Section 51

Subsection 51(1) - Convertible property

Administrative Policy

2017 Ruling 2017-0696791R3 F - Reduction of PUC/capital

s. 51(1) will apply where convertible note, that was issued as boot, will be converted to shares
Amended and supplemented by 2017-0696792R3 F

Bco will transfer to a newly-incorporated subsidiary (Newco) all its shares of a wholly-owned subsidiary (Cco) on a s. 85(1) rollover basis in consideration for common shares and a demand non-interest bearing promissory note (the "Bco-Newco Note"), which is convertible after a specified period at the holder’s option into Newco common shares with an FMV equaling that of the note. Following a short-form amalgamation of Newco and Cco, Bco will exercise its right to convert the Bco-Newco Note to common shares of Amalco.

Rulings include the application of s. 51(1) and non-application of s. 51(2).

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 20 - Subsection 20(1) - Paragraph 20(1)(c) - Subparagraph 20(1)(c)(i) interest on money borrowed by Subco for distribution of share-capital account to its parent is deductible if the Subco property continues generating business income 532

2020 Ruling 2019-0824211R3 F - Post-mortem Hybrid Pipeline

s. 51 applicable to exchange of common shares of Opco for common and preferred shares of Opco

The described preliminary transactions (on which CRA did not rule) included the estate exchanging its Class A shares of Opco under s. 51(1) for non-voting non-cumulative retractable Class F shares of Opco and Class A shares of Opco.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 84 - Subsection 84(2) pipeline rulings where the underlying operating business was sold for cash after the death and before the pipeline transactions 450

6 May 2014 Internal T.I. 2014-0524651I7 - Loss on conversion

conversion not under Note terms

Canco indirectly controlled ULC which was the sole member (holding common membership units) of LLC. ULC also held non-interest-bearing Notes which were convertible into "Shares" (membership interests) at a specified price per share. The Notes were converted into "Preferred Shares" of LLC having a fair market value equal to the "fair market value of LLC as a whole (i.e., the remaining equity interests in LLC had no value at that time)."

The Directorate found that the exchange did not occur pursuant to the terms of the Notes given the number of Preferred Shares which were issued. Accordingly, s. 51 did not apply, so that the loss which otherwise was realized on the exchange was denied. It also stated: "We have not considered the application of GAAR to the conversion, but you may wish to consider it further."

The Directorate further noted that "in 58563 [see below]… CRA stated that subsection 51(1)… applied to a conversion made pursuant to the holder's right to convert even if the issuer had the option to repurchase the shares in the meantime."

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 40 - Subsection 40(2) - Paragraph 40(2)(g) - Subparagraph 40(2)(g)(ii) non-interest-bearing loan to wholly-owned ULC 171
Tax Topics - Income Tax Act - Section 51 - Subsection 51(1) s. 51 applies where issuer had a cash redemption override 208

6 May 2014 Internal T.I. 2014-0524651I7 - Loss on conversion

s. 51 applies where issuer had a cash redemption override

After being asked whether "the right of exchange must be absolute for purposes of subsection 51(1)," a specific example was described. Preferred shares were redeemable at the option of the company upon giving at least 30 days' notice to the holder and were convertible by the holder into common shares upon 30 days' notice by the holder. In addition, the corporation, without a requirement to give a notice, could during the 30-day period preceding a redemption [sic], proceed with a redemption of shares which were the subject of a conversion notice.

CRA stated (TaxInterpretations translation):

Subsection 51(1)...is applicable when a taxpayer has acquired shares of the capital stock of a corporation in exchange for capital property of the taxpayer which was a share, an obligation or note of the corporation, the terms of which conferred on the holder such right of exchange. We are of the view that the provisions of section 51 of the Act are applicable when the taxpayer has received shares in exchange for a convertible security after having required such exchange in accordance with the right of exchange attached to the convertible security - even if the corporation had the opportunity to redeem such security before such exchange was effected.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 40 - Subsection 40(2) - Paragraph 40(2)(g) - Subparagraph 40(2)(g)(ii) non-interest-bearing loan to wholly-owned ULC 171
Tax Topics - Income Tax Act - Section 51 - Subsection 51(1) conversion not under Note terms 185

7 October 2011 Roundtable, 2011-0412191C6 F - Sec. 86 - Reorganisation of the Capital of a Corp.

s. 51(1) applies where share conversion pursuant only to directors’ resolution

Q.B.C.A. s. 91 of the new Q.B.C.A. permits a corporation to convert the shares of a particular class into shares of a new class, through a simple resolution of the board of directors, and with no filing of articles of amendment being required unless this is necessary to change the authorized share capital.

After finding that s 86 would not apply given its general view “that capital will be reorganized for the purposes of section 86 in the situation where the provisions of the corporation's incorporating act require an amendment of its articles,” whereas here there was none, CRA went on to state:

[W]here, for tax purposes, there is a disposition of a share held by a taxpayer resulting from a conversion permitted by Q.B.C.A. section 91, we believe that such a transaction would normally come within subsection 51(1) … .

...[B]y virtue of subsection 51(4), section 86 takes precedence over subsection 51(1). Thus, an interpretation that would enable the application of section 86 to transactions permitted by Q.B.C.A. section 91would significantly restricts the scope of subsection 51(1). That does not seem appropriate or desirable.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 86 - Subsection 86(1) reorganization of capital generally requires articles of amendment 216

8 October 2010 Roundtable, 2010-0373231C6 F - Application of subsections 51(1) and 85(1)

simultaneous exchange

CRA's position in IT-291R3, that an election under s. 85(1) potentially is available even if the shares to be issued are not yet part of the transferee's authorized capital, is inapplicable to s. 51(1) because the wording of s. 51(1) is clear as to the simultaneous nature of the exchange.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 85 - Subsection 85(1) share consideration need not be immediately issuable 123

11 January 2010 External T.I. 2009-0340591E5 F - Specified class - 256(1.1) of the Act

s. 51(1) exchange regarded as the new shares having been issued for consideration equalling the FMV of the old shares

Where a shareholder exchanged all its Class A shares for Class B shares of the same corporation pursuant to what CRA accepted as being a s. 51 exchange, CRA characterized the Class B shares as having been issued, for purposes of the test in s. 256(1.1)(e), for consideration equalling the FMV of the exchanged Class A shares.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 256 - Subsection 256(1.1) - Paragraph 256(1.1)(d) s. 256(1.1)(d) must be met throughout the period the shares were outstanding – but can cleanse with s. 51 exchange 442

2006 Ruling 2006-0177541R3 - Amendments to Debt, Conversion

addition of conversion right to debt followed by conversion

CCo and GCo will agree to amend the terms of the "Tier 2 Debt" owing to CCo to accord it with the right to convert the Tier 2 Debt into common shares of GCo with an aggregate fair market value at the time of conversion equal to the principal amount of the Tier 2 Debt. This amendment will not, pursuant to the governing law result in novation of Tier 2 Debt the creation of a new obligation in its place. CCo will then exercise the conversion right.

Rulings inter alia respecting the addition of the conversion right not giving rise to a disposition and respecting the application of s. 51(1) to the conversion

6 July 2004 External T.I. 2004-0081631E5 F - Price Adjustment Clauses

no requirement to notify CRA of price-adjustment clause regarding a s. 86 or 51 exchange

After indicating that ticking the box on any prescribed rollover election form is sufficient notification to it of the existence of a price adjustment clause, CRA went on to state:

[W]here no form is required (for example, with respect to a transfer of property by pursuant to section 86 or 51), the CRA considers that the mere failure of the parties to notify the CRA of the transaction does not preclude the application of the provisions of … IT-169, provided that all other conditions set out in that Bulletin are satisfied.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 85 - Subsection 85(1) ticking "yes" box on election form is sufficient notice of price adjustment clause 70
Tax Topics - General Concepts - Effective Date no requirement to notify CRA of price-adjustment clause otherwise than by ticking box on any prescribed form 136

29 March 2001 External T.I. 2000-0050265 - Mutual fund corporation - "switch" shares

redemption of MFC switch shares for shares of another class

A shareholder of a mutual fund corporation redeems his shares in accordance with their terms in exchange for shares of another class of the same corporation. CRA stated:

Subject to the application of subsections 51(4) and 245(2), subsection 51(1) would apply to deem the exchange not to be a disposition of the convertible shares and …there would not be an "amount paid by the corporation in the year on the redemption of shares of its capital stock" for the purposes of factor A in the definition "capital gains redemptions" in subsection 131(6).

