6 June 1997 Internal T.I. 9631867 - REDEMPTION OF SHARES HELD BY FINANCIAL INSTITUTIONS

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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues:

Whether subsection 84(3) or 142.5(1) takes precedence on a redemption of shares held by a financial institution as mark-to-market property.

Position:

It is our view that there is a tenable argument that the provisions of subsection 142.5(1) are more specific than those in subsection 84(3) and therefore subsection 142.5(1) should take precedence on a redemption of shares held by a financial institution. To the extent that an amount is included in computing income under subsection 142.5(1), such amount should not be taken into account a second time for the purposes of subsection 84(3).

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Reasons:

Wording of legislation.

			June 6, 1997

	TORONTO NORTH TAX SERVICES OFFICE	HEADQUARTERS
	Industry Specialist Services 	J. Leigh
	                                   	952-1505
	Attention:  D.W. Mitchell
	              Banking Specialist
			7-963186

Redemption of shares held by financial institutions

This is in reply to your memorandum of September 18, 1996 requesting our views on the application of subsections 84(3), 142.5(1) and 248(28) of the Income Tax Act (the "Act") to a redemption of shares held by a "financial institution" as "mark-to-market property". We apologize for the delay in responding to your request.

You have set out two examples to illustrate your concerns with respect to the interplay between the above-noted provisions. The examples relate to the receipt of deemed dividends by a corporation and do not include: circumstances where subsection 55(2) of the Act might apply; a Part II.1 circumstance; an instance where the stop loss rules would be applicable; taxes that may or may not be payable under Parts IV, IV.1 and VI.1.

Example 1:

• The taxpayer is a corporation that is a "financial institution" as defined in subsection 142.2(1) of the Act.
• The year-end of the taxpayer is October 31st.
• The taxpayer acquired 100 preferred shares in Co. X at a cost of $50,000 on January 1, 1994.
• The shares are assumed not to be capital property to the taxpayer.
• The paid-up capital of these shares was $15,000.
• The taxpayer and persons related to it do not own greater than 5% of the issued stock of the shares acquired.
• It is assumed that the market value of the shares on October 31, 1994 was $50,000.
• On July 1, 1995, the shares in Co. X were redeemed for $60,000.

Example 2:

The facts are the same as in Example 1, but the market value of the shares on October 31, 1994 was $60,000.

With regard to Example 1, your analysis indicates that a deemed dividend of $45,000 will result on the redemption of the shares in 1995 pursuant to subsection 84(3) of the Act. The deemed dividend of $45,000 is the difference between the redemption amount of $60,000 and $15,000, the paid-up capital of the shares. The profit taxable under subsection 142.5(1) of the Act on the disposition is $10,000, being the difference between the proceeds of disposition of $60,000 and the cost amount of $50,000. You note that paragraph (j) of the definition of "proceeds of disposition" in section 54 of the Act, which provides for a reduction to the proceeds by the amount of a deemed dividend, is not relevant since the shares in this example are not capital property. You further note that in the circumstances described there is no provision in the Act that provides for a decrease in the cost base of the shares by the amount of the deemed dividend.

In Example 2, your analysis notes that subsection 142.5(2) of the Act would apply to deem the taxpayer to have disposed of the shares immediately before the end of the 1994 taxation year for $60,000 and to have reacquired the shares at a cost of $60,000. Accordingly, the taxpayer would have realized a profit of $10,000 for 1994 pursuant to subsection 142.5(1) of the Act. On the redemption of the shares in 1995, the taxpayer would have a deemed dividend of $45,000 pursuant to subsection 84(3) of the Act which may be offset by the subsection 112(1) deduction. Since a profit of $10,000 is included in income in 1994 and then again in the 1995 as a deemed dividend, you note that subsection 248(28) of the Act might apply to prevent a double income inclusion.

Prior to addressing your questions with respect to the interplay between subsections 84(3) and 142.5(1) of the Act, we note that in Example 2 the profit of $10,000 for 1994 would be included in income pursuant to subsection 9(1) of the Act rather than subsection 142.5(1) of the Act. The preamble of subsection 142.5(1) of the Act refers to a taxation year that begins after October 1994 notwithstanding that the coming into force rule for subsection 142.5(1) of the Act indicates that it is applicable to taxation years that end after October 30, 1994.

Your questions relating to the two examples may be summarized as follows:

1.Do the provisions of subsection 142.5(1) of the Act take precedence over those in subsection 84(3) on the redemption of shares by Co. X?

2.If subsections 84(3) and 142.5(1) both apply, would subsection 248(28) of the Act apply to prevent a double income inclusion? If the answer is yes, which double inclusion should be removed?

As noted by you, we have previously considered the question of whether subsection 9(1) or 84(3) of the Act has precedence on the redemption of shares held as inventory. The use of the limiting phrase "subject to this Part" in subsection 9(1) of the Act means that subsection must defer to other provisions of Part I where such other provisions dictate that income from a business is to be calculated on some basis other than profit as determined by generally accepted accounting principles. The other provision in the case of a redemption of shares is subsection 84(3) of the Act. Accordingly, subsection 84(3) of the Act would take precedence over subsection 9(1) of the Act. The deemed dividend under subsection 84(3) of the Act would be the difference between the redemption amount and the paid-up capital. To the extent that the paid-up capital exceeds its cost, the excess is included as business income under subsection 9(1) of the Act.

With regard to the interplay between subsections 84(3) and 142.5(1) of the Act, there is no limiting phrase in subsection 142.5(1) of the Act. The preamble of subsection 142.5(1) of the Act reads as follows:

"Where, in a taxation year that begins after October 1994, a taxpayer that is a financial institution in the year disposes of a property that is a mark-to-market property for the year..."

The preamble of subsection 84(3) of the Act reads as follows:

"Where at any time after December 31, 1977 a corporation resident in Canada has redeemed, acquired or cancelled in any manner whatever (otherwise than by way of a transaction described in subsection (2)) any of the shares of any class of its capital stock..."

In the absence of clear language that one provision is subordinate to other provision(s) in the Act, the more specific of the two provisions would take precedence. In our view, there is a tenable argument that subsection 142.5(1) of the Act takes precedence over subsection 84(3) of the Act in the situation described. We find the wording in subsection 142.5(1) of the Act to be quite specific as that provision applies only to a "financial institution" and only to dispositions of property that is a "mark-to-market property". The term "mark-to-market property" is defined in subsection 142.2(1) of the Act to include a share. On the other hand, subsection 84(3) of the Act applies to any corporation that is resident in Canada on the redemption, acquisition or cancellation in any manner whatever of any of its shares. To the extent that an amount has been included in computing income under subsection 142.5(1) of the Act, it is our view that such amount would not be taken into account again for the purposes of subsection 84(3) of the Act by virtue of subsection 248(28) of the Act.

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In our opinion, the prevailing view should be that subsection 142.5(1) of the Act takes precedence over subsection 84(3) of the Act since that interpretation provides the more appropriate result from a tax policy standpoint.

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We hope that our comments are of assistance to you.

Chief
Financial Institutions Section
Financial Industries Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch