Principal Issues: Whether subsection 256(1.4) applies because of a provision of a shareholder agreement?
Position: Yes
Reasons: Wording of subsection 256(1.4).
XXXXXXXXXX 2006-019784 R. Gagnon September 28, 2006
Dear Sir,
Subject: Section 256(1.4) of the Income Tax Act
This is in response to your letter of June 15, 2006, which was sent to the Ottawa Technology Centre of the Canada Revenue Agency ("CRA"), and forwarded to us for response on July 21, 2006. In your letter, you question the possible application of subsection 256(1.4) of the Income Tax Act ("Act") in the situation described below.
Unless otherwise indicated, all statutory references herein are to provisions of the Act.
Facts and assumptions
1. Mr. A, Mr. B, Mr. C and Mr. D are individuals who are resident in Canada for the purposes of the Act.
2. Aco, Bco, Cco, Dco and Opco are "taxable Canadian corporations" as defined in subsection 89(1) and "Canadian-controlled private corporations" as defined in subsection 125(7).
3. Mr. A, Mr. B, Mr. C and Mr. D respectively own all the issued and outstanding shares of the capital stock of Aco, Bco, Cco, Dco. For the purposes of the Act, Mr. A, Mr. B, Mr. C and Mr. D have effective (de jure) control of Aco, Bco, Cco, Dco respectively.
4. Mr. A, Mr. B, Mr. C and Mr. D are not related person within the meaning of paragraph 251(2)(a). In addition, Mr. A, Mr. B, Mr. C and Mr. D deal with each other at arm's length within the meaning of subsection 251(1).
5. The issued and outstanding shares of the capital stock of Opco consist solely of common shares of one class. Mr. A, Mr. B, Mr. C and Mr. D each own 25% of the issued and outstanding common shares of the capital stock of Opco.
6. Aco, Bco, Cco, Dco and Opco are not associated with each other pursuant to subsection 256(1), without regard to the application of subsection 256(1.4).
7. Mr. A, Mr. B, Mr. C and Mr. D and Opco entered into a unanimous shareholders' agreement ("Agreement") during 2004, which is still in force. The Agreement contains, inter alia, the following clause:
Purchase and sale of shares
In the event that a shareholder wishes, for any reason other than death or compulsory retirement, to terminate his or her association with the other shareholders in the corporation, such shareholder (the "Offeror") may at any time give written notice to the other shareholders, and the following provisions shall apply:
Voluntary withdrawal from business
If a shareholder's intention to terminate the shareholder's association with the other shareholders is based primarily on the shareholder's intention to withdraw from the business of the corporation, then and for such case, it is agreed as follows:
The Offeror shall request the other shareholders to purchase the Offeror's shares and/or other interests in the corporation within 30 days of written notice by it to that effect.
In such case, the price of the shares to be sold shall be the price set out in the Annex to this Agreement.
If the other shareholders do not comply with the Offeror's request within the above-mentioned period of thirty days, then all shareholders are bound:
In the first instance, i.e. within 30 days of the expiry of the first deadline mentioned above, to try to find a buyer for all the shares issued by the corporation, on terms acceptable to all parties.
Secondly, if the steps taken under the preceding paragraph have proved unsuccessful, to proceed to the liquidation and dissolution of the corporation.
8. In the clause of the Agreement described in paragraph 7 above, where none of the other shareholders respond to the offeror's request, the buyer would be a person other than a shareholder of the corporation.
Your Question
Does the Agreement clause described in paragraph 7 above constitute a right under section 256(1.4) that would have the effect of making Opco associated with Aco, Bco, Cco and Dco?
Your Comments
You are of the view that Article 256(1.4) would not be applicable only because of the existence of the clause in the Agreement described in paragraph 7 above, which you described as a put option. By way of analogy, you referred us to a technical opinion dated April 30, 1990 where, in the context of the application of subparagraph 251(5)(b)(i), it is stated that a put option granted to a selling shareholder in a buy-sell agreement might not constitute a right referred to in that subparagraph to the selling shareholder.
Our Comments
It appears to us that the situation described in your letter could constitute an actual situation involving taxpayers. The CRA does not generally provide written opinions on proposed transactions otherwise than by way of advance rulings. Furthermore, it is the responsibility of the relevant Tax Services Office to determine whether completed transactions have received the appropriate tax treatment. We can, however, offer the following general comments which may not fully apply to the present situation.
The CRA's position on "buy-sell" agreements for the purposes of subsection 256(1.4) is set out in paragraph 37 of Interpretation Bulletin IT-64R4. Among other things, although the wording in subsection 256(1.4) may be broad enough to include almost any buy-sell agreement, this subsection will not normally be applied solely because of:
- a “right of first refusal”; or
- a “shotgun arrangement” (i.e., an arrangement under which a shareholder offers to purchase the shares of another shareholder and the other shareholder must either accept the offer or purchase the shares owned by the offering party)
contained in a shareholder agreement.
It appears to us that subsection 256(1.4) would technically apply in the situation described in your letter because of the existence of the unanimous shareholder agreement clause described in paragraph 7 above. Mr. A, Mr. B, Mr. C and Mr. D would each be deemed to control Opco because of the application of paragraph 256(1.4)(a). Consequently, each of Aco, Bco, Cco and Dco would be technically associated with Opco by virtue of paragraph 256(1)(b).
Please note that this opinion is not an advance ruling and, as stated in paragraph 22 of Information Circular 70-6R5 dated May 17, 2002, is not binding on the CRA with respect to any particular factual situation.
Best regards,
Maurice Bisson, CGA
for the Director
Corporate Reorganizations and Resource Industries Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch