29 August 1991 External T.I. 9116815 F - Disposition of Common Shares and Subsection 85(1)

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.

5-911681

Dear Sirs:

Re: Disposition and Subsection 85(1) of the Income Tax Act (the "Act")

We are writing in response to your letter of June 13, 1991 wherein you requested our views as to whether the common shares described in the following hypothetical situation outlined in your letter would be considered to be disposed of for the purposes of subsection 85(1) and section 110.6 of the Act.

The Hypothetical Situation

1.      A Co is a taxable Canadian corporation within the meaning of paragraph 89(1)(i) of the Act.  The issued and outstanding share capital of A Co consists of only common shares.

2.      Mr. A, a shareholder of A Co, transfers all of his common shares of A Co to A Co in exchange solely for special/preferred shares of A Co having an aggregate fair market value equal to the aggregate fair market value of the common shares so transferred.  Mr. A and A Co jointly file an election pursuant to subsection 85(1) of the Act, within the time referred to in subsection 85(6) of the Act.

3.       A Co adds to the stated capital account of its special/preferred shares that are issued to Mr. A as a result of the transfer described in 2 above an amount equal to the aggregate paid-up capital of the common shares of A Co that are transferred by Mr.A.

          The expression "paid-up capital" has the meaning assigned by paragraph 89(1) (c) of the Act.

4.     Mr. A reports the disposition of A Co's common shares on his income tax return and claims a capital gains deduction under section 110.6 of the Act.

5.     The common shares of A Co, immediately before the transfer described in 2 above, constitute capital property, within the meaning assigned by paragraph 54(b) of the Act, to Mr. A.

Your Request

You requested our views on the following:

If the special/preferred shares of A Co were convertible back to common shares of A Co (at an appropriate fair market value conversion formula), would this conversion feature affect the conclusion that a disposition has occurred? In this regard, are there any guidelines as to the length of time or circumstances that must be met before the conversion back to the common shares can occur, e.g. one day, one year, or until an arm's length sale to outsiders?

Our Comments

It is the Department's view that where a taxpayer transfers shares of a corporation to a taxable Canadian corporation in exchange for shares having attributes different from the attributes of the transferred shares, subsection 85(1) of the Act would apply provided that a valid election is jointly filed by the taxpayer and the corporation involved in the transfer. Where shares of a corporation that are received by the taxpayer as a result of the transfer have the same attributes as those of the transferred shares, it is our view that a disposition would not have occurred, and hence, subsection 85(1) of the Act would not have application.

In determining whether a disposition of the common shares of A Co would occur as described in the hypothetical situation outlined in your letter, it is relevant to determine, inter alia, whether the terms and conditions of the special/preferred shares of A Co are essentially the same as the terms and conditions of the common shares of A Co, whether the conversion of the special/preferred shares is automatic without any action being taken by the holders of the shares, and how soon after the issuance of the special/preferred shares the conversion would take place.  However, the conversion feature apart, if the attributes of the special/preferred shares of A Co are different from those of the common shares so transferred by Mr. A to A Co, we think that a disposition would generally occur.

The Department has not established any guidelines as to the length of time that must elapse before convertible special or preferred shares could be converted back into common shares, as described above. In this connection, although the determination of whether  the provisions of subsection 245(2) of the Act would apply to a given situation is a question of fact which can only be determined following a review of all of the relevant facts, it is our general view that the addition of a conversion feature, in and by itself, would not, for the purposes of subsection 245(2) of the Act, be considered to be a misuse of the provisions of the Act, or an abuse having regard to the provisions of the Act, read as a whole, as set out under subsection 245(4) of the Act.

Yours truly,

for DirectorReorganizations and Non-Resident DivisionRulings DirectorateLegislative and Intergovernmental Affairs Branch