e n t an e l e c t i o n w h i c h would reduce a g a i n o r i n c r e a s e a l o s s - see P a r t 2 o f Chapter One (the l a s t p a r a g r a p h ) . 84 P a r a . 29 s c h . 6 F.A. 1965 85 Bonds o r d e b e n t u r e s a r e i d e n t i c a l t o o t h e r bonds o r d e b e n t u r e s i f i n each case the d e b t o r and the r i g h t s a t t a c h e d (except as t o p r i n c i p a l amount) a r e the same - s . 47(3). 153 86 S. k7(2) 87 F o r an example o f the a p p l i c a t i o n of t h e s e r u l e s , see M i n i s t r y o f N a t i o n a l Revenue, supra n. 63 a t 6. 88 These p r o v i s i o n s a l s o a p p l y t o s e c u r i t i e s ( p a r a * 2 ( 8 ) ) and t o a l l o t h e r i d e n t i c a l a s s e t s - p a r a * 2(7), 89 P a r a . 2 ( 1 ) 90 P a r a . 2 ( 2 ) . F o r an example of the o p e r a t i o n o f t h e s e p r o v i s i o n s , see G. W h e a t c r o f t and A. Park supra n. 22 a t p a r a . 12-07* 91 P a r a . 2 ( 5 ) 92 Thus, i f the d i s p o s a l would be i n b r e a c h o f a r e s t r i c t - i o n a t t a c h e d t o s h a r e s r e c e i v e d as an employee, they would come from the o t h e r s h a r e s - Simon's Taxes V o l . C P a r a . C 6 .402. 93 S. 26(3) - see t h i s p a r t o f t h i s c h a p t e r S e c t i o n B ( t e x t a t nn. 6 3 - 6 ) . 94 F o r a c c o u n t s o f the a p p l i c a t i o n o f t h e s e t r a n s i t i o n a l i d e n t i f i c a t i o n r u l e s , see I n t e r p r e t a t i o n B u l l e t i n I.T* 78 i s s u e d 3 1 s t December 1971 and M i n i s t r y o f N a t i o n a l Revenue, supra n. 63 a t 11. 95 The r u l e a l s o a p p l i e s to d e b e n t u r e s and o t h e r i d e n t i c a l a s s e t s . 96 S. 32 and s c h . 11 F.A. 1968 and p a r a s . 26 and 22 s c h . 6 F.A. 1965* 97 See Chapter F i v e . 98 See P a r t 1 o f Chapter F i v e S e c t i o n A ( t e x t a t nn. 8-11) 99 I t seems t h a t the two e x p r e s s i o n s w i l l be g i v e n the same meaning. 100 S. 44(3) 101 For example, the h o l d i n g i s w o r t h more because i t g i v e s c o n t r o l o f the company o r i s w o r t h l e s s because i t i s a m i n o r i t y h o l d i n g - G. W h e a t c r o f t and A. P a r k , supra n. 22 a t p a r a . 18-08. 102 P a r a . 22(3) s c h . 6 F.A. 1965. 154 103 S. 2 4 I.T.A.R. - see n. 63 s u p r a . 104 M i n i s t r y o f N a t i o n a l Revenue, supra n. 63 a t 14 105 p-91*8j| 2 A.E. 3 7 9 . 106 At 38**. 107 G. W h e a t c r o f t and A. P a r k , supra n. 22 a t p a r a . 18 -12 i n t he UVK. a n d , i n Canada, G. Ovens and I . Campbell Notes on P r i c e and Value Problems i n Canada 18 Canadian Tax J o u r n a l 2 0 6 (1970) and G. Ovens P r e l i m i n a r y Notes on Canadian P r i c e and Value Problems R e s u l t i n g from Tax Reform 19 Canadian Tax J o u r n a l 401 ( 1 9 7 1 ) . 108 Untermeyer E s t a t e v A.G. o f B.C. ( l 9 2 9 J S.C.R. 84 109 For a c c o u n t s o f t h e s e p r i n c i p l e s see G. W h e a t c r o f t and A. P a r k , supra n. 22 a t p a r a s . 18 - 1 2 t o 18 - 1 5 , K. C a r m i c h a e l Share V a l u a t i o n - R e a l o r H y p o t h e t i c a l 1971 B r i t i s h Tax Review 3 4 9 , G. Ovens and I . Ca m p b e l l , supra n. 107 and G. Ovens, supra n. 107* 110 I . e . s. 4 4 ( 3 ) and P a r a . 2 2 ( 3 ) s c h . 6 F.A. 1965 i n the U.K. and s. 2 6 ( 1 1 ) I.T . A . . % i n Canada. 111 M i n i s t r y o f N a t i o n a l Revenue, supra n. 63 a t l 4 and G. Ovens, supra n. 107 a t 402 - 3 and 4 0 6 . 112 G. Ovens and I . Campbell, supra n. 1 0 7 a t 2 1 3 - 4 and G. W h e a t c r o f t and A. P a r k , supra n. 22 a t p a r a . 18-15. 113 G. Ovens, supra n. 107 a t 4 0 3 . 114 M i n i s t r y o f N a t i o n a l Revenue, supra n. 63 a t l 4 . 115 G. Ovens and I . Campb e l l , supra n. 107 a t 208 - 1 0 and 2 1 3 - 4 . 116 S. 3 ( b ) i n Canada and s. 2 0 ( 4 ) F.A. 1965 and s. 2 6 5 I.C.T.A. 1970 i n the U.K. 117 S. l l l ( l ) ( b ) i n Canada and s. 2 0 ( 4 ) F.A. 1965 and s. 2 6 5 I.C.T.A. 1970 i n the U.K. 118 s. 1 7 7 ( 2 ) , s. 248 and s. 3 0 4 - 5 I.C.T.A. 1970 and s. 74 C a p i t a l A l l o w a n c e s A c t 1968 - see t e x t a t nn. 139-41 i n f r a . 119 S. l l l ( l ) ( b ) ( i ) 155 120 S. l l l ( l ) ( b ) 121 S. 3(e) and s. I l l ( 1 ) ( b ) ( i i ) 122 "Control" i s not d e f i n e d by s t a t u t e and so w i l l have i t s j u d i c i a l l y d e t e r m i n e d meaning - see C h a p t e r One P a r t 2 ( t e x t a t n. 29). 123 see E. M o c k l e r B u s i n e s s and P r o p e r t y Income 1971 Con- f e r e n c e Report Canadian Tax F o u n d a t i o n 382 a t 386, where i t i s p o i n t e d out how b r o a d i s the e f f e c t o f the r e s t r i c t i o n , i n t h a t the t r a n s m i s s i o n on d e a t h of s h a r e s amounting t o a c o n t r o l l i n g i n t e r e s t w i l l cause acchange of c o n t r o l . 124 s. 483 I.C.T.A. 1970. 