28 March 1990 Income Tax Severed Letter AC59499 - Admissibility of Flow-through Shares as Prescribed Shares

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.

19(1) 5-9499

A.S. Nelson
(613) 957-8984

March 28, 1990

Dear Sirs:

Re: Opinion Request
Draft Regulation 6202.1

We are writing in response to your letter to us dated January 3l, 1990, wherein you request our opinion as to whether a particular method of converting flow-through shares into common shares of another class of the same corporation would cause the flow-through shares to be prescribed shares within the meaning of draft Regulation 6202.1.

You described a hypothetical situation where Units consisting of 2,000 Class "A" (non flow-through) common shares and 46 Class "B" (flow-through) common shares of a newly formed corporation are offered to the public. Each Unit is issued for $5,000. $ 400 of the Unit price is attributable to the Class "A" common shares, or 20¢ per share. $4,600 of the total Unit price is attributable to the 46 Class "B" common shares, or $ 100 per share. The Class "A" commom shares are not prescribed shares for the purposes of Regulation 6202.1. The Class "B" common shares are convertible into Class "A" common shares at the option of the holder at any time within a six month period commencing three years after the date of issue of the Class "B" common shares. The stated capital per share of the Class "B" common shares (i.e. $ 100 per share) will be divided by the current market price per Class "A" common shares into which each Class "B" common share is convertible. All Class "B" common shares outstanding at the end of the conversion period will be automatically converted into Class "A" common shares on the same basis.

You are concerned that the broad wording in draft Regulation 6202.1, and in particular, paragraphs 6202.1(1)(b) and (c) and paragraph 6202.1(2) (a), may be interpreted so as to cause the Class "B" common shares to be prescribed shares.

In responding to you, reference is made to section 6202.1 of the Regulations, which was promulgated on January 18, 1990.

We are unable to address your specific queries concerning the hypothetical situation noted above due to a lack of sufficient facts on which to base our opinion. However, we do offer the following general comments which may be of assistance to you.

• 1. For the purposes of the definition of flow-through share pursuant to paragraph 66(l5)(d.l) of the Income Tax Act, where a new share of the capital stock of a corporation is, at the time it is issued, convertible or exchangeable into another security issued by the corporation, the new share will be a prescribed share by virtue of subparagraph 6202.1(1) (a) (iii) of the Regulations, unless the conditions stipulated in both clauses (A) and (B) are met.
• Clauses 6202.1(1) (a) (iii) (A) and (9) provide that the new share will not be a prescribed share under subparagraph 6202.1(1) (a) (iii) of the Regulations if, inter alia, the new share is convertible or exchangeable only into another share of the corporation that, if issued, would not be a prescribed share ("non-prescribed share") and, if all the consideration receivable by the holder on the conversion or exchange of the new share is I imited to such a non-prescribed share receivable on the conversion or exchange.
• In a situation where shares that othervise qualify as flow-through shares are convertible or exchangeable into shares of the same corporation, such that the provisions of subparagraph 6202.1(l) (a) (iii) of the Regulations do not apply, it is our view that the shares may be prescribed shares pursuant to one or more of the other provisions of section 6202.1 of the Regulations, if the facts so dictate.

This would be so, for example, in a situation where

• (i) the fair market :value of the shares received on conversion exceeds the fair market value of the flow-through shares given up in return there for (the "payment or benefit"), and
• (ii) at the time of the issuing the flow-through shares the conversion feature was in place and it was reasonable to consider the payment or benefit would be a repayment or return by the corporation of all or part of the consideration.for which the flow-through share was issued (refer to paragraph 6202.1(1)(b) of the Regulations).
• For greater certainty, we note that the conversion right, in and of itself, would not trigger the application of paragraph 6202.1(l) (b) . In our view there must be more than a fair market value conversion in order for paragraph 6202.1(l)(b) to apply. There must be some sort of benefit or payment etc. conveyed to the shareholder on the conversion that may reasonably be considered to be a repayment or return by the corporation (or a specified person) of all or part of the consideration for which the share was issued.
• 2. Similarly, it is our view that notwithstanding that subparagraph 6202.1(1) (a) (iii) of the Regulations does not apply in a particular situation because of the application of clauses (A) and (8), paragraph 6202.1(1)(c) could apply to cause the flow-through shares to be prescribed shares. This would be so in a situation where the conversion feature in the flow-through shares is such that at the time of their issue the shareholder is entitled to receive non flow-through shares having a fair market value at the time of conversion in excess of the fair market value of the flow-through shares which are being converted and where this conversion feature may reasonably be considered to have been given to limit any loss that the holder of the flow-through share may sustain from holding, owning or disposing of the share.
• Where the flow-through shareholder merely has the right to convert its shares into non flow-through shares of the same corporation on a fair market value basis, it is our view that the flow-through shares would not be prescribed shares by virtue of the application of subparagraph 6202.1(1) (a) (iii) (assuming the provisions of clauses (A) and (B) are met).
• This position would appear to be consistent with subsection 6202.1(4) of the Regulations which allows agreements for the sale of flow-through shares at fair market value for the purposes of determining whether paragraphs (1) (c) and (e) of the Regulations apply.
• 3. Where a person agrees to acquire flow-through shares and non flow-through shares from a corporation for fair market value consideration and the consideration for which flow-through shares are to be issued is determined within 60 days of entering into the flow-through share agreement, and the terms of the flow-through shares provide for their conversion into additional non flow-through shares of the corporation on a fair market value basis, it is our view that paragraph 6202.l(2)(a) of the Regulations will not apply to cause the flow-through shares to be prescribed shares.

The above comments are expressions of the opinions of those officials of the Department named in this response and as such are not to be construed as advance income tax rulings nor are they binding on the Department.

Yours truly

Section Chief
Resource Industries section
Bilingual Services and Resource
Industries Division
Rulings Directorate

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