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 certain share put/call rights contemplated in a unanimous shareholder agreement would be considered an integral part of the purchase and sale agreement such that the saving provision in paragraph 110.6(14)(b) of the Act will apply.
Position: No
Reasons: The put/call rights were not referred to in the purchase and sale agreement.
January 13, 2012
Judy Berard HEADQUARTERS
Auditor Income Tax Rulings
Winnipeg TSO Directorate
Sandro D'Angelo
(613)952-5803
2011-042837
Paragraph 110.6(14)(b) and Share Put/Call Rights
This is in response to your correspondence of November 17, 2011, wherein you requested our views on whether the exception in paragraph 110.6(14)(b) of the Income Tax Act (the "Act") applies to certain share put/call rights.
Facts
Based on the information you have provided, our understanding of the key facts is as follows:
XXXXXXXXXX is a taxable Canadian corporation that was incorporated in Canada. XXXXXXXXXX appears to have XXXXXXXXXX subsidiaries.
Prior to XXXXXXXXXX was considered to be a "Canadian-controlled private corporation" ("CCPC") as that term is defined in subsection 125(7) of the Act.
XXXXXXXXXX . One of XXXXXXXXXX 's subsidiaries is described as being a XXXXXXXXXX company while certain other subsidiaries are described as providing other XXXXXXXXXX products such as XXXXXXXXXX .
The shareholders of XXXXXXXXXX (before the transactions described below) were as follows:
- XXXXXXXXXX ("Trust 1");
- XXXXXXXXXX ("Trust 2");
- XXXXXXXXXX
- Certain executives of XXXXXXXXXX who acquired shares of XXXXXXXXXX under a Management Share Ownership Plan. (footnote 1)
Trust 1 and Trust 2 appear to be Canadian resident trusts with numerous beneficiaries.
The issued and outstanding voting common shares of XXXXXXXXXX held by Trust 1, Trust 2, XXXXXXXXXX immediately before the XXXXXXXXXX share transactions described below, were as follows:
- Trust 1 owned XXXXXXXXXX Class A common shares;
- Trust 2 owned XXXXXXXXXX Class A common shares;
- XXXXXXXXXX owed XXXXXXXXXX Class B common shares; and
- XXXXXXXXXX owned XXXXXXXXXX Class B common shares.
Pursuant to a term sheet dated XXXXXXXXXX ("Term Sheet"), it appeared that XXXXXXXXXX intended to purchase all the issued and outstanding common shares of XXXXXXXXXX owned by Trust 1, Trust 2, XXXXXXXXXX over a XXXXXXXXXX period.
XXXXXXXXXX is a "public corporation" as that term is defined in subsection 89(1) of the Act.
Pursuant to a share purchase agreement dated XXXXXXXXXX ("Agreement 1"), XXXXXXXXXX acquired all of the Class B common shares of XXXXXXXXXX that were owned by XXXXXXXXXX and XXXXXXXXXX Class A common shares that were owned by Trust 2.
In addition, pursuant to a share subscription agreement between XXXXXXXXXX and XXXXXXXXXX dated XXXXXXXXXX ("Subscription Agreement"), XXXXXXXXXX subscribed for additional Class B common shares of XXXXXXXXXX .
Immediately following XXXXXXXXXX 's acquisition of the shares of XXXXXXXXXX pursuant to Agreement 1 and that acquisition of the additional Class B common shares of XXXXXXXXXX under the Subscription Agreement XXXXXXXXXX held approximately XXXXXXXXXX % of the shares of XXXXXXXXXX that had voting rights.
Pursuant to paragraph (l) of Article 8.1 and paragraph (h) of Article 8.2 of Agreement 1, a mutual condition for the closing of that share sale was for the remaining shareholders of XXXXXXXXXX (i.e., Trust 1 and Trust 2) and XXXXXXXXXX to enter into a new unanimous shareholders agreement in the form and content mutually acceptable to all parties. However, Agreement 1, which dealt only with the acquisition of certain number of shares held by Trust 2 and the shares held by XXXXXXXXXX , does not appear to make any reference to XXXXXXXXXX 's intention to purchase the remaining issued and outstanding common shares of XXXXXXXXXX owned by Trust 1 and Trust 2 (hereinafter collectively referred to as the "Vendors").
On XXXXXXXXXX , the Vendors and XXXXXXXXXX entered into a new unanimous shareholders agreement (the "New USA"). Included in the New USA (at Article XXXXXXXXXX ), were the share put/call rights ("Put/Call Rights") that essentially gave XXXXXXXXXX (subject to certain conditions) the ability to ultimately acquire all of the voting shares (and control) of XXXXXXXXXX owned by the Vendors on or before XXXXXXXXXX . If the Put/Call Rights were exercised, the Vendors were expected to enter into a share purchase and sale agreement with XXXXXXXXXX in respect of such share sale. In addition, Article XXXXXXXXXX of the USA also contained a "shot-gun" provision that could only take effect after XXXXXXXXXX .
Pursuant to a share purchase and sale agreement dated XXXXXXXXXX ("Agreement 2"), XXXXXXXXXX acquired XXXXXXXXXX Class A common shares from Trust 1 and XXXXXXXXXX Class A common shares from Trust 2 such that immediately thereafter XXXXXXXXXX held approximately XXXXXXXXXX % of the shares of XXXXXXXXXX that had voting rights.
Pursuant to a share purchase and sale agreement dated XXXXXXXXXX ("Agreement 3"), XXXXXXXXXX purchased the remainder of the XXXXXXXXXX shares owned by Trust 1 (XXXXXXXXXX Class A common shares) and Trust 2 (XXXXXXXXXX Class A common shares) such that immediately after it held XXXXXXXXXX % of the shares of XXXXXXXXXX that had voting rights.
Several beneficiaries of Trust 1 and Trust 2 have claimed a capital gains exemption under subsection 110.6(2.1) of the Act on the capital gains allocated to them by such trusts that arose from the XXXXXXXXXX share dispositions described in Agreement 2 and Agreement 3.
On XXXXXXXXXX , a voluntary disclosure was made by XXXXXXXXXX to the CRA on behalf of XXXXXXXXXX (and presumably its subsidiaries). This voluntary disclosure indicated that XXXXXXXXXX ceased to be a CCPC on XXXXXXXXXX as a result of the Put/Call Rights described in Article XXXXXXXXXX of the New USA as these Put/Call Rights were rights described in paragraph 251(5)(b) of the Act. As a result of this voluntary disclosure, the CRA reassessed XXXXXXXXXX to disallow the small business deduction claims it made for its XXXXXXXXXX taxation years and XXXXXXXXXX was deemed to have a taxation year ending on XXXXXXXXXX as a consequence of the application of subsection 249(3.1) of the Act.
Issue
As a consequence of the Put/Call Rights described in the New USA the shares of XXXXXXXXXX would not be "qualified small business corporation shares" ("QSBCS") as that term is defined in subsection 110.6(1) of the Act after XXXXXXXXXX unless the exception in paragraph 110.6(14)(b) of the Act applies. (footnote 2)
Tax Service Office's (TSO) Position
It is your position that the Put/Call Rights described in the New USA are not in respect of a right under a purchase and sale agreement in relation to the sale of the shares of XXXXXXXXXX such that the exception in paragraph 110.6(14)(b) of the Act does not apply.
Taxpayer's Position
The taxpayer's representative (XXXXXXXXXX ), in a letter to the TSO dated XXXXXXXXXX , has argued that the Put/Call Rights described in the New USA are in respect of a right under a purchase and sale agreement in relation to the sale of the shares of XXXXXXXXXX essentially for the following reasons:
- The New USA cannot be looked at as a stand alone document. Accordingly, in their view the proper question is not whether the Put/Call Rights described in the New USA constitute a purchase and sale agreement alone but whether the Put/Call Rights constitute rights under a purchase and sale agreement.
- In their view, the New USA must be considered as an integral part of the agreement pursuant to which the shares in question were sold and the Put/Call Rights are therefore rights under a purchase and sale agreement. It was intended, as evidenced by the Term Sheet, that the Vendors would sell all of their shares of XXXXXXXXXX to XXXXXXXXXX , and the mechanism for achieving this result was a combination of the various share purchase agreements and the New USA. They point out that Agreement 1 required the parties enter into the New USA and that the Put/Call Rights set out therein completed the means of fulfilling the intention of the parties.
- The taxpayer's representative also draws a parallel between the current fact situation and the conclusion reached by the Tax Court of Canada in Chartier v. R, 2007 DTC 686 ("Chartier"). (footnote 3)
Paragraph 251(5)(b) of the Act is an anti-avoidance provision that applies, inter alia, for the purpose of the definition of CCPC in subsection 125(7) of the Act. This provision will cause a corporation to lose its status as a CCPC where a non-resident person or public corporation has a right (contingent or otherwise) to acquire shares of that corporation, or to control the voting rights of such shares. Absent a relieving provision, once a corporation ceases to be a CCPC such shares could not qualify as QSBCS for the purpose of the capital gains exemption under subsection 110.6(2.1) of the Act.
Paragraph 110.6(14)(b) of the Act is such a relieving provision. That paragraph essentially provides that for the purposes of the definition of QSBCS where the particular "right" referred to in paragraph 251(5)(b) of the Act is considered to be "... a right under a purchase and sale agreement relating to a share of the capital stock of a corporation" that right is to be ignored for the purposes of determining whether the particular corporation is a CCPC or a "small business corporation" as that term is defined in subsection 248(1) of the Act. (footnote 4) The CRA has been advised by the Department of Finance in the past that the exception in paragraph 110.6(14) (b) of the Act is not intended to cover option agreements.
As noted above, the taxpayer's representative has referred to the Tax Court's decision in Chartier as support for their position that the exception in paragraph 110.6(14)(b) of the Act should apply to the Put/Call Rights described in the New USA, in part, because the Term Sheet outlined XXXXXXXXXX 's intention to acquire all of the voting shares of XXXXXXXXXX .
