7 November 1988 Income Tax Severed Letter 5-6496 - [Subsection 87(4) of the Income Tax Act (the "Act")]

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.

XXXX

R.H. Joyce (613) 957-2092

NOV - 7 1988

Dear Sirs:

Re: Subsection 87(4) of the Income Tax Act (the "Act")

This is in response to your letter of August 24, 1988 wherein you requested our technical interpretation of the applicability of subsection 87(4) of the Act to a situation described in your letter.

To summarize the information submitted, two brothers, X and Y, each own 50% of the common shares of Company A and Company B. In addition, X owns 400,000 preferred shares in Company A, redeemable at $1.00 per share, for which he paid $100,000, or $.25 per share. No other shares have been issued in either company.

Company A has no assets other than $100,000 in cash and has no liabilities. Company B also has no assets other than $100,000 in cash and no liabilities. You have summarized the value of the ownership interests of X and Y in each company as follows:

                       Company A                            Company B
         Common               Preferred                  Common
           Shares                    Shares                       Shares

 X     $ NIL                      $100,000                     $50,000
 Y        NIL                            ---                           50,000
            -----                         --------                      --------
         $ NIL                      $100 000                   $100 000
       =====                    ======                 ======

It is proposed that Company A and Company B amalgamate under circumstances described in subsection 87(1) of the Act. You have indicated that two common shares of the amalgamated company will be issued upon amalgamation, one each to X and Y. You are uncertain, however, as to the appropriate number of preferred shares to be issued to X by the amalgamated company. You are concerned with the possible application of subsection 87(4) of the Act to the issuance of the preferred shares and have requested our interpretation in this regard.

Your request appears to relate to a specific proposed transaction. Confirmation of the tax consequences of a specific proposed transaction will only be provided in response to a request for an advance income tax ruling. The procedures for requesting an advance ruling are set out in Information Circular 70-6R. Although we are unable to provide any opinions on the specific transactions included in your request, we are able to provide the following general comments.

Subsection 87(4) of the Act provides that where the fair market value of predecessor shares owned by a particular shareholder is greater than the fair market value of shares received by the shareholder on the amalgamation, and it is reasonable to regard a portion of the excess as a gift to a related person, the gift portion will be added to the shareholder's deemed proceeds of disposition of the predecessor shares, any capital loss otherwise determined on the disposition will be denied and the adjusted cost base of the shares received from the amalgamated company may be adjusted.

In determining whether subsection 87(4) of the Act would apply in a situation such as the one described in your letter, it would appear that the number of preferred shares to be issued to the shareholder upon amalgamation would depend entirely upon the redemption and retraction amount of each preferred share. If the aggregate redemption and retraction amount of the preferred shares issued to the shareholder on the amalgamation does not equal the aggregate fair market value of the shareholder's preferred shares of the predecessor corporation, the provisions of paragraphs 87(4)(c), (d) and (e) of the Act could apply to the transaction. If the redemption or retraction amount of the preferred shares of the amalgamated company is less than the value of the preferred shares of the predecessor corporation, it is possible that a benefit would be considered to have been bestowed upon the other shareholder of the amalgamated corporation by the owner of the preferred shares. If the redemption or retraction amount of the preferred shares of the amalgamated company is greater than the value of the preferred shares of the predecessor corporation, it would follow, in your example, that the value of the common shares of the predecessor corporations would be less than the value of the common shares of the amalgamated corporation. It could, therefore, be said that a benefit has been conferred by the other shareholder of the corporation upon the owner of the preferred shares.

The opinions expressed herein are not rulings, and are therefore not binding on Revenue Canada, Taxation, as stated in paragraph 24 of Information Circular 70-6R.

Yours truly,

for Director Reorganizations and Non-Resident Division Specialty Rulings Directorate Legislative and Intergovernmental Affairs Branch