Translation disclaimer
This translation was prepared by Tax Interpretations Inc. The CRA did not issue this document in the language in which it now appears, and is not responsible for any errors in its translation that might impact a reader’s understanding of it or the position(s) taken therein. See also the general Disclaimer below.
Principal Issues: An individual (X") owns all of the issued and outstanding shares of the capital stock of a corporation ("GESCO"). Another individual (Y") owns all of the issued and outstanding shares of the capital stock of another corporation ("HOLDCO"). Each of GESCO and HOLDCO owns 50 common shares of the capital stock of an operating corporation ("OPCO"). GESCO and HOLDCO are the only shareholders of OPCO and they deal with each other at arm's length. Pursuant to a shareholders' agreement, GESCO or HOLDCO, as the case may be, would have the right to acquire the shares of the capital stock of OPCO held by the other shareholder, if X or Y, as the case may be, would leave his or her employment with OPCO. Whether each of GESCO and HOLDCO would be deemed to own all of the issued and outstanding shares of the capital stock of OPCO pursuant to paragraph 256(1.4)(a) of the Act.
Position: Yes. Each of GESCO and HOLDCO would be deemed to own all of the issued and outstanding shares of the capital stock of OPCO pursuant to paragraph 256(1.4)(a). Consequently, GESCO would be associated with OPCO pursuant to paragraph 256(1)(a) or 256(1)(b) of the Act. Furthermore, HOLDCO would be associated with OPCO pursuant to paragraph 256(1)(a) or 256(1)(b) of the Act. It should be noted that pursuant to subparagraph 256(1.2)(b)(ii) of the Act, a corporation may be controlled by a person notwithstanding that the corporation is also controlled or deemed to be controlled by another person.
Reasons: Wording of the Act and previous positions.
2005-011990
XXXXXXXXXX S. Prud'Homme
(613) 957-8975
April 20, 2005
Dear Sir,
Subject: Request for Technical Interpretation - Paragraph 256(1.4)(a) of the Income Tax Act
This is in response to your email of March 8, 2005, in which you requested our opinion regarding the potential application of paragraph 256(1.4)(a) of the Income Tax Act (the "Act") in a particular situation.
Unless otherwise indicated, all references to a statutory section or included provision in this letter are to a section of the Act or one of its provisions.
It appears to us that the situation described in your letter and summarized below may be an actual situation involving taxpayers. As explained in Information Circular 70-6R5, it is not the practice of this Directorate to provide comments on proposed transactions involving specific taxpayers otherwise than in the form of an advance income tax ruling. If your situation involved specific taxpayers and one or more completed transactions, you should submit all relevant facts and documentation to the appropriate Tax Services Office for its opinion. However, we are able to offer the following general comments that may be helpful. It should be noted that the application of one or more provisions of the Act generally requires an analysis of all the facts relating to a particular situation. Accordingly, and given that your letter only briefly describes a hypothetical situation, the comments we provide below may not be fully applicable in a particular situation.
(1) Particular Situation
You have presented us with the situation described below (the "Particular Situation") as part of your request for a technical interpretation.
(a) Three corporations ("Gesco", "Holdco" and "Opco," respectively) were "Canadian-controlled private corporations" within the meaning of the definition in subsection 125(7).
(b) An individual ("X") held all of the issued and outstanding shares of the capital stock of Gesco.
(c) Another individual ("Y") held all of the issued and outstanding shares of the capital stock of Holdco.
d) Each of Gesco and Holdco held 50% of the issued and outstanding shares of the capital stock of Opco. Specifically, each of Gesco and Holdco held 50 common shares of the capital stock of Opco.
(e) Gesco and Holdco dealt with each other at arm's length.
(f) Gesco and Holdco entered into a shareholders' agreement which included, inter alia, the following provision: in the event that X or Y left the employ of Opco, Gesco or Holdco, as the case may be, would be required to offer the shares of Opco capital stock then held by it to the other shareholder.
We understand that, if subsection 256(1.4) is not taken into account, Gesco, Holdco and Opco would not be associated with each other.
(2) Your Comments on the Particular Situation
You indicated that based on the approach taken by the Canada Revenue Agency ("CRA") in Technical Interpretation No. 2004-009699 dated November 10, 2004, Gesco or Holdco would be deemed to control Opco as a result of the application of paragraph 256(1.4)(a) in the Particular Situation. Also based on that document, you understand that the CRA's position is that the fact that Gesco would be deemed to hold all of the common shares of Opco by virtue of paragraph 256(1.4)(a) would not change the effect of that legislation with respect to Holdco.
You also indicated that in Technical Interpretation No. 2003-0020895 dated June 16, 2003, the CRA indicated the following: [TaxInterpretations translation]
In the situation you have presented to us, we are of the view that paragraph 256(1.4)(a) of the Act has the effect of deeming each of Invest1 Inc. and Invest2 Inc. to hold, simultaneously, a number of additional common shares of XYZ Inc. at any given time equal to the number of common shares that they may acquire under the convertible debentures, and such shares are deemed to be, simultaneously, issued and outstanding at that time for the purpose of determining whether a corporation is associated with another corporation.
You point out that this quote refers to simultaneous possession of the shares for the purposes of paragraph 256(1.4)(a). It is your view that if the same reasoning were applied in the Particular Situation, Holdco would hold its 50 common shares of Opco's capital stock, plus the 50 shares of Opco's capital stock held by Holdco but deemed to be held by Gesco under paragraph 256(1.4)(a). As for Gesco, it would hold 50 common shares of Opco's capital stock, plus the 50 shares of Opco's capital stock held by Holdco but which would be deemed to be held by Gesco under paragraph 256(1.4)(a). In your view, each of Gesco and Holdco would therefore be deemed to hold 100 common shares of the capital stock of Opco by virtue of paragraph 256(1.4)(a), and in particular by virtue of the presumption that the shares covered by that provision are deemed to be issued and outstanding at the relevant time. In those circumstances, you are of the view that neither Gesco nor Holdco would control Opco alone for the purposes of section 256.
(3) Our Comments on the Particular Situation
We disagree with your interpretation of paragraph 256(1.4)(a) as set out in the last paragraph in (2) above.
It should first be noted that documents Nos. 2004-0096999 and 2003-0020895 deal with different situations. Document No. 2004-0096999 deals with a situation where each shareholder of a corporation would, under the terms of a shareholders' agreement and under certain conditions, have the right to acquire shares of the capital stock of the corporation held by another shareholder. Document No. 2003-0020895 deals with a situation where each shareholder of a corporation holds debentures entitling him to convert them into newly issued shares of the capital stock of the corporation.
The position taken by the CRA in 2003-0020895 is based, inter alia, on the fact that the shareholders referred to in that document were entitled to acquire new shares of the capital stock of a corporation that were not yet issued and outstanding and that, under paragraph 256(1.4)(a), such shares were deemed issued and outstanding at the relevant time.
In the hypothetical situation described in document No. 2004-0096999 and in the Particular Situation, no person has a right to acquire new shares of the capital stock of a corporation not yet issued and outstanding. Those situations involve only persons with a right to acquire shares of the capital stock of a corporation already issued and outstanding. In our view, the presumption in paragraph 256(1.4)(a) that shares are deemed to be issued and outstanding is relevant only in respect of new unissued and outstanding shares to which persons would be entitled, not in respect of shares already issued and outstanding.
Based on the foregoing, we are of the view that Gesco would have a right to acquire shares of the capital stock of Opco held by Holdco and that this right would be covered by paragraph 256(1.4)(a). Consequently, Gesco would be deemed to hold the shares of the capital stock of Opco held by Holdco. Gesco would therefore be deemed to hold all of the issued and outstanding shares of the capital stock of Opco. Thus, each of X and Gesco would control Opco. Consequently, Gesco and Opco would be associated with each other under paragraph 256(1)(a) or 256(1)(b).
We are also of the view that Holdco would have a right to acquire shares of the capital stock of Opco held by Gesco and that this right would fall within paragraph 256(1.4)(a). Consequently, Holdco would be deemed to hold the shares of the capital stock of Opco held by Gesco. Holdco would therefore be deemed to hold all of the issued and outstanding shares of the capital stock of Opco. Thus, each of Y and Holdco would control Opco. Consequently, Holdco and Opco would be associated with each other under paragraph 256(1)(a) or 256(1)(b).
Note that under subparagraph 256(1.2)(b)(ii) and for the purposes of, among others, subsections 256(1) and 256(1.4), a person may control a corporation even if another person also controls or is deemed to control the corporation. Thus, it would be possible to conclude in the context of the Particular Situation that Opco would be controlled by both Gesco and Holdco.
We hope that our comments are of assistance.
Best regards,
Stéphane Prud'Homme, Notary, M.Fisc.
For the Director
Corporate Reorganizations and Resource Industries Division
Income Tax Rulings Directorate
Policy and Planning Branch
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