1 July 1980 Income Tax Severed Letter RCT 85-191 F

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.

Corporate Rulings Directorate Position Paper on Estate Freezes

1. Purpose of an Estate Freeze

The purpose of an estate freeze is to allow a taxpayer (freezor) to fix the value of his interest in a growth property at its present fair market value with the result that any future increase in the value of such a growth property will accrue for the benefit of his children (in some cases his spouse). In many cases the freezor retains control over the growth property after the freeze.

Estate freezing is acceptable to the Department particularly if the object of the freeze is to encourage the participation of the freezor's children in the family business and to encourage the continuance of that business after the freezor's death. There should be no intention to sell the growth property ie. business.

In addition, "key-man" freezes are acceptable since it is desirable to keep small Canadian businesses operative and the shareholders of these company's should be encouraged and assisted to transfer shares of their company to their key employees.

2. Types of Freezes

Usually freezes involving corporations and their shareholders involve the provisions of section 85 or section 86 of the Income Tax Act (the Act).

Generally speaking the results of these freezes is that the freezor has exchanged his growth property for a non-growth property in the form of redeemable special shares (freeze shares) in a corporation in which his children or a trust on behalf of his children own the common shares (i.e. new growth shares).

This can be accomplished without any immediate tax consequences to the freezor if certain conditions including the operative conditions of section 85 or 86 of the Act are met. Where these conditions are met we are prepared to give favourable rulings subject to the general limitations and qualifications set forth in Information Circular 70-6R subject to the following guidelines:

1. If there is an unacceptable feature in the ruling request, we should refuse to rule on the entire request.

2. A section 85 freeze normally involves the creation of a Holding Company in which the freezor's children own the common shares and the freezor holds freezor shares (see IT-291 Rand Information Circular 76-19R).

3. If the growth property is a capital property (other than depreciable property or an interest in a partnership) that was owned by a taxpayer on June 18, 1971 the application of section 85 of the Act will be subject to the provisions of subsections 26(5) and 26(5.2) of the Income Tax Application Rules (ITAR).

4. Normally in a section 86 freeze, the freezor's common shares in the operating company are exchanged for freezor shares in that corporation and the children are issued common shares in that corporation.

5. If section 86 of the Act applies to the transaction and the old shares were owned by the freezor on December 31, 1971 and thereafter without interruption until immediately before the reorganization and the new shares were the sole consideration for the old shares, the application of section 86 will be subject to the provisions of 26(27) of the ITAR.

6. If a freezor redeems the freeze shares which he received as the result of a section 86 freeze which was subject to the provisions of 26(27) of the ITAR and he is prevented from using the provisions of 26(7) of the ITAR, he will in effect be taxed on the capital gain accrued on the old shares up to December 31, 1971. This problem can be avoided if the freezor uses subsection 85(1) of the Act rather than subsection 86(1) of the Act to carry out the freeze or by taking back a small amount of cost in consideration.

7. The statement of facts in the ruling should include appropriate statements to cover the conditions set out in this paper and/or in the sections of the Act involved for example:

(a) The rights and conditions attached to the freeze shares,

(b) The classification (e.g. capital property) of the property being transferred by the freezor, and

(c) For a section 85 freeze a statement that the present fair market value of the property being transferred is greater than the elected amount. (see IT-291R)

3. Importance of the Rights Attaching to Freeze Shares

It is essential that the pre-freeze value of the freezor's interest in the growth property be maintained to ensure that any gains accrued up to the point of the freeze are eventually taxed in the hands of the proper person. Therefore the rights attaching to the freeze shares (those shares received in exchange for the growth property) must be such that the fair market value of the freeze shares at the time of issue is equal to the fair market value of the property that they were exchanged for. In addition this value must be maintained until the freeze shares are redeemed. If the pre-freeze value of the growth property is not maintained in the value of the freeze shares, the following provisions of the Act could apply to the freeze transactions:

(i) subsections 15(1), 56(2), 245(2),

(ii) paragraph 85(1)(e.2),

(iii) section 55.

Department's Position re: Rights Attaching to Freeze Shares

(A) Preference and Priority on Liquidation, Dissolution or Winding-up

In the event of the liquidation, dissolution or winding-up the Corporation, whether voluntary or involuntary, the holders of freeze shares shall be entitled to receive before any distribution on any part of the assets of the Corporation among the holders of other shares an amount equal to the redemption price for each freeze share and any dividends declared thereon and unpaid.

(B) The freeze shares must be retractable (i.e. shares redeemable at the option of the holder

The freeze shares shall be redeemable by the Corporation at the redemption amount at the option of the holder (There is no objection if they are also redeemable at the option of the Corporation.).

The freeze shares should be retractable even for minority shareholdings. It is recognized that the retractable feature may enhance the value of minority shareholdings and that the majority shareholder has control over the redemption of his shareholdings.

However, where Opco's minority shareholders are the freezor's children, ideally we prefer that different classes of shares be taken back. The redemption amount per share of each class should be determined separately and reflect premiums on control blocks and discounts on minority interests. The remaining characteristics of the different classes of freeze shares should be identical. Where no children are involved, only one class of freeze shares need be taken back, or where the children's shareholdings are insignificant, only one class of freeze shares need be taken back. In any case when giving an advance ruling we should rule separately for each shareholder who is exchanging shares and state that the FMV of the shares given in exchange should be equal to the FMV of the freeze shares taken back.

The loss of the retractability feature only on death provided it is lost in the estate of the freezor; the preferred shares become cumulative with a reasonable dividend rate (say 2/3 of prime) and the shares are redeemed over an acceptable period of time is acceptable (see para. I below for further details).

Note: It is our view that non-retractable shares do not have value equal to their par value or redemption amount but retractable freeze shares do in the same way as a non-interest bearing note retains its face value as long as it is a demand note. (Corporate Rulings Division takes the position that the freeze shares should be valued based on the going concern concept). In addition, any other restrictions on the freeze shares, eg. non-transferable that might be considered to reduce their F.M.V., will not be acceptable.

(C) Redemption Amount

Where only freeze shares are taken back, the freeze shares in aggregate should have a redemption amount equal to the fair market value of the property they were exchanged for. Where there is non-share consideration the redemption amount should be equal to the fair market value of the property exchanged less the fair market value of the non-share consideration.

Note: (1) Where the proposed transactions are subject to a price adjustment clause only the redemption price per share should be subject to adjustment and there should not be any requirement to issue or cancel freeze shares if the price adjustment clause becomes applicable.

(2) If the condition with respect to the redemption amount is met, paragraph 85(1)(e.2) of the Act will not apply because the FMV of the freeze shares will be equal to the FMV of the property given in exchange. (This is assuming the freeze shares have the other rights restrictions as set out in this section).

(D) Dividends

The freeze shares are usually entitled to a non-cumulative dividend at either a fixed rate or a rate set by the directors on each dollar of the "redemption price". We do not insist on dividend rate when the freeze shares are non-cumulative. This is usually the case where there is a freeze in favour of the freezor's children and the freeze shares are redeemable at the option of the holder.

The payment of dividends on the freeze shares may or may not have preference to the payment of dividends on other classes of shares. In any case, the rate of dividend cannot exceed a reasonable amount.

(E) Purchase by the Corporation

There must be a clause in the facts stating that if the corporation at any time acquires any of the freeze shares by purchase, redemption or cancellation it shall pay the lessor of the aggregate redemption price of the freeze shares to be purchased, redeemed or cancelled at that time and the realizable value of the assets less liabilities of the corporation immediately before such an acquisition. This clause will prevent the value of the common shares from being increased by the corporation purchasing, redeeming or cancelling the freeze shares at an amount less than their FMV. If the value of Opco decreases the purchase redemption or cancellation may be for an amount which is less than the redemption amount.

Note: Where there is more than one owner of freeze shares it may be advisable for the freeze shares to be redeemable at the option of the corporation. If the value of Opco decreases and a holderof the freeze shares demands redemption, the corporation would then be in a position to call all the freeze shares for redemption and pay these shareholders on a pro rata basis.

(F) Limitation of Dividends on Other Shares of the Corporation

No dividends are to be paid on other classes of shares so as to reduce the value of the freeze share below the redemption amount.

Note:This statement should be part of the facts in the ruling rather than just being in the letters patent.

(G) Voting

Depending upon the choice of the taxpayer the freeze shares may or may not be voting shares. However, freeze shares should at least have a vote as set out in the following sentence. The freeze shares shall have a provision that any preference, right, condition or limitation attaching to the preference shares can only be amended on a two-thirds majority vote of the holders of the freeze shares and on a two-thirds majority vote of the holders of the other classes of shares, each voting separately (Unless the relevant corporate law requires a higher percentage).

(H) Paid-up Capital

(a) When the growth property is shares of a corporation care must be taken to ensure the following:

(i) Section 86 Freezes

To avoid the application of subsection 84(1) of the Act or subsections 84(3) and 84(5) of the Act the paid-up capital of the freeze shares (new shares) should be equal to the paid-up capital of the old shares. (Where there is consideration other than shares taken back, the F.M.V. of the other consideration plus the paid-up capital of the new shares must not exceed the paid-up capital of the old shares.)

(ii) Section 85 Freezes

(1) Where section 84.1 of the Act applies to the transaction the paid-up capital of the freeze shares, if the consideration paid by the purchaser corporation consists solely of freeze shares, should not exceed the paid-up capital of the shares transferred. In this way the income tax consequences of the application of section 84.1 of the Act are avoided.

(2) The consideration other than freeze shares could include corporate debt and other consideration and there will be no income tax consequences as the result of the application of section 84.1 of the Act as long as the aggregate of

the fair market value of the other consideration,

the principal amount of the corporate debt, and

the paid-up capital of the freeze shares

does not exceed the paid-up capital of the shares transferred.

(3) If the paid-up capital of the freeze shares does not exceed the paid-up capital of the shares transferred in order to avoid the tax consequence of section 84.1 of the Act (see H(a)(ii)(1) above) then subsection 84(1) will not apply to the transaction.

(4) When section 84.1 of the Act has no application to the transaction, the paid-up capital of the freeze shares plus the FMV of other property taken back cannot exceed the FMV of the shares given in exchange or subsection 84(1) of the Act will apply to the excess. A freezor is usually deferring capital gains and such an excess should not occur in an estate freeze transaction.

(iii) Paid-up capital as used in H(a)(i) and (ii) is paid-up capital as defined in paragraph 89(1)(c) of the Act and this point must be covered in the facts of the ruling.

Note: For both section 85 and 86 freezes the transactions are much cleaner if freeze shares are the only consideration taken back and we should encourage that this be the case in our rulings.

(b) For section 85 freezes when the property is other than shares of a corporation subsection 84(1) of the Act should be considered in relation to the paid-up capital of the freeze shares. There should be no problem in the context of an estate freeze under section 85 of the Act because the FMV of the property given in exchange will usually exceed the paid-up capital of the freeze shares plus the FMV of other consideration taken back.

(I) After Death

The pre-freeze value must be maintained before and after death. This means that the freeze shares must retain their rights on the death of the freezor. However, we can accept the loss of the retractable feature only on death and only if the following conditions are present:

(i) that such a feature is lost in the estate of the freezor;

(ii) that the freeze shares become cumulative with a reasonable rate of return. A reasonable rate of return is considered to be 2/3 of prime adjusted on a quarterly basis. (2/3 of prime will yield approximately the same amount after income taxes as a taxpayer would have after taxes if the redemption amount of the freeze shares was invested to earn interest at the prime rate.);

(iii) that there is a fixed plan for the redemption of the freeze shares over a period not exceeding 10 years with at least 1/10 redeemed each year.

Note:We also have to guard against a capital loss by the estate on the freeze shares in the first taxation year of the estate because of the provisions of subsection 164(6) of the Act which in effect would treat such a capital loss by the estate as capital loss of the freezor for taxation year in which he died.

The loss of the retractable feature on the transfer of the freeze shares to the children before the death of the freezor is not acceptable because the value of these shares will be greatly reduced.

4. Classes of Common Shares

Only one class of common shares is acceptable for the purposes of an estate freeze. Where there are more than one class of common shares to be issued we will refuse to rule and where there are more than one class of common shares in the authorized capital or proposed authorized capital of the corporation our ruling should be on the condition that none of the other classes of common shares will be issued.

The reason for this position is to prevent income splitting at the discretion of the freezor particularly if the freezor, his spouse and his children would all receive a different class of common shares and the directors could declare dividends on one class of common shares and exclude the remaining classes. More important it is very difficult to place a value on the various classes of shares. Valuation problems occur when different children of the freezor are holders of the various classes of common shares and such a structure is not acceptable.

In addition, the holders of the freeze shares should not be permitted to waive dividends in order to assist or aid income splitting.

5. Income Splitting

A. In favour of the Children

In the process of accepting an estate freeze in favour of the children we are in effect allowing future earnings of the company to accrue for the benefit of the freezor's children.

While discretionary trusts in favour of the children are acceptable, we insist that for the purposes of an estate freeze there be only one class of common shares.

Guidelines

Minor children will be acceptable in a trust situation if

(a) the income accumulates in the trust until the minor reaches 18 (restricted because of specific attribution rules for minors) (see IT-260R) but if the minor makes a preferred beneficiary election attribution to father will be triggered, and

(b) the trust acquires new shares by purchase out of the proceeds of a genuine loan under terms comparable to those that a reasonable businessman would offer to an arm's-length borrower under similar circumstances.

B. In favour of Spouse

Income splitting in favour of the spouse is generally not acceptable.

While the onus is on the taxpayer to provide bona fide reasons for the inclusion of a spouse in the freeze we will accept the spouse's participation if, and only if, the spouse is part of the "commercial animus" of the business ie. the spouse has contributed capital or talent to the business. If the contribution is talent a thorough description of her educational qualifications, etc., duties and involvement in the business will be required. If capital is contributed it may be out of the proceeds of a genuine loan (see comments above) and the contribution must be a significant one, not a nominal contribution.

It is also possible for income splitting in favour of the spouse to be achieved by having the spouse invest in cumulative preference shares of Holdco, having an unreasonable dividend rate. We should not rule unless the dividend rate is reduced to one that is considered reasonable (e.g. 2/3 of prime).

Note:The ruling should contain the following facts:

(a) Jurisdiction under which Opco was incorporated.

(b) Opco's present authorized and issued share capital including a list of the present shareholders and their shareholdings.

(c) The relationship of the shareholders of Opco to the freezor.

(d) When Opco's shareholders acquired their shares and from whom they acquired them.

(e) The paid-up capital of Opco's issued shares.

(f) The nature of Opco's business.

(g) If a Holdco is to be created the jurisdiction in which it will be incorporated.

(h) The proposed authorized capital of Holdco for a section 85 freeze or of Opco for a section 86 freeze and the proposed list of shareholders and their shareholdings.

(i) The relationship of the proposed shareholders to the freezor with an indication as to whether or not the freezor's children are adults or minors.

(j) The proposed paid-up capital of the new shares.

This information will give us better understanding of transactions and assist us in determining whether or not our position in relation to income splitting is in danger of being violated.

Guidelines

1. In determining whether or not a spouse is actively engaged in the business, both the time expended and the expertise provided are taken into consideration. Generally, if the function performed by the spouse does not require a specialized skill or training, it is expected that the spouse's involvement will be on a regular basis and will require a significant amount of his or her time. On the other hand, if the spouse possesses special expertise relevant to the business being carried on, the spouse's involvement could be on an irregular basis and involve only limited demands on his or time.

2. In many cases there is no real reason other than income splitting for spouse in the freeze and freezing in favour of the wife is usually not necessary. It should be noted that it is possible on the death of a taxpayer to rollover the deceased's tax cost of capital property to a spouse or spouse trust. (See subsections 70(5), (6), (6.1) and (6.2) and IT-305R).

