Regulation 6202.1

Administrative Policy

2003 Ruling 2003-000724 -

Various series of shares of a mutual fund corporation are redeemable by their holders for the net asset value per class, and are exchangeable for shares of another class that had the same net asset value but represent a different investment opportunity. This exchange right does not cause the shares to be prescribed under Regulation 6202.1.

Subsection 6202.1(1)

Cases

Canada v. JES Investments Ltd., 2007 DTC 5608, 2007 FCA 337

An exploration company ("Deena") that entered into an agreement styled as a flow-through share agreement with the taxpayer failed to incur any Canadian exploration and development expenses so that its purported renunciation of such expenses was invalid, and went into receivership. The shares issued were found to be prescribed shares in light of a provision in the agreement providing:

"The Corporation hereby agrees to indemnify and save harmless the Subscriber from and against any liability loss, damage or expense which the Subscriber may sustain or incur arising out of or in any way connected with the expenditure of the Subscription Amount."

See Also

Furukawa v. The Queen, 99 DTC 474 (TCC), aff'd 2000 DTC 6669 (FCA)

Various "sweeteners" provided by the issuer of what otherwise would be flow-through shares, namely, lifetime playing privileges and a building lot at a proposed golf course, and shares in another company, were items that a reasonable person would have very little expectation of getting and would attach little significance to and, in fact, did not appear to influence the taxpayer's decision to purchase the shares. Accordingly, they did not represent a return of consideration paid for the shares.

Rip TCJ. noted (at p.478) that "the term 'reasonably' implies an objective, rather than a subjective, examination of the facts."

In the Court of Appeal, Evans J.A. stated (at para. 41) that such objective standard

does not include benefits of very little intrinsic economic value or those that are in fact unlikely ever to be provided.

Words and Phrases
reasonably

Administrative Policy

2012 Ruling 2012-0466731R3 - Donation of flow-through shares

Donors (mostly Canadian-resident individuals) as well as non-donors use cash to subscribe for flow-through shares of a listed Canadian resource company, pursuant to a subscription agreement entered into by a dealer as their agent (the Agent), so that Canadian exploration expenses will be renounced to the subscribers.

The Donors issue directions to the Agent to transfer a portion (the Donated Shares) of their shares to the account of the relevant registered charity, which issues a charitable receipt. Independent persons (the Liquidity Providers) agree to purchase the Donated Shares for their fair market value from the charities. The Liquidity Providers also agree to purchase the balance of the Donors' shares (the Sale Shares) for their fair market value.

The charities receiving Donated Shares will pay a financial services fee to the Agent for its services in selling the Donated Shares to the Liquidity Providers; and Donors who sell Sale Shares will also pay a financial services fee to the Agent for its services in selling those shares to the Liquidity Providers. Mr. X, who is not a Donor, will also sell his shares on the same terms.

Rulings include:

  • the sale of a Donated Share to the Liquidity Providers will not cause the Donated Share to be a "prescribed share" (Reg. 6202.1(1))
  • the agreement for the sale of the Sale Share by each Donor to a Liquidity Provider will not cause the Sale Share to be a "prescribed share" (Reg. 6202.1(1))

94 C.P.T.J. - Q. 12

A right of recission potentially accorded by securities laws in respect of a misrepresentation in a prospectus generally would not, by itself, result in a share issued pursuant to a prospectus being a prescribed share by virtue of Regulation 6202.1(1)(b).

17 October 1991 T.I. (Tax Window, No. 11, p. 9, ¶1527)

An agreement of the corporation giving it the right, but not the obligation, to acquire the shares for the amount determined by the corporate accountant to be the fair market value of the shares based on an arm's length voluntary liquidation of the corporation's assets would not result in the purchase price of the shares being limited by way of a formula or otherwise.

90 C.P.T.J. - Q.7; 91 C.P.T.J. - Q.19

Where an issuer agrees to pay damages to the subscriber only to the extent of any additional tax payable by the subscriber as a consequence of a reduction under s. 66(12.73) of the expected tax deductions, such an indemnity will not cause the shares to be prescribed shares. It is also permissible where no shares have been issued in respect of any unspent proceeds for the issuer to agree to refund such proceeds to the subscribers provided that the price of any shares subsequently issued is not reduced because of the refund.

90 C.R. - Q. 48

An indemnity by the issuer of flow-through shares to pay tax payable by the subscriber as a consequence of a failure to renounce will not cause the shares to be prescribed shares.

16 March 1990 T.I. (August 1990 Access Letter, ¶1373)

Detailed discussion.

88 C.R. - Q. 25

The agreement of the issuer of the share to pay damages to the subscriber to the extent of any additional tax payable by the subscriber as a consequence of a reduction, pursuant to s. 66(12.73), of the expected tax deductions is acceptable.

Paragraph 6202.1(1)(c)

Articles

Gregory M. Johnson, Wesley R. Novotny, "An Update on Flow-through Shares in the Energy Sector", 2016 Conference Report (Canadian Tax Foundation),12:1-39

No need to contractually preclude general common law right to sue (p. 12:23)

Most provinces have certain statutory rights of rescission. …

All subscription agreements will generally have a covenant that the PBC will indemnify FTS holders if the tax deductions promised are not delivered. ...

In private discussions, the CRA has confirmed that the subscription agreement need not restrict damages to additional federal and provincial taxes payable since the CRA does not consider a general common-law right to sue for damages otherwise available to constitute a prescribed-share issue.

Protection through escrowing subscription receipts (p. 12:28)

A basic plan involves having the investors sign the subscription agreement with the PBC and pay the subscription amounts to the PBC. As part of the agreement, the PBC immediately transfers the funds to an escrow agent. As the PBC incurs the relevant expenses, the funds are released by the escrow agent to the PBC, which then issues the FTS to the investor. At a predetermined point in the future, if the PBC has not incurred the required relevant expenses, whatever funds remain with the escrow agent are returned to the investors and are not amounts used to subscribe for a FTS or a right to a FTS. [f.n. 105 Care must be taken in using the escrow approach with the lookback rule. … [I]t may be necessary for the escrow agreement to provide that the amount that the PBC has been spent on or before December 31 of the first year (at the latest) will be released to the PBC in return for FTS, with the remaining unspent amounts being returned to the investors.] …

...In such a case, are the investors actually putting their invested funds at risk? The CRA has stated that this escrow arrangement would not offend the prescribed share rules. [f.n. 106 "Revenue Canada Roundtable" … 1988, … question 23…]

Paragraph 6202.1(1)(d)

Articles

Gregory M. Johnson, Wesley R. Novotny, "An Update on Flow-through Shares in the Energy Sector", 2016 Conference Report (Canadian Tax Foundation),12:1-39

Potential issue if flow-through share issued after signing of merger agreement (pp 12:17-18)

Regulation 6202.1(1)(d) could result in a prescribed-share issue if it can reasonably be expected that the PBC or a "specified person" will acquire or cancel the FTS within five years of issuance. ... A potentially problematic scenario is one in which a merger agreement has been signed between the PBC and an acquiror and the FTS are subsequently issued. The acquiror could be a "specified person" and the merger does not have a fair market value exclusion for the purposes of Regulation 6202.1(1)(d).

Flow-through shares issued after announcement of long-form amalgamation may be prescribed shares (pp. 12:20-21)

On an amalgamation, it is possible that subsection 84(9) will apply to deem the FTS to be disposed of to the PBC. [f.n. 78 The CRA stated that subsection 84(9) could potentially apply to an amalgamation in CRA document no. 9415495, August 12, 1994, CRA document no. 9429925, March 20, 1995; and CRA document no. 9130715, May 11, 1994]. ... Assuming that subsection 84(9) applies to an amalgamation, FTS that are issued after an announcement of a long-form amalgamation may result in a prescribed-share issue under regulation 6202.1(1)(d). This result occurs because the PBC, as a consequence of subsection 84(9), may reasonably be expected to acquire the FTS within five years.

Subsection 6202.1(1.1)

Paragraph 6202.1(1.1)(c)

Articles

Gregory M. Johnson, Wesley R. Novotny, "An Update on Flow-through Shares in the Energy Sector", 2016 Conference Report (Canadian Tax Foundation),12:1-39

Prescribed share issues if flow-through subscription receipts (p. 12:21-22)

[I]f the subscription agreement for subscription receipts were structured as FTS, a prescribed-right issue would immediately be triggered – namely, it would be possible that the holder could get the subscription price back for the subscription receipt if the escrow conditions were not met. The fact that the subscription receipt offering is subject to conditionality falls squarely within regulation 6202.1(1.1)(c) because the PBC has a contingent obligation to return the subscription receipt proceeds. The only way to structure around this would be to issue the shares received on the exchange of subscription receipts as FTS. …

...[P]aragraphs 66(12.66)(a.1) and (c) require that the subscription agreement and the consideration be received in the same calendar year... .

[and earlier:] In the interim period, the subscriber may also be entitled to dividend equivalents payments ("DEPs"). …

...DEPs are typically funded out of interest on the escrowed funds with any shortfall made up by effectively paying a portion of the escrow property back to the subscribers, which in turn reduces the price of the shares that will be issued. Thus, it is possible that the actual issuance price of the shares (and thus the FTS) will be reduced over time. This raises an issue under regulation 6202.1(2)(a).

Subsection 6202.1(2)

Paragraph 6202.1(2)(b)

Administrative Policy

21 November 2013 External T.I. 2013-0497641E5 - Flow-through shares and stock options

employee stock option shares

An employee of a principal-business corporation is granted a stock option, at no cost, to purchase shares of the PBC at a specified exercise price. Would the consideration paid for the purposes of a flow-through share agreement be the fair market value of the shares acquired, or the amount paid by the employee (the exercise price)? After noting that Reg. 6202.1(2)(b)(iv) applies where the corporation provides any assistance whatsoever to acquire a treasury share of the corporation, CRA stated:

Generally, under a stock option plan, the corporation is providing a financial incentive to the employee by allowing the employee the right to acquire a share at a pre-determined price that may be less than the market price. It is our view that a share issued under an employee stock option plan would be a prescribed share by virtue of [Reg.] 6202.1(2)(b)(iv)…and, consequently, would not qualify as a FTS.

Subsection 6202.1(5)

Excluded Obligation

Articles

Gregory M. Johnson, Wesley R. Novotny, "An Update on Flow-through Shares in the Energy Sector", 2016 Conference Report (Canadian Tax Foundation),12:1-39

No need to contractually preclude general common law right to sue (p. 12:23)

Most provinces have certain statutory rights of rescission. …

All subscription agreements will generally have a covenant that the PBC will indemnify FTS holders if the tax deductions promised are not delivered. ...

In private discussions, the CRA has confirmed that the subscription agreement need not restrict damages to additional federal and provincial taxes payable since the CRA does not consider a general common-law right to sue for damages otherwise available to constitute a prescribed-share issue.