28 September 1989 Ministerial Letter 32558 F - Taxable Preferred Share - Dividend or Liquidation Entitlement Established to be not Less than Minimum Amount

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.

Subject: - Taxable Preferred Shares ("TaxPS") - Dividend and Liquidation entitlements "established to be not less than a minimum amount" - Entitlement determined solely by reference to the entitlement of a non-TaxPS

This memorandum concerns the circumstances in which the dividend or liquidation entitlement of a share will be regarded as being not less than a minimum amount for purposes of clauses (b)(i)(C) and (b)(ii)(C) in the definition "taxable preferred share" in subsection 248(1) of the Income Tax Act (Canada) (the "Act").

Facts

In a ruling request, a t payer planned to established a Holdco to hold all the shares of an Opco.  Opco had accumulated retained earnings in excess of $10 million. Holdco would have two classes of "common" shares with identical rights and restrictions except that no dividends or liquidation proceeds could be paid on the Class B shares until $10 million in dividends or liquidation proceeds had first been paid on the Class A shares (the "Class B Entitlement Event").  Following occurrence of the Class B Entitlement event, the Class A and B shares would be entitled to share rateably on dividends and liquidation proceeds.

Issue

Are the Class A shares TaxPS's by reason of having a dividend or liquidation entitlement that is "established to be not less than a minimum"?  If so, do the entitlements come within the exemption in paragraphs (c) and (d) of the TaxPS definition?

Position

The Class A shares have a minimum dividend and liquidation entitlement and do not come within paragraph (c) or (d) of the TaxPS definition.   Accordingly, the shares are TaxPS's.

Rationale re Minimum Dividend Entitlement

The taxpayer's representative argued as follows:

     Although the (Class A) shares are entitled to a preference of $10,000,000 in dividends, the shares provide no guarantee that the full preferential dividend will be paid. Accordingly, this preference cannot be said to establish a minimum dividend entitlement.

We rejected this argument for several reasons.

No share conditions ever "guarantee" that a specific amount of dividends will be received by a shareholder.  The declaration of dividends is entirely in the discretion of the directors.  Accepting the taxpayer's argument would mean that shares could have minimum dividend entitlements only if the shares were guaranteed shares within the meaning of subsection 112(2.2)(b) of the Act.  Given the different wording used in the two provisions, the TaxPS concept of "minimum dividend entitlement" must mean something other than a guarantee of a minimum dividend receipt.

In clause (b)(i)(C) of the TaxPS definition, the "dividend entitlement of a share is the "amount of dividends that may (not must) be declared or paid on the share" (emphasis added).  This indicates that we must determine whether a minimum dividend would be paid on the share if (i) the corporation had an unlimited amount available for the payment of a dividend and (ii) the directors declared the dividend.  In the case under consideration, a minimum dividend entitlement of `$10 million would be paid on the Class A shares if the directors were to declare a $12 million dividend.

In any event, clause (b)(i)(C) of the TaxPS definition requires that one have "regard to all the circumstances" of the situation.  "All the circumstances" include facts outside of the terms and conditions of the share.  In this case, $10 million is immediately available for the payment of dividends and likely will be paid immediately after issuance of the Class A shares.  Even if the analysis in the two preceding paragraphs is incorrect, the shares would still have a factual minimum dividend entitlement.  Note that the reasoning in the two preceding paragraphs differs from that set out in an opinion letter provided that (file #3-1411) which letter was based on a different version of the TaxPS definition.

While not raised by the taxpayer's representative, we considered the impact of the second test in clause (b)(i)(C) of the TaxPS definition.  In order to come within clause (b)(i)(C), a share must have (i) a minimum dividend entitlement and (ii) a preferential dividend entitlement.  While most minimum dividend entitlements will also be preferential, this is not necessarily so.  For example, consider a hypothetical corporation with share classes Y and Z.  Both classes are entitled to participate rateably in the first $20 of aggregate dividends and, thereafter, only the Z shares are entitled to further dividends.  The Y shares would be TaxPS's because their dividend entitlement is limited to a maximum ($10).  The Z shares, however, are not TaxPS's:  While their dividend entitlement is not less than a minimum, they enjoy no preference in respect of that minimum amount.  Accordingly, the "preference" test does not in any way colour the ordinary meaning to be given to the "minimum entitlement" test.

Rationale Re Minimum Liquidation Entitlement

Clause (b)(ii)(C) of the TaxPS definition also requires the one look at "all the circumstances".  in this case, the $10 million in retained earnings is a very relevant circumstance.

Unlike clause (b)(i)(C), clause (b)(ii)(C) refers to the entitlement as "the amount that the shareholder is entitled to receive" on dissolution, liquidation or winding-up (emphasis added).  Use of the word "entitled" does not import a guarantee concept, however.  On liquidation, a shareholder is legally entitled to enforce a return of his proportionate share of whatever capital may be left after the payment of creditors.  The directors have no discretion in the matter.  One should read clause (b)(ii)(C) as referring to a minimum liquidation entitlement assuming that the corporation has sufficient net assets (after payment of creditors) to distribute an unlimited count to its shareholders.  in our case, if the corporation has $12 million to distribute, the Class A shareholders get the first $10 million.

Rationale re Paragraphs (c) and Cd) of TaxPS Definition

In general, paragraphs Cc) and (d) of the TaxPS definition provide that a share does not have a minimum dividend or liquidation entitlement (as the case may be) if the entire amount of dividends payable on the share or all the liquidation entitlement of the share is determined solely by reference to the dividend or liquidation entitlement of a non-TaxPS common share.  The taxpayer's representative argued that the dividend and liquidation entitlement of the Class A shares was determined solely by reference to the entitlement of the Class B shares.

We rejected this argument as being backwards.  The entitlement of the Class B shares is determined by reference to the entitlement of the Class A shares (i.e. the B's get nothing until the A's have received $10 million) not the other way around.

24(1)

Comments

In the face of our negative position, the taxpayer withdrew the ruling request.

For further details, see the T2 file of 24(1).