1 May 1997 External T.I. 9639985 - SECTION 3860 OF THE CICA HANDBOOK

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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues:

Due to the new accounting rules on financial instruments contained in section 3860 of the CICA Handbook, will the removal of the retraction feature of the preferred share cause any tax consequences.

Position:

Yes.

Reasons:

Our position on this issue has not changed, regardless of the new rules contained in the Handbook. That is, the Department is concerned that the value of the preferred shares (ie. the "freeze shares") plus other consideration given must equal the fair market value of the asset being transferred or exchanged, as the case may be. It is our view that non-retractable shares generally do not have value equal to their redemption amount but retractable freeze shares do in the same manner as a non-interest bearing note retains its face value as long as it is a demand note.

		963998
XXXXXXXXXX		Jim Wilson

Attention: XXXXXXXXXX

May 1, 1997

Dear Sirs:

Re: Section 3860 of the CICA Handbook

This is in reply to your letter dated November 25, 1996 in which you requested our opinion with respect to the new accounting rules on financial instruments contained in section 3860 of the CICA Handbook and its impact on preferred shares which are commonly issued in the course of an estate freeze. Under the new rules, if the preferred shares are redeemable at the option of the holder ("retraction feature"), they are considered to have the attributes of a liability and therefore must be disclosed on the financial statements as a liability at their redemption amount. If the retraction feature is removed, the new rules will not require the preferred shares to be restated as a liability at the redemption amount as they will no longer have the attributes of a liability. You have described three situations in which the retraction feature of the preferred shares would be removed and you wish to know our views thereto.

As you are aware, the Department's position with respect to the retraction feature was publicly stated in Question 13 of the Revenue Canada Roundtable at the 1980 Canadian Tax Conference. Our position on this issue has not changed, regardless of the new rules contained in the Handbook. That is, the Department is concerned that the value of the preferred shares (ie. the "freeze shares") plus other consideration given must equal the fair market value of the asset being transferred or exchanged, as the case may be. It is our view that non-retractable shares generally do not have value equal to their redemption amount but retractable freeze shares do in the same manner as a non-interest bearing note retains its face value as long as it is a demand note.

You have described three situations in which the retraction feature of the freeze shares (which do not carry a fixed cumulative dividend entitlement at a rate which reflects fair market value) would be removed. The three situations involve non-wholly-owned corporations in which i) the holder of the freeze shares has de jure control of the corporation, ii) the holder of the freeze shares has de facto control of the corporation and iii) control of the corporation rests with persons who deal at arm's length with the holder of the freeze shares. The Department would not be prepared to accept, in any of the above situations, that immediately after the removal of the retraction feature from the freeze shares the fair market value of such shares would continue to be equal to their redemption amount. In our view, the value of freeze shares should be determined by the terms of the shares. Their value should not normally be influenced by who owns the shares.

As described in subparagraph 15(f) of Information Circular 70-6R3 dated December 30, 1996 issued by Revenue Canada, we are unable to provide any advance income tax rulings on the determination of fair market value. However, as requested, we would expect that a preferred share would, at the time of its issue, generally have a fair market value equal to its redemption amount when the share does not have a retraction feature but carries a fixed cumulative dividend entitlement at a rate which reflects market conditions at the time the share is issued.

The foregoing comments represent our general views with respect to the subject matter of your letter.

Yours truly,

for Director
Reorganizations and International Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch