7 September 1993 External T.I. 9322585 F - Prescribed Shares for 110.6(8)

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.

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Attention:  XXXXXXXXXX

Dear Sirs:

This is in reply to your letter dated July 29, 1993 wherein you requested our opinion regarding the application of subsection 110.6(8) of the Income Tax Act (Canada) (the "Act") and section 6205 of the Income Tax Regulations (the "Regulations") to the following hypothetical situation.

A Co., a small business corporation within the meaning assigned by subsection 248(1) of the Act, has two authorized classes of shares which consist of voting, redeemable common shares and non-voting redeemable preferred shares. On incorporation, an individual (Mr. A) subscribed for common shares of A Co. Immediately after the acquisition of the common shares, Mr. A transferred the assets of an active business to A Co., pursuant to subsection 85(1) of the Act, in exchange for preferred shares of A Co. having a redemption amount and fair market value equal to the fair market value of the transferred assets. The transferred assets have appreciated significantly in value and Mr. A would like to crystallize his capital gain on the common shares of A Co.

For discussion purposes, we shall assume that A Co.'s income over the years has been paid to Mr. A in the form of salary and A Co. has never paid any dividends on any of its issued and outstanding common and preferred shares. As a result of the redeemable feature attached to the common shares of A Co., they would not be prescribed shares within the meaning of subsection 6205(1) of the Regulations because they would not satisfy the condition set out in clause 6205(1)(a)(i)(G) of the Regulations. The preferred shares would not qualify as prescribed shares within the meaning of subsection 6205(2) of the Regulations because subparagraph 6205(2)(a)(i) requires that the value of the property of A Co. accrue to other shares that would, at the time of their issue, be prescribed shares and the other shares would have been the common shares which do not qualify as prescribed shares.

You are of the view that if A Co. files Articles of Amendment to remove the redeemable feature attached to its common shares then the common shares and preferred shares of A Co. would qualify as prescribed shares for purposes of subsection 110.6(8) of the Act. Consequently, Mr. A would be entitled to claim a capital gains deduction pursuant to subsection 110.6(2.1) of the Act on the crystallization of any capital gain. Your position is based upon the fact that the provisions of paragraph 6205(4)(e) of the Regulations would deem the common shares to have been issued at that time and without the redemption feature they would qualify as prescribed shares pursuant to subsection 6205(1) of the Regulations. In addition, you are of the view that the preferred shares would also qualify as prescribed shares pursuant to subparagraph 6205(2)(a)(i) of the Regulations because the main purpose of the arrangement was to permit any increase in the value of the property of the corporation to accrue to the common shares which qualify as prescribed shares as a result of being deemed to have been issued at that particular time.

You are also of the view that subsection 110.6(8) of the Act would not apply, in any case, because Mr. A was aware that A Co. would have little or no cash available to pay dividends and, as a prudent and knowledgable investor, he would not expect to receive any dividends on any of his shares of A Co. Therefore, the fact that dividends were not paid on any shares of A Co. should not preclude Mr. A from accessing the capital gains deduction pursuant to subsection 110.6(2.1) of the Act.

Our Comments:

The situation described in your letter appears to involve seriously contemplated transactions and identifiable taxpayers. Consequently, we would like to bring your attention to paragraph 21 of Information Circular 70-6R2, dated September 28, 1990, issued by Revenue Canada, Taxation wherein it is stated that when a requested interpretation relates to a contemplated transaction, a taxpayer should request an advance income tax ruling rather than an opinion. The procedures for requesting an advance income tax ruling are set out in paragraph 15 of the said circular. We are, however, able to provide you with the following general comments.

Paragraph 6205(4)(e) of the Regulations provides that where, at any time after November 21, 1985, the terms of a share are changed, the share is deemed, for the purpose of determining whether it is a prescribed share, to have been issued at that particular time. Therefore, where the terms or conditions of a class of shares that does not qualify as prescribed shares within the meaning of subsection 6205(1) of the Regulations are amended to comply with the requirements of subsection 6205(1) of the Regulations, such shares would be deemed to be prescribed shares as of the date of the amendment. However, we are of the view that such amendment should not affect whether any other issued and outstanding shares would qualify as prescribed shares pursuant to subsection 6205(2) of the Regulations. The provisions of paragraph 6205(4)(e) of the Regulations will only apply in the determination of whether the specific shares, the terms of which have been amended, is a prescribed share for purposes of subsections 110.6(8) and (9) of the Act. The provisions of paragraph 6205(4)(e) would not apply in the determination of whether any other class of issued and outstanding shares are prescribed shares. Since the original shares, the terms of which were amended, were not prescribed shares at the time of their issue, any other class of shares which was issued at the same time would not satisfy the condition found in subparagraph 6205(2)(a)(i) of the Regulations. In other words, we would not generally consider the amendment of the terms of the shares as being part of the arrangement which included their issuance.

Subsection 110.6(8) of the Act is an anti-avoidance rule enacted to prevent the conversion of dividend income into exempt capital gains. Subsection 110.6(8) of the Act will apply if it may reasonably be concluded, having regard to all the circumstances, that a significant part of a capital gain is attributable to the fact that dividends were not paid on a share (other than a prescribed share) of a corporation. It is our view that such a determination is a question of fact which can only be decided having regard, as the subsection states, to all of the circumstances of a particular case. However, the fact that no dividend or an inadequate dividend was paid in a particular year would not, in and by itself, mean that subsection 110.6(8) will automatically apply to deny the capital gains deduction.

Finally, even if the terms of a corporation's shares were amended such that all of its issued and outstanding shares qualified as prescribed shares within the meaning of section 6205 of the Regulations, it would still be necessary to determine whether subsection 110.6(8) would apply in respect of any period when such shares did not qualify as prescribed shares.

The foregoing comments represent our general views with respect to the subject matter of your letter. The foregoing comments are not rulings and, in accordance with the guidelines set out in Information Circular 70-6R2 dated September 28, 1990 and the Special Release thereto dated September 30, 1992, are not binding on the Department.

Yours truly,

for DirectorReorganizations and Foreign DivisionRulings DirectorateLegislative and Intergovernmental Affairs Branch