3. Where income splitting is the only reason for having the spouse in the freeze and the freezor insists on spousal participation we will accept this if a portion of the freeze shares that relates to the spouse's interest have a cumulative dividend at a reasonable rate. This position is usually not acceptable to the freezor as it defeats the purpose of the freeze but it reinforces our stand on income splitting in favour of the spouse.

4. In some cases the freezor wishes to have his or her spouse involved in the control of company but not in its growth. This is acceptable under the following conditions:

(a) A class of preferred shares is set up for this purpose.

(b) All of the shares of the class are issued to the spouse.

(c) The class of shares has nominal paid-up capital and is redeemable at the same amount.

(d) The dividend rate on the shares is fixed and is reasonable.

(e) The shares are non-participating and rank behind freeze shares but ahead of common shares in return of capital and unpaid dividends.

(f) The shares are voting but if any shares of the class are transferred or the holder dies then all shares of the class cease to vote.

The freezor usually retains control until his or her death at which time control shifts to his or her spouse, if the spouse is alive.

C. In favor of key employees ie. "Key-man"

As previously indicated, income splitting in favour of key-man will generally be acceptable. However, since it is likely that these freezes will be equivalent to arm's-length transactions our requirements will be less stringent.

Guidelines

1. The freeze shares must be frozen in an acceptable manner,

2. there will be no requirement on our part to force a dividend rate on the frozen shares (although this might be expected if the old shares are frozen at current f.m.v. and the lack of one might be an indication that the value incorporates some future earnings),

3. we will not require that an independent appraisal be made to support f.m.v. of the freeze shares but will require as a statement of fact that the freeze value is f.m.v. - and a prudent freezor may well want an appraisal anyway, since the "fact" remains open to challenge by us, and

4. if a "Holdco" is involved, section 55 may well have application and will be invoked if the situation fits.

Note:For any type of freeze to be acceptable there must be no second or arm's-length sale contemplated in the foreseeable future.

6. Specific Comments on Freeze Transactions

1) A. Purpose of Section 84.1

The purpose of subsection 84.1(1) of the Act is to prevent a corporation from converting its surplus accumulated before 1972 into debt or paid-up capital. If such a result was obtained, subsection 84.1(1) of the Act would be applied even though the shares were acquired from the treasury of a corporation which was incorporated after 1971. However, if the transferred shares were acquired from the treasury of corporation which was incorporated after 1971 and such a result is not obtained, it is our administrative practice not to apply subsection 84.1(1) of the Act.

B. Application in Estate Freeze Transaction

In the context of an estate freeze where the P.U.C. of the freeze shares as defined by paragraph 89(1)(c) of the Act (such shares being the only consideration received by the freezor) is equal to the P.U.C. of the subject shares as so defined, subsection 84.1 of the Act may be applicable but there is no deemed capital gain or reduction of ACB of the freeze shares.

(i) No Deemed Capital Gain

Where the freeze shares are the only consideration received by the freezor, the computation of the deemed capital gain under paragraph 84.1(1)(a) of the Act is nil.

(ii) No Adjustment to ACB

The adjusted cost base of the subject shares is usually greater than their P.U.C. because of pre-1972 accumulated surpluses and where the P.U.C. of the freeze shares (such shares being the only consideration received by the freezor) equals the P.U.C. of the subject shares there is no excess under paragraph 84.1(1)(b).

(Note:consider the application of subsections 84.1(2) and 84.1(3) of the Act).

(iii) In cases where there is an addition to the cost of the shares to the purchaser section 84.1 should be applied.

Note: A sells the shares of his corporation Y to his brother B's corporation X. 84.1 applies as A and X do not deal at arm's-length 251(2)(b)(iii) and Y and X are connected corporations 186(4).

If A receives cash and or other consideration other than shares of X in addition to the capital gain otherwise calculated there would be an additional capital gain calculated pursuant to 84.1(1)(a), i.e. the excess of A's ACB in the shares of Y are the puc of those shares. ITAR 26(5)(c) would add this gain to X's cost in the shares of Y regardless of whether we taxed this gain or not.

