22 December 2011 Internal T.I. 2011-0410531I7 - ACB calculation of shares acquired prior to 1972

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.

Principal Issues: Whether the receipt of one share for every share held in the form of a stock dividend should be treated the same as a 2 for 1 stock split in determining the adjusted cost base of shares acquired prior to 1972

Position: No.

Reasons: Reasons outlined below.

								December 22, 2011

Ms. Kerri-Lynn McGrath					Katie Campbell
Basic Tax Auditor						Income Tax Rulings Directorate
Nova Scotia Tax Services Office				

								2011-041053

Impact of a stock dividend on the adjusted cost base of shares acquired before 1972

This is in reply to your email of June 16, 2011 wherein you requested our opinion as to whether shares received on a stock dividend could be treated as shares received by way of a stock split in determining the adjusted cost base ("ACB") of identical property held on December 31, 1971.

Facts

In 2004 the Bank of Nova Scotia (footnote 1) (the "Bank") declared a stock dividend to double the number of the Bank's outstanding common shares such that each shareholder was entitled to receive one additional common share for each common share held (the "100% stock dividend"). The purpose of the payment of the 100% stock dividend was to effectively achieve a two for one split of the Bank's common shares. (footnote 2) The question we have been asked is whether the 100% stock dividend should be treated as a stock split for income tax purposes. The distinction between a stock dividend and a stock split is relevant for a shareholder who held common shares of the Bank that were purchased prior to 1972. This is because, by virtue of subsection 26(8) of the Income Tax Application Rules (ITAR), a stock dividend would result in a higher ACB per share, of shares held on December 31, 1971, than a stock split.

The issue arose based on a request by a taxpayer to amend previously filed tax returns for the 2008 and 2009 taxation years. In those years, the taxpayer had disposed of some Bank shares that had been acquired prior to 1972. Originally, in calculating the ACB of the shares disposed of, the taxpayer treated the shares, received on the 100% stock dividend, as having been received on a stock split. The taxpayer requested to amend his tax returns to increase the ACB of the shares disposed of by treating the shares received on the 100% stock dividend as having been received as a stock dividend rather than a stock split.

Calculation of ACB of identical property owned on December 31, 1971

In general, when a taxpayer holds property and subsequently acquires identical property the ACB of each property is determined pursuant to subsection 47(1) of the Act. (footnote 3) Typically, when a taxpayer receives additional shares, identical to those previously held, by way of a stock split or a stock dividend (with no increase in the shares' paid-up capital), the ACB per share is reduced as the cost of the existing shares is averaged over a greater number of shares. However, subsection 47(1) only applies to property acquired after 1971.

In order to determine the ACB of identical properties purchased prior to 1972, the rules in subsection 26(8) of the Income Tax Application Rules ("ITAR") apply. The relevant portions of subsection 26(8) of the ITAR read as follows:

"For the purposes of computing, at any particular time after 1971, the adjusted cost base to a taxpayer of any capital property (other than depreciable property or an interest in a partnership) that was owned by the taxpayer on December 31, 1971 and thereafter without interruption until the particular time, if the property was one of a group of identical properties owned by the taxpayer on December 31, 1971,

(a) section 47 of the amended Act does not apply;
...
(c) where the property was not an obligation,

(i) for the purpose of paragraph (3)(a), its actual cost to the taxpayer shall be deemed to be the quotient obtained when the total of the actual costs to the taxpayer of all properties of that group is divided by the number of properties of that group, and

(ii) for the purpose of paragraph (3)(b), its fair market value on valuation day shall be deemed to be the quotient obtained when the fair market value on that day of all properties of that group is divided by the number of properties of that group;...

(e) for the purposes of distinguishing any such property from an otherwise identical property acquired by the taxpayer after 1971, properties owned by the taxpayer on December 31, 1971 shall be deemed to have been disposed of by the taxpayer before properties acquired by the taxpayer at a later time (emphasis added)."

Essentially, identical properties acquired before December 31, 1971 and identical properties acquired after December 31, 1971 are not averaged together in determining the ACB of each identical property. Furthermore, when a taxpayer disposes of the identical property subsequent to 1971, it is deemed to dispose of the property owned on December 31, 1971 before property acquired after 1971. (footnote 4) As discussed below, shares received as a stock dividend are considered to be acquired while shares received on a stock split are not. Therefore, in calculating the ACB of shares held on December 31, 1971, it is necessary to determine whether shares have been received on a stock split or as a stock dividend.

