Principal Issues: The issued and outstanding share capital of a corporation consists of common shares and preferred shares. The common shares are voting and the preferred shares are non voting, except for the "Right to Veto" described below. The preferred shares were issued in the context of a typical estate freeze. Whether the common shares of the capital stock of a corporation will be considered as having full voting rights under all circumstances for the purposes of subsection 186(2) and subparagraph 186(4)(b)(i) of the Act where the corporation may not make any amendments that affect the rights, conditions or privileges of the preferred shares without obtaining the consent of a certain number of the holders of the preferred shares (the "Right to Veto").
Position: Only excerpts of the articles of the corporation were submitted. When the part of the articles of incorporation describing the voting rights attached to the common shares are considered in isolation, one could argue that the said common shares do not have full voting rights under all circumstances. However, after examining all of the constating documents of the corporation, it is possible that it may be established that the common shares would effectively have full voting rights under all circumstances, despite the fact that the corporation may not make any amendments that affect the rights, conditions or privileges of the preferred shares without obtaining the consent of a certain number of the holders of the preferred shares. In itself, the fact that the holders of the preferred shares have this type of Right to Veto would not normally result in the common shares being considered not having full voting rights under all circumstances for the purposes of subsection 186(2) and subparagraph 186(4)(b)(i) of the Act. It should be noted that under certain corporate laws in Canada, this type of Right to Veto is granted by law to the shareholders. Subsection 186(2) or subparagraph 186(4)(b)(i) of the Act should not apply differently depending on whether the Right to Veto has been granted legislatively or under the terms of the articles of incorporation.
Reasons: Wording of the Act.
2006-020490 XXXXXXXXXX S. Prud'Homme (613) 957-8975 November 16, 2006
Dear Sir,
Subject: Application of subsection 186(2) and subparagraph 186(4)(b)(i) of the Income Tax Act
This is in response to your email of September 12, 2006, in which you requested our opinion regarding the potential application of subsection 186(2) and subparagraph 186(4)(b)(i) of the Income Tax Act (the "Act") in a particular situation.
Unless otherwise stated, any statutory reference herein is to a provision of the Act.
It appears to us that the situation described in your letter and summarized below may be an actual situation involving taxpayers. As explained in Information Circular 70-6R5, it is not the practice of this Directorate to provide comments on proposed transactions involving specific taxpayers otherwise than in the form of an advance income tax ruling. If your situation involved specific taxpayers and one or more completed transactions, you should submit all relevant facts and documentation to the appropriate Tax Services Office for its opinion. However, we are able to offer the following general comments that may be helpful. It should be noted that the application of one or more provisions of the Act generally requires an analysis of all the facts relating to a particular situation. Consequently, and given that your letter only briefly describes a hypothetical situation, the comments we provide below may not be fully applicable in a particular situation.
(1) Particular Situation
You have presented us with the situation described below (the "Particular Situation") as part of your request for a technical interpretation.
The issued and outstanding capital stock of a particular corporation ("Opco") consists of common shares and preferred shares. Those preferred shares were issued as part of a typical estate freeze.
We understand that the common shares in the capital stock of Opco are voting shares. Specifically, the characteristics of those common shares provide, inter alia, the following:
Right to vote
The holders of shares of this class shall be entitled to vote at meetings of the shareholders of the Corporation and to receive notice of such meetings; each share of that class shall entitle the holder to one (1) vote, except at a meeting where the right to vote is restricted to shareholders of another class.
We also understand that the preferred shares would be non-voting. However, the holders of the preferred shares would have a sort of "veto right" with respect to any amendment to the articles of incorporation that would affect the rights, conditions or privileges attached to the preferred shares. Specifically, such an amendment to the articles would first have to be approved by the vote of at least 3/4 in value of the preferred shares represented by the holders present at a special or special general meeting called for that purpose.
(2) Your Question
You wish to know whether the Canada Revenue Agency considers that, in the Particular Situation, the common shares of the capital stock of Opco would carry full voting rights in all circumstances for the purposes of subsection 186(2) and subparagraph 186(4)(b)(i).
(3) Our Comments
Firstly, it should be noted that your email contained only short extracts from the articles of incorporation of a particular corporation. In the absence of a review of all of the incorporation documents for a particular corporation and the principal facts and circumstances of a particular situation, it is impossible for us to make a definitive determination as to the application of subsection 186(2) or 186(4) in a particular situation. We can, however, make the following general comments.
Subsection 186(2) provides that for the purposes of Part IV (other than for the purpose of determining whether a corporation is a “subject corporation” within the meaning of subsection 186(3)), one corporation is controlled by another corporation if more than 50% of its issued share capital (having full voting rights under all circumstances) belongs to the other corporation, to persons with whom the other corporation does not deal at arm’s length, or to the other corporation and persons with whom the other corporation does not deal at arm’s length.
Furthermore, for the purposes of Part IV, a payer corporation is connected with a particular corporation at a particular time in a taxation year if either of the circumstances described in paragraph 186(4)(a) or (b) applies. With respect to paragraph 186(4)(b), subparagraph 186(4)(b)(i) requires that the particular corporation own at that time more than 10% of the issued shares (having full voting rights under all circumstances) of the capital stock of the payer corporation.
In the absence of a review of all of Opco's governing documents, it is difficult for us to interpret the clause in Opco's Articles of Incorporation relating to common shares and entitled "Voting Rights".
On its face, it seems to us that when this "Voting Rights" clause is considered in isolation, it would be possible to argue that the common shares of the capital stock of Opco would not carry full voting rights in all circumstances for the purposes of subsection 186(2) and subparagraph 186(4)(b)(i).
However, upon a full review of the particular corporation's constating documents, it may be found that the common shares of the capital stock of Opco would indeed have full voting rights in all circumstances, although the corporation could not make an amendment affecting the rights, conditions or privileges of the preferred shares without first obtaining the consent of a number of the preferred shareholders. In and of itself, the fact that the holders of the preferred shares have such a "veto right" in relation to amendments to Opco's articles would not normally result in the common shares being considered as not having full voting rights in all circumstances for the purposes of subsection 186(2) and subparagraph 186(4)(b)(i).
In that regard, we understand that under certain corporate statutes applicable in Canada, this type of "veto right" is automatically granted by law to shareholders. In our view, the application of subsection 186(2) or subparagraph 186(4)(b)(i) should not vary depending on whether such a "veto right" is granted to shareholders by statute or by the articles of incorporation.
We hope that our comments are of assistance.
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