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

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

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

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

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

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

Taxpayer T loses
On the other hand, the Court found that T and HCo acted in concert without separate interests. The transaction was undertaken to provide a tax benefit for T, with HCo simply accommodating T’s wishes. The transaction did not reflect normal commercial relations between parties acting in their own interest.

For further information see VTN Monthly Tax Update Seminar, Issue No. 420