The only issued and outstanding share of Opco (which has retained earnings of $500,000) is 1 Class A common share, with a fair market value of $1,000,000 owned by Mr. A. Opco issues to Mrs. A, for nominal consideration, 1 non-voting Class B preferred share, which is redeemable and retractable “for the fair market value for which it is issued” and entitled to discretionary dividends as and when declared.
In Scenario 1, Opco immediately declares and pays out a $100,000 dividend on the Class B preferred share, which would have the effect of reducing the FMV of Opco and the 1 Class A common share by the same amount.
In Scenario 2, Opco does not declare and pay the $100,000 dividend until after it has earns an additional $100,000 of income, and the FMV of Opco after the dividend is at least $1,000,000.
What would be the consequences for Opco and its shareholders of such issuance and dividend? CRA responded:
It is possible that…one could take the position that an economic advantage is being conferred by Opco to Mrs. A…[and] that subsection 15(1) applies upon the issuance of the Class B preferred share, particularly if the amount that is being paid by Mrs. A as consideration for the share does not represent the fair market value of such share at the time of subscription.