8 May 1996 External T.I. 9613115 - PUC SHIFT ON SECTION 86 SHARE EXCHANGE

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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues:

Whether a PUC shift on a section 86 share exchange works; mechanics of the formula, whether a dividend results

Position:

there is no deemed dividend or PUC reduction, no GAAR

Reasons:

mechanics of the Act, nothing offensive happening

		961311
XXXXXXXXXX	V. Plant
(613) 957-2120
Attention:  XXXXXXXXXX

May 8, 1996

Dear Sirs:

Re: Calculation of paid-up capital ("PUC")

This is in reply to your letter of April 15, 1996 in which you requested our opinion regarding the application of subsections 86(2.1) and 84(3) of the Income Tax Act (the "Act") to a hypothetical situation where one class of shares owned by three shareholders who deal with each other at arm's length will be exchanged for three new classes of shares of the same corporation in order to restore each shareholder to the amount of PUC each would have had, had he originally purchased a separate class of shares.

It is your understanding that amount "A" of the formula set out in subsection 86(2.1) of the Act refers to the increase in the PUC of the issued shares of the corporation as a whole since A is defined to be the total of all of the amounts each of which is an increase in the PUC of a class of shares as a result of the reorganization. Any reduction required under the formula would then be applied on a proportionate basis to each particular class of shares since "C" in the formula refers to a particular class of shares.

You also are of the opinion that the provisions of subsection 84(3) would apply on an aggregate basis rather than on an individual shareholder basis. Only when there is an excess determined under paragraph 84(3)(a) of the Act on an aggregate basis would each shareholder be allocated his share of deemed dividend on a pro rata basis. Accordingly, there would be no deemed dividend resulting from a reorganization since the total PUC of the corporation after the exchange of shares is the same as the PUC of the old Class A shares.

Our comments

We agree that "A" of the formula found in subsection 86(2.1) of the Act refers to the increase in the PUC of all the classes of shares, and not the PUC of a particular class of shares, since it refers to the "...total of all amounts, each of which is the increase...in the paid-up capital in respect of a class of shares...". This means that the increase in the PUC of all the relevant classes of shares should be added together, with the total giving "A" of the formula. The excess, if any, of "A" minus "B" is allocated to each particular class of shares using "C" of the formula.

Pursuant to subsection 84(3) of the Act, where a corporation resident in Canada has redeemed, acquired or cancelled any of the shares of a class of its capital stock, the corporation is deemed to have paid a dividend in an amount equal to the amount, if any, by which the aggregate amount paid by the corporation exceeds the PUC of the particular share or shares. Also, each holder of shares which were redeemed, acquired or cancelled is deemed to have received a proportional share of such dividend. However, where the consideration paid by the corporation includes a share of its capital stock, subsection 84(5) of the Act provides that for purposes of determining the amount paid by the corporation under subsection 84(3), the share is to be valued at an amount equal to the amount by which the PUC of the class of shares to which it belongs has been increased by virtue of the issue of the share. Consequently, assuming that all the shares are exchanged at the same time, where the aggregate PUC of the shares of a corporation issued upon an exchange of shares is equal to the aggregate PUC of the shares prior to the exchange, and there is no consideration other than shares, there would be no deemed dividend under subsection 84(3) of the Act resulting from the exchange.

We would like to draw your attention to the possible application of subsection 245(2) of the Act to a series of transactions where there is a shift of PUC occurring between classes of shares. It would be essential to review all of the relevant facts associated with the particular situation in order to determine whether the provisions of subsection 245(2) of the Act would apply. However, it is our general view that a shift of PUC to restore each shareholder to the amount of PUC that the shareholder would have had had he originally purchased a separate class of shares would not be abusive.

The above comments represent our general views with respect to the subject matter of your letter and are provided in accordance with the practice described in paragraph 21 of Information Circular 70-6R2, dated September 28, 1990, issued by Revenue Canada, Customs, Excise and Taxation.

for Director
Reorganizations and International Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch