Section 84.1: What Brought Poulin And Turgeon To The Table?

Section 84.1 of the Income Tax Act (Act), in its current form, was introduced in 1985 (concurrent with the introduction of the capital gains deduction), and the provision has always been a source of heartburn for planners. It is a very broad anti-avoidance rule that tries to prevent surplus from being stripped from corporations as a tax-free capital distribution, rather than a taxable distribution in the form of dividends. In order for section 84.1 to apply, there needs to be a transfer of shares of a corporation by an individual or trust to another corporation with which the individual does not deal at arm's length, and immediately after the disposition, the purchaser corporation and the corporation whose shares are being transferred are connected. While the Act deems related persons to not deal at arm's length, it also states that it is a question of fact whether persons who are not related to each other are, at a particular time, dealing with each other at arm's length. If section 84.1 applies, then the otherwise tax-free return of surplus in the form of capital distributions will be turned into a taxable distribution in the form of dividends.

The analysis as to whether or not section 84.1 applies to a particular share transfer by an individual to a corporation often comes down to the elusive determination of factual arm's length. On June 14, 2016, the Tax Court of Canada released its decision in the cases of Poulin v Queen and Turgeon v Queen heard on common evidence1. These cases involve two unrelated shareholders, both of whom attempted to extract corporate surplus as a capital gain to which they could claim the capital gains deduction. One of such shareholders was exiting the company, the other remained active. This decision is particularly useful in that it compares two slightly different scenarios, and decides that section 84.1 applies to one of the scenarios but not the other. We will review the judgment and extrapolate it to provide useful takeaways for practitioners.

Poulin and Turgeon, two unrelated Canadian individuals, were principal shareholders of Amiante, a Canadian corporation. Over a number of years, several conflicts arose between Poulin and Turgeon to the point where both parties contemplated parting ways and selling their respective interests in Amiante to the other. Ultimately, Poulin expressed his desire to gradually leave Amiante, and Hélie, an employee of Amiante, would become a new shareholder to replace Poulin's role within the company.

Poulin and Turgeon reached an agreement in 2007 whereby Poulin would sell all his interest in, and depart from, Amiante by 2012. As part of this, Poulin was to sell a portion of his shares to Turgeon and his holding company, Gestion Turgeon (GT), in 2007. Amongst other transfers in 2007 that resulted in Turgeon taking over control of Amiante, Poulin sold $450,004 of Amiante Class F preferred shares to GT. At the same time, Turgeon sold $388,861 of Amiante Class D preferred shares to Hélie's holding company, Gestion Hélie (GH). Both the Class F and D preferred shares were fixed value and non-voting. Both Poulin and Turgeon reported capital...