20 April 1990 Income Tax Severed Letter AC59404 - Associated Corporations - Exemption for Options and Rights Contingent on Permanent Disability

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.

5-9404
                                   P. Diguer
                                   (613) 957-2123

Dear Sirs:

Re: Subsection 256(1.4) of the Income Tax Act (Canada) (the "Act")

We are writing in response to your letter of January 11, 1990 wherein you requested our views concerning three particular issues, each involving the provisions of subsection 256(1.4) of the Act.

In particular you ask:

1. Whether the definition of permanent disability included in a particular shareholders agreement would come within the exemption provided for in paragraph 256(1.4)(a). Specifically, for purposes of the shareholders agreement, a person will be deemed to be permanently disabled if the person is physically disabled, or mentally incompetent or absent from the business due to illness for a period of one year. You also asked whether a shorter period, such as six months, would be acceptable.

2. Whether paragraph 256(1.4)(b) would apply in a situation where three shareholders who deal at arm's length each own one-third of the shares of a corporation.

In your view, it would appear that no single shareholder could cause the corporation to redeem shares since such right generally rests with the corporations board of directors.

3. Whether Revenue Canada agrees with the following comments found on page 11:23 of an article published in the 1988 Conference Report of the Canadian Tax Foundation:

"An event that triggers an automatic acquisition by a corporation of its own shares may not create a problem under budget paragraph 256(1.4)(b). For example, if a shareholders' agreement were to provide that, should a shareholding employee cease to be employed by the corporation, his shares would automatically be acquired by the corporation, no one would appear to have a right to cause the corporation to acquire the employee's shares."

Our Comments

Our reply to your queries will follow the order in which they are presented above.

The provisions of subsection 256(1.4) provide, inter alia, that anyone having an option or right to acquire shares or having a right to cause a corporation to redeem, acquire or cancel shares of its capital stock owned by other shareholders of the corporation, shall be treated, for purposes of certain provisions of the Act, as having exercised the option or right or, alternatively, as having caused the redemption, acquisition or cancellation of shares as outlined above. Exceptions to the above are provided "... where the contract provides that the right is not exercisable until the death, bankruptcy or permanent disability of an individual designated therein...".

A disability, as defined by the World Health Organization, is "any restriction or lack of ability to perform an activity in the manner or within the range considered normal for a human being". This concept is characterized by excesses or deficiencies of customarily expected behaviour or activity and these may be temporary or permanent, reversible or irreversible, and progressive or regressive.

The determination of whether a particular disability can be characterized as "permanent", for purposes of paragraph 256(1.4) (a) and (b) is a question of fact and accordingly, each case must be considered individually. As such, we are unable to provide a detailed reply with regards to the concerns expressed in your earlier referenced letter. Nevertheless, we can offer the following general comments with regards to this particular matter.

The term "permanent disability" is not defined in the Act and, therefore, in accordance with the "modern rule" for the construction of statutes as expressed by E.A. Dreidger in his book "Construction of Statutes", 2nd ed., (1983) and referred to by Estey J. in Stubart Investments Limited v. Her Majesty the Queen, (5 C.C.) 84 DTC 6305 at page 6323 these words "are to be read in their entire context and in their grammatical and ordinary sense harmoniously with the scheme of the Act, the object of the Act, and the intention of Parliament". The ordinary sense of the words "permanent" and "permanent disability" have been commented on as follows:

The Oxford English Dictionary, Second edition, 1989, defines "permanent" to mean, inter alia:

"continuing or designed to continue indefinitely without change; abiding, lasting, enduring, persistent. Opposed to temporary".

Webster's Ninth New Collegiate Dictionary, 1987, defines the same term to mean, inter alia:

"continuing or enduring without fundamental or marked change".

In addition, Black's Law Dictionary, fifth edition, 1979, defines "permanent disability" to mean, inter alia:

"Incapacity forever from returning to work formerly performed before accident, though this incapacity may be either total or partial."

"...one which will remain substantially the same during remainder of workers' compensation claimant's life it is also important to note that a tax credit for mental or physical impairment (disability tax credit) is available, pursuant to subsection 118.3(1) of the Act, to any individual who has a "severe and prolonged mental or physical impairment".

Paragraph 118.4(1)(a) provides, inter alia, that for purposes of this disability tax credit, "a person shall be considered to have a severe and prolonged impairment only if by reason thereof he is markedly restricted in his activities of daily living and the impairment has lasted or can reasonably be expected to last for a continuous period of at least 12 months."

The fact that Parliament chose the term "permanent disability" for purposes of paragraphs 256(1.4)(a) and (b), and not "severe and prolonged mental or physical impairment" as outlined above, would indicate, in our view, an intent on their part to target the exceptions therein to impairments which are expected to last for continuous periods that well exceed the period provided in paragraph 118.4(1)(a) of the Act. This intent is also evident from the framework in which the reference to "permanent disability" is situated within the particular provisions of the law as cited earlier, i.e. death, bankruptcy or permanent disability.

The intent of Parliament as discussed above, along with the definition of "permanent" and "permanent disability" as described above, would all indicate, in our view, that the exceptions as contemplated in subsection 256(1.4) of the Act, target events, the results of which would be, lifelong.

As such, it is our view that a permanent disability for purposes of paragraphs 256(1.4) (a) and (b) would involve a disability which has incapacitated the individual from performing functions formerly performed before the event which has caused the disability and there is no reason to believe that such incapacity will not continue throughout the lifetime of the person. Accordingly, in our view the definition of "permanent disability" provided in the above-referenced shareholders agreement would not fall within the exception found in paragraph 256(1.4) (a) of the Act.

With regards to your second query, we agree that, in the absence of any special provisions in the articles of incorporation, amendments thereto, or by-laws of a corporation or any contractual arrangement to the contrary, the directors of a corporation would normally be responsible for determining the redemption of shares. Nevertheless, it is the shareholders who elect the directors and who can, therefore, ultimately, determine if and when shares are redeemed.

It is, a question of fact whether any combination of shareholders are dealing at arm's length. Nevertheless, in a situation where no one shareholder alone controls the corporation as described in your second query, the fact that a particular board of directors may cause a corporation to redeem its shares would not, in and by itself, cause the provisions of subsection 256(1.4) to be applicable.

Your third and final query relates to a situation where employees of a particular corporation are parties to a shareholders agreement pursuant to which they are obligated to sell and the corporation is obligated to purchase all the shares of the particular corporation held by the employee in the event that the employee ceases for any reason to be employed by the particular corporation. In general, we agree that the provisions of paragraph 256(1.4)(b) would not apply in such circumstances.

The comments set out in this letter are of a purely general nature and do not take into account considerations that might arise in the context of a specific transaction. In accordance with paragraph 24 of Information Circular 70-6A, the comments expressed herein do not constitute advance income tax rulings and consequently are not binding on the Department.

Yours truly,

for Director Reorganizations and Non-Resident Division Specialty Rulings Directorate Legislative and Intergovernmental Affairs Branch