8 July 1993 External T.I. 9309595 F - Paragraph 256 (1.1)(c) of the Income Tax 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.

XXXXXXXXXX

Attention:  XXXXXXXXXX

Dear Sirs:

RE:  Paragraph 256(1.1)(c) of the Income Tax Act

This is in reply to your letter of March 23, 1993 in which you raised numerous questions concerning the interpretation of paragraph 256(1.1)(c) of the Income Tax Act (the "Act").

Paragraph 256(1.1)(c) of the Act reads as follows:

"(c)      the amount of each dividend payable on the shares is calculated as a fixed amount or by reference to a fixed percentage of an amount equal to the fair market value of the consideration for which the shares were issued;"

This provision forms part of the requirements set out under subsection 256(1.1) of the Act in determining whether a class of shares of a corporation constitutes a "specified class" for the purposes of the associated corporation rules set out under subsection 256(1) of the Act.

Pursuant to the provisions of subsection 256(1.1) of the Act the requirement that the dividend be payable as a fixed amount or calculated as a fixed percentage must be part of the terms and conditions of the shares or any agreement in respect thereof. If, for example, we consider certain preferred shares which are redeemable at $100 per share, being the amount of the consideration for which the shares were issued, at a time when the prescribed rate of interest was 6%, generally, the requirement that the dividend be fixed in amount or rate will be met where the terms or conditions of the shares specify that the annual dividend will be $6.00 per share or 6% of the redemption amount. This requirement will not, however, be satisfied where the terms or conditions of the shares provide that the holders are entitled to dividends at a rate to be determined by the board of directors at the time the dividend is declared provided that the rate of such dividends does not exceed 6% (the prescribed rate at the time that the shares were issued) of their redemption price. Furthermore, the dividend may be cumulative or it may be preferential. It is also acknowledged that the directors' ability to pay a dividend in a particular year may be constrained by corporate law or by other factors such as the availability of corporate profits or cash flow; however, if a dividend is declared and paid it should be equal to the fixed entitlement.

"The Explanatory Notes to Legislation Relating to Income Tax" which were issued by the Minister of Finance in June 1988 state that the purpose of subsection 256(1.1) of the Act is to "permit a person to invest funds in a corporation controlled by a related person — such as a spouse or child — without subjecting his own corporation to a reduced small business deduction, provided that the investment takes the form of fixed-rate, non-voting, preferred shares...". It is our understanding that the fixed rate requirement was included in paragraph 256(1.1) as the types of shares to be included were intended to be those which were substantially the same as debt. Since most indebtedness bears a fixed rate of interest, the requirement that the shares be entitled to a fixed dividend was included.

We trust that these comments will be of assistance.

Yours truly,

for DirectorReorganizations and Foreign DivisionRulings DirectorateLegislative and Intergovernmental Affairs Branch