22 February 2000 External T.I. 2000-0005075 - transitional rules to ss 112(3)

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 an amendment to an agreement in writing which was in existence on April 26, 1995 which provides for the corporation to purchase life insurance to fund the repurchase of shares on death is a material change?

Whether an amendment requiring the corporation to elect under subsection 83(2) is a material change?

Position: Yes.

Reasons: The change is fundamental enough to result in a new agreement.

XXXXXXXXXX 						2000-000507
F. Francis
Attention: XXXXXXXXXX 

February 22, 2000

Dear Madam:

Re: Subsection 112(3) of the Income Tax Act (the "Act")

This is in reply to your letter of January 24, 2000, wherein you request our comments with respect to the transitional rules to subsection 112(3) of the Act (the "Grandfathering Status").

In particular, you request our views in respect of the following situation:

1. A shareholders agreement (the "Agreement") was entered into prior to April 27, 1995.

2. The parties to the Agreement remain unchanged after April 26, 1995.

3. The Agreement provides that in the event of the death of an individual shareholder, the shares owned by the estate of the deceased shareholder will be repurchased by the corporation.

4. The fair market value of the shares in the corporation exceed their adjusted cost base and the paid-up capital as those terms are defined in the Act.

5. The corporation has never owned any insurance on the life of any individual shareholder for the purpose of funding the agreement.

You enquire as to whether any of the following, taken alone or together, would be considered material changes to the Agreement resulting in the loss of Grandfathering Status:

a. a requirement that the corporation fund the buy-out on death by purchasing insurance on the life of an individual shareholder; and

b. a requirement that in the event of a share redemption on the death of a shareholder, the corporation would elect, pursuant to subsection 83(2) of the Act, that any dividend deemed to arise on redemption be elected to be a capital dividend to the extent of any increment to the corporation's capital dividend account by reason of receiving life insurance proceeds on the death of the shareholder.

You also ask whether the answers to the questions above would be the same regardless of whether the changes were made as an amendment to the Agreement or as a separate but supplementary agreement to the Agreement.

OUR COMMENTS

As you have noted, we have taken positions indicating that a material change to a written agreement that was in existence on April 26, 1995 will be considered to result in a new agreement and will therefore result in loss of Grandfathering Status. The determination as to whether a particular change to an agreement is sufficiently material such that it results in a new agreement can only be made on a case-by-case basis. The courts have determined that fundamental changes which substantially affect the basic elements of an agreement represent a whole new agreement.

Generally, in our view, an amendment that requires the corporation to fund the repurchase of shares by purchasing life insurance substantially affects the basic elements of the Agreement and results in loss of Grandfathering Status. Consistent with the foregoing comment, the amendment requiring the corporation to make an election under subsection 83(2) of the Act would also be considered a material change. Finally we note that our response would be the same notwithstanding that the changes were made as a separate but supplementary agreement to the Agreement.

We trust the above comments are of assistance to you. However, as noted in Information Circular 70-6R3 issued on December 30, 1996, the above comments are not binding on the Canada Customs and Revenue Agency.

Yours truly,

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