7 January 2003 External T.I. 2002-0133675 - Cash Call Provisions & Contingent Rts

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 paragraph 251(5)(b) and/or subsection 256(1.4) applies to rights under cash call provisions of shareholders' agreement in particular situation?

Position: Yes

Reasons: The rights are contingent rights

XXXXXXXXXX 								2002-013367
	Gwen Watson
January 7, 2003

Dear Mr. XXXXXXXXXX:

Subject: Cash Call Provisions

This is in reply to your letter of March 28, 2002 wherein you requested a technical interpretation on the application of paragraph 251(5)(b) and subsection 256(1.4) of the Income Tax Act (Canada) (the "Act") in respect of rights arising under a cash call agreement.

In your hypothetical scenario, Opco is a Canadian-controlled private corporation with three corporate shareholders, Aco, Bco and Cco. None of Aco, Bco or Cco own more than 50% of the voting shares of Opco or form an unrelated or related group that controls Opco. The key terms of the cash call agreement are contained in a shareholders' agreement, as follows:

1. In the event that Opco is unable to raise necessary operating funds from a bank or other financial institution, Opco can issue a demand for cash to each shareholder in proportion to its shareholdings;

2. In the event that a shareholder fails to advance the requested funds (the "defaulting shareholder"), another shareholder (the "advancing shareholder"), who is not in default, may choose to advance all or a portion of the funds requested of the defaulting shareholder; and

3. If the defaulting shareholder fails to pay to the advancing shareholder the amount advanced by the advancing shareholder to Opco within 90 days from the date the advancing shareholder made the payment, the advancing shareholder may cause Opco to proportionately reduce the defaulting shareholder's shareholdings in Opco, in accordance with a formula stipulated in the shareholders' agreement, and the advancing shareholder's shareholdings will be proportionately increased.

You have asked for our views on whether paragraph 251(5)(b) or subsection 256(1.4) of the Act would apply to deem each shareholder of Opco to own the shares of all the other shareholders of Opco. In your view, those provisions would not apply because the rights described in the cash call provisions in the shareholders' agreement are based on multiple contingencies.

The particular situation outlined in your letter appears to relate to a factual one, involving a specific taxpayer. As explained in Information Circular 70-6R5, it is not this Directorate's practice to comment on proposed transactions involving specific taxpayers other than in the form of an Advance Income Tax Ruling. Should your situation involve a specific taxpayer and a completed transaction, you should submit all relevant facts and documentation to the appropriate Tax Services Office for their views. However, we are prepared to provide the following comments.

Our Comments

We do not agree. As a preliminary point, we have assumed that the reduction in shareholdings described in paragraph 3 above is by way of redemption or purchase for cancellation and the corresponding increase in shareholdings is by way of an issuance of shares. Accordingly, in our view, each shareholder would have rights described under both subparagraphs 251(5)(b)(i) and (ii), and paragraphs 256(1.4)(a) or (b), given that each shareholder would be entitled to cause Opco to redeem or purchase a proportion of the shares held by the defaulting shareholder and also receive a proportional number of shares. The fact that the exercise of either of these rights is dependent on the happening of more than one event does not alter this position.

We trust our comments will be of assistance to you. These comments are provided in accordance with the practice outlined in paragraph 21 of Information Circular 70-6R5 issued on May 17, 2002.

Yours truly,

Mark Symes
Section Manager
for Director
Reorganizations and Resources Division
Income Tax Rulings Directorate
Policy and Legislation Branch
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