Translation disclaimer
This translation was prepared by Tax Interpretations Inc. The CRA did not issue this document in the language in which it now appears, and is not responsible for any errors in its translation that might impact a reader’s understanding of it or the position(s) taken therein. See also the general Disclaimer below.
Principal Issues: In the two given fact situations:
1) Whether the "exchange" of common shares of the capital stock of a corporation for preferred shares and common shares of the capital stock of the same corporation would constitute a disposition of all the common shares for the purposes of subsection 85(1) of the Act.
2) Whether the "exchange" of preferred shares of the capital stock of a corporation for shares of a different class of preferred shares having the same rights except the rate of dividend entitlement, would constitute a disposition for the purposes of subsection 85(1) of the Act.
Position: 1) No.
2) Yes.
Reasons: Wording of the Act and current positions.
2004-009256
XXXXXXXXXX Guy Goulet, CA, M. Fisc.
(613) 957-9768
November 10, 2004
Dear Sir,
Subject: Technical Interpretation - Paragraphs 85(1) and 248(1)
This is in response to your email of August 25, 2004 requesting our comments on the application of subsections 85(1) and 248(1) to two Particular Situations described below.
Unless otherwise indicated, all statutory references herein are to provisions of the Income Tax Act (the "Act").
Particular Situations:
The Particular Situations as described by you are as follows:
1. Particular Situation 1:
1.a) An individual ("Mr. X") held 100 common shares of the capital stock of a taxable Canadian corporation ("Aco"). The fair market value ("FMV") of those common shares was $1,000,000, while their adjusted cost base ("ACB") was $500,000 and their paid-up capital ("PUC") was $100. We have assumed for the purposes hereof that Mr. X was an individual resident in Canada and that the common shares of the capital stock of Aco were "capital property" to him within the meaning of section 54.
1.b) Mr. X exchanged all of the common shares of the capital stock of Aco that he held in consideration for the issuance by Aco of 500,000 preference shares and 100 common shares. You indicated that as part of this transaction, Aco cancelled the originally-issued 100 common shares of its capital stock. Mr. X and Aco made an election pursuant to subsection 85(1) in the prescribed form and within the time limit set out in subsection 85(6).
2. Particular Situation 2:
2.a) An individual ("Mr. Y") held 100 Class A preferred shares of the capital stock of a taxable Canadian corporation ("Bco"). The FMV of those Class A preferred shares was $1,000,000, while their ACB was $500,000 and their PUC was $100. We have assumed for the purposes hereof that Mr. Y was an individual resident in Canada and that the Class A preferred shares of the capital stock of Bco constituted "capital property" to him within the meaning of the definition in section 54.
2.b) Mr. Y exchanged in favour of Bco all of the Class A preferred shares of the capital stock of Bco that he held in consideration for the issuance by Bco of 500,000 Class B preferred shares and 1,000 Class C preferred shares. You informed us that, as part of that transaction, Bco cancelled the 100 Class A preferred shares in its capital stock. Mr. Y and Bco made an election pursuant to subsection 85(1) in the prescribed form and within the time limit set out in subsection 85(6). The Class B and C preferred shares had the same rights, privileges, restrictions and conditions as the Class A preferred shares except for the dividend rate.
Your Questions:
You asked whether the position set out by the CRA in October 1994, at Question 2.1 of the Roundtable on Federal Taxation, at the 19th Annual APFF Conference ("1994 APFF Conference") regarding the concept of disposition of property is still current.
In particular, you asked whether, in our view, the transactions described in paragraph 1.b) of Particular Situation 1 and paragraph 2.b) of Particular Situation 2 above result in a disposition, for the purposes of subsection 85(1), by Mr. X of the common shares of the capital stock of Aco and by Mr. Y of the Class A preferred shares of the capital stock of Bco.
Your Analysis:
In your view, subparagraph (b)(i) of the definition of "disposition" in subsection 248(1) results in a mandatory disposition where a share is cancelled under corporate law. Consequently, you are of the view that the transactions described in paragraphs 1.b) and 2.b) above result in a disposition, for the purposes of subsection 85(1), by Mr. X of the common shares of the capital stock of Aco and by Mr. Y of the Class A preferred shares of the capital stock of Bco, since there would be a cancellation of the shares disposed of.
