Principal Issues: [TaxInterpretations translation] In a Particular Situation:
(1) Would, for the purposes of paragraph 110(1)(d), newly issued common shares that were purchased for cancellation by the corporation immediately after their issue be prescribed shares under section 6204 of the Regulations?
(2) Could subsection 248(28) apply to prevent the application of subsection 84(3) to the Particular Situation because a benefit under subsection 7(1) would already have been computed?
Position:
No.
No.
Reasons:
At the time of the issue of the common shares, the condition in paragraph 6204(1)(b) would not be satisfied because at that time it was reasonable to expect that the shares would be acquired and cancelled by the corporation.
2005-012581
XXXXXXXXXX