125 See t h i s p a r t o f t h i s c h a p t e r S e c t i o n B. 126 P. Whiteman Fundamental D e f e c t s o f the C a p i t a l G a i n s S t r u c t u r e 1970 B r i t i s h Tax Review 461. A f o r t i o r i , the same arguments a r e r e l e v a n t t o the p o s i t i o n o f the U.K. i n d i v i d u a l , who cannot even deduct n o n - c a p i t a l l o s s e s from c a p i t a l g a i n s . 127 Honourable E. Benson, M i n i s t e r o f F i n a n c e Summary of 1971 Tax Reform L e g i s l a t i o n 30. 128 L. S e l t z e r The Nature and Tax Treatment o f C a p i t a l G a i n s and L o s s e s 106-7 and 112-115. 129 See t h i s p a r t o f t h i s c h a p t e r S e c t i o n D. 130. S. 4 0 ( 2 ) ( g ) ( i i i ) . P e r s o n a l use p r o p e r t y i s g i v e n a l e n g t h y d e f i n i t i o n i n s. 5 4 ( f ) , b u t b a s i c a l l y means p r o p e r t y owned by a t a x p a y e r w h i c h i s u s e d p p r i m a r i l y f o r h i s p e r s o n a l use and enjoyment. 131 S. 3 9 ( l ) ( b ) ( i ) 132 S. 27(1) F.A. 1965 133 P a r a . 6 s c h . 6 F.A. 1965. The d i s a l l o w a n c e i s o n l y to the e x t e n t o f c a p i t a l a l l o w a n c e s r e c e i v e d . 134 For an a c c o u n t of s. 55 see P a r t 2 o f C hapter One ( l a s t p a r a g r a p h ) . 135 S. 3. 136 S. l l l ( l ) ( a ) and s. l l l ( 8 ) ( b ) . 156 137 S. 111(5) 138 S. 21 F.A. 1965 - see t e x t a t nn. 170-171 i n f r a . However, even h e r e , t r a d i n g l o s s e s cannot be s e t a g a i n s t c a p i t a l g a i n s - s. 21(2) ( a ) . 139 S. 238 (4) I.C.T.A. 1970. 140 I n t h i s c o n n e c t i o n , see s. 251(2) and (3), w h i c h l i m i t s the i n t e r e s t and o t h e r payments w h i c h a r e o t h e r w i s e d e d u c t i b l e i n computing income from any s o u r c e . 141 S. 248(2)(3)(5)(6)(8). See a l s o s. 74 o f t h e C a p i t a l A l l o w a n c e s A c t 1968, w h i c h a l l o w s d e p r e c i a t i o n a l l o w a n c e s to be deducted from " p r o f i t s " , i n so f a r as they exceed the income o f the t r a d e i n w h i c h the a s s e t i n q u e s t i o n i s used and s. 304-305 I.C.T.A. 1970, w h i c h a l l o w , i n the c a s e o f c e r t a i n i n v e s t m e n t and i n s u r a n c e companies and u n i t t r u s t s , the d e d u c t i o n o f expenses o f manage- ment from " t o t a l p r o f i t s " . 142 T r u s t s a r e e x p r e s s l y e x c l u d e d by s. 48(1) from the b e n e f i t o f the exemption. 143 For a f u l l e r a c count o f s. 48, see t e x t a t nn. 264-9 i n f r a . 144 S. 91(2) - see P a r t 1 o f Chapter Four S e c t i o n C ( t e x t a t nn. 78). 145 S. 34(2)&(6) 146 A " f a m i l y company" i s d e f i n e d as one i n w h i c h the t a x - payer w n s 25% o f the v o t i n g r i g h t s o r one as to w h i c h 75% o f the v o t i n g r i g h t s a r e e x e r c i s a b l e by the member and h i s f a m i l y and \Q% a r e e x e r c i s a b l e p e r s o n a l l y - S. 34(6). " F a m i l y " i s a l s o d e f i n e d i n the s e c t i o n . 147 S. 3 4 ( l ) ( b ) 148 See n. 145 s u p r a . 149 S. 34(3) 150 P a r a . 2(1) s c h . 10 F.A. 1966. 151 P a r a . 2(3) s c h . 10 F.A. 1966. 152 S. 38 - see P a r t 2 o f t h i s c h a p t e r S e c t i o n A ( t e x t a t nn. 58-60). 157 153 S. 117. Note that there are income averaging pro- v i s i o n s i n s. 118. and s. 6 l , which aim at e l i m i n a t i n g the more harsh r e s u l t s of the progressive system and personal allowances contained i n s. 109 and s. 110, n e i t h e r of which are a v a i l a b l e to c o r p o r a t i o n s . Note a l s o that the personal r a t e s have been reduced and the allowances increased as a r e s u l t of the 1973 budget (now 1973 B i l l C-193), 15.4 In B.C. the r a t e i s 30.5% - s. 4(3) (g). Income Tax Act. 155 Thus the maximum rat e i n B.C. i s 6l.335%. 156 S. 123. Under S.C. 1972 c. 9, s. 123.1 was added to the Act to provide that the tax otherwise payable by a c o r p o r a t i o n f o r i t s 1972 tax year and f o r so much- of i t s 1973 tax year as f a l l s w i t h i n 1972 i s reduced by 7%. Although i t was proposed i n the 1973 budget (now B i l l 1973 C-192) to reduce c o r p o r a t i o n taxes on manufacturing and processing p r o f i t s , t h i s w i l l not a f f e c t c a p i t a l g a ins. 157 S. 124. Each province imposes a tax on corporate income, which i n B.C. i s 10% f o r 1972 (S. 5(1) Income Tax Act) and which brings the o v e r a l l corporate r a t e back up to 50%. For 1973 the B.C. r a t e i s 12%. 158 For the years f o l l o w i n g 1972 the b a s i c corporate r a t e of 50% i s reduced by 1% per year, u n t i l i t reaches 46% i n 1976 - S. 123. 159 S. 129 - see part 2 of Chapter Three S e c t i o n B. Note a l s o the various refunds given to and low rates of tax paid by the various investment i n s t i t u t i o n s described i n Part 5 of t h i s chapter. 160 S. 20(3) F.A. 1965. 161 S. 62 F.A. 1972 162 S. 66 F.A. 1972 163 S. 3 I.C.T.A. 1970 164 S. 3 2 ( l ) ( b ) F.A. 1971 165 I d . 166 S. 63 F.A. 1972 167 S. 66(a) 1972 158 168 S. 3 2 ( l ) ( a ) F.A. 1971 169 S. 3 2 ( l ) ( a ) and s. 6 6 ( l ) ( b ) F.A. 1972 170 S. 21 (2) F.A. 1965 171 S. 21(5) F.A. 1965. The term "connected p e r s o n " i s d e f i n e d i n p a r a . 21 s c h . 7 o f the same A c t . See p a r t 2 o f Chapter One ( t e x t a t nn. 25-31) and t e x t a t n. 207 i n f r a . 172 S. 238 I.C.T.A. 1970. The term " p r o f i t s " i n c l u d e s c h a r g e a b l e g a i n s - s. 238(4). 173 S. 238 I.C.T.A. 1970. A l t h o u g h companies a r e a s s e s s e d on the p r o f i t s o f an a c c o u n t i n g p e r i o d ( s . 247), the r a t e i s f i x e d f o r F i n a n c i a l Y e a r s , so t h a t i f d i f f e r e n t r a t e s a r e f i x e d f o r a d j o i n i n g y e a r s and the a c c o u n t - i n g p e r i o d s do not c o i n c i d e w i t h them, the p r o f i t s o f the f o r m e r a r e a p p o r t i o n e d t o the l a t t e r onaa time b a s i s . - S. 243(3). 174 S. 64 F.A. 1972. T h i s A c t a l s o p r o v i d e s a low r a t e o f tax f o r c o r p o r a t i o n s whose p r o f i t s do not exceed -£25000, b u t f o r o ur p u r p o s e s , t h i s i s not i m p o r t a n t , as the low r a t e does not a p p l y t o c a p i t a l g a i n s - S e c t i o n 95. 175 See P a r t 2 o f t h i s c h a p t e r S e c t i o n A ( t e x t a t nn. 6l-2 ) 176 1972 budget speech a t 833 P a r l i a m e n t a r y Debates House of Commons (5th s e r i e s ) 1363* 177 As the c o r p o r a t e r a t e s a r e f i x e d , t h i s depends on the p a r t i c u l a r r a t e o f an i n d i v i d u a l , b u t i t appears t h a t the c o r p o r a t e r a t e i n the U.K. w i l l n e ver be l e s s than the i n d i v i d u a l r a t e . 178 Regard s h o u l d a l s o be had to s. 33 F.A. 1965, w h i c h a l l o w s a d e f e r r a l o f t a x on c a p i t a l g a i n s r e a l i s e d when b u s i n e s s a s s e t s a r e d i s p o s e d o f and r e p l a c e d By o t h e r b u s i n e s s a s s e t s . The c o s t p r i c e o f the new a s s e t i s reduced by the g a i n on the o l d a s s e t . Thus tax on g a i n s may be d e f e r r e d i n d e f i n i t e l y . 179 See Chapter Four and F i v e . 180 S. 219. C e r t a i n c o r p o r a t i o n s a r e exempt, e.g. banks, s. 219(2) 159 181 For the d e f i n i t i o n o f "Canadian c o r p o r a t i o n " see P a r t 3 o f C h a p t e r One ( t e x t a t n. 59) 182 "Taxable income* i s d e f i n e d i n s. 2 ( 2 ) and a p p l i e s t o c o r p o r a t i o n s w h i c h a r e r e s i d e n t a t any time i n the y e a r . I t i n c l u d e s a l l t a x a b l e c a p i t a l g a i n s . 183 "Taxable income earned i n Canada" i s d e f i n e d i n s. 115(1) and a p p l i e s t o c o r p o r a t i o n s r e s i d e n t throughout the y e a r . I t i n c l u d e s a l l t a x a b l e c a p i t a l g a i n s on t a x a b l e Canadian p r o p e r t y . 184 Honourable E. Benson, supra n. 127 a t 58. 185 S. 212 186 As the r a t e o f w i t h o l d i n g t a x f o r the y e a r s 1972-5 i s t o be 15%, the s p e c i a l t a x i s a l s o a t t h a t r a t e f o r t h o s e y e a r s - s. 11 I.T.A.R. 187 Thus o r d i n a r y Income Tax p a i d c a n be deducted ( s . 219 ( 1 ) ( e ) - ( f ) ) a n d a l s o an a l l o w a n c e f o r r e i n v e s t m e n t o f earned income - s. 219(1)(h). 188 S. 2 i 9 ( l ) ( d ) 189 F o r the d e f i n i t i o n o f "Canadian c o r p o r a t i o n " see P a r t 3 o f Chapter One ( t e x t a t n. 59) 190 There i s some r e l i e f f o r such c o r p o r a t i o n s i n t h a t by s. 2 1 9 ( 1 ) ( g ) a c o r p o r a t i o n w h i c h has a t any time been r e s i d e n t i n Canada i n a y e a r can deduct any f o r e i g n t a x c r e d i t t o w h i c h i t i s e n t i t l e d and one h a l f o f i t s net f o r e i g n income from b u s i n e s s and p r o p e r t y and one h a l f o f i t s f o r e i g n t a x a b l e c a p i t a l g a i n s . 191 See P. K i r k p a t r i c k Tax Consequences o f a C o r p o r a t i o n D e a l i n g w i t h i t s own S t o c k . 13 Tulane Tax I n s t i t u t e 85 a t 85-6 (1964) 192 G. W h e a t c r o f t and A. P a r k , supra n. 22 a t p a r a . 11-11. 193 T h i s w i l l be the c a s e as the c o r p o r a t i o n w i l l have no a c q u i s i t i o n c o s t i n r e s p e c t o f the s h a r e s . 194 See, f o r example, s. 256 B.C. Companies A c t . 195 See P a r t 1 o f C hapter Three S e c t i o n C. 196 F o r a d i s c u s s i o n o f the American p o s i t i o n see D. Watts R e c o g n i t i o n o f G a i n , or Loss t o a C o r p o r a t i o n on a D i s t r i b u t i o n o f P r o p e r t y i n Exchange f o r i t s Own S t o c k 22 The Tax Lawyer 161 (1968-9) l 6 o 197 S. 5 M c ) ( i i ) ( A ) 198 See t e x t a t nn, 191-3 supra 199 S. 5 ^ ( c ) ( v i i ) 2 0 0 F o r an a c c o u n t of t h e s e r u l e s , see P a r t 1 o f Chapter One. 201 For an account o f the a p p l i c a b l e r u l e s when the p a r t i e s do not d e a l a t arras l e n g t h , see P a r t 2 o f C h a p t e r One and t e x t a t n. 207-9 i n f r a . 