In Chartier, Judge Tardif commented on the vendors' intentions and made the following comments at paragraphs 30, 31 and 32:
"[30] There is indeed a reference to the Option Agreement in section 3.1. Can such a reference to a right create a "right under a purchase and sale agreement" [un droit prévu par convention d'achat-vente ]?
[31] Indeed it can: Hubert Reid, Dictionnaire de droit québécois et canadien, 2d ed. (Cowansville, Que.: Wilson & Lafleur, 2001); the term " prévu"is defined at page 438 as [TRANSLATION] "imagined, envisaged".
[32] Thus, it is enough for the option to have been contemplated or envisaged in the purchase and sale agreement, and section 3.1 shows that the option in the instant case was so contemplated or envisaged. Moreover, the evidence is clear that the Option Agreement was envisaged at the time that the Purchase and Sale Agreement was signed."
Judge Tardif also stated at paragraph 48:
"[48] In my opinion, the parties' intention is clear: they wanted to sell all the shares of CFCDN. This is not a case in which the intention of the parties must be interpreted. The issue is essentially whether to accept or reject the argument that an error was committed."
Based on the above, it was clear from the facts in Chartier that since the particular option agreement was clearly referred to in the purchase and sale agreement, the court agreed that the particular rights under that option were rights under a purchase and sale agreement relating to a share of the capital stock of a corporation. However, in our particular fact situation, the Put/Call Rights set out in the New USA were not specifically mentioned or referred to in any of the purchase and sale agreements. For instance, as noted above, while paragraph (l) of Article 8.1 and paragraph (h) of Article 8.2 of Agreement 1 did mention that the shareholders of XXXXXXXXXX were required to enter into a new USA with mutually agreeable terms and conditions, there was no indication in Agreement 1 that the terms and conditions had to (or would) contain the Put/Call Rights. Further, Agreement 1 only dealt with the sale of the specific shares that were defined in Article 1 of Agreement 1 as the "Purchased Shares" and, as such, Agreement 1 clearly did not contemplate the subsequent share sales that were covered by Agreement 2 and Agreement 3.
The taxpayer's representative also indicates that because the Term Sheet indicated that XXXXXXXXXX intended to buy XXXXXXXXXX % of the voting shares of XXXXXXXXXX over a period of time that the Term Sheet and the New USA must be considered as forming an integral part of the various purchase and sale agreements. However, in our view neither the Term Sheet nor the New USA, are purchase and sale agreements. The following comments in Chartier at paragraphs 51 and 52 provide support for our position on this point:
"[51] It is obvious that a contract entitled "Option Agreement" would not be a purchase and sale agreement; however, a clause in a contract, stating that the purchaser and vendor offer each other the option to sell or purchase the remaining shares, could be a "right under a purchase and sale agreement" [droit prévu par convention d'achat-vente ].
[52] It is clear to me that since the Option Agreement was referred to, and therefore envisaged, in the Purchase and Sale Agreement; it was "under" that agreement and was therefore an integral part of it."
Accordingly, while the court in Chartier was satisfied that the specific reference to option agreement in the purchase and sale agreement was sufficient for it to conclude that the rights created under the option agreement were rights under that purchase and sale agreement relating to those shares, the facts in our present situation do not appear to support a similar conclusion.
At the 2007 APFF round table the CRA stated that, "upon reading the Chartier case, the CRA is of the view that it is not clear that the Tax Court of Canada has accepted the deferment of a transaction by the means of buy-sell options containing suspensive conditions ("put/call") in order to allow the shares of the appellant to benefit from the status of qualified small business corporation shares." This statement indicates that the CRA is of the view that it is not clear whether the Tax Court of Canada has accepted the position that all put/call options will automatically be considered to be part of a purchase and sale agreement for the purposes of the saving provision in paragraph 110.6(14)(b) of the Act.
Based on the above, it is our view that the facts and circumstances in your particular situation can be distinguished from those in Chartier. As such, we agree with you that there appears to be a reasonable basis for taking the position that the Put/Call Rights described in the New USA should not be considered as being rights under a purchase and sale agreement for the purposes of paragraph 110.6(14)(b) of the Act.
We trust our comments will be of assistance.
Yours truly
Michael Cooke
Manager
Business and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
FOOTNOTES
Note to reader: Because of our system requirements, the footnotes contained
in the original document are shown below instead:
1 For the purposes of this memorandum we will ignore the MSOP shares unless otherwise indicated. We understand that the MSOP shares did not have voting rights and were not subject to the Put/Call Rights described in the New USA (discussed below).
2 Absent the specific issue we have been asked to consider, the status of the XXXXXXXXXX shares as QSBCS to a particular holder will depend on all the other conditions of the QSBCS definition being met at the particular time of each disposition.
3 The taxpayer's representative has also indicated in the Submission that the MSOP shares are subject to a different treatment than the shares held by Trust 1 or Trust 2 because there were no rights under the New USA or any of the share purchase agreements requiring XXXXXXXXXX to purchase such shares.
4 Applicable to share dispositions after June 17, 1987.
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