1 June 1990 Income Tax Severed Letter ACC9085 - Tax Re Dividends on Preferrred Shares - Impact of Price Adjustment Clause on Part IV.1 and VI.1

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.

In view of the difficulties in accurately determining fair market values, many corporate reorganizations include one or more price adjustment clauses relating to transfers of property in the course of the reorganization. Will the operation of such a price adjustment clause have any impact on Part IV.1 and Part VI.1 tax?

Department's Position

In our view the potential impact that the operation of a price adjustment clause will have on tax exigible under Parts IV.1 and VI.1 will depend on the nature of the price adjustment clause and the direction of the adjustment.

If the price adjustment clause is part of the share conditions, the operation of the clause subsequent to the redemption/cancellation of the shares will generally result in the shareholders receiving any additional payment in the form of dividends.

If the price adjustment clause contained in the share conditions provides for an additional amount in the form of additional shares having a nominal paid-up capital and a fixed redemption amount, for purposes of subsection 84(3), subsection 84(5) will apply to the issue of the additional shares resulting in a deemed dividend equal to the aggregate paid-up capital of the shares issued. On the subsequent redemption of those additional shares a deemed dividend will result pursuant to subsection 84(3) of the Act.

In the two situations described above the additional dividends will, where subsection 191(4) applies, exceed the amount specified therein. Accordingly, pursuant to subsection 191(5) such additional dividends will not qualify as exempt dividends and will be subject to tax under Parts IV.1 and VI.1 of the Act.

If the price adjustment clause is part of the purchase-sale agreement and not part of the share conditions, its becoming operative subsequent to the redemption/cancellation of those shares will constitute the disposition of a right and, as such, the recipient would have proceeds of disposition of a right that has an adjusted cost base of nil.

In all of the above situations, the dividends which originally arose on the redemption/cancellation of the shares should not be affected by the operation of the price adjustment clauses. Where, however subsection 191(4) of the Act is applicable, and one of the price adjustment mechanisms mentioned previously becomes operative due to an overstatement of the fair market value of the consideration for which the preferred shares were issued, the full amount of the original deemed dividend may be subject to tax under Parts IV.1 and VI.1 if the aggregate amount specified for purposes of subsection 191(4) exceeds the revised fair market value of the consideration for which the preferred shares were issued.

Prepared by: T. Harris

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