27 August 2002 External T.I. 2002-0157745 - Reverse Stock Split

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: Does a pro rata cancellation of shares result in a reverse stock-split with no income tax consequences?

Position: No. The outright cancellation of some of the issued shares of a corporation results in a disposition of those shares and possibly a benefit. Based on IT-65 a reverse stock-split can be accomplished without income tax implications but the change to the number of shares under the applicable corporate law must not result in a disposition of those shares.

Reasons: See above.

XXXXXXXXXX 2002-015774

August 27, 2002

Dear XXXXXXXXXX:

Re: Cancelled Shares

This is in response to your facsimile letter dated August 12, 2002, wherein you requestedd our opinion on the consequences under the Income Tax Act ("the Act") where some of the shares of the capital stock issued by a corporation are cancelled.

In the situation described in your letter, a corporation that has two major shareholders wants to reduce the number of its issued and outstanding shares of capital stock. You indicate that this reduction will be accomplished by the corporation cancelling a pro rata number of its shares held by each of the two major shareholders without any payment. You ask whether such cancellation results in any income tax consequences to the shareholders.

Your request appears to relate to a proposed transaction. Confirmation of the income tax consequences of proposed transactions involving specific taxpayers will only be provided in response to a request for an advance income tax ruling. To make such a request the advance income tax ruling must be submitted in accordance with the guidelines set out in Information Circular 70-6R5 ("IC-70-6R5") dated May 17, 2002. However, if your situation relates to a completed transaction a request for the Canada Customs and Revenue Agency's views must be made to your local Tax Services Office. As a result we are only able to offer the following general comments.

Where shares of the issued and outstanding capital stock of a corporation are cancelled (with or without payment) a disposition of those shares will result pursuant to the definition of "disposition" in subparagraph 248(1)(b)(i) and, pursuant to subsection 84(9), such shares are deemed to be disposed of by the shareholder to the issuing corporation. 1 The cancellation of shares of the capital stock of a corporation can, depending on the facts and circumstances, result in a capital gain/loss and a deemed dividend to the shareholder on their cancellation and also a benefit to the other shareholders of the corporation.

For example, pursuant to subsection 84(3), where the amount paid by the corporation on the cancellation of a share of its capital stock exceeds the paid-up capital attributable to that cancelled share, a dividend will be deemed to have been paid by the corporation and received by the shareholder for an amount equal to such excess. Moreover, if the shareholder did not deal at arm's length with the corporation, and if the amount paid by the corporation for the cancellation of the share was less than the fair market value of the share at that time, subparagraph 69(1)(b)(i) would apply to deem the shareholder to have received proceeds of disposition equal to that fair market value. To the extent that the cancellation of a share of a corporation's capital stock results in the increase in the value of another shareholder's interest in the particular corporation a "benefit" under subsections 15(1), 56(2) or 246(1) would result.

Notwithstanding the above, it is possible to effect a reduction in the number of issued and outstanding shares of a corporation (a "reverse stock-split") without triggering any immediate income tax consequences. Interpretation Bulletin IT-65 dated September 8, 1972 states:

"Where all the shares of a class of stock of a corporation are replaced by a greater or lesser number of shares of the same class of stock of the same corporation in the same proportion for all shareholders, in circumstances where there is no change in the total capital represented by the issue, there is no change in the interest, rights or privileges of the shareholders and there are no concurrent changes in the capital structure of the corporation or the rights and privileges of other shareholders, no disposition or acquisition is considered to have occurred. The cost of the new shareholding to each shareholder will be the cost of the old shareholding divided into a different number of shares, e.g. in a 2 for 1 split each old share will be represented by two shares and if the cost of the old share was $100 the cost of each new share is $50 and in a 1 for 10 consolidation if the cost of an old share was $5 the cost of a new share is $50.

Where the original shares were owned by a taxpayer on December 31, 1971, the median rule provided in subsection 26(3) of the Income Tax Application Rules, 1971, will apply. For example, if the taxpayer owned shares of X Corporation which he acquired before 1972 at a cost of $25 each and the value on valuation day was $40 each, then subsequently these were split 5 for 1, each new share will be considered to have a cost of $5 and a V-Day value of $8."

A reverse stock-split or stock split is usually accomplished by way of an amendment to the corporation's articles that simply changes the number of shares into a different number without causing a disposition of the shares. However, the specific methodology for effecting a reverse stock split will depend on the corporate law to which the particular corporation is subject.

Our comments are provided in accordance with the practice described in paragraph 22 of IC-70-6R5.

Yours truly,

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

ENDNOTES

1 Depending on the legal form of a particular transaction the cancellation of one class of shares of a corporation followed by the issuance of shares of another class of the corporation may result in a "rollover" under subsection 86(1) or 51(1) (see also IT-448 Dispositions - Changes in Terms of Securities).