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: The meaning of the term "contributed surplus" for purposes of 84(1)(c.3).

Position: Based on generally accepted accounting purposes

Reasons: The term is not defined in the Act.

XXXXXXXXXX 	2002-014665
		Fiona Francis
October 30, 2002

Dear XXXXXXXXXX:

Re: Technical Interpretation - Meaning of "Contributed Surplus"

This is in reply to your letter of June 7, 2002 in which you requested our comments regarding the meaning of the expression "contributed surplus" contained in paragraph 84(1)(c.3) of the Income Tax Act (Canada) ("the Act") in relation to a hypothetical situation.

The situation outlined in your letter appears to relate to a factual situation, involving a specific taxpayer. As explained in Information Circular 70-6R5, it is not the Income Tax Rulings 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 its views. However, we are prepared to offer the following general comments that may be of assistance.

Background

? "Xco" is a taxable Canadian corporation that is neither an insurance corporation nor a bank. Xco has been a private corporation since its incorporation.

? In a prior year subsequent to March 31, 1977, Xco reduced its stated capital account and its paid-up capital in respect of a class of shares of its capital stock for tax purposes, but did not make a distribution to its shareholders in respect of such a reduction. For accounting purposes, the reduction was recorded as a transfer from Xco's share capital account to its "contributed surplus" account. At that time, Xco had an accumulated deficit. The purpose of the reduction in stated capital was to assist Xco in meeting the solvency test under the relevant corporate statute for the payment of dividends on its shares.

? Xco proposes to pass a resolution to transfer its contributed surplus account to its stated capital account for corporate law purposes and to its paid-up capital in respect of the shares of that class of shares for income tax purposes. At this time, Xco continues to have an accumulated deficit that exceeds its contributed surplus account.

You request our view as to whether the contributed surplus arising on the reduction of stated capital is considered to be "contributed surplus" for the purpose of paragraph 84(1)(c.3) of the Act and can be converted into paid-up capital for tax purposes without triggering a deemed dividend under subsection 84(1) of the Act. You also want to know whether our answer would be different if Xco no longer had a deficit at the time of the conversion of contributed surplus into paid-up capital.

OUR COMMENTS

Where a corporation increases the paid-up capital in respect of the shares of any particular class of its capital stock, (other than in certain circumstances), subsection 84(1) of the Act deems the corporation to have paid a dividend. One of the exceptions is contained in paragraph 84(1)(c.3) and allows a corporation, that is neither a bank nor an insurance corporation, to convert into paid-up capital in respect of a class of shares of its capital stock any of its contributed surplus that arose after March 31, 1977, as a result of certain actions which are described in subparagraphs 84(1)(c.3)(i), 84(1)(c.3)(ii) and 84(1)(c.3)(iii). Subparagraph 84(1)(c.3)(iii) allows the corporation to convert any contributed surplus, that arose as a result of any previous action by which the paid-up capital in respect of a class of shares was reduced, into paid-up capital of that class of shares without triggering a deemed dividend pursuant to subsection 84(1).

The term "contributed surplus" is not defined in the Act. It is our view, however, that the meaning of "contributed surplus" should be based on its meaning under generally accepted accounting principles.

We cannot confirm that a company can, in accordance with generally accepted accounting principles, create "contributed surplus" as a consequence of the reduction in stated capital at a time when it also has an accumulated deficit. If the reduction in stated capital was, in accordance with generally accepted accounting principles, credited against the accumulated deficit for accounting purposes, contributed surplus was not created and any subsequent transfer of amounts from accumulated deficit into stated capital will not fall within the ambit of paragraph 84(1)(c.3) of the Act. The fact that the corporation no longer has an accumulated deficit at the time of the conversion should not have any impact on the applicability of paragraph 84(1)(c.3) of the Act. The issue to be determined is whether contributed surplus was created at the time of the reduction in stated capital.

The above comments represent our general view with respect to the subject matter and are not binding on the CCRA, as explained in paragraph 22 of Information Circular 70-6R5. We trust that the foregoing will be of assistance to you.

Yours truly,

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