1 March 1989 Income Tax Severed Letter 5-7467 - [Section 86 and Qualified Small Business Corporation Shares]

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.

Revenue Canada Revenu Canada Taxation Impôt

Head Office Bureau principal

Your file Votre reference Our file Notre reference H.K. Tilak (613) 957-2119

MAR - 1 1989

Dear Sirs:

Re: Section 86 and Qualified Small Business Corporation Shares --------------------------------------------------------------

This is in reply to your letter dated January 19, 1989 in which you requested our opinion regarding a reorganization of capital pursuant to section 86 of the Income Tax Act (the "Act") and the implications thereof to shares issued on such a reorganization for the purposes of section 110.6 of the Act in the hypothetical situation described below.

Facts

1. The issued and outstanding shares in the capital stock of a corporation ("Opco") consists solely of common shares, 50% of which are held by another corporation ("Holdco"). Opco is not controlled by Holdco.

2. The shareholders of Holdco are Mr. A, who holds 1,000 voting preferred shares of Holdco and Mr. A's daughter who holds 100 common shares of Holdco. There are no other issued and outstanding shares in the capital stock of Holdco.

3. Mr. A's daughter is not involved in the business of Opco but Mr. A's son is actively involved in the business of Opco, so that Opco's future growth is largely dependent upon the continuing involvement of the son in Opco's business.

4. In order to permit 100% of any future increase in the value of Opco to accrue to the son, the daughter will exchange, pursuant to a section 86 reorganization, her common shares of Holdco for non-voting preferred shares of Holdco having a fair market value equal to the fair market value of the common shares so exchanged.

5. The son will then subscribe for 100 common shares of Holdco.

You have asked whether the preferred shares of Holdco owned by daughter would be qualified small business corporation shares of the daughter as defined in subsection 110.6(1) of the Act. You are concerned that, assuming that the preferred shares would otherwise be qualified small business corporation shares, such shares might not meet the requirements of the definition, pursuant to paragraph 110.6(14)(f) of the Act, if the shares are not considered to have been issued as consideration for other shares. You note that changes to the terms and conditions of a share in the course of a reorganization of capital made by filing Articles of Amendment may not necessarily give rise to a share being disposed of and a share being issued.

In order for subsection 86(1) of the Act to apply to a reorganization of capital, there must be a disposition by the taxpayer of all of his shares of a particular class and property that includes other shares of the capital stock of the corporation must be receivable by the taxpayer for the shares disposed of by him. Accordingly, and assuming that the hypothetical situation that you describe involves a section 86 reorganization, the preferred shares would be considered, for the purposes of paragraph 110.6(14)(f) of the Act, to have been issued to the daughter as consideration for other shares, that is, the common shares that were disposed of in the course of the reorganization.

Where the capital of a corporation is reorganized by filing Articles of Amendment that make changes to the rights, preferences, terms or conditions of certain shares without cancellation of those shares, section 86 of the Act may be applicable if, among other things, there has been a disposition of those shares for the purposes of the Act. The significance of the changes is the determining factor in deciding whether shares have been disposed of and other shares have been issued as consideration for the shares disposed of. Interpretation Bulletin IT-448 entitled "Dispositions - Changes in Terms of Securities", dated June 6, 1980 states the Department's views on events that may be considered to constitute dispositions of shares.

You have also asked whether, for the purposes of subsection 110.6(8) of the Act, the preferred shares held by the daughter would be prescribed shares pursuant to paragraph 6205(2)(a) of the Regulations. You are concerned that the requirements of that paragraph might not be met if the preferred shares would not be considered to have been issued to the daughter or because the other shares referred to in that paragraph, that is, the common shares issued to the son, were not issued to a person described by any of clauses 6205(2)(a)(ii)(A) to (D) of the Regulations.

Assuming that the hypothetical situation that you describe involves a section 86 reorganization, the preferred shares held by the daughter would, for the reasons given earlier, be considered to have been issued to the daughter. The other shares, that is, the common shares issued to the son, would be considered to have been issued to a person described by clause 6205(2)(a)(ii)(D) of the Regulations, that is, a person who did not deal at arm's length with the daughter, the original holder. The Department's view is that such a person is included in the persons described in clause 6205(2)(a)(ii)(C) of the Regulations and, hence, is a person described by clause 6205(2)(a)(ii)(D) of the Regulations.

The foregoing represents our general views with respect to the subject matter of your letter. The facts of a particular situation may result in a different conclusion. The foregoing opinion is not a ruling and, in accordance with the guidelines explained in Information Circular 70-6R dated December 18, 1978, is not binding on the Department.

Yours truly,

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