30 October 1990 Internal T.I. 9027997 F - Flow-through Shares and Identical Properties

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:  Flow-Through Shares (paragraph 66(15)(d.1)) and Identical Properties (subsection 47(1))

We are writing in reply to your memorandum to us dated October 5, 1990, concerning the above-noted subject.

You have advised us of certain instances, where in the same period, corporations have issued flow-through shares ("FTS") and non-flow-through shares ("NFTS") to investors. All of these issued shares were of the same type and category, being identical except for the tax benefits attached to the FTS and the difference in calculating their actual cost base.

You also forwarded us a copy of a paper presented by 19(1) concerning the topic FTS and accounting treatment or CEDIP grants. Therein, at page 13, he states his position that if an investor owned NFTS, which were otherwise identical to the FTS also owned by him, it would result in a weighted averaging of the adjusted cost bases of the shares prior to their sale. Presumably, his position is based on the application of subsection 47(1) of the Income Tax Act (the "Act").

Queries

1.     Assuming that both the FTS and the NFTS are properties which are the same in all material respects, are they considered to be identical properties pursuant to subsection 47(1) of the Act?

2.     In some instances FTS may bear some resale restrictions which prevent their owner from dealing in them before a certain date. Assuming that the FTS and the NFTS would otherwise be identical properties, would the shares still be identical properties under these circumstances?

General Comments

The cost base of NFTS to an investor, subject to any adjustments provided for in the Act (for example, section 47 and section 53), includes amounts paid or payable for the acquisition of those shares.

In contrast, subsection 63.3(3) of the Act deems an investor, who was a party to an agreement pursuant to which FTS were issued, to have acquired the FTS at a cost to him of nil.

Subsection 47(1) of the Act provides special rules applicable to determine the adjusted cost base of "identical properties" for purposes of calculating any capital gain or loss on their disposition. If the identical properties are shares acquired after 1971, subsection 47(1) provides an adjusted cost base averaging mechanism that deems the revised cost base of each such share to be equal to the quotient obtained when the aggregate adjusted cost bases of the identical shares is divided by the number of such shares owned by the taxpayer.

In order to respond to your queries we have assumed the investors hold their FTS and NFTS as capital property.

Our Position

1.     The FTS and NFTS noted in your memo to us would be identical properties to each other for the purposes of subsection 47(1) of the Act.

2.     The fact that in some instances the FTS have certain resale restrictions imposed by the Securities Exchange Commission (i.e. not referring to restrictions imposed by articles of incorporation or amendments thereto) would not alter our view in 1 above.

Rationale

Interpretation Bulletin IT-448, at paragraph 9, states the Department's position that a "shareholder's interest in a corporation consists of a bundle of rights and privileges attached to the shares by the articles of incorporation or the directors in accordance with the corporate law of the particular jurisdiction." (Underlining is ours).

Subsection 24(3) of the Canada Business Corporations Act provides details concerning that bundle of rights and privileges by stating that where a corporation has only one class of shares, the rights of the holders thereof will be equal in all respects and include the rights to

a)     vote at any meeting of shareholders of the corporation;

b)     receive any dividend declared by the corporation; and

c)     receive the remaining property of the corporation on dissolution.

In our view, a FTS agreement and any resale restrictions imposed by the Securities Exchange Commission in respect of the FTS are external conditions and are not constituent elements of the shares. Therefore, when comparing FTS to NFTS, we can look past the FTS agreement and any resale restrictions directly to the bundle of rights and privileges attached to the FTS by the particular company's articles of incorporation. If these rights and privileges are the same for the FTS and the NFTS then subsection 47(1) of the Act would apply to calculate a revised adjusted cost base.

This position appears to be consistent with the comments in Interpretation Bulletin IT-387R2 where at paragraph 3 it states

     Two properties which are otherwise identical do not cease to be so merely because one is subject to a charge or other external condition which may affect its price and the other is not, provided the external condition does not change any of the constituent elements of the particular property (e.g., provincial retail sales tax, commission fees).

Paragraph 6 of the same Bulletin states in part

     Shares of the capital stock of a corporation which are subject to an escrow agreement so as to prevent the owner thereof from dealing in them (escrowed shares) and shares of the same class and kind of the capital stock of the same corporation which are not so restricted (free shares) are considered to be identical properties, notwithstanding that the value of the escrowed shares may be less than the value of the free shares, provided that

(a)     the escrowed shares have been issued by the corporation, and

(b)     the escrow agreement restricts only the right of sale of the escrowed shares.

The position in paragraph 6 above appears to treat the escrow agreement as an external condition, apart from the constituent elements of the shares.

To reiterate, it is our view that the FTS agreement and the above-noted resale restrictions with respect to the FTS would also be external conditions which do not change any of the constituent elements of the FTS. Therefore, subsection 47(1) of the Act would apply to calculate a revised adjusted cost base for the FTS and the NFTS.

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If you have any further queries on this matter, please contact the writer.

Acting/DirectorBilingual Services and ResourceIndustries DivisionRulings Directorate