Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.
Principal Issues: Whether amounts can be renounced by a principal-business corporation in respect of consideration given on behalf of an investor to the corporation upon the exercise of a share purchase warrant originally issued by the corporation to a partnership of which the investor was a limited partner.
Position: Potentially; among the requirements to be met is that the investor be the person giving consideration under an agreement in writing with the principal-business corporation for the issue of the flow-through share.
Reasons: Based upon the nature of the determination and the provisions of the Act in question.
March 7, 2005
Tax Avoidance and Special Audits Division Resources Industry Section
Special Audits Section A.A. Cameron
David Duff (613) 347-1361
Manager
Attention: Gilles Rochette
2004-010848
XXXXXXXXXX
We are writing in response to your memorandum of December 15, 2004, wherein you requested our views as to whether a share acquired by a limited partner, upon the exercise of a share purchase warrant originally acquired by the XXXXXXXXXX (the "LP"), would constitute a flow-through share ["FTS" as defined in subsection 66(15) of the Income Tax Act (the "Act")]. You also forwarded a copy of the LP's offering memorandum dated XXXXXXXXXX (the "Offering Memorandum") and other related documents. We also acknowledge the information provided during our telephone discussions (Cameron/Rochette).
Our understanding of the major components of the arrangements under consideration is as follows:
1. The LP was formed as a limited partnership under the Partnership Act (XXXXXXXXXX ) on XXXXXXXXXX with the general partner (the "GP") being a company newly incorporated under the Canada Business Corporations Act.
2. XXXXXXXXXX.
3. XXXXXXXXXX.
4. XXXXXXXXXX.
5. XXXXXXXXXX.
The term FTS is defined in subsection 66(15) of the Act to mean a share [other than a prescribed share, within the meaning of subsection 6202.1(1) of the Income Tax Regulations (the "Regulations")] of the capital stock of a PBC that is issued to a person under an agreement in writing entered into between the person and the PBC, where certain conditions are met, and includes "a right of a person to have such a share issued to that person". [Amendments to the definition of FTS were released by the Department of Finance on December 20, 2002, intended to be applicable to such an "agreement in writing" entered into after that date. Under those proposed amendments, the FTS definition would encompass "a right (other than a prescribed right) to acquire a share of the capital stock of a" PBC, where certain conditions are met, with the definition of a "prescribed right" in proposed subsection 6202.1(1.1) to the Regulations containing similar restrictions to those contained in the above-mentioned definition of "prescribed share".]
In light of the above definition, a share purchase warrant issued by a PBC will constitute a FTS if it is a right to have a share (which is not a prescribed share) issued pursuant to a written agreement to be entered into meeting all of the requirements of that definition (such an agreement being a "FTS Agreement"). Such determination would have to be made with reference to the particular warrant in question; however, it is our understanding that the rights arising under a share purchase warrant would generally encompass a right to have the share in question issued (which right may be conditional upon additional consideration being given to acquire the share upon the exercise of the warrant).
Where consideration is given for a share purchase warrant that constitutes a FTS, we have generally accepted that renunciations may be made by a PBC to the person who gave the consideration for, and acquired, the warrant up to the amount of such consideration. In such circumstances, we have generally viewed the "24 month" period, in which the PBC is to incur the qualifying expenses in relation to the consideration given for the warrant, as commencing at the time the agreement to issue the warrant was entered into. However, it is also our view that the agreement to issue the actual share of the PBC is generally not entered into when the right under the warrant is granted, but rather when the warrant is exercised. Therefore, where the terms of the warrant require additional consideration to be paid upon the exercise thereof to acquire actual shares of the PBC, it is also our position that renunciations in respect of qualifying expenses may potentially be made by a PBC up to the amount of such consideration (with the "24 month" period, in which the PBC is to incur the qualifying expenses in relation to the consideration given for the shares, generally not viewed as commencing until the warrant is exercised). It will be a question of fact as to whether a new "agreement in writing" would be necessary at the time the warrant is exercised in order to satisfy the requirements of the FTS definition upon the exercise of the warrants.
With regard to the situation at hand, we note that subsection 66(16) of the Act deems a partnership to be a person for certain purposes under the Act, including the definition of FTS and the renunciation to investors in FTS of amounts in respect of qualifying expenses incurred by a PBC. Therefore, provided the LP constituted a bona fide partnership (which determination must be made after consideration of all relevant factors including conduct of the parties and all documentation regarding the LP) the LP would be the "person" acquiring the Warrants and to which, if consideration was given by the LP to the PBC for the acquisition of the Warrants, renunciations in respect of qualifying expenditures incurred by the PBC could potentially be made, up to the amount of such consideration. XXXXXXXXXX.
Subsection 66(12.6) of the Act provides that a renunciation of amounts in respect of qualifying expenses incurred by a PBC may only be made to the person who gave consideration under a FTS Agreement with the PBC for the issue of a FTS. As such, in the situation under consideration, in order for PBCs to be able to renounce amounts to a person that is an Investor (a limited partner or former limited partner of the LP), that person would have to have given consideration for the issuance of a FTS by the PBC under a FTS Agreement entered into between that person and the PBC. Given this factor and that, as noted above, the LP would be the "person" which entered into and gave consideration under the Warrant Agreements, in our view it appears that in order for such a renunciation to an Investor to be possible, the relevant Investment Agreement must constitute a FTS Agreement that is entered into between that Investor and the PBC, and the Investor must be the person giving the consideration under that agreement for the issuance of the FTS.
Whether or not the Investment Agreements satisfied the requirements detailed in the preceding paragraph would have to be determined from a review of such agreements, e.g., do those agreements support the view that the Investor is the party giving consideration for and acquiring the shares intended to be FTS; do they contain the provisions required by the FTS definition regarding the incurring of qualifying expenses and the renunciation of amounts in respect thereof. However, in our view, the fact that the LP, acting as attorney or agent of the Investors, entered into the Investment Agreements with the PBCs and paid the consideration due to them on the exercise of the Warrants on behalf of the Investors would not, in and by itself, preclude satisfaction of the above requirements.
Where an Investment Agreement is found to constitute a FTS Agreement, provided the shares issued on the exercise of the relevant Warrant are not "prescribed shares" under section 6202.1 of the Regulations and that all of the other requirements in the provisions of the Act relating to FTS are satisfied, it is our view that a PBC would not be precluded from renouncing amounts to an Investor with respect to qualifying expenses incurred by the PBC after the time that the Investment Agreement is entered into with the Investor. Other factors to be considered in light of all the arrangements and circumstances relevant to a particular situation would include: has an appropriate allocation of the consideration given been made where FTS are acquired along with other securities of a PBC; whether the provisions of any specific anti-avoidance provisions of the Act [such as the "anti-warehousing" rules contained in subsection 66(19)] may apply; and whether the provisions of subsection 245(2) of the Act may apply as a result of the arrangements relating to a particular situation (the latter determination including consideration of whether the arrangements relating to a particular situation potentially involve the circumvention of the above-mentioned anti-warehousing rules, prescribed share rules or proposed rules relating to prescribed rights).
If we can be of further assistance with regard to this matter, please contact the writer.
for Director
Reorganizations and Resources Division
Income Tax Rulings Directorate
Policy and Planning Branch
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