15 June 1992 External T.I. 9207555 F - Capital Gains Deduction -- Prescribed Shares

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.

June 15, 1992

Dear Sirs:

Re:  Prescribed Shares, Subsection 110.6(8)

This is in reply to your letter of March 6, 1992 in which you requested our opinion as to whether certain shares in your hypothetical situation would be prescribed shares for purposes of subsection 110.6(8) of the Income Tax Act (the "Act").

It is apparent that the circumstances outlined in your letter involve actual taxpayers who are contemplating specific proposed transactions.  That being so, it would be appropriate for you to request an advance income tax ruling in order for the taxpayers to receive assurance as to the tax consequences of their proposed transactions.  Please refer to Information Circular 70-6R2 dated September 28, 1990 for information regarding advance rulings.

Although we are unable to provide any opinion in respect of the specific case you have described, we have set out below some comments of a general nature which may be of assistance to you.

Our comments

The following example has some similarities to the situation you described.  Where a shareholder (Mr. X) holds common shares of a corporation and wishes to do an estate freeze so as to enable his son (for instance) to participate in the future appreciation in the value of the corporation through share ownership, it is typical that Mr. X's common shares would be exchanged (relying on subsection 86(1) of the Income Tax Act) for preferred shares having a redemption amount equal to the fair market value of the exchanged shares, and that new common shares would be issued to Mr. X and to his son.  Subsection 6205(2) of the Income Tax Regulations is intended to exempt such preferred shares from the rules described in subsection 110.6(8) of the Act by deeming such shares to be prescribed shares for purposes of subsection 110.6(8).

To fit within the rules of Regulation 6205(2), it is not necessary for new common shares to actually have been issued to the taxpayer's son (to continue with the example).  There is an ownership test in subparagraph 6205(2)(a)(ii) which provides for the other shares (being the common shares in this example) being owned by the person who owned, at the time of the issue of the particular shares (being the preferred shares in this example), the particular shares.  There is also a purpose test, stated in subparagraph 6205(2)(a)(i), which states that the main purpose of the arrangement under which the preferred shares were issued was "to permit any increase in the value of the property of the corporation to accrue to other shares that would ... be prescribed shares ...".  However, it is noted that the main purpose of the arrangement must be as is described in subparagraph 6205(2)(a)(i) of the Regulations.  If there was some other purpose to the transactions which was the main purpose, the preferred shares would not qualify as prescribed shares.

Whether or not the preferred shares in our example are prescribed shares for purposes of subsection 110.6(8) of the Act, it may be possible to subsequently transfer the new common shares to a corporation under a subsection 85(1) election and, depending on the facts, still not be subject to subsection 110.6(8).  For instance, if the payment of dividends on the preferred shares would not have resulted in the fair market value of the new common shares being sufficiently lower so as to affect the amount agreed upon for purposes of subsection 85(1), then no part of the capital gain on the new common shares (which would be calculated with reference to the agreed amount rather than their fair market value) would be due to the fact that dividends were not paid on the preferred shares.

We trust that these comments are of assistance.

Yours truly,

G. Thornleyfor DirectorBusiness and General DivisionRulings DirectorateLegislative and Intergovernmental Affairs Branch