If A sold the shares of Y to B directly 84.1(2) would prevent such an addition to B's cost in Y.

C. Redemption of the Freeze Shares

On the redemption of the freeze shares the freezor will be deemed to have received a deemed dividend under subsection 84(3) of the Act. Such a deemed dividend will theoretically include the accumulated pre-1972 surpluses.

Note:If the freezor should incur a capital loss on redemption equal to the difference between the ACB of the freeze shares and their P.U.C., the resulting allowable capital loss may or may not be immediately deductible by the freezor. This depends whether or not the freezor would be subject to the provisions of subsection 85(4) of the Act and whether or not the freezor had taxable gains to be offset if subsection 85(4) of the Act does not apply.

2) Discretionary Trusts in Favour of Children

A.(i) Provided that no funds from the trust may be allocated to the spouse of the freezor a discretionary trust in favour of the freezor's children or freezor's children and grandchildren is acceptable.

(ii) The following is an example of the conditions to be met in setting up such a trust XXX

(a) The freezor and two independent parties are the trustees of the trust.

(b) The trust will be established by the freezor settling on the trust such an amount in cash that he or she will qualify as a settlor under paragraph 108(1)(h) of the Act. (If a non-resident contributes funds to trust to purchase the common shares, in order for the freezor to qualify as settlor the FMV of his contribution must be greater than the FMV of the non-resident's contribution.)

(c) This cash will be used by the trustees to acquire an investment such as a Canada Savings Bond.

(d) The funds used by the Trust to purchase the common shares in Holdco (Opco for a section 86 freeze) will be borrowed funds or funds introduced by a non-resident.

(e) The potential beneficiaries of the trust will include issue of the freezor, issue of the issue of the freezor and one or more charitable organizations (Note: A trust cannot be a preferred beneficiary (paragraph 108(1)(g) of the Act). If one of the beneficiaries of the Discretionary Trust is another trust the provisions of subsection 104(14) and paragraph 104(15)(c) of the Act will not apply).

(f) The division of the trust assets will be at the discretion of the trustees.

(g) The trust agreement may provide that the income from the trust may be accumulated by the trustees or paid to the beneficiaries from time to time.

(h) The trust will be irrevocable and at no time shall any of the assets of the trust revert to the freezor or his or her spouse.

(i) Decisions respecting the trust will be made by a majority vote of the trustees.

(j) In the event of a vacancy in the office of trustee the freezor or his or her personal representative shall have authority to replace the trustee provided that neither freezor nor his or her spouse should at any time be sole trustee of the trust, nor shall the freezor and his or her spouse be trustees at the same time.

B. Application of Subsections 75(1) and 75(2)

As the payment of a dividend on the shares held by the trust or the disposition of the shares held by the trust are not proposed transactions we are not in a position to rule on the application of subsections 75(1) or 75(2) of the Act. However, we can give an opinion to the effect that in the event of a dividend being paid subsections 75(1) and (2) of the Act will not apply and in the event of disposition of the shares that subsection 75(2) will not apply provided that the freezor's funds were not used to acquire the growth shares.

Subsection 75(1) of the Act does not apply where all the value of the freezor's interest in Opco is reflected in the value of the freeze shares and where the cash used by the trust to purchase the shares held by the trust was not contributed by the freezor. Subsection 75(2) of the Act does not apply because none of the conditions that make that subsection operative are present.

Note: (1) Subsection 75(1) of the Act will apply to any income or loss from the property purchased with the cash used to settle the trust or property substituted therefor, which becomes payable to a beneficiary under 18 years of age by virtue of a provision of section 104 of the Act including subsection 104(14) of the Act.

(2) If the freeze shares do not have priority on the payment of dividends, the freezor may agree to pay a nominal dividend on the common shares. Provided that the freezor's funds were not used by the trust to acquire the common shares of Opco or Holdco as the case may be, we could give a favourable ruling on the non-application of subsections 75(1) and (2) of the Act in relation to the proposed dividend.