9 September 1997 External T.I. 9721405 - CONVERSION OF DEBT OBLIGATION

conversion conditional on issuer notice

Where a debt obligation provides that it is convertible at the option of the holder into another debt obligation of the same issuer provided that the issuer has first given notice to the holders allowing them to make such a conversion, the rollover will be available on such a conversation because s. 51.1 applies at the point of conversion and, at that time, the terms of the debt obligation provides that the rollover is available. CRA stated:

Section 51.1...applies at a point in time, namely at the time of conversion. So long as the right to make the exchange is part of the terms of the debt obligation at that time the rollover will be available provided, of course, that the conditions in paragraphs 51.1(a) and (c) are also satisfied. Thus, a right of exchange which is part of the terms of the obligation from its inception or which becomes a term of the obligation at any time prior to the moment of exchange will satisfy paragraph 51.1(b)... .

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 212 - Subsection 212(1) - Subparagraph 212(1)(b)(vii) notice by issuer before convertible 95
Tax Topics - Income Tax Act - Section 51.1 conversion subject to issuer notice 173

12 February 1997 External T.I. 9631575 - INTERACTION OF SECTIONS 51 AND 116

s. 51(1) does not deem the issuer not to have acquired the exchanged share

A non-resident exchanged pursuant to s. 51(1) his common shares (which were taxable Canadian property) of a Canadian private corporation for preferred shares of the corporation. Although agreeing that, under s. 51(1)(c), “the exchange would be deemed not to be a disposition of the common shares,” CRA went on to state that “subsection 51(1) of the Act does not deem that there is no acquisition of the common shares acquired by the corporation for cancellation,” so that s. 116(5) would apply to the “purchaser” (the corporation) if the conditions in ss. 116(5)(a) and (b) had not been satisfied.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 116 - Subsection 116(5) s. 116(5) is applicable to issuer if s. 51(1) exchange of TCP 201
Tax Topics - Income Tax Act - Section 54 - Adjusted Cost Base cost of shares acquired by issuer on s. 51(1) exchange is stated capital of new shares 141

1 November 1994 External T.I. 9416305 - EXCHANGE SHARES OF SAME CORP

s. 51 applies on transfer of existing shares to corporation

An employee, who holds 100 common shares of an employer corporation (the "Old Shares") with an adjusted cost base and paid-up capital of $500 ($5 per share) and a fair market value of $1,500 ($15 per share), will satisfy the exercise price of $10 per share ($300 in aggregate) for an employee stock option to acquire 30 treasury common shares (the "New Shares") of the employer corporation by exchanging 20 Old Shares having an aggregate fair market value of $300. Will such exchange be considered a disposition? CRA stated:

Subject to subsection 51(4) of the Act, section 51 will apply to any situation where a share of the capital stock of a corporation is acquired by a taxpayer in exchange for a capital property that is another share of the particular corporation and no other consideration is received for the old shares.

Handbook on Securities Transactions, 94-110 (e), p. 12

$200 exception

No reporting is required if, in the course of a conversion, the security owner receives cash or some other consideration totalling $200 or less, instead of a fractional interest in shares.

92 C.R. - Q.4

no ACB increase for foregone interest

Where on the conversion of a debenture into shares, the holder foregoes any accrued but unpaid interest, such interest will not be added to the cost or adjusted cost base of the shares acquired.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 12 - Subsection 12(3) 33

87 C.R. - Q.67

automatic conversion

The rollover is not available on an automatic conversion.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 86 - Subsection 86(1) 24

IT-115R "Fractional Interests in Shares"

Articles

Didier Fréchette, Ryan Rabinovitch, "Current Issues Involving Foreign Exchange", 2015 CTF Annual Conference paper

Dealing with FX gain on U.S. dollar loan by Can LP to Cansub to fund on-loan to US Opco: asymmetrical application where s. 51 applies (pp. 26:19-22)

A private equity fund, Can LP, makes a US$100 million loan to its wholly owned Canadian subsidiary, Cansub. Cansub, in turn, uses the funds to make a loan denominated in US dollars to its US operating subsidiary, US Opco. At the time the loan is made, the Canadian dollar is at par with the US dollar. Subsequently, the value of the US dollar increases to Cdn$l.25….

