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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: [TaxInterpretations translation] 1. Based on the assumptions given for the situation, the transitional rules in paragraph 131(11)(b) of the Income Tax Amendments Act, 1997 (Bill C-28, assented to June 18, 1998) regarding the application of subsection 112(3) or (3.2) apply to common shares held by a taxpayer in the capital stock of a particular corporation. The common shares are exchanged for preferred shares in a transfer to which section 85 applies. Would the transitional rules apply in respect of preferred shares?
2. In determining whether shares are covered by the transitional rules, should transactions by other shareholders or shares of different companies be taken into account?
Position: 1. The taxpayer's preferred shares are deemed to be the same shares as the common shares that were held by the taxpayer before the exchange. Provided the condition in subparagraph 131(11)(b)(iv) is satisfied, the preferred shares would be subject to the transitional rules if the common shares were.
2. A taxpayer should not take into account transactions by other shareholders or in respect of shares of different corporations when determining whether shares are covered by the transitional rules.
Reasons: 1. Section 131(12) of Bill C-28.
2. Section 112(3.2) and the transitional rules apply in respect of a share.
XXXXXXXXXX 2006-017788
Sylvie Labarre,CA
July 10, 2007
Dear Madam,
Subject: Subsections 112(3) and (3.2) of the Income Tax Act
This is in response to your letter of March 17, 2006, requesting our views on subsections 112(3) and (3.2) of the Income Tax Act (the "Act") and, in particular, on the application of the transitional relief provided for in paragraph 131(11)(b) of the Income Tax Amendments Act, 1997 (Bill C-28 assented to on June 18, 1998) ("transitional relief"). We apologize for the delay in responding to this request.
Facts
On April 26, 1995, Mr. X held the common shares of the holding company XYZ Inc.
XYZ Inc held preferred shares in the operating company ABC Inc.
On April 26, 1995, Mrs. X held the common shares of the operating company ABC Inc.
Since 1994, ABC Inc and XYZ Inc have held life insurance policies on the lives of Mr. X and Mrs. X. These policies were taken out in order to redeem the shares of Mr. X and Mrs. X in the event of their death. Following the purchase of these life insurance policies, Mr. X had prepared agreements between the parties in which each of the companies undertook to redeem the shares of Mr. X or Mrs. X, as the case may be, in the event of their death.
In 1997, Mrs. X transferred her common shares in the capital stock of ABC Inc. to ABC Inc. and received preferred shares in the capital stock of ABC Inc. in return. Mrs. X and ABC Inc. used the rollover rules in section 85. New common shares of ABC Inc were issued to XYZ Inc, and to Mr. X's son and daughter. Later, the common shares of ABC Inc held by Mr. X's son and daughter were converted into preferred shares so that XYZ Inc owned 100% of the common shares of ABC Inc.
Questions
You have assumed that the transitional relief would have applied to the shares of ABC Inc and XYZ Inc held by Mr. X and the common shares of ABC Inc held by Mrs. X before the 1997 freeze in ABC Inc. You asked us whether the 1997 freeze would have any impact on such application of transitional relief.
You asked whether our answer would remain the same in respect of the XYZ Inc shares held by Mr. X if we assume that the transitional relief does not apply to the ABC Inc shares held by Mrs. X and Mr. X.
Our Comments
It appears to us that the situation described in your letter is an actual situation involving taxpayers. The CRA does not generally provide written opinions on proposed transactions otherwise than by way of advance ruling. Furthermore, it is the responsibility of the relevant Tax Services Office to determine whether completed transactions have received the appropriate tax treatment. However, we can offer the following general comments which may not apply in full to the situation submitted.
Subsections 112(3) and (3.2) were amended by S.C. 1998, c. 19, s. 131(1), applicable to dispositions occurring after April 26, 1995, except for dispositions referred to in subsection 131(11), the following of which is referred to in paragraph (b):
(b) a disposition of a share of the capital stock of a corporation that is made to the corporation if
(i) on April 26, 1995 the share was owned by an individual (other than a trust) or by a particular trust under which an individual (other than a trust) was a beneficiary,
(ii) on April 26, 1995 a corporation, or a partnership of which a corporation is a member, was a beneficiary of a life insurance policy that insured the life of the individual or the individual's spouse,
(iii) it was reasonable to conclude on April 26, 1995 that a main purpose of the life insurance policy was to fund, directly or indirectly, in whole or in part, a redemption, acquisition or cancellation of the share by the corporation that issued the share, and
(iv) the disposition is made by
(A) the individual or the individual's spouse,
(B) the estate of the individual or of the individual's spouse within the estate's first taxation year,
(C) the particular trust where it is a trust described in paragraph 104(4)(a) or (a.1) of the Act in respect of a spouse …
(D) ...
Subparagraph (iv) was amended by S.C. 2001, c. 17, s. 251(1). The purpose of that change was to replace the word "spouse" with "spouse or common-law partner".
Subsection 131(12) provides that for the purposes of paragraph 131(11)(b) and subsection 131(12), a share of the capital stock of a corporation that is acquired in exchange for another share in a transaction to which section 51, 85, 86 or 87 of the Act applies is deemed to be the same share as the other share.
In a situation such as the one you have referred to us, it is necessary to determine separately whether the preferred shares held by Mrs. X in ABC Inc qualify for transitional relief. That determination is independent of the determination that will be made for the preferred shares of ABC Inc held by Mr. X and the determination that will be made for the common shares of XYZ Inc also held by Mr. X.
Thus, the freeze implemented by Mrs. X in 1997 whereby she transferred her ABC Inc common shares in exchange for ABC Inc preferred shares will not affect the application of the transitional relief in respect of the shares held by Mr. X. Based on the assumptions you provided that the conditions in subparagraphs (i), (ii) and (iii) of the transitional relief in subsection 131(11)(b) were satisfied, the transitional relief would apply to the shares held by Mr. X as long as the condition in subparagraph (iv) is satisfied.
Furthermore, the preferred shares held by Mrs. X in the capital stock of ABC Inc were acquired in exchange for shares in a transaction to which section 85 applies. As a result, the preferred shares are deemed to be the same shares as the common shares of ABC Inc. that Mrs. X held on April 26, 1995. Thus, under the assumptions you provided, to the effect that the conditions in paragraphs (i), (ii) and (iii) of the transitional relief in subsection 131(11)(b) were satisfied in respect of the ABC Inc common shares held by Mrs. X, the transitional relief would apply to the ABC Inc preferred shares held by Mrs. X provided that the condition in subparagraph (iv) was satisfied. For the purposes of your second question, you asked us to consider that the conditions in paragraphs (i), (ii) and (iii) of the transitional relief in subsection 131(11)(b) were not satisfied for the shares held by Mrs. X and Mr. X in the capital stock of ABC Inc. That assumption would not affect the application of the transitional relief in respect of the XYZ Inc common shares held by Mr. X since the determination in respect of the XYZ Inc shares is independent of the determination in respect of the ABC Inc shares. Consequently, based on the assumptions you provided that the conditions in paragraphs (i), (ii) and (iii) of the transitional relief in subsection 131(11)(b) are satisfied in respect of the XYZ Inc common shares held by Mr. X, the transitional relief would apply to those shares as long as the condition in subparagraph (iv) was satisfied. On the other hand, the transitional relief would not apply in respect of the ABC Inc shares held by Mrs. X and Mr. X.
We hope that these comments will be of assistance.
Best regards,
Alain Godin
for the Director
International Operations and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch.
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