202 For an account o f t h e s e p r o v i s i o n s , see P a r t 3 o f C h a p t e r One. 203 G. W h e a t c r o f t and A. Park supra n. 22 a t p a r a . 11-11. 20k See P a r t s 1 and 2 o f C h a p t e r F i v e . 2 0 5 See P a r t 2 o f C hapter F i v e ( t e x t a t n. 1 1 6 ) 2 0 6 See P a r t 1 o f C hapter Three S e c t i o n C ( t e x t a t n. k7) 207 See P a r t 2 o f C hapter One ( t e x t a t nn. 25-31) 208 Note t h a t the w i d e r d e f i n i t i o n o f "connected p e r s o n " i s a l s o r e l e v a n t f o r the purposes o f p a r a . 17 - see P a r t 2 o f C hapter One ( t e x t a t nn. 4 0 - 1 ) 2 09 I t s h o u l d be noted t h a t s. 4 0 ( 2 ) ( e ) i s perhaps narrower than p a r a . 17» as the l a t t e r a p p l i e s to a l l d i s p o s a l s t o c o n n e c t e d p e r s o n s , whereas the f o r m e r o n l y a p p l i e s where the c o n t r o l r e l a t i o n s h i p e x i s t s . As t o the meaning of c o n t r o l see n. 122 s u p r a . 210 By s. 2 6 ( 1 7 ) I.T.A.R., added by s. 75(7) 1973 B i l l C-17P the a c q u i s i t i o n c o s t o f p r o p e r t y r e c e i v e d by way of d i v i d e n d i n k i n d p r i o r t o 1972 i s t h e market v a l u e a t the time o f r e c e i p t . 211 I f the c o r p o r a t i o n and s h a r e h o l d e r do not d e a l a t arms l e n g t h and the v a l u e o f the c o n s i d e r a t i o n g i v e n by the l a t t e r exceeds the v a l u e o f the p r o p e r t y a p p r o p r i a t e d , t h e n t h e c o r p o r a t i o n ' s proceeds of d i s p o s i t i o n w i l l e q u a l the f a i r market v a l u e o f the p r o p e r t y d i s p o s e d o f ( s . 6 9 ( 1 ) ( b ) ) and the s h a r e h o l d e r ' s a c q u i s i t i o n c o s t w i l l e q u a l t h a t amount ( s . 6 9 ( 1 ) ( a ) ) - see P a r t 2 o f C h a p t e r One and t e x t a t n. 207 s u p r a . 212 D. Ewens The Winding Up o f C o r p o r a t i o n s Otherwise than under S e c t i o n 88 21 Canadian Tax J o u r n a l 1 a t 4 - 5 (1973) 161 213 See t e x t a t nn. 208 - 9 s u p r a . 214 S. 69(1) (a) w i l l not be r e l e v a n t , as i t w i l l o n l y a p p l y when the c o n s i d e r a t i o n g i v e n by the member exceeds i n v a l u e the p r o p e r t y r e c e i v e d from the c o r p o r a t i o n . 215 D. Ward Tax C o n s i d e r a t i o n s R e l a t i n g t o the Purchase o f A s s e t s o f a B u s i n e s s C o r p o r a t e Management Tax Conference 1972 22 a t 2k, 216 For t h e meaning o f the e x p r e s s i o n "deemed d i v i d e n d " , see P a r t 1 o f Chapter Three S e c t i o n C. 217 R. Brown C a p i t a l R e o r g a n i z a t i o n s C o r p o r a t e Management Tax Conference 1972 114 a t 132. 218 See n. 216 s u p r a . 219 D. Evens, supra n. 212 a t 8 - 9 * 22 0 Id 221 I d a t 1-2 222 See P a r t 1 o f Chapter Three S e c t i o n C ( t e x t a t nn. 68470) 223 For the d e f i n i t i o n o f " c l o s e company" see P a r t 1 o f Chapter Four S e c t i o n A ( t e x t a t nn. 13-19)* 224 See P a r t 1 o f Chapter Three S e c t i o n C. 225 G. W h e a t c r o f t and A. Park supra n. 22 a r P a r a . 11-23. The p r o v i s i o n does not i n any c a s e a p p l y t o t r a n s f e r s between members o f a group o f companies.- p a r a . 5(1) s c h . 13 F.A. 1967. 226 S. 532 and s. 2?2 227 " I n d i r e c t l y " here means t h r o u g h i n t e r m e d i a r y s u b s i d - i a r i e s . The p e r c e n t a g e o f any i n d i r e c t h o l d i n g h e l d by a p a r e n t i n a s u b s i d i a r y i s o b t a i n e d by m u l t i p l y i n g t o g e t h e r a l l the p e r c e n t a g e s o f *he d i r e c t h o l d i n g s h o l d by each c o r p o r a t i o n i n the c h a i n o f c o r p o r a t i o n s between t h e p a r e n t and the u l t i m a t e s u b s i d i a r y - s. 532. 228 S. 272(1) and 532. 229 S u b s i d i a r y here r e f e r s t o any company w h i c h i s a member of a group o f w h i c h a p r i n c i p a l company i s the head. 162 230 S. 272(3) 231 I n f a c t , the I n d i r e c t p e r c e n t a g e h o l d i n g o f the u l - t i m a t e p a r e n t c o r p o r a t i o n , c a l c u l a t e d as s e t out i n n. 227 s u p r a , may be l e s s than 75%, f o r i n s t a n c e where one company has a 75% h o l d i n g i n one company w h i c h i n t u r n has a 75% h o l d i n g i n a n o t h e r company - Simon's Taxes V o l . D. P a r a . D2.622. 232 S. 275(2) 233 S. 273(1) o n l y a p p l i e s "so f a r as r e l a t e s t o C o r p o r a t i o n Tax on c h a r g e a b l e g a i n s " . 234 S. 274. The deemed d i s p o s a l may be by the a c q u i r i n g o r d i s p o s i n g c o r p o r a t i o n , depending on the s i t u a t i o n . 235 S. 273(2) (a) 236 P a r a . 11(1) s c h . 7 F.A. 1965. 237 P a r a . 5(3 ) ( b ) s c h . 7 FA. 1965. 238 S. 273(2)(b) 239 S. 273(2). For the meaning of " c a p i t a l d i s t r i b u t i o n , " see n. 42 s u p r a . 240 See J . T a l b o t and G. W h e a t c r o f t C o r p o r a t i o n Tax p a r a . 4-30 where the view i s t a k e n t h a t the c o r p o r a t i o n a l s o i s p r e c l u d e d by the e x c e p t i o n s . 241 See n. 178 s u p r a . 242 The d e f e r r a l i s o b t a i n e d by d e d u c t i n g the amount of any g a i n from the a c q u i s i t i o n c o s t o f the new a s s e t . 243 s . 276 does not a p p l y where the a s s e t i s d i s p o s e d to o r a c q u i r e d from a n o t h e r group member. 244 T h i s i s l i m i t e d t o a s s e t s w h i c h have r e p l a c e d o t h e r a s s e t s a c q u i r e d from group members w i t h i n the s i x y e a r p e r i o d - S. 278(3) and s. 278(1). 245 S. 278(2) and 4 ( c ) . 246 S. 278(1) 247 See P a r t 1 o f C h a p t e r F i v e S e c t i o n B ( t e x t a t nn. 70-6) 248 For a f u l l e r a c c o u n t see Simon's Taxes V o l . D P a r a . D2.631. 163 249 S. 2 8 0 ( 1 ) and ( 2 ) . For the purpose of this rule one or more members of the group may be non-residents. 2 5 0 S. 280(5) 2 5 1 S. 280(6) 252 see Part 3 of Chapter One. 253 See Part 2 of Chapter One (text at nn. 4o-4l) 2 5 4 S. Edwards Corporations and Shareholders 1971 Conference Report Canadian Tax Foundation 124 at 134-5. 255 P. Whiteman, supra n. 1 2 6 . 2 5 6 Simon's Taxes Vol. 0 Para. D2-663. 257 See n. 252 supra. 2 5 8 S. 2 6 8 ( 2 ) and ( 4 J 2 5 9 S. 2 6 8 ( 2 ) 2 6 0 Para. 15 sch. 19 F.A• 1969 - see n. 252 supra. 2 6 1 The events listed in s. 2 6 8 ( 2 ) are as follows: (a) The transferee company disposes, or partly disposes, of the assets, or ceases to use them, or is wound up or dissolved, or (b) The transferor company disposes of a l l or any of the shares or loan stock issued by the transferee company in return for the transfer, or (c) The expiration of a period of ten years beginning with the transfer,or(d)the passing of a resolution or the making of an order, or any other act, for the winding up of the transferor company (unless that company is not in fact wound up). 262 S. 2 0(7) F.A. 1965 - see text at nn. 2 0 - 1 supra. 263 Honou£able E. Benson Minister of Finance Proposals for Tax Reform Para. 3 . 4 7 . 2 6 4 S. 48 ( 1 ) . Note the partial exemption for individuals other than trusts - see text at nn. 142-3 supra. 265 For the definition of "Canadian corporation'1 see Part 3 of Chapter One (text at n. 5 9 ) . 164 266 S. 48(1) 267 S. 48(2) 268 S. 48(1) 269 S. 48(3) 270 Note that s. 46(2) of the Canadian Act, which restricts losses realised on shares i f they are caused by the depreciation of personal use property held by a cor- poration, also applies to trusts - see text at nn. 130-4 supra. 271 These are set out in s. 133(8)(d) I.T.A. and s. 59 I.T.A.R. 2 72 Or 18th June 1971, i f later. The company must be incorporated in Canada. 273 S. 59 I.T.A.R. provides that for the period up to the 1976 tax year only 95% of issued shares and debentures need be held by non-residents. 274 Other than foreign a f f i l i a t e s (defined in s. 9 5(D(b)- see. Part 1 of Chapter Four Section C (text at nn. 58- 62 ))' of r e s i d e n t s of Canada - s. 133 (8)(d)(i)(A). 275 S. 133(8)(d)(v) 276 See n. 273 supra. 277 See Part 1 of this chapter Section B. 278 S. 133(D(c) 279 S. 133(3) 280 See Part 3 of Chapter Three Section A. 281 I n f a c t t h e corporation pays a tax equal in amount to the withholding tax rates (s. 133(2) and s. 59 I.T.A.R.),,; but this is refunded when that income is distributed (s. 133(6) and(8)(a). However, whereas the rate payable on capital gains is 25%, until the 1976 tax year the rate on other income is 15%. In that year, i t w i l l go up to 25%. 282 There is no legal prohibition on i t s being a public co r p o r a t i o n . Rather, i t is unlikely that i t would ever be large enough. 165 2 8 3 S. H 5 ( D ( b ) ( i i i ) For an account of the l i a b i l i t y o f n o n - r e s i d e n t s i n r e s p e c t o f c a p i t a l g a i n s see P a r t 1 o f t h i s c h a p t e r S e c t i o n B. 2 8 4 I n r e g a r d to b u s i n e s s a s s e t s , the n o n - r e s i d e n t would be f u l l y t a x a b l e , even i f he h e l d the a s s e t s p e r s o n a l l y ~ see P a r t 1 o f t h i s c h a p t e r S e c t i o n B ( t e x t a t nn. 35-6 ) 2 8 5 The c o r p o r a t i o n must be a Canadian c o r p o r a t i o n and a p u b l i c c o r p o r a t i o n i n Canada - s . 1 3 0 ( 3 ) ( a ) ( i ) . I n the U.K., i t must be a c l o s e company, the s h a r e s o f w h i c h a r e not quoted on a r e c o g n i s e d s t o c k exchange - s. 3 5 9 ( 1 ) and ( l ) ( c ) I.C.T.A. 1 9 7 0 . F o r the d e f i n i t i o n o f "Canadian c o r p o r a t i o n " see P a r t 3 o f C hapter One ( t e x t a t n. 59)» o f " p u b l i c c o r p o r a t i o n " see the C o n c l u s i o n t o C hapter Three ( t e x t a t nn. 2 8 1 - 9 2 ) and o f a " c l o s e company" see P a r t 1 o f C hapter Four S e c t i o n A ( t e x t a t nn. 13-9). 286 S. 3 5 9 ( D ( a ) I.C.T.A. 1 9 7 0 . 2 8 7 S. 1 3 0 ( 3 ) ( a ) ( i i ) 288 S. 1 3 0 ( 3 ) ( a ) ( i i i ) 2 8 9 S. 1 3 0 ( 3 ) ( a ) ( v i i i ) i n Canada and s. 3 5 9(D(e) I.C.T.A. 1970 i n the U.K. 2 9 0 S. 3 5 9 ( D ( d ) 2 9 1 S. 3 5 9 ( D ( b ) i n the U.K. and s. 1 3 0 ( 3 ) (a) ( v i ) i n Canada. 2 9 2 S. 1 3 0 ( 3) ( a ) ( i v ) "Gross revenue" 13 d e f i n e d i n s. 2 4 8 ( 1 ) and does not appear t o i n c l u d e c a p i t a l g a i n s , so t h a t i n v e s t m e n t c o r p o r a t i o n s c o u l d h o l d s u b s t a n t i a l f o r e i g n i n v e s t m e n t s f o r the purpose of r e a l i s i n g c a p i t a l g a i n s - D. Ward C u r r e n t Tax P l a n n i n g P a r a . 7 3 . 1 ( d ) . 2 9 3 S. 130 (3 M a ) ( v i i ) 2 9 4 See P a r t 3 o f C h a p t e r Three S e c t i o n C. 2 9 5 S. 9 3 ( 2 ) F.A. 1 9 7 2 2 9 6 See t e x t a t nn. 1 7 0 - 1 s u p r a . 2 9 7 See n. 2 9 4 s u p r a . 298 S. 130(1) 166 299 See Part 1 of Chapter Three Section A. 300 S. 131(8)(a). For the definition of"Canadian Cor- poration" see Part 3 of Chapter One (text at n. 59). 301 S. 131(8)(a). For the definitionaof "public corpor- ation" see the Conclusion to Chapter Three (text at nn. 281-92). 302 S. 131( 8 )(b). This prevents the corporation carrying on an active business) e.g. dealing in securities - D. Ward, supra n. 292 at para. 73.4(c) 303 S. 13l (8)(c) 304 S. 131^2)(a)(1)(B) - See Part 3 of Chapter Three Section B 305 S. 130(1) The mutual fund corporation pays normal tax rates in respect of i t s income. 306 S. 108(2) 307 Id 308 S. 108(2)(a) - see text at nn. 300-3 supra. Thus i t w i l l be noted that there is no limitation on the activities which may be undertaken by the trust, other than practical ones arising from the fact that the unit holder can at any* time redeem his units, so that part of the trust funds must be kept liquid -D. Ward, supra n. 292 at para. 113U(a) and 73.4(d). 309 S. 108(2)(b)(vi) 310 See this part of this chapter section B (text at nn. 285-91). 311 S. 108(2)(b)(ii) 312 s. 108(2)(b)(i) 313 s. 108(2)(b)(iii) 314 s. 108(2)(b)(iv) 315 s. H08(2)(b)(v) 316 S. 358 I.C.T.A. 1970 16? 317 I n f a c t , u n a u t h o r i s e d u n i t t r u s t s a r e r a r e , b e i n g f o r b i d - den from o f f e r i n g t h e i r u n i t s t o the p u b l i c - J . T a l b o t and G. W h e a t c r o f t C o r p o r a t i o n Tax P a r a . 21-12A. 318 S. 26(1) P r e v e n t i o n o f Frauds (Investments) A c t 1958 319 See s. 17 and the 1 s t s c h . 320 P a r a . 1.1st s c h . 321 S. 1 0 4 ( 2 ) . T r u s t s have no r i g h t t o make p e r s o n a l d e d u c t i o n s ( s . 104(3)) and where t h e r e i s a deemed d i s p o s a l o f t h e i r a s s e t s t h r o u g h t h e i r c e a s i n g t o be r e s i d e n t , they do not r e c e i v e the e x e m p t i o n a a v a i l a b l e t o i n d i v i d u a l s - see t e x t a t n. 143 s u p r a . 322 C e r t a i n i n t e r v i v o s t r u s t s r e s i d e n t on and s i n c e 1 8 t h June 1971 s i m p l y pay the i n d i v i d u a l r a t e s o f tax - s. 1 2 2 ( 2 ) . 323 Assuming a p r o v i n c i a l r a t e o f t a x e q u a l t o 30%, t h i s makes an o v e r a l l t a x r a t e o f 50% - see P a r t 3 o f t h i s c h a p t e r S e c t i o n D ( a t n. 157 and t e x t ) . 324 S. 122(1) 325 F o r a d i s c u s s i o n o f the l i a b i l i t y o f n o n - r e s i d e n t s i n r e s p e c t o f c a p i t a l g a i n s , see P a r t 1 o f t h i s c h a p t e r S e c t i o n B. 326 S. 5 4 ( c ) ( i i i ) 327 See P a r t 2 o f C h a p t e r One. 328 I d 329 S. 104(4) - (5) and s. 1 0 8 ( I ) ( j ) 330 T h i s , o f c o u r s e , has the advantage t h a t no g a i n o r l o s s a c c r u e s to the t r u s t . 331 S. 107 and s. 1 0 8 ( I ) ( j ) 332 An amount i s p a y a b l e i f a c t u a l l y p a i d i n a y e a r o r i f the b e n e f i c i a r y i s e n t i t l e d t o have i t so p a i d - s. 104(24). 333 S e c t i o n 104(6) 334 S. 12(1)(m) and s. 104(13) 168 335 S. 104(7). On the o t h e r hand, such amounts w i l l not be s u b j e c t t o t h e w i t h o l d i n g t a x when p a i d o u t . Thus such a b e n e f i c i a r y may be i n no worse p o s i t i o n t h r o u g h the income a c c r u i n g t o t h e t r u s t . 336 S. 2 1 2 ( l ) ( c ) . T h i s w i l l not be the case where, as a r e s u l t o f income b e i n g d e s i g n a t e d by the t r u s t e e s , the amount i s exempt f r o m t h a t t a x - see P a r t 3 o f Chapter Three S e c t i o n D ( t e x t a t nn. 216-20). 337 S. 35*Ml) I.C.T.A. 1970 338 I d 339 As t o w h i c h , see t h i s p a r t o f t h i s c h a p t e r S e c t i o n B. 3**0 S. 355 I.C.T.A. 1970. 34l The p r i c e he r e c e i v e s f o r t h e u n i t s w i l l r e f l e c t t h e s e g a i n s w h i c h w i l l thus be t a x e d a g a i n as a c a p i t a l g a i n onthe u n i t s . These p r o v i s i o n s w i l l be d i s c u s s e d more f u l l y l a t e r - see P a r t 3 o f C h a p t e r Three ( t e x t a t n. 238). 3^2 The p r o v i s i o n s o f F.A. 1965, as they s t a n d , a p p l y to a l l t a x p a y e r s . I t i s s. 238 o f t h e I.C.T.A. 1970 w h i c h e x c l u d e s c o r p o r a t i o n s p a y i n g C o r p o r a t i o n Tax from C a p i t a l G a i n s Tax. 3^3 These p r o v i s i o n s a r e found i n s. 25 F.A. 1965. 344 S. 22(5) F.A. 1965. 345 S. 21 F.A. 1965. 346 Simon's Taxes V o l . £• Para E6.313 347 Simon's Taxes V o l . E . P a r a . E6.308-310. 348 Simon's Taxes V o l . E . P a r a . E6.302. I t s h o u l d be noted t h a t t h e r e was an announcement i n the 1973 budget speech t h a t t r u s t s would a l s o be s u b j e c t e d t o the Investment Surcharge - see 1973 Budgetspeech d a t e d 6th March 1973. 349 As t o the s i g n i f i c a n c e o f t h i s , see P a r t 3 o f C h a p t e r Three S e c t i o n 0 ( t e x t a t n. 245). 350 See n. 325 s u p r a . 351 S. 1 1 5 ( l ) ( b ) ( v i i ) 169 352 See D. Ward, supra n. 292 a t p a r a . 1 1 3 . 3 ( c ) ( i i ) , f o r a d i s c u s s i o n o f the p r a c t i c a l d i f f i c u l t i e s o f e n f o r c i n g t h i s p r o v i s i o n and the p o s s i b i l i t i e s o f a v o i d i n g i t . 353 There i s no s e t o f f f o r a c c r u e d c a p i t a l l o s s e s . 35* See n. 352 s u p r a . 355 P a r a . 2 2 ( l ) ( b ) s c h . 6 F.A. 1965 as amended by s. 114(2) F.A. 1972. 356 S. 44(4) F.A. 1965 as amended by s. 114(2) F.A. 1972. 357 S. 132(6) 358 See t h i s p a r t o f t h i s c h a p t e r S e c t i o n D. 359 S. 122(3) 360 See P a r t 3 o f C h a p t e r Three S e c t i o n £• 361 C o n t r a s t the p o s i t i o n w i t h t h a t o f the u n i t t r u s t , f o r w h i c h t h e r e i s no t a x r e f u n d on red e m p t i o n o f u n i t s . 362 S. 1 1 5 ( 1 ) ( b ) ( v i i i ) . For a d i s c u s s i o n o f the l i a b i l i t y o f n o n - r e s i d e n t s i n r e s p e c t o f c a p i t a l g a i n s see P a r t 1 of t h i s c h a p t e r S e c t i o n B. 363 See s. 1 1 5 ( l ) ( b ) ( v i ) 364 S. 130.1(6). S. 130.1 i s b e i n g added t o the A c t by the R e s i d e n t i a l Mortgage F i n a n c i n g A c t ( a t p r e s e n t 1973 B i l l C-135). 365 I d . F o r t h e d e f i n i t i o n o f " p u b l i c c o r p o r a t i o n " see the C o n c l u s i o n t o Chapter Three ( t e x t a t nn. 281-92). F o r the d e f i n i t i o n o f "Canadian c o r p o r a t i o n " see P a r t 3 o f Cha p t e r One ( t e x t a t n. 59). 366 S . , 1 3 0 . 1 ( 6 ) 367 I d . 368 S. 130.1(1) and (4) - see Part 3 of Chapter Three Section F. 369 S. 130.1(1)-(2) The A c t t r e a t s t h e d i v i d e n d s i n the hands o f s h a r e h o l d e r s as i n t e r e s t , as i f t h e s h a r e h o l d e r s p e r s o n a l l y owned the c o r p o r a t i o n ' s mortgages. 170 370 I n p r a c t i c e , i t w i l l c o v e r a l l i n s u r a n c e companies. 371 S . 138(2) a p p l y i n g t o income from c a r r y i n g on the l i f e i n s u r a n c e b u s i n e s s , s. 138(9) a p p l y i n g t o i n v e s t m e n t income and s. l 4 2 ( l ) a p p l y i n g t o c a p i t a l g a i n s . 372 S. 138(3) 373 S. 1 3 8 ( 3 ) ( b ) , s. 1 3 8 ( 4 ) ( b ) and s. 138(11*) 374 S. 1 3 8 ( 3 ) ( d ) and s. 1 3 8 ( 4 ) ( c ) 375 S . 138(11) and ( 1 2 ) ( b ) 376 I.e i n v e s t m e n t c o r p o r a t i o n s , m utual f u n d c o r p o r a t i o n s , e t c . 377 S . l 4 8 ( l ) ( b ) 378 S. l 4 8 ( l ) ( b ) and s. 13.8(3)'(a) (.vi) i n i c r e s p e c t o f income o t h e r t h a n c a p i t a l g a i n s and s. 142(2) i n r e s p e c t o f c a p i t a l g a i n s . 379 S. l 4 8 ( 3 ) ( b ) 380 S . l 4 8 ( l ) ( a ) . The c o s t o f the p o l i c y i s t h e sums p a i d t o a c q u i r e i t , e.g. premiums - s. l48(9)(a)» 381 S. 138(3) 382 S. 2 0 8 ( 1 ) . W. C a r l y l e T a x a t i o n o f L i f e A s s u r a n c e Proceeds 17 Canadian Tax J o u r n a l 321 a t 324 (1969) " 383 S. 209 384 S. 209(1) 385 S. 2 0 9 ( 3 ) ( c ) 386 Simon's Taxes V o l . 0 P a r a . D4.505. 387 S. 304-6 I.C.T.A. 1970. 388 S. 309 I.C.T.A. 1970. 389 S . 311 I.C.T.A. 1970. 390 S. 310 I.C.T.A. 1970. 391 S. 28(2) F.A. 1965. T h i s r u l e does not a p p l y i f the p o l i c y h o l d e r i s not t h e o r i g i n a l h o l d e r and a c q u i r e d the p o l i c y f o r c o n s i d e r a t i o n i n money o r money's w o r t h . 171 392 T h i s i s o n l y a g e n e r a l s t a t e m e n t , w h i c h i s not q u i t e c o r r e c t where the p o l i c y h o l d e r ' s income i s low and t h e a l t e r n a t i v e r a t e o f C a p i t a l Gains Tax i s a v a i l a b l e t o him i n r e s p e c t o f g a i n s r e a l i s e d p e r s o n a l l y . 393 S. 93(2) F.A. 1972. S. 3 1 1 . IC.T.A. 1970 i s r e p e a l e d by t h i s A c t . 39* T h i s c o n c e p t i s d e f i n e d i n S. 315 I.C.T.A. 1970. 395 T h i s would seem t o be the c a s e even where the a s s e t forms p a r t o f t h e company's s e g r e g a t e d f u n d . A l t h o u g h the A c t g e n e r a l l y t r e a t s the f u n d as i f i t were the p o l i c y h o l d e r ' s , i n f a c t i t remains the company's p r o p e r t y . 396 I n t h i s c a s e the proceeds w i l l e q u a l the market v a l u e o f the a s s e t under s. 6 9 ( l ) ( b ) o f t h e A c t - see P a r t 2 o f C h a p t e r One. 397 As t o t h i s , see P a r t 3 o f C h a p t e r Three S e c t i o n G. 172 CHAPTER I I I CORPORATE DISTRIBUTIONS AND CAPITAL GAINS Th i s chapter i s concerned w i t h the tax t r e a t - ment of d i s t r i b u t i o n s made out of c a p i t a l gains by c o r p o r - a t i o n s and c e r t a i n t r u s t s to t h e i r members and the extent to which d i s t r i b u t i o n s out of such gains and out of ofeher income r e s u l t i n c a p i t a l gains or l o s s e s to the r e c i p i e n t s which are taxed as such. I t w i l l c o n s i d e r the q u e s t i o n as to how f a r the s t a t u t o r y treatment of d i s t r i b u t i o n s b r i n g s about the i n t e g r a t i o n of the t a x a t i o n of these e n t i t i e s and that of t h e i r members, so that the member r e c e i v i n g the d i s t r i b u t i o n i s i n the same p o s i t i o n as i f he had p e r s o n a l l y r e a l i s e d the income d i s t r i b u t e d . In the preceding chapter the b e n e f i c i a l treatment of c a p i t a l g a i n s , as opposed to other income, r e a l i s e d by taxpayers was p o i n t e d out. The obvious r e s u l t of t h i s i s t h a t , i n order to o b t a i n f u l l i n t e g r a t i o n i n r e s p e c t of c a p i t a l g a i n s , not only i s i t necessary that any tax p a i d by the e n t i t y r e a l i s i n g the g a i n be regarded as a prepayment of tax by the member to which i t i s d i s t r i b u t e d , 1 but that the g a i n of the e n t i t y should remain a c a p i t a l g a i n i n the hands of the member. In the case of other income, the f i r s t r e q u i r e - ment i s e q u a l l y a p p l i c a b l e , but the second i s , S a t i s f i e d as lo n g as the d i s t r i b u t i o n i s o r d i n a r y income i n the shareholder's hands, un l e s s i t i s from some s p e c i a l source to which s p e c i a l 173 b e n e f i t s a r e a t t a c h e d , e.g. f o r e i g n income w i t h i t s f o r e i g n t a x c r e d i t . The o n l y types o f p r o v i s i o n found i n b o t h systems w h i c h a p p l y t o a l l types o f c o r p o r a t i o n a r e those w h i c h t r e a t the t a x p a i d by the c o r p o r a t i o n as a prepayment o f t h e i r 2 s h a r e h o l d e r s ' t a x . These a r e the d i v i d e n d t a x c r e d i t and the r i g h t g i v e n t o c o r p o r a t i o n s t o deduct from t h e i r income d i v i d e n d s r e c e i v e d from o t h e r c o r p o r a t i o n s , w h i c h a r e d i s - c u s s e d i m m e d i a t e l y f o l l o w i n g t h i s i n t r o d u c t i o n . However, i n a p p l y i n g t h e s e r u l e s , b o t h systems draw a d i s t i n c t i o n between those d i s t r i b u t i o n s w h i c h a r e o r d i n a r y income i n the hands o f t h e i r r e c i p i e n t s (termed "income d i s t r i b u t i o n s " i n t h i s t h e s i s ) and those w h i c h l e a d t o c a p i t a l g a i n s o r l o s s e s i n these hands (termed i n t h i s t h e s i s " c a p i t a l d i s t r i b u t i o n s " ) . The d i s t i n c t i o n i s n o t , as might be e x p e c t e d , made by r e f e r e n c e t o the n a t u r e o f the sour c e i n the c o r p o r a t i o n , i . e . c a p i t a l g a i n s o r o t h e r income,from w h i c h the d i s t r i b u t i o n i s made, b u t a c c o r d i n g t o the t i m i n g o r n a t u r e o f the d i s t r i b u t i o n i t s e l f . I n p r a c t i c e , t h i s d i s t i n c t i o n i s l e s s i m p o r t a n t i n Canada, s i n c e , e xcept i n If the c a s e o f mutual f u n d c o r p o r a t i o n s , a l l c o r p o r a t e d i s t r i - b u t i o n s a r e income d i s t r i b u t i o n s o t h e r t h a n t h o s e w h i c h s i m p l y r e t u r n p a i d up c a p i t a l . I n the U.K., the p o s i t i o n i s the same u n t i l the c o r p o r a t i o n i s wound up, when a l l d i s t r i - b u t i o n s made a r e deemed to be c a p i t a l d i s t r i b u t i o n s . There 174 i s , however, a l i m i t e d o p p o r t u n i t y here f o r the s h a r e - h o l d e r t o pay the l o w e r c a p i t a l g a i n s t a x r a t e s on d i s - t r i b u t i o n s o o f not j u s t c o r p o r a t e c a p i t a l g a i n s , b u t o t h e r i n c o m e . On t h e o t h e r hand, t h e r e i s no d i v i d e n d *ax c r e d i t f o r c a p i t a l d i s t r i b u t i o n s , nor can a c o r p o r a t i o n r e c e i v i n g such a d i s t r i b u t i o n deduct i t from i t s income. I n a d d i t i o n t o the r u l e s w h i c h a p p l y t o a l l c o r p o r a t i o n s , t h e r e a r e i n b o t h systems, b u t p a r t i c u l a r l y i n Canada, r u l e s w h i c h a p p l y o n l y t o c e r t a i n t y p e s o f c o r p o r - a t i o n s . These r e i n f o r c