[T]he following steps could be carried out...:

1) Cansub establishes Forco in a jurisdiction that has an income tax treaty with the United States and Canada.

2) Cansub transfers the US Opco loan to Forceco as consideration for shares of Foreco.

3) The Cansub loan is amended to add a conversion right…

4) Can LP exercises the conversion right and converts the Cansub loan into preferred shares of Cansub having a redemption and liquidation value equal to the outstanding amount under the loan, converted into Canadian dollars on the date of the conversion. ... Cansub realizes a foreign exchange loss of Cdn$25 million. This loss is used to offset the Cdn$25 million gain realized upon the transfer of the US Opco loan to Forco.

[P]ursuant to paragraph 51(1)(c), the conversion [in 4] should be deemed not to be a disposition for Can LP... .

[T]he application of section 51 to the transaction should not affect the issue of whether a gain or loss is realized by the debtor (Cansub)….[T]he amount paid pursuant to the agreement of the parties and the amount added to stated capital would be equal to the amount outstanding under the debt, converted into Canadian dollars on the date of the conversion (namely, Cdn$125 million). ...

The above example illustrates the asymmetry that is inherent in section 51. It is unclear whether the CRA would seek to invoke GAAR in this scenario. As mentioned above, the CRA has noted in the past, with respect to a convertible debenture issued by a Canadian corporation to its US parent, that this type of arrangement seemed "artificial" and could be challenged if it gave rise to "anomalous tax results." [f.n. 67: …"Canada Revenue Agency Round Table," in the 2009 Conference Report, ... question 33]

Conversion into shares on a s. 51 rollover basis nonetheless would give rise to a repayment for s. 15(2.6) purposes (pp. 26:24-25)

A Canadian company, Canco, has made a loan denominated in US dollars to its foreign parent, Forco. Canco has a wholly owned Canadian operating subsidiary, Cansub. ...

As a result of the significant appreciation in the value of the US dollar…the repayment of the loan in cash by Forco would result in a capital gain in the hands of Canco under 39(1). ...

1) Cansub assumes the loan as consideration for a cash payment by Forco equal to the amount outstanding under the loan. Cansub is added as a co-obligor, and Forco remains liable for the debt. Under the applicable commercial law, the assumption of the debt does not result in a novation of the original debt… .

2) The terms of the loan are amended, without novation, to add a conversion right... .

3) Canco converts the loan into additional common shares of Cansub. ...

[T]he assumption of the debt by Cansub would be expected to be a non-event as far as Canco is concerned. ...

[T]he addition of a conversion right to a debt would generally not be expected to result in the creation of a new debt or a novation of the original debt. On that basis, this step would not result in a disposition of the loan by Canco. ...

Finally, the conversion of the loan into shares of Canco should occur on a rollover basis pursuant to subsection 51(1). ... The conversion of the debt into shares of Cansub will result in the extinguishment of the debt at law, which should also result in the debt being "repaid" for the purposes of subsection 15(2.6). This was, in fact, the conclusion in Agnico. Accordingly, subsection 15(2) would not apply.

Gabrielle M.R. Richards, "Capital Financing by Non-Residents: Section 116 Obligations", Corporate Structures and Groups, Vol. VII, No. 3, 2002, p. 375

CCRA is of the view that the cost for purposes of s. 116(5)(c) of shares acquired pursuant to a convertible share is the amount credited to the stated capital account of the shares issued on conversion.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 116 - Subsection 116(5) 36

Hugh Chasmar, "Mutual Fund 'Switch Funds'", Taxation of Corporate Reorganizations, Canadian Tax Journal, Vol. 46, No. 1, 1998, p. 172.

Discussion as to whether an exchange by an investor of shares of one class for shares of another could be treated as a redemption enabling utilization of a mutual fund corporation's capital gains dividend account.

Ewens, "Convertible Property: Section 51 - Part 1", 1994 Canadian Tax Journal, Vol. 42, No. 5,.

Ross, "Equity Preferred Shares", 1992 Canadian Tax Journal, No. 3, p. 793.

Ruby, "Recent Financing Techniques", 1989 Conference Report, C.27 under "Adjustable Rate Convertible Debentures"

Subsection 51(2) - Idem [Convertible property]

Administrative Policy

11 April 2005 External T.I. 2005-0112321E5 F - Price adjustment clause

CRA may accept a price adjustment clause adjusting of share consideration on s. 51 exchange if genuine attempt to establish FMV and issue of intervening share cancellation is addressed

An estate freeze entailed the exchange by Mr. A of his common shares of Opco by way of purchase for cancellation for Class A preferred shares with a redemption value of $1 million, followed by a common share subscription by his two adult children for nominal consideration. The exchange agreement contained a price-adjustment clause providing that in the event of a CRA challenge to the FMV of the Class A preferred shares received by Mr. A as consideration, Mr. A and Opco would agree to exchange the those Class A preferred shares for an equal number of Class B preferred shares.

After noting that in such a situation “it is not subsection 15(1) that the CRA would consider applying if the FMV of the freeze preferred shares was less than the FMV of the exchanged common shares, but rather subsection 51(2),” and that the price adjustment clause was not one described in IT-169 as it addressed adjusting the consideration received rather than the purchase price, and that the clause as described “would not be acceptable because … it did not provide for the necessary measures to settle any difference between the FMV of the consideration in relation to the transferred assets, should the preferred shares be redeemed before the CRA contests the FMV of the preferred shares,” CRA stated:

The CRA would generally agree to recognize a clause for adjustment to the consideration and not apply subsection 51(2), where the facts (including the contract) evinced that the parties actually intended to deal in the shares at their FMV and established the FMV of the preferred shares for the purposes of the arrangement, by a fair and reasonable method, and the relevant adjustments provided for in the adjustment clause were effected by the parties where the FMV of the preferred shares was less than the FMV of the common shares. …

Locations of other summaries Wordcount
Tax Topics - General Concepts - Effective Date CRA may also accept a price adjustment clause for improving the attributes of the shares received on an exchange so as to equal the exchange price 332
Tax Topics - Income Tax Act - Section 15 - Subsection 15(1) where FMV of pre shares received on estate-freeze s. 51 exchange was less than that of the exchanged common shares, CRA would apply s. 51(2), not s. 15(1) 142

S4-F3-C1 - Price Adjustment Clauses

CRA will consider a price adjustment clause to represent pricing at fair market value if:

  • the agreement reflects a bona fide intention of the parties to transfer property at FMV;
  • the purported FMV is determined by method that is fair and reasonable in the circumstances (which does not necessarily entail using CRA's preferred method, nor engaging a valuation expert);
  • the parties agree that a CRA or Court valuation, if any, will supersede the price otherwise determined; and
  • the excess or shortfall is actually refunded or paid, or legal liability therefor is adjusted (para. 1.5).

Price adjustment clauses involving shares may use a number of adjustment mechanisms. CRA non-exhaustively mentions changes in redemption value, the issuance of a note or change in the principle amount of a note, or a change in the number of shares issued - although CRA recommends against using the latter because of inherent legal and technical difficulties (para. 1.6).

1996 Corporate Management Tax Conference Round Table, Q. 13 (C.T.O. "Benefit of Conversion")

Although s. 51(2) does not contain an exclusion for wholly-owned corporations, ordinarily RC would not consider that it is reasonable to regard any difference between the fair market value of preferred shares of a wholly-owned subsidiary and the fair market value of common shares of the subsidiary for which they are exchanged as a benefit that the parent corporation desired to confer on the subsidiary.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 86 - Subsection 86(2) 64