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:
Does a formula conversion of a convertible preferred share under which the share is converted in common shares having a value equal to the shareholder's original investment constitute a form of guarantee or security for the purposes of subparagraph (a)(iii) of the term preferred share definition?
Position:
It is a form of guarantee or security within the ordinary meaning of these words
Reasons:
The scope of subparagraph (a)(iii) is wide enough to encompass a situation where a share could be converted into shares having a value equal to the amount the holder subscribed for the share.
September 11, 1996
MONTREAL T.S.O. HEADQUARTERS
Gilbert Deneault G. Martineau
Section 441-4-1 (613) 957-8962
7-961310
XXXXXXXXXX - Term Preferred Shares
This is in reply to your memorandum dated April 25, 1996, containing your comments to the representations of the taxpayer on your proposed assessment of the dividends received on the shares on the XXXXXXXXXX (collectively referred as the "Shares"). You propose to characterize the Shares held by XXXXXXXXXX as term preferred shares ("TPS").
In our memorandum 932552 (the "Memorandum") dated December 17, 1993, we expressed the view that the XXXXXXXXXX preferred shares were term preferred shares pursuant to subparagraph 248(1)(a)(iii) of the TPS definition because the pricing formula contained in the conversion feature provides a form of guarantee or security with respect to the shares. You determined that the Shares are similar to the XXXXXXXXXX shares.
The Shares are convertible or exchangeable into a number of common shares determined by dividing the redemption value of the Shares (which is equal to its issue price) by the greater of a stipulated amount (which is the agreed value of a common share on the date of issuance of the Shares), and the average trading value of a common share during a specified number of days in a period preceding the date of conversion or exchange.
Subparagraph (a)(iii) of the TPS definition provides, inter alia, that a share will be considered to be a TPS when the issuing corporation provides "... any form of guarantee, security or similar indemnity or covenant...with respect to the share...". In the Memorandum, we stated that the pricing formula created a form of guarantee or security with respect to the share as contemplated by subparagraph 248(1)(a)(iii).
A guarantee refers to a contract in which a guarantor agrees to be answerable for the payment of a debt.(1) In Re J.H. (1911), 25 O.L.R., a security was held to mean:
"Something which makes the payment of money more secure - such as "binds lands or something to be answerable for it".
Black's Law Dictionary (5th ed.) defines security as follows:
Protection; assurance; indemnification. The term is usually applied to an obligation, pledge, mortgage, deposit, lien, etc., given by a debtor in order to assure the payment or performance of his debt, by furnishing the creditor with a resource to be used in the case of failure in the principal obligation.
The definitions of "security" and "to secure" in the Webster's New World Dictionary (2nd College Ed.) read respectively as follows:
Security.1 The state of being or feeling secure; freedom from fear, anxiety, danger, doubt, etc.; state or sense of safety or certainty. 2. Something that gives or assures safety, tranquillity, certainty, etc.; protection; safeguard...
Secure.1 to make safe; guard; protect.
2. to make sure or certain; guarantee; ensure, as with a pledge....
It is our view that the pricing formula creates a form of guarantee or security that makes an investor more secure or has some guarantee within the ordinary meaning of these words. In our view, the pricing formula is a form of guarantee or security because the conversion is based on the issue price of the preferred shares and it insures that the XXXXXXXXXX investment may be recovered to a certain extent with common shares having a fair market value equal to the subscription price of the Shares.
The Shares do not fall within the definition of TPS by virtue of subparagraph (a)(iv) and they are excluded from (a)(i) and (ii) of the TPS definition. Consequently, one might conclude that, generally speaking, a conversion feature is not intended to run afoul of the provisions of subparagraph (a)(iii) of that definition.
However, the terms of the conversion feature are such that they in fact ensure the holder that upon exchange he will receive marketable securities having in most circumstances a fair market value equal to the amount subscribed for the Shares. It appears that the holder is being granted rights intended to secure the recovery of his original investment. In our view, it is a form of security that would not ordinarily be present with what one might call normal convertible shares - that is convertible shares which have a conversion ratio based on the common shares value at the time of issue would not be caught by subparagraph (iii) of the TPS definition.
At the time the Shares were issued, the minimum conversion price of the common shares was in fact lower than their trading value. For example, the low trading value of the XXXXXXXXXX common shares in XXXXXXXXXX was $ XXXXXXXXXX and the minimum amount was set at $ XXXXXXXXXX. We attach for your information a schedule showing the trading values of the Shares in XXXXXXXXXX. Being given the spread between the minimum amount conversion price and the low trading price of the Shares, an investor in the Shares had in fact a guarantee or a security to recover its investment upon the conversion; he was more secure within the ordinary meaning of the words guarantee or security.
In our view, the broad wording of subparagraph (a)(iii) of the definition "term preferred share" provides ample scope for its application to many forms of guarantees and securities and certainly to a guarantee or a security which takes the form of a right to exchange the Shares for other shares having a value equal to the shareholder's original investment.
Furthermore, it is our view that the Shares are TPS pursuant to subparagraph 248(1)(a)(iii) notwithstanding that subparagraph (a)(iv) of that definition is not applicable.
We trust you find our comments helpful.
for Director
Financial Industries Division
Income Tax Rulings and
Interpretations Directorate
Policy & Legislation Branch
ENDNOTES
1. Shorter Oxford English Dictionary, (3rd ed.), Vol. 1
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