13 January 1999 External T.I. 9821715 - STOP LOSS RULES - GRANDFATHERING

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: Application of grandfathering of shares for the purpose of the stop loss rules of subsection 112(3) to (3.2) of the Act. Will the rollover of previously grandfathered shares to a new corporation qualify?

Position: Question of fact as to whether grandfathering rules apply and some general discussion of grandfathering rules was provided. However, exchange of share rule only applies for purpose of paragraph 131(1)(b) of c.19.

Reasons: See paragraph 131(1)(b) and subsection 131(12) of c. 19 - grandfathering rules - for purpose of subsection 112(3) to (3.2) of the Act.

XXXXXXXXXX 			982171

Attention: XXXXXXXXXX

January 13, 1999

Dear Sirs:

Re: Stop Loss Rules - Grandfathering

This is in reply to your letter to the Peterborough Tax Services Office of June 3, 1998, that has been forwarded to us for our reply. In your letter you requested the Department’s opinion on the application of subsection 112(3) of the Income Tax Act (the “Act”) in the following situation.

An individual (“Mr. A”) owns shares of a corporation (“Opco”) that he wishes to transfer to a new corporation (“Holdco”) pursuant to subsection 85(1) of the Act (Mr. A receive shares of Holdco in exchange for his shares in Opco). You are concerned that the Holdco shares Mr. A receives may no longer be considered to be “grandfathered” from the application of stop loss rules of subsection 112(3) of the Act as a result of the transfer. You would like our views on as to whether the Holdco shares would be grandfathered based on the assumption that Mr. A’s Opco shares originally were grandfathered under either of the following grandfathering rules:

1. The Opco shares were subject to a written buy/sell agreement that was in place before April 26, 1995; or

2. Opco was a beneficiary under a life insurance policy it held on the life of the Mr A that was entered into before March 31, 1997 and the proceeds of the life insurance policy were intended (at that time) to be used by Opco to purchase Mr. A’s shares after his death.

You also would like to know if our views under 2 would change if the life insurance policy is transferred from Opco to Holdco and Holdco becomes the new beneficiary under the policy.

Our Comments

Your request appears to relate to a proposed transaction. Confirmation of the income tax consequences of proposed transactions involving specific taxpayers will only be provided in response to a request for an advance income tax ruling. To make such a request the advance income tax ruling should be submitted in accordance with the guidelines set out in Information Circular 70-6R3 (“IC 70-6R3”) dated December 30, 1996, issued by Revenue Canada. Although we are not able to comment specifically on the situation you have provided, we can offer the following general comments.

The “stop loss” rules set out in subsection 112(3) to (3.2) of the Act may reduce the loss from the disposition of a share held as a capital property by the amount of tax-free dividends received on the share subject to certain grandfathering rules. As indicated in Income Tax Technical News No. 12 dated February 11, 1998 the Department set out general comments which it hopes will be helpful to taxpayers in determining whether the grandfathering provisions would apply in their particular situation. As noted therein, we will follow the normal practice of providing advance income tax rulings rulings on these grandfathering rules in situations where there is a definite proposed disposition of a share (i.e., the proposed disposition should generally be expected to occur within 12 months of the request). In this regard the determination as to whether the grandfathering rules will apply remain essentially a question of fact and the main task that a taxpayer must face will be the provision of documentation to establish the facts to our satisfaction.

The grandfathering rules to subsection 112(3) of the Act will apply to a disposition of a share held as capital property by an individual any time after April 26, 1995 if the share was owned by the individual on April 26, 1995, and inter alia:

(a) the disposition occurs pursuant to a written agreement made before April 27, 1995 (the “grandfathered agreement”) and such agreement is not subsequently altered or modified in any way; or

(b) the disposition was made to the corporation that issued the share and on April 26, 1995 a corporation, or a partnership of which a corporation is a member, is a beneficiary of a life insurance policy that insured the life of the individual or the individual’s spouse and it was reasonable to conclude on April 26, 1995 that a main purpose of the life insurance was to fund, directly or indirectly, in whole or in part, a redemption, acquisition or cancellation of the share by the corporation that issued the share (the “grandfathered policy”).

For the purpose of the rule described in (a) above, the parties to a grandfathered agreement may choose to revise the terms of their relationship by concluding a separate agreement so that the existing grandfathered agreement remains unchanged and the grandfathered status of the share will continue. However, if the revisions contained in the separate agreement are considered to cancel, nullify or otherwise replace the grandfathered agreement the grandfathered status of the share will be lost.

For the purpose of the rule in (b) above, the taxpayer must be able demonstrate that the requirements described under (b) actually existed on April 26, 1995. For example, one requirement is that a main purpose for the acquisition of the life insurance policy was to fund, directly or indirectly, in whole or in part, a redemption, acquisition or cancellation of a share. While we recognize that there can be more than one main purpose for the acquisition of a life insurance policy the policyholder must be able to provide documentary evidence to substantiate that this requirement was met on April 26, 1995. While not exhaustive, some documentary evidence that we would expect to see are as follows:

• documents issued by the insurance company or any correspondence relating to the issuance of such a life insurance policy;
• minutes of the directors and/or shareholders meeting of the corporation;
• correspondence from the taxpayer’s legal advisors or the accountants.

If a life insurance policy was acquired after April 26, 1995 then the grandfathering rule in (b) would not apply. However, if a grandfathered policy existed on April 26, 1995, modifications, alterations or cancellation of such a policy after April 26, 1995 would not, in and of themselves, result in a loss of grandfathered status of the share. It is possible however, that any subsequent actions in respect of a life insurance policy that existed on April 26, 1995 may be relevant in determining whether the requirements described in (b) above were actually met on April 26, 1995.

It should also be noted that if a taxpayer acquires a share(s) (the “new share”) in exchange for a share(s) that was subject to the rule described in (b) above (the “grandfathered share”) and the acquisition of the new share arose as a result of a transaction in which section 51, 85, 86 or 87 of the Act applies the new share will be deemed to be the same share as the grandfathered share. This exchange of share rule does not apply for the purpose of the rule described in (a) above.

While we trust the foregoing comments are useful they are given in accordance with the practice referred to in paragraph 21 of the IC 70-6R3 and are not binding upon the Department.

Yours truly,

F. Lee Workman
Manager
Financial Institutions Section
Financial Industries Division
Income Tax Rulings and
Interpretations Directorate

cc. Mr. Dave Cormack

Peterborough TSO