Principal Issues: In the example provided, shares of a particular class of the capital stock of a corporation were issued in three different years. The annual rate of dividend on such shares was higher than the prescribed rate of interest at the time of the issuance of some shares of that class. The corporation would amend its articles in order to decrease the annual rate of dividend in the shares of the particular class. Whether this would allow the requirement set out under paragraph 256(1.1)(d) of the Act to be satisfied.
Position: In the example provided, the requirement set out in paragraph 256(1.1)(d) would not be met even with the amendment of the articles of the corporation. CRA's position is that the condition in paragraph 256(1.1)(d) of the Act must be met throughout the period that the shares in question are issued and outstanding.
Reasons: Previous positions.
XXXXXXXXXX 2009-034059 Sylvie Labarre, CA January 7, 2010
Dear Madam,
Subject: Specified class - subsection 256(1.1) of the Income Tax Act
This is in response to your email of September 14, 2009, requesting our views on the interpretation of paragraph 256(1.1)(d) of the Income Tax Act (the "Act").
Unless otherwise stated, all statutory references herein are to provisions of the Act.
You provided the example of a shareholder who held shares of a class (Class A) of the capital stock of a particular corporation bearing an annual dividend rate of 6% of the fair market value of the consideration for which the share was issued. Several years later, the corporation amended its articles to change the annual dividend rate on the shares of that class. Those shares thenceforth carried a rate of 1% of the fair market value of the consideration for the issue of the share.
The shareholder acquired those Class A shares of the capital stock of the particular corporation on the occasion of three share issuances:
|
Date |
Dividend rate |
Prescribed rate of interest at that time |
|
Year 1 |
6% |
7% |
|
Year 4 |
6% |
5% |
|
Year 13 |
1% |
1% |
You are asked whether Class A would be a specified class in Year 14 within the meaning of subsection 256(1.1), and specifically whether the shares of that class would satisfy the condition in paragraph 256(1.1)(d). Based on your analysis, Class A would be a specified class for Years 1 to 3 inclusive and for Years 13 and 14.
On the other hand, you question Technical Interpretation 9204567 issued by our Directorate on May 5, 1992, because it would run counter to your analysis. You therefore wish to know whether the interpretation provided in that document still represents our position.
If that were the case, you wish to know whether the condition in paragraph 256(1.1)(d) would be satisfied if, in Year 14, the shareholder acquired Class B shares of the capital stock of the particular corporation in exchange for the Class A shares held by the shareholder. The characteristics of the Class B shares would be identical to those of the Class A shares except that the fixed annual dividend rate, expressed as a percentage of the fair market value of the consideration for which the shares were issued, would be equal to the prescribed rate of interest at the time of the exchange. Section 51 would apply to this share exchange. In that regard, you queried if there is a specific provision (tracking or tracing rule) that would result in Class B not satisfying the condition in paragraph 256(1.1)(d) because it was issued on an exchange of shares of a class that was not excluded.
Our Comments
As stated in paragraph 22 of Information Circular 70-6R5 dated May 17, 2002, it is the practice of the Canada Revenue Agency ("CRA") not to issue written opinions regarding proposed transactions otherwise than by way of advance income tax rulings. Furthermore, when it comes to determining whether a completed transaction has received adequate tax treatment, the determination is made first by our Tax Services Offices as a result of their review of all facts and documents, which is usually performed as part of an audit engagement. However, we can offer the following general comments that we hope may be helpful to you. These comments, however, may not apply to your particular situation in certain circumstances.
Subsection 256(1.1) provides that a class of shares of the capital stock of a corporation is excluded for the purposes of subsection 256(1) where, under the terms or conditions of the shares or any agreement in respect thereof, the shares of that class satisfy the conditions referred to in paragraphs 256(1.1)(a) to (e).
The condition in paragraph 256(1.1)(d) is as follows:
d) the annual rate of the dividend on the shares, expressed as a percentage of an amount equal to the fair market value of the consideration for which the shares were issued, cannot in any event exceed,
(i) ...
(ii) where the shares were issued after 1983, the prescribed rate of interest at the time the shares were issued;
In February 1989, the CRA took a position with respect to your question (Technical Interpretation 5-6979). In that document, we stated that the annual dividend rate condition had to be satisfied throughout the period during which shares of that class were issued and outstanding. The CRA was of the view that the preamble to subsection 256(1.1) and the use of the words "cannot in any event" in paragraph 256(1.1)(d) supported such an interpretation. The CRA also noted that the tests in subsection 256(1.1) were relevant throughout the period in which shares of the class were issued and outstanding in two 1991 technical interpretations, namely, 911358 and 912244.
In our view, Technical Interpretation 9204567 to which you referred was based on the position taken in 1989 and not on an interpretation of the text of paragraph 256(1.1)(d) that you believe would have the effect of adding the words "at the time of issue" after the "annual dividend rate". In the situation described in 9204567, the fact that the dividend rate at the time of issue was higher than the prescribed rate at that time meant that the condition in paragraph 256(1.1)(d) was not satisfied throughout the period in which the shares of the class were issued and outstanding.
We maintain the interpretation of paragraph 256(1.1)(d) taken in 1989 and reiterated thereafter. In our view, the fact that subsection 256(1) applies for a particular taxation year for the purpose of determining whether corporations are associated in that year does not preclude us from interpreting subsection 256(1.1) with reference to the period during which shares are issued and outstanding. Furthermore, as stated in 9204567, it does not appear to us that the condition in paragraph 256(1.1)(d) can be satisfied by changing only the dividend rate when the articles of the corporation are amended if the issued and outstanding shares are not purchased or redeemed by the corporation.
Consequently, in the example you provided, we are of the opinion that the Class A shares of the capital stock of the particular corporation would not be shares of a specified class as defined in subsection 256(1.1) since the Class A shares were issued in Year 4. Whether Class A of the capital stock of the particular corporation would qualify as a specified class (within the meaning assigned by subsection 256(1.1)) for the period before the issuance of the shares in Year 4 would depend on whether all the conditions in subsection 256(1.1) were satisfied. We reach this conclusion despite the change in the dividend rate that occurs in Year 13.
To remedy such a situation, you suggested the following planning: the shareholder would acquire Class B shares of the capital stock of the particular corporation in exchange for the Class A shares held by the shareholder. The characteristics of the Class B shares would be identical to those of the Class A shares except that the fixed annual dividend rate, expressed as a percentage of the fair market value of the consideration for which the shares were issued, would be equal to the prescribed rate of interest at the time of the exchange. Based on your assumptions, section 51 would apply to this share exchange.
We understand that the only Class B shares of the capital stock of the particular corporation that would be issued and outstanding would be the shares received by the shareholder on the exchange and that this issuance would take place on the exchange. Thus, depending on the facts, the fixed annual dividend rate, expressed as a percentage of the fair market value of the consideration for the issuance of the Class B shares, would not exceed the prescribed rate of interest on the issuance of the Class B shares. It is our understanding that the condition in paragraph 256(1.1)(d) would then be satisfied in respect of the newly issued Class B shares of the capital stock of the particular corporation. There is no specific provision in the Act, such as a tracking or tracing rule, that would allow the CRA to consider that the Class B shares of the capital stock of the particular corporation do not satisfy the condition in paragraph 256(1.1)(d) because the Class A shares of the capital stock of the particular corporation, exchanged for the Class B shares, did not satisfy the condition in paragraph 256(1.1)(d).
However, at the time of the exchange, the fair market value of the Class A shares and the Class B shares received in exchange should be ascertained in order to determine, inter alia, whether subsection 51(2) applies to the situation or whether the condition in paragraph 256(1.1)(e) is satisfied.
In closing, we do not comment on any other tax implications that may result from your proposed solution as your letter does not contain all the information necessary for a complete analysis of those implications.
These comments are not advance income tax rulings and are not binding on the CRA in respect of any particular situation.
Best regards,
Stéphane Prud'Homme, Notary, M. Fisc.
For the Director
Corporate Reorganizations and Resource Industries Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch.