I am often asked during the course of a year whether a taxpayer, for whatever reason, can make a sale of property at a price lower than fair market value, transfer an asset for no consideration, make a gift to a relative or friend, either personally or through a corporation, etc. You get the idea.
The Income Tax Act (“the Act”), being the complex animal that it is, contains many provisions that deal with these questions, and, depending upon the circumstances, any one or more of them could apply. And we won’t even get into the General Anti-Avoidance Rule. What follows is a general discussion of some of these provisions.
Subsection 69(1) – Inadequate consideration
Subsection 69(1) of the Act provides rules that apply where any consideration other than fair market value is provided in any transaction between people who are not dealing at arm’s length. Generally, the provision provides a one-sided adjustment to the selling price. If the proceeds are too high, then the purchaser’s cost amount will be adjusted downwards. If the price is too low, then the seller’s proceeds will be adjusted upwards. If there are no proceeds at all (i.e., a gift) then the transfer will be deemed to have been made at fair market value for both parties.
Subsection 15(1) – Shareholder Benefits
Subsection 15(1) of the Act is a broad provision that taxes shareholders (and future shareholders) on the value of any benefit conferred on them by a corporation. This subsection would cover such transactions as the issuance of treasury stock at less than fair market value, and the forgiveness of shareholder debt.
Some exceptions apply, such as stock dividends, and treasury shares where identical offers are made to all existing shareholders.
Subsection 56(2) – Indirect payments
Subsection 56(2) of the Act applies to “indirect payments”. It deals with situations where a benefit is conferred on a person, where that benefit would, if it were paid to the taxpayer, be taxed in the taxpayer’s hands. The effect of the provision is to tax the person who confers the benefit.
According to the CRA, there are four conditions that must be met for this provision to apply:
(a) there is a payment or transfer of property to a person other than the taxpayer;
(b) the payment or transfer is pursuant to the direction of, or with the concurrence of, the taxpayer;
(c) there is a benefit to the taxpayer or a benefit the taxpayer wishes to confer on the other person;
(d) the taxpayer would have been taxable on the amount under some other section of the Act if the payment or transfer had been made directly to the taxpayer.
A simple example is where a director of a corporation makes a payment to a person who is a non-shareholder of the corporation at the request of a shareholder.
It has been held that subsection 56(2) cannot be applied to dividends paid to one shareholder to exclusion of another at the discretion of the directors of a corporation (i.e., discretionary dividends).
Subsection 246(1) – Benefit Conferred On A Person
Subsection 246(1) of the Act is another broad rule that provides that where a person confers a benefit on a taxpayer, the amount of the benefit must be included in income of the taxpayer.
Subsection 246(2), however, provides an “arm’s length” exception, where all of the following four conditions are met:
(a) The person and the taxpayer are dealing at arm’s length;
(b) The transaction is bona fide;
(c) The transaction is not pursuant to, or part of any other transaction; and
(d) The transaction was not entered into to effect payment of an obligation.
There is very little jurisprudence with respect to the saving provision in subsection 246(2). The only case involving this provision is Pelletier et al v. the Queen. In that case, a shareholder sold his shares to the other arm’s length shareholders of the same corporation for less than fair market value. The exception was held to apply.
Generally, the CRA likes transactions to occur at market value. Any deviation could invoke any one of the above provisions, so as always, be cautious.