(3) In many cases the freezor will request a ruling to the effect the trust and a preferred beneficiary will be eligible to make the election under subsection 104(14) of the Act. This election must be made for each taxation year and here again we can only give opinion rather than a ruling.

(4) Refer to Meaning of Settlor IT-374 and Preferred Beneficiary Election - IT-394 for further explanations.

(5) It should be noted that assets of the trust will be deemed to be disposed of after 21 years pursuant to subsection 104(4) of the Act.

3) Application of Section 55 - Section 85 Freezes No Intention to Sell Opco's Shares

In the case of a section 85 freeze and the creation of Holdco the Department is concerned about the possible deferral of a capital gain on the disposition of the shares of Opco. For example assume that instead of paying the freezor for his shares in Opco, the purchaser, pays an amount equivalent to FMV of the freezor's shares in Opco to Opco for additional shares in Opco. Then the capital gain that freezor would have incurred can be deferred in Holdco by having Opco redeem or otherwise cancel its common shares held by Holdco. Any proceeds of disposition to Holdco in excess of the paid-up capital of the shares it held in Opco would be a deemed dividend and not taxable income to Holdco. Section 55 of the Act will apply to such a series of transactions.

In order to assure ourselves that the freezor is planning a freeze for estate planning purposes and is not attempting to defer tax on a capital gain which would result from an intended sale of Opco's shares, the ruling request should state that there is no intention to redeem or otherwise cancel the shares of Opco held by Holdco.

If such a statement is made a favourable ruling may be in respect of the application of section 55 of the Act to the proposed transactions.

4) Application of subsections 15(1), 56(2), 245(2) and 247(1)

Where we are otherwise satisfied with the proposed estate freeze we will give a favourable ruling on the application of subsections 15(1), 56(2), 245(2) and 247(1) with respect to the proposed transaction in and by themselves.

Note: If there is an unacceptable feature in the ruling request we should not rule on at all.

5) Price Adjustment Clause

A. The transaction of transferring the common shares of Opco under section 85 of the Act for freeze shares in Holdco or of exchanging the common shares of Opco for freeze shares of Opco under section 86 of the Act is usually subject to a prixce adjustment clause. This clause concerns the fair market value of the common shares and therefore the redemption price of the freeze shares.

As the taxpayers are required to use a fair and reasonable method to value the common shares, normally the price adjustment clause will not become operative. Furthermore the coming into effect of the price adjustment clause is not a proposed transaction. As a result we should not rule on the application of the law in the event that the price adjustment clause becomes operative.

The preferable way to treat such an item in a ruling is to simply state the fact that the transaction is subject to a price adjustment clause. Then we should qualify our ruling by stating that it does not apply to the operation of the price adjustment clause.

B. Where taxpayers insist on having more detail the following points should be covered.

(i) In the facts

(a) The agreement reflects a bona fide intention of the parties to transfer the common shares at fair market value and arrives at that value for the purpose of the agreement by a fair and reasonable method.

(b) All the terms and conditions of IT-169 "Price Adjustment Clauses" must be satisfied.

(c) The adjustment should only be in respect to the redemption price of the freeze shares and not involve the cancelling of issued freeze shares or the issuing of additional freeze shares. (Since it is questionable whether or not shares can be issued or cancelled retroactively and the effect on the changing of paid-up is not clear we will not accept it).

(d) The redemption amount of each freeze share should not be a fixed amount but be subject to its proportionate share of the fair value of the common shares. A retroactive change in the redemption amount will be accepted provided it is immediately covered by a cash payment if any redemption has occurred.

(e) The agreement should cover the redemption, acquisition or cancellation of the freeze shares as follows. If the amount received by the freezor from the Corporation on the redemption, acquisition or cancellation of the freeze shares is greater or less than the adjusted redemption price of such shares the freezor will refund the excess to the corporation or the shortfall will be paid to the freezor by the corporation. In recognizing this part of the agreement appropriate adjustments in computing the income of all parties to the agreement will be made in their taxation years in which the redemption, acquisition or cancellation took place.

Note: The freeze shares must have a redemption amount expressed in dollars even if such an amount is subject to a price adjustment clause. K.H. Major