3 March 2003 External T.I. 2001-0094085 - Redeemable Prefered Shares and 70(5)

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 CCRA.

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

Principal Issues: Whether we would apply GAAR to a series of transactions involving the use of shares which are automatically redeemed upon death of the shareholder for a nominal amount.

Position: We may apply GAAR. However, we do not accept that the FMV of the shares can be set at a nominal amount by such a condition in the Articles of Incorporation.

Reasons: In the case of Nussey Estate v. The Queen, 99 DTC, it was concluded that a shareholder's agreement was not binding on the Minister and did not negate the effect of subsection 70(5).

XXXXXXXXXX 2001-009408
F. Francis
March 3, 2003

Dear XXXXXXXXXX:

Re: Technical Interpretation on the use of redeemable shares

This is in reply to your letter of July 19, 2001, wherein you requested a technical interpretation of the Income Tax Act (the "Act") with respect to a situation whereunder the terms of the Articles of Incorporation of a particular corporation provide that the shares of the corporation are automatically redeemed for a nominal amount upon the death of the holder of the shares. A discretionary trust whose beneficiaries are the children of the majority shareholder will own the common shares of the corporation. You question whether, pursuant to the terms of the Articles of Incorporation, the majority shareholder would be deemed to have disposed of the shares of the corporation immediately before his death for a nominal amount for purposes of subsection 70(5) of the Act.

As noted in Information Circular 70-6R5 issued on May 17, 2002, we do not provide opinions in respect of actual proposed transactions otherwise than as a reply to an advance income tax ruling request. We note that your particular situation involved numerous issues which would necessitate a review of all the pertinent facts and supporting documentation. Consequently, we will provide the following general comments with respect to the foregoing issue.

Upon the death of an individual, subsection 70(5) will deem the individual to have, immediately before death, disposed of the shares of the corporation and received proceeds of disposition equal to the fair market value ("FMV") of the shares immediately before death.

We refer you to the case of Nussey Estate v. The Queen, 99 DTC 1211, (confirmed by the Federal Court of Appeal, 2001 DTC 5240) involving a situation where the taxpayer purchased shares of N Ltd. which were subject to a shareholder's agreement in which N Ltd. was deemed to have redeemed all shares held by any shareholder as of the day immediately preceding his death. The issue was whether the shareholder's agreement was binding on the Minister such that the redemption of the shares occurred prior to the death of the taxpayer. On page 1214, the following comments are made by the Tax Court:

"To hold the shareholder agreement to be binding in this regard on the Minister would in effect permit the shareholders to negate the effect of subsection 70(5) of the Income Tax Act ... The shareholders cannot by agreement amend the provisions of the Act as applicable to them."

Further, we refer to the case of Wood v. M.N.R., 88 DTC 1180, where the articles of incorporation of a company provided that a resolution signed by all the members of the Board of Directors could essentially provide that the timing of a dividend payment could be deemed to occur at a particular time other than the actual time of payment. In dismissing the taxpayer's appeal, Judge Bonner said (at 1182):

"Nothing in the wording of the statute [Corporations Act of Alberta] makes the Articles binding on persons other than the company and its members. They do not bind the Respondent who is a stranger to them. I find unacceptable the notion that a company and its shareholders are entitled, for purposes affecting the rights of third parties, to rewrite history, that is to say to treat imaginary events as having happened."

It is our view that the FMV of property is the value available in an open and unrestricted market between informed prudent parties, acting at arm's length and under no compulsion to act, expressed in terms of money or money's worth. This definition is essentially the same as that accepted by the Supreme Court of Canada in Minister of Finance of British Columbia v. Mann Estate, [1974] CTC 222.

Consequently, it is our position that the redemption value of the shares of the corporation as set forth in the Articles of Incorporation will not necessarily be the FMV of the shares for purposes of subsection 70(5).

Finally, we note that subsection 245(2) may apply to redetermine the tax consequences, depending on all the pertinent facts of the particular case.

Yours truly,

for Director
Reorganizations and Resources Division
Income Tax Rulings Directorate
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