Interpretation Bulletin IT-65 - Stock Splits and Consolidations provides "Where all the shares of a class of stock of a corporation are replaced by a greater or lesser number of shares of the same class of stock of the same corporation in the same proportion for all shareholders, in circumstances where there is no change in the total capital represented by the issue, there is no change in the interest, rights or privileges of the shareholders and there are no concurrent changes in the capital structure of the corporation or the rights and privileges of other shareholders, no disposition or acquisition is considered to have occurred (emphasis added)." IT-65 also states that a stock split would reduce the ACB per share of shares held on December 31, 1971. The effect of this is that on a 2 for 1 stock split, occurring after 1971 for a taxpayer holding shares acquired both before and after 1971, the ACB per share, for all of the taxpayer's shares, would be one half of the original ACB.

In contrast, subsection 52(3) outlines the amount to be added to the ACB of the shares received on a stock dividend. Subsection 52(3) reads as follows:

"Where a shareholder of a corporation has, after 1971, received a stock dividend in respect of a share owned by the shareholder of the capital stock of the corporation, the shareholder shall be deemed to have acquired the share or shares received by the shareholder as a stock dividend at a cost to the shareholder equal to the total of ... where the stock dividend is a dividend, the amount of the stock dividend..."

Therefore, by virtue of subsection 52(3), the shares received on a stock dividend after 1971 would be considered to be acquired at that time such that, by virtue of subsection 26(8) of the ITAR, the additional shares would only be used in calculating the ACB of the shares, identical to those received on the stock dividend, acquired after 1971.

In summary, in the situation at hand, additional shares received in the form of a stock split would reduce the ACB per share of all Bank shares, including shares held on December 31, 1971, while additional shares received in the form of a stock dividend would only reduce the ACB per share of the Bank shares purchased after 1971. As a result, the ACB of the shares held on December 31, 1971, which would be considered to be sold first on a subsequent disposition, would be greater when the additional shares are received in the form of a stock dividend rather than a stock split.

Conclusion

In this case, the corporate documents and the news release issued by the Bank, (footnote 5) indicate that, for corporate law purposes, the Bank issued a stock dividend. The Supreme Court of Canada stated in Shell Canada Limited v. The Queen 99 DTC 5669 that the economic realities of a situation cannot be used to recharacterize a taxpayer's bona fide legal relationships. Consequently, in this case, the legal form of the transaction should be respected.

For income tax purposes, the definition of a stock dividend is found in subsection 248(1) and states "'stock dividend' includes any dividend (determined without reference to the definition of dividend in this subsection) paid by a corporation to the extent that it is paid by the issuance of a share of any class of the capital stock of the corporation". (footnote 6) As, in this case, each shareholder received one common share for every common share held, the dividend declared by the Bank should meet the definition of stock dividend in the Act.

Accordingly, the shares received on the 100% stock dividend should not be treated as having been received as a stock split.

For your information, we contacted our Banking Industry Specialist, Emidio De-Angelis. He contacted the large case file auditors for several of the large Canadian banks and asked whether they had considered this issue with respect to shares held by shareholders prior to 1972. None of them had identified it as an issue.

Yours truly,

David Palamar
Section Manager
for Division Director
Reorganizations Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

FOOTNOTES

Note to reader: Because of our system requirements, the footnotes contained
in the original document are shown below instead:

1 The analysis contained in this memo also applies to the stock dividend declared by the Royal Bank of Canada in 2006.
2 From a corporate law perspective, the method to accomplish a stock split versus a stock dividend is different. A stock split is completed by virtue of paragraph 173(1)(h) of the Canada Business Corporations Act (the "CBCA") which requires shareholder approval. A stock dividend is completed by virtue of subsection 43(1) of the CBCA which requires approval from the board of directors. Therefore, it is easier to accomplish a stock split through the issuance of a stock dividend as it can be approved through a director's resolution rather than a shareholder vote.

3 The Act means the Income Tax Act R.S.C. 1985 (5th Supp.) c.1 as amended from time to time and consolidated to the date of this letter and, unless otherwise expressly stated, every statutory reference herein is a reference to the relevant provision of the Act.

4 IT-78 - Capital property owned on December 31, 1971 - Identical Properties (Archived) demonstrates how to calculate the ACB in the situation where identical properties are acquired prior to December 31, 1971 and after December 31, 1971.

5 See Material Change Report and News Release issued by the Bank of Nova Scotia on March 2, 2004 and the Material Change Report and News Release issued by the Royal Bank of Canada on March 3, 2006.
6 Generally, the amount of a stock dividend, as defined in subsection 248(1), is "the amount by which the paid-up capital of the corporation that paid the dividend is increased by reason of the payment of the dividend".