27 April 2005 External T.I. 2005-0112921E5 - Interaction of subsections 84(3) and 112(3.01)

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: Whether "the separate class of shares" referred to in subsection 84(3) should apply to "the issued shares of any class of the capital stock of the corporation" referred to in subsection 112(3.01)?

Position: No.

Reasons: It is consistent with the tax policy underlying subsection 112(3.01).

2005-011292
XXXXXXXXXX Daniel Wong
(613) 954-4949
April 27, 2005

Dear XXXXXXXXXX:

Re: Technical Interpretation Request: Interaction of subsections 84(3) and 112(3.01) of the Income Tax Act ("Act")

This is in reply to your letter of January 25, 2005 wherein you requested our opinion with respect to the interaction of subsections 84(3) and 112(3.01) of the Act to a scenario as described below.

Aco (and all non-arm's length persons) owned in total less than 5% of the issued shares of a class of a corporation ("Bco"). Bco redeemed all the shares of the class that were owned by Aco and some of the shares of the class that were owned by other shareholders of Bco such that the shares redeemed from Aco constituted more than 5% of the total number of shares redeemed. Immediately prior to the redemption, Aco had held its Bco shares for more than 365 days. Both Aco and Bco were taxable Canadian corporations.

Subsection 84(3) would deem the shares that Bco redeemed to be a "separate class of shares" for the purposes of determining a dividend that Bco was deemed to have paid, and Aco and other shareholders of Bco were deemed to have received, to the extent that the amount that Bco paid for the redemption of the Bco shares exceeded their paid-up capital.

Where the disposition by Aco of its Bco shares would result in a loss to Aco, paragraph 112(3)(b) would, inter alia, reduce that loss otherwise determined by the total of all amounts of taxable dividends that Aco had received on its Bco shares so redeemed, to the extent that the dividends were deductible under section 112 in computing Aco's taxable income.

However, subsection 112(3.01) would, inter alia, not include a dividend in the total determined under paragraph 112(3)(b) if the dividend was received when a taxpayer and persons with whom the taxpayer was not dealing at arm's length owned in total not more than 5% of the issued shares of any class of a corporation from which the dividend was received and further, held those shares for at least 365 days before the redemption.

You were concerned that subsection 112(3.01) might not apply to not include the subsection 84(3) dividend that Aco was deemed to have received on the disposition of its Bco shares in the total determined under paragraph 112(3)(b). This would be the case if the 5% limit in subsection 112(3.01) was calculated based on "the separate class of shares" referred to in subsection 84(3), because the Bco shares that Aco disposed of represented more than 5% of the Bco shares that Bco redeemed.

You opined that this result would be inappropriate, as Aco's shareholding in Bco gave it no control of Bco in respect of the number of Bco shares that Bco redeemed from each shareholder of Bco or the timing of such redemptions. Further, in your view, if this interpretation was taken, a shareholder that holds more than 5% but less than 10% of an actual class of shares of a corporation could escape the application of paragraph 112(3)(b) by the shareholder's tendering for a particular redemption by the corporation only such number of shares as amount to not more than 5% of all shares of that class to be redeemed at that time by the corporation.

Our Comments

In your letter, you outlined what appears to be an actual fact situation related to transactions and events that have taken place. The review of such situations is generally the responsibility of the local taxation services offices and, as outlined in paragraph 22 of Information Circular 70-6R5, it is not our practice to provide specific opinions on factual situations otherwise than in the context of an advance income tax ruling. In any event, a request cannot be considered for a ruling when the transactions are completed or where the issues involved are primarily questions of fact. Nevertheless, we are prepared to provide the following comments that we hope will be of assistance to you.

In our view, "the issued shares of any class of the capital stock of the corporation" referred to in subsection 112(3.01), refers to the actual number of shares of that class issued and not to the number of shares redeemed that constitute "the separate class of shares" referred to in subsection 84(3).

These comments are provided in accordance with paragraph 22 of Information Circular 70-6R5.

Yours truly,

David Palamar
Section Manager
For Division Director
Reorganizations and Resources Division
Income Tax Rulings Directorate
Policy and Planning Branch