10 November 1997 Administrative Letter 970972A - : Direct or Indirect Interest

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 a right, arising from the tendering of shares pursuant to a takeover bid, to acquire shares of a corporation, would constitute a direct or indirect interest in any issued shares of that corporation within the meaning of subparagraph 88(1)(c.2)(iii).

Position:

No.

Reasons:

To decide otherwise would lead to unintended results.

XXXXXXXXXX

Attention: XXXXXXXXXX

Dear Madam:

Re: Proposed Definition of Specified Shareholder for Purposes of Paragraph 88(1)(c) of the Income Tax Act (the "Act")

This is in response to your letter of April 11, 1997 wherein you requested our views on the above-captioned definition in the context of the following assumptions.

Assumptions

1. Xco is a public corporation and a taxable Canadian corporation for the purposes of the Act.¹

2. Xco owns all of the issued shares of certain other taxable Canadian corporations and foreign subsidiaries (collectively, the "Subsidiaries").

3. Aco, Bco and Cco are taxable Canadian corporations for the purposes of the Act.

4. Four employees of Xco (either personally or through holding corporations) (collectively "Management") together with Aco, Bco and Cco, desire to form a new corporation ("Bidco") for the purpose of acquiring all of the shares of Xco.

5. In particular, the following steps would occur:

(i) Bidco would be incorporated under the laws of Ontario;

(ii) Aco and Bco would each subscribe for more than 10% of the shares of the same class of voting shares of Bidco, Cco would subscribe for all the shares of another class of voting shares of Bidco and Management would subscribe for all the shares of another class of voting shares of Bidco;

(iii) Bidco would borrow funds from financial institutions (including Aco and Bco);

(iv) Bidco would make a takeover bid (the "Bid") for all of the outstanding shares of Xco and would pay for such shares with cash consideration. This cash would be acquired by Bidco through the equity subscriptions described in (ii) above, and through borrowings described in (iii) above; and

(v) Bidco, after acquiring all of the outstanding shares of Xco, would dissolve Xco in a manner that would satisfy the requirements of subsection 88(1) and would file a designation under paragraph 88(1)(d) to increase the cost of the shares of the Subsidiaries.

6. Aco, Bco, Cco and Bidco (together with "specified shareholders" as defined in subsection 248(1)) thereof and persons with whom they do not deal at arm's length) do not, and would not at any time prior to the acquisition of control of Xco, own any shares of Xco or of any corporation related to Xco. Management, on a fully diluted basis, owns approximately 6% of the issued common shares of Xco and would not acquire any further shares of Xco prior to the acquisition of control of Xco.

You have requested a technical interpretation that, based on these assumptions, any shareholder of Bidco which owns 10% or more of the shares of any class of shares of Bidco will not be considered to be a specified shareholder of Xco prior to the acquisition of control of Xco by Bidco, for the purposes of paragraph 88(1)(c) of the Act.

Our Views

A. Analysis

Only capital property, other than "ineligible property", is eligible for the "bump" in cost under paragraph 88(1)(c). Ineligible property is defined in subparagraphs 88(1)(c)(iii) to (vi). The relevant portion of subparagraph 88(1)(c)(vi) provides as follows:

(vi) property distributed to the parent on the winding-up where, as part of the series of transactions or events that includes the winding-up,

(A) the parent acquired control of the subsidiary, and

(B) any property distributed to the parent on the winding-up or any other property acquired by any person in substitution therefore is acquired by

(I) a particular person (other than a specified person) that, at any time during the course of the series and before control of the subsidiary was last acquired by the parent, was a specified shareholder of the subsidiary,

. . .

For the purposes of addressing your inquiry, subparagraph 88(1)(c)(vi) has to be read in conjunction with subparagraph 88(1)(c.2)(iii), which extends the definition of specified shareholder, and paragraph 88(1)(c.3), which extends the meaning of property distributed on the winding-up.

A specified shareholder of a corporation is defined in subsection 248(1) to be a shareholder which owns not less than 10% of the issued shares of any class of the capital stock of the corporation or of any other corporation that is related to the corporation. Subparagraph 88(1)(c.2)(iii) provides that, for the purposes of paragraph 88(1)(c), the words "and that has a direct or indirect interest in any issued shares of the capital stock of the corporation" be added to the end of the words "or of any other corporation that is related to the corporation".

Paragraph 88(1)(c.3) provides that, inter alia, for the purposes of clause 88(c)(vi)(B), property acquired in substitution for property distributed to the parent on the winding-up includes property the fair market value of which is wholly or partly attributable to the particular property or properties.

Applying these provisions to your assumptions, Aco, Bco, Cco and member(s) of Management of Xco will each own 10% or more of the issued shares of any class of shares of Bidco. You have advised us that, unless the Bid is extended or amended, shares tendered to the Bid cannot be withdrawn after 21 days and before 45 days after the Bid documents are mailed. Bidco will therefore, upon waiver of any bid conditions, have a legal right to acquire control of Xco during this period of time. Bidco will be related to Xco by reason of paragraph 251(5)(b) once more than 50% of the shares of Xco have been deposited pursuant to the Bid and such shares cannot be withdrawn by the shareholders of Xco. Accordingly, if Bidco is considered, prior to the actual acquisition of shares of Xco, to have a direct or indirect interest in the issued shares of Xco, Aco, Bco, Cco and member(s) of Management will each be considered to be a specified shareholder of Xco prior to the acquisition of control of Xco by Bidco.

Since the value of the shares of Bidco would be partly attributable to the value of shares of the Subsidiaries, once Bidco acquires Xco, they would, by virtue of subparagraph 88(1)(c.3)(i), be considered to be property substituted for property distributed to the parent on the winding-up for the purposes of clause 88(1)(c)(vi)(B). If any of the shareholders of Bidco are considered to be specified shareholders of Xco before Bidco acquires control of Xco, the shares of the Subsidiaries would be considered to be ineligible property.

B. Conclusion

In our view, the shareholders of Bidco should not be considered to be specified shareholders of Xco, prior to the acquisition of control of Xco by Bidco, for the purposes of clause 88(1)(c)(vi)(B)(I) solely as a result of Bidco's right to acquire the shares of Xco in the circumstances described.

The foregoing opinion is not a ruling and, in accordance with the guidelines set out in Information Circular 70-6R3 dated December 30, 1996, is not binding on the Department. It is based on the assumption that the Act will be amended in substantially the same manner as proposed in the former Bill C-69 which received first reading on December 2, 1996 but which was not passed.

Yours truly,

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