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: Can ownership of multiple classes of shares satisfy bright line tests in paragraph (b) of the definition of "excluded shares"?
Reasons: General not specific language used in preamble "specified individual owns shares".
August 21, 2018
Re: New “Excluded Shares” definition in section 120.4 of the Income Tax Act
This is in reply to your email of June 29, 2018, regarding your question with respect to the definition of “excluded shares” in section 120.4 of the Income Tax Act (endnote 1).
In your request you asked, if a shareholder has non-voting common shares with a fair market value (“FMV”) equal to 20% of the total FMV of the corporation and “skinny” voting preferred shares having a nominal FMV but having 20% of the total votes of the corporation, would the shares be considered excluded shares assuming the tests in paragraphs (a) and (c) of the definition are met?
This technical interpretation provides general comments about the provisions of the Act and related legislation (where referenced). It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination. The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R7, Advance Income Tax Rulings and Technical Interpretations.
The definition of “excluded shares” in section 120.4 of the Act sets out the conditions that must be met in order for income from the shares be considered excluded in paragraph (g) of the definition of “excluded amount” in subsection 120.4(1).
Paragraph (b) of the “excluded shares” definition sets out two threshold tests that must be met in conjunction with the tests set out in paragraphs (a) and (c) of the definition to deem the shares of a specified individual to be excluded shares. It states:
(b) immediately before that time, the specified individual owns shares of the capital stock of the corporation that
(i) give the holders thereof 10% or more of the votes that could be cast at an annual meeting of the shareholders of the corporation, and
(ii) have a fair market value of 10% or more of the fair market value of all of the issued and outstanding shares of the capital stock of the corporation;
The question describes a scenario where a specified individual owns two classes of shares that in aggregate meet the votes and fair market value threshold tests described above. Therefore the issue is whether these two tests can be met in aggregate where multiple classes of shares are owned by the specified individual.
The preamble in paragraph (b) states that “the specified individual owns shares of the capital stock of the corporation…”. The language used in the preamble to discuss the share ownership is general (“owns shares”) and therefore, in our view, these tests are to be applied at the shareholder level (i.e., based on the aggregate of all classes of shares so owned) versus on each specific class of shares owned by the specified individual.
Therefore, in the above described situation, assuming that the requirements of paragraphs (a) and (c) of the definition of “excluded shares” have been met; the two classes of shares owned by the specified individual would meet the definition of “excluded shares” (endnote 2).
We trust these comments will be of assistance to you.
Michael Cooke, CPA, CA
Corporate Reorganizations Section II
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
1 R.S.C. 1985, c. 1 (5th suppl.) as amended; hereinafter “the Act”.
2 Assumptions with respect to voting rights and valuation of the corporation are assumed correct. The Income Tax Rulings Directorate does not provide opinions with respect to the fair market value of property.
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