28 June 2001 External T.I. 2001-0073205 - SUBSTANTIAL ISSUER BID

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:

Will Part VI.1 apply to a corporation in regards to a deemed dividend on taxable preferred shares arising on the purchase of its issued common shares by way of a substantial issuer bid.

Position TAKEN:

Generally, yes.

However, Part VI.I may not apply if it is determined that the common shares are purchased by the issuing corporation for an amount which does not exceed their fair market value.

Reasons FOR POSITION TAKEN:

Consistent with previously published positions (file # 9609563 and E9M19190).

XXXXXXXXXX 							2001-007320
P. Diguer
June 28, 2001

Dear XXXXXXXXXX:

Re: Substantial issuer bid

This is in reply to your letter dated February 26, 2001 in which you request our views on the application of Part VI.1 of the Income Tax Act (Canada) (the "Act") to a corporation in regards to a dividend arising on the repurchase, under the terms of a substantial issuer bid, of its common shares.

Specifically, in your letter you describe a situation where a corporation determines that its common shares are undervalued relative to their trading price on a prescribed stock exchange. Therefore, the corporation proceeds to acquire, under the rules of a substantial issuer bid as set out in the relevant securities act and stock exchange by-laws and rules, a number of its shares at a premium above the trading price.

Your comments

If the trading price of the shares on a stock exchange is taken to be the only measure of their fair market value the payment of a premium over trading price may result in the said common shares qualifying as "short-term preferred shares" and "taxable preferred shares", as defined in subsection 248(1) of the Act for purposes of Part VI.I of the Act (tax on dividends on taxable preferred shares). Moreover, for the same reason, any deemed dividend under subsection 84(3) arising on the redemption may not be an excepted dividend pursuant to subsection 191(4) of the Act. Accordingly, the corporation may be subject to Part VI.I tax on a deemed dividend paid on the said shares.

In your view, given the tax policy objectives for which the short-term preferred share rules were enacted in 1987, it would appear inconsistent with this purpose if the Act were interpreted so that any dividends arising on a repurchase of common shares would be

subject to corporate distributions tax levied under Part VI.I of the Act. You ask if, for purposes of the definition of short-term preferred shares and subsection 191(4) of the Act, the Canada Customs and Revenue Agency's ("CCRA") position is that the fair market value of a share is always the trading price or can fair market value be determined by other valuation methods.

Our Comments

Written confirmation of the tax implications inherent in particular transactions are given by this Directorate only where the transactions are proposed and are the subject matter of an advance ruling request submitted in the manner set out in Information Circular IC-70-6R4 dated January 29, 2001. Nevertheless, we offer the following general comments in connection with your request which we hope are of assistance to you.

Short-term preferred share and taxable preferred share

The definitions in subsection 248(1) for "taxable preferred share" and "short-term preferred share" are very general and apply, among other things, when an issuing corporation or related person (within the meaning of paragraph (h) of the definition of taxable preferred share) to the corporation is party to an agreement to acquire a share for a specified amount. In a general sense, the exception to this rule is when the amount specified in the agreement to acquire the share does not exceed the fair market value of the share when it is acquired. To this end, the fair market value of a share must be determined without referring to the agreement in question.

With respect to the situation at hand, the issuance of an issuer bid by the corporation may be viewed as constituting "an agreement relating to the share" in which an amount in respect of the share is specified and under the terms of which the corporation "is or may, at any time within 5 years ... be required to ... acquire... the share", such that the share could be characterized as a "short-term preferred share" as that term is defined in subsection 248(1) of the Act and thus a "taxable preferred share" also defined in subsection 248(1) of the Act. In this situation the corporation could be subject to Part VI.I tax (tax on dividends on taxable preferred shares) on a portion of the amount paid for the share under the terms of an issuer bid.

However, it is CCRA's view that in the situation described, the corporation's common shares will not necessarily become taxable preferred shares or short-term preferred shares as a result of the substantial issuer bid. Such a determination is a question of fact that can only be made once the fair market value of the shares at the time of their acquisition is known. In this regard, it is observed that the provisions of clause (a)(i)(B) of the definition of "short-term preferred share" and paragraph (f) of the definition of "taxable preferred share" in subsection 248(1) of the Act specifically make reference to alternative

valuation methods employing assets and/ or earnings of the corporation. Therefore, although the value of a share on the stock exchange is an indication of its fair market value, the CCRA feels that all the circumstances surrounding each particular situation must be examined to make this determination.

We trust our comments will be of assistance to you.

Yours truly,

for Director
Financial Industries Division
Income Tax Rulings Directorate
Policy and Legislation Branch