You are of the view that the reservations expressed by the CRA at the 1994 APFF Conference, as well as those set out in paragraph 2 of Interpretation Bulletin IT-448, Disposition - Changes in Terms of Securities, to the effect that we could conclude that there is no disposition if there is essentially no difference in the characteristics of the shares, have no legal foundation.
Our Comments
It appears to us that the situation described in your letter may be an actual situation involving taxpayers. The Canada Revenue Agency ("CRA") does not generally provide written opinions on proposed transactions otherwise than by way of an advance ruling. Furthermore, it is the responsibility of the relevant Tax Services Office to determine whether completed transactions have received appropriate tax treatment. We can, however, offer the following general comments which may not be fully applicable in a particular situation.
The CRA's longstanding position on the concept of disposition in situations similar to the Particular Situations is to focus on the nature of the changes made to the shares of the capital stock of a particular corporation rather than the method by which the changes are accomplished. Our approach is based on the fact that we consider a shareholder's interest in a corporation to be an intangible asset, consisting of a bundle of rights and privileges attached to the shares granted by the articles of incorporation and the relevant corporate laws. Thus, a particular transaction in a particular share of the capital stock of a particular corporation held by a taxpayer may not constitute a disposition where, after the transaction, the taxpayer is left with another share of the capital stock of the particular corporation that has identical rights, privileges, restrictions and conditions as the rights, privileges, restrictions and conditions attached to the particular share.
It is also to be noted that, pursuant to subparagraph (b)(i) of the definition of "disposition" in subsection 248(1), the cancellation of shares is an event that generally results in a disposition for tax purposes. Corporate legislation provides for situations where a corporation must cancel shares of its capital stock. Generally, a corporation must cancel shares of its capital stock that it acquires by way of redemption or purchase for cancellation. However, a stock split, a stock consolidation and a redesignation of shares generally do not result in the cancellation of shares, even if a share certificate is cancelled and a new share certificate is issued.
Notwithstanding the terms of subparagraph (b)(i) of the definition of "disposition" in subsection 248(1), the CRA has in the past indicated that it is concerned about transactions where taxpayers are left with shares identical to those they held prior to the transaction. It is our view that such transactions may not constitute a disposition for purposes of the Act.
In light of the facts presented in Particular Situation 1, we are of the view that, in actual fact, the transaction described in paragraph 1.b) above would not result in a disposition of the common shares of the capital stock of Aco held by Mr. X. In fact, it appears to us that Mr. X would not dispose of any rights or privileges attached to the 100 common shares of the capital stock of Aco since, after the transaction, he would still hold the same 100 common shares of the capital stock of Aco, which are identical to those originally issued. It appears to us that there would be no change in the nature of Mr. X's shareholding in Aco from a legal point of view. Consequently, it appears to us that, in actual fact, the transaction described in paragraph 1.b) would only constitute an issue by Aco of 500,000 preferred shares of its capital stock to Mr. X. We are of the view that subsection 84(1) could apply to that share issue.
With respect to Particular Situation 2, we are of the view that the transaction described in paragraph 2.b) above would result in a disposition of the Class A preferred shares of the capital stock of Bco held by Mr. Y. It appears to us that there would indeed be a change in the nature of Mr. Y's interest in Bco from a legal standpoint and therefore a disposition of the Class A preferred shares of the capital stock of Bco. This position is consistent with our general position set out in paragraph 2 of Interpretation Bulletin IT-448 Disposition - Changes in Terms of Securities, which states that “the cancellation of a security necessarily results in its disposition in the hands of the holder, even though the result achieved could have been accomplished by a change in terms.”
We hope that our comments are of assistance.
Best regards,
Maurice Bisson, CGA
for the Director
Corporate Reorganizations and Resource Industries Division
Income Tax Rulings Directorate
Policy and Planning Branch
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