27 October 2020 CTF Roundtable Q. 10, 2020-0860961C6 - Refreeze and 74.4(2)

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: If subsection 74.4(2) applies to an estate freeze do shares received on a subsequent refreeze reduce the "outstanding amount" (as determined under subsection 74.4(3) and will the redemption of refrozen preferred shares reduce the "outstanding amount" only to the extent of the value of those shares?

Position: Shares received on a refreeze will not reduce the outstanding amount in subsection 74.4(3) and the redemption of the refrozen shares will only reduce the outstanding amount to the extent of the value of the refrozen shares.

Reasons: The definition of "outstanding amount" in subsection 74.4(3).

2020 CTF Annual CRA Round Table – October 27, 2020

Question 10: Refreezes and Subsection 74.4(2) Corporate Attribution

Refreeze transactions generally involve an individual exchanging preferred shares received on an earlier estate freeze for newly issued preferred shares with a redemption amount equal to the current (lower) equity value of the underlying corporation. The preferred share redemption amount is thus “reset” at present values.

Subsection 74.4(2) provides for an attribution of income when an individual transfers or loans property to a corporation and certain conditions are met. One condition is that the loan or transfer be for the purpose of reducing the individual’s income and to benefit a “designated person” (defined in subsection 74.5(5)) in respect of the individual. If the rule is applicable, the individual may be subject to an annual deemed interest benefit.

If subsection 74.4(2) applies to the original estate freeze, the preferred shares received on the refreeze do not appear to reduce the “outstanding amount” (as determined under subsection 74.4(3)) on which the deemed interest benefit is computed under subsection 74.4(2). In addition, if the refrozen preferred shares are redeemed, the “outstanding amount” seems to only be reduced to the extent of the value of those shares, leaving a potential indefinite “outstanding amount” on which the corporate attribution rules could continue to compute deemed interest income.

Does the CRA agree that:

A. shares received on a refreeze do not reduce the “outstanding amount” (as determined under subsection 74.4(3); and

B. the redemption of refrozen preferred shares for cash consideration reduces the “outstanding amount” only to the extent of the value of those shares leaving an indefinite “outstanding amount” on which the corporate attribution rules will continue to compute deemed interest income?

CRA Response (A)

Generally, it is expected that a taxpayer will not undertake an estate freeze that is subject to the attribution rule in subsection 74.4(2). However, if an estate freeze is subject to subsection 74.4(2), as noted above, the deemed interest benefit is computed based on the “outstanding amount” determined under subsection 74.4(3). Paragraph 74.4(3)(b) applies where money or property is loaned and, therefore, would not generally apply to the transfer of shares under an estate freeze. Paragraph 74.4(3)(a) provides as follows:

(a) in the case of a transfer of property to a corporation, the amount, if any, by which the fair market value of the property at the time of the transfer exceeds the total of

(i) the fair market value, at the time of the transfer, of the consideration (other than consideration that is excluded consideration at the particular time) received by the transferor for the property, and

(ii) the fair market value, at the time of receipt, of any consideration (other than consideration that is excluded consideration at the particular time) received by the transferor at or before the particular time from the corporation or from a person with whom the transferor deals at arm’s length, in exchange for excluded consideration previously received by the transferor as consideration for the property or for excluded consideration substituted for such consideration;

Subparagraph 74.4(3)(a)(i) takes into account consideration received on the initial transfer and, therefore, would not apply to an exchange of shares under a subsequent refreeze. Subparagraph 74.4(3)(a)(ii) would also not apply as the shares received on the refreeze constitute “excluded consideration”, as that term is defined in subsection 74.4(1). Therefore, we agree the shares received on a refreeze do not reduce the “outstanding amount” under subsection 74.4(3).

CRA Response B.

Subparagraph 74.4(3)(a)(ii) will reduce the outstanding amount by the fair market value, at the time of receipt, of consideration from the corporation in exchange for excluded consideration previously received by the transferor as consideration for the property or for excluded consideration substituted for such consideration. Therefore, we agree the redemption of refrozen preferred shares for cash consideration will reduce the “outstanding amount”, but only to the extent of the fair market value of those shares. While the redemption of the refrozen preferred shares will leave an “outstanding amount” on which the corporate attribution rules will continue to compute deemed interest income, the corporate attribution rules will only apply during the period the conditions in paragraphs 74.4(2)(a), (b) and (c) continue to be met.

Tobias Witteveen
(613) 670-0590
October 27, 2020
2020-086096