14 April 1989 Income Tax Severed Letter 5-7472 - [Paragraph 85(1)(e.2) of the Income Tax Act (the "Act")]

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.

F. Ahmed (613)957-1092

APR 14 1989

Dear Sirs:

Re: Paragraph 85(1)(e.2) of the Income Tax Act (the "Act")

This letter is in response to the questions raised in your letter of January 16, 1989 regarding the use of redeemable and retractable preferred shares issued pursuant to a transfer of property governed by the provisions of subsection 85(1) of the Act. For purposes of this letter, we assume that no non-share consideration is taken back on such a transfer.

Opinions

Paragraph 85(1)(e.2) of the Act does not necessitate the use of preferred shares in subsection 85(1) transactions. That is, the transferor could take back common shares of the transferee corporation and avoid the application of paragraph 85(1)(e.2) of the Act provided that the value of such common shares is not exceeded by the value of the property transferred to the transferee corporation. However, as a practical matter, the provisions of paragraph 85(1)(e.2) of the Act favour the issue of preferred shares for the reasons discussed below.

A precondition to the application of paragraph 85(1)(e.2) of the Act is that the value of the property transferred to the transferee corporation must exceed the value of the consideration received from the transferee corporation. Where common share consideration only is used, a valuation of the transferred property and of the corporation would be required in order to determine the appropriate number of common shares to be issued. Further, where the value of the common shares of the transferee corporation issued to the transferor is less than the value of the property transferred, a price adjustment clause may not be effective since it is the number of shares issued that would have to be adjusted and not the value of the consideration.

The use of redeemable/retractable preferred shares may often alleviate such problems. For example, it should be possible to determine the value of the preferred shares without valuing the entire company. The use of a price adjustment clause may be included for this purpose. The Department's views on the use of a price adjustment clause are set out in Interpretation Bulletin IT-169 .

Although paragraph 85(1)(e.2) of the Act may favour the use of preferred share consideration, it certainly does not mandate such use in all cases. In order that paragraph 85(1)(e.2) apply, it is not sufficient that the value of the property transferred to the corporation exceed the value of the consideration received from the corporation (referred to herein as the "Excess Value"); rather, it must also be reasonable to regard any part of the Excess Value as a benefit that the transferor desires to have conferred on a person related to him, and this of course, is a question of fact.

Revenue Canada, Taxation's position regarding the application of paragraph 85(1)(e.2) of the Act is outlined in a paper given by Robert M. Beith at the 1988 Canadian Tax Foundation Conference held in Vancouver. This paper should now be available from the Canadian Tax Foundation.

We hope that the above addresses the concerns raised in your letter, but we point out that, as stated in paragraph 24 of Information Circular 70-6R dated December 18, 1978, the opinions expressed in this letter are not rulings and are consequently not binding on the Department.

Yours truly,

for Director Reorganizations and Non-Resident Division Specialty Rulings Directorate Legislative and Intergovernmental Affairs Branch