2 March 2005 External T.I. 2004-0108511E5 - Minority discount

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.

Principal Issues:

For purposes of the (clause 248(1)(a)(i)(B) of the definition of short-term preferred share and subparagraph 248(1)(f)(ii) of the definition of taxable preferred share [hereinafter the "Excepting Provisions"], will the CRA allow a share of the issuing corporation to be acquired for an amount equal to its fair market value determined with no account being taken of the discount for minority interest.

Position:

A minority discount, if any, should be applied in determining the fair market value of a taxable preferred share and a short term preferred share, at the time described in subparagraph 248(1)(f)(ii) of the Act and clause 248(1)(a)(i)(B) of the Act, respectively.

Reasons:

To the extent that no account is taken of any "minority discount" in determining an amount for which a share could be repurchased under the terms of the agreement to acquire the share, it is possible that this amount could exceed the share's fair market value. This position is supported by jurisprudence (see below) and CRA published position (see below). Moreover, in connection with file # 911137, Finance was consulted on this very issue and in regards to the Excepting Provisions, Finance confirmed that "fair market value means fair market value and that if it was intended that minority discount be excluded in the calculation of fair market value the legislation would specifically so state."

XXXXXXXXXX 							2004-010851
P. Diguer, CGA
March 2, 2005

Dear XXXXXXXXXX:

Re: Paragraph 20(1)(c) of the Income Tax Act (Canada) (the "Act")

We are writing in response to your letter dated December 20, 2004 in which you request our views in regard to the application of subparagraph 248(1)(f)(ii) of the definition of taxable preferred share in the Act and clause 248(1)(a)(i)(B) of the definition of short term preferred share in the Act in the circumstances described in your letter.

In particular, you state as follows.

It is not uncommon for private companies to provide for a periodic repurchase program whereby each year the company would offer the opportunity to its shareholders to sell a certain number of shares back to the corporation in order to provide liquidity. The price is often determined by a formula which is designed to represent the fair market value of the share. However, the issue arises as to how to treat minority discounts in determining the value of the share. If a minority discount must be factored into the purchase price, the provision which provides the relief for fair market value purchases becomes unworkable since the amount of the minority discount of the company would vary from shareholder to shareholder.

You ask that we confirm that in determining the fair market value of a taxable preferred share and a short term preferred share, at the time described in subparagraph 248(1)(f)(ii) and clause 248(1)(a)(i)(B) of the Act, respectively, the minority discount need not be applied.

Our comments

The situation that is described in your letter appears to relate to either a series of proposed or completed transactions involving specific taxpayers. As explained in Information Circular IC-70-6R5 dated May 17, 2002 ("IC-70-6R5") 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 IC-70-6R5. Where the particular transaction is completed, the inquiry should be addressed to the relevant Tax Services Office. Although we are unable to provide any opinion in respect of the specific transactions described in your letter, we have set out some general comments which we hope are of assistance to you. However, written opinions are not advance tax rulings and, accordingly are not binding on the Canada Revenue Agency.

Minority discount

Briefly, a minority discount is a recognized reduction in the value of an ownership interest to reflect the fact that the interest lacks the ability to control the operations of the company.

248(1) definition of "short term preferred share" and "taxable preferred share"

A share will be a short term preferred share if, inter alia, the issuing corporation or a specified person in relation to the issuer may under the terms of the share or an agreement in respect of the share be required to redeem, acquire or cancel the share or to reduce its paid-up capital within 5 years of the date of issue.

A share will be a taxable preferred share if, inter alia, it may reasonably be considered that the amount that a shareholder is entitled to receive for the share upon the dissolution, liquidation or winding-up of the issuing corporation, or on the redemption, acquisition or cancellation of the share, or on a reduction of the paid-up capital in respect of the share is fixed, limited to a maximum or established to be not less than a minimum.

Paragraphs (a) and (e) of the definition "short term preferred share" and paragraph (f) of the definition "taxable preferred share" in subsection 248(1) of the Act contain exceptions to the applications of these definitions for an agreement to acquire the share for its fair market value at the time of acquisition.

In this regard, the specific relieving provisions in question (clause 248(1)(a)(i)(B) of the definition of short-term preferred share and subparagraph 248(1)(f)(ii) of the definition of taxable preferred share [hereinafter the "Excepting Provisions"] in the Act) would only apply if there is an agreement in existence under which a person agrees to acquire a share for an amount that does not exceed the fair market value of the share at the time of the acquisition, determined without reference to the agreement.

Our understanding of your request is that you wish confirmation that the CRA would, for purposes of the Excepting Provisions, allow a share of a private issuing corporation to be acquired for an amount equal to its fair market value determined with no account being taken of the discount for minority interest.

Jurisprudence

It is our understanding that, depending on the circumstances, Canadian courts have found that a discount applied in valuing shares of a corporation owned by a minority shareholder to reflect that minority position.¹ In this regard, with respect to private corporations and valuation problems in relation to minority shareholdings, a brief survey of the courts decisions indicates the tendency of the courts to apply a minority discount.

However, as indicated in William Russell Steen² the Court indicated that with respect to publicly traded shares, a minority discount need not always be computed to reflect the value of a minority interest on the following basis.

There is no clog on the disposal of Plaintiff's shares that would justify a discount from the market price quotation nor is it necessary to take into account Plaintiff's minority position in BCFP in view of the fact that stock market prices of shares in a company listed on a public stock exchange, widely distributed and regularly traded in, as is the case at bar, will reflect a minority discount given that the stock exchange is a market of minority interest (Re Domglas Inc.; Domglas Inc. v.Jarislowsky, [1980] C.S. (Que.) 925; aff'd 138 D.L.R. (3d) 521).

(our emphasis added)

As such, determining whether to apply a minority discount in valuing shares of a public corporation owned by a minority shareholder depends on the facts of the case. However, with respect to valuing shares of a private corporation owned by a minority shareholder, to the extent that no account is taken of any "minority discount" in determining an amount for which a share could be repurchased under the terms of the agreement to acquire the share, it is possible that this amount could exceed the share's fair market value.

Published position

With respect to a private corporation, the Agency's views in regards to whether minority discounts should be considered when determining, for purposes of subparagraph 186(4)(b)(ii) of the Act [regarding Part IV Tax on taxable dividends received by private corporations], the fair market value of the shares held by a shareholder having a minority interest in the corporation, where the controlling interest in the said corporation is held by an unrelated party were provided at the 1987 Canadian Tax Foundation Round Table.

Question 38 - Estimating Fair Market Value of Minority Holdings

In estimating the fair market value of a minority holding of the payer corporation's shares,

1) Is it Revenue Canada's general policy to apply a minority discount in all cases?

2) What criteria are considered in determining the appropriate size of a minority discount?

The Agency's response was as follows:

1) Whether or not a minority discount will be recognized depends upon the facts of the case.

2) The principal criteria that are considered in estimating the appropriate magnitude, if any, of a minority discount include the following:

a) the size of the particular holding;
b) the dispersion of the other shareholdings (that is, is the company a "house of minorities"?);
c) the existence of a control group or groups;
d) the normal trading pattern of the shares;
e) dividend payout record and projection;
f) past record of treatment of minorities by the control group;
g) purpose of the valuation and the expected future of the company;
h) effect of company bylaws and shareholder agreements; and
i) effect of applicable legislation and jurisprudence.

The foregoing is not intended to be all inclusive. Judgment and experience are required to establish quantum.

(our emphasis added)

Conclusion

Given the possibility of an overstatement of the fair market value of a share of a private corporation if a minority discount is not applied in determining the fair market value of the said share at the time described in the Excepting Provisions, it is our view that a minority discount, if any, should be applied in determining the fair market value of a taxable preferred share and a short term preferred share, at the time described in subparagraph 248(1)(f)(ii) of the Act and clause 248(1)(a)(i)(B) of the Act, respectively.

We trust our comments will be of assistance to you.

Yours truly,

Steve Tevlin
for Director
Financial Industries Division
Income Tax Rulings Directorate
Policy and Planning Branch

ENDNOTES

¹ See for example, Harrold P. Connor v. The Queen, 78 DTC 6497 (FCTD), Willian C. Krafve v. MNR, 84 DTC 1002 (TCC) and William Russell Steen v. The Queen, 86 DTC 6498 (FCTD).

² Supra 1 above.