15 May 1985 Income Tax Severed Letter RCT 5052-1

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.

DECISION SUMMARY

Reference: Sections 84.1, 85 and 86, ITAR 26(27).

Subject: Section 86 exchange of shares prior to a section 85 rollover in order to differ application of section 84.1.

Problem: 1) A taxpayer holds pre-1972 shares of Opco having a PUC of $14,400, an ACB (V. Day value) of $1.5 M and a FMV of $5 M.

• 2) The capital of the corporation is reorganized and the shares are exchanged for preferred shares with a PUC of $14,400, same ACB of $1.5 M and redemption value of $1.5 M. No benefit under 86(2).
• 3) New common shares are issued for $500 cash. The excess of value of old shares over new preferred shares ($3.5 M) is transferred on new common shares.
• 4) New common shares of Opco are rolled to Newco under 85(1). Consideration received includes preferred shares of Newco with a PUC of $3.5 M, redeemable at $3,500,500, ACB $500.

See Appendix.

Are we going:

• a) to consider that the new common shares (step 3) are issued as part of the exchange of shares in course of reorganization of capital with the result that the ACB of the old shares will have to be pro-rated between the new common and new preferred shares and that ITAR 26(27) would not apply (creating a possibility of future capital loss)?
• b) to deny to rule on the reorganization on the basis that it was done to circumvent the provisions of section 84.1?

Position: To rule favorably.

Comments: As the pre-1972 surplus will have to be distributed in dividends (crystallized in the new preferred shares of Opco), we should not object to an increase of the paid-up capital to the extent of the post-1971 surplus (crystallized in the new preferred shares of Newco on which a capital gain will be realized).

Appendix

1. Actual organization:

Common shares
ACB         $1.5 M
Paid-up     $14,400
FMV           $5 M

2. Step 1 - Section 86

Conversion of common shares into redeemable shares, redeemable at ACB of exchanged common shares:

Preferred shares
ACE          $1.5 M
Paid-up      $14,400
FMV          $1.5 M
(redeemable at)

In a standard 86 reorganization, this step normally follows the issue of new common shares, step 2 in this case.

3. Step 2 - Issue of common shares for cash $500

New common shares now have a FMV of $3,500,500 i.e. cash $500 plus excess of FMV of common shares over FMV of new redeemable shares.

Common           Preferred
ACB  $500        $1.5 M
Paid-up  $500    $14,400
FMV  $3,500,500  $1.5 M

4. Step 3 - Rollover of common shares under 85(1)

Preferred
ACB  $500
Paid-up  $3,500,500
FMV  $3,500,500
Common           Preferred
ACB  $500        ACB  $1.5 M
Paid-up  $500    Paid-up  $14,400
FMV  $3,500,500  FMV  $1.5 M

5. Normal organization after 85(1) rollover + 84.1 application

ACB  $14,400
Paid-up between $1.5 M and $5 M
FMV $5 M
ACB $1.5 M
Paid-up  $14,400
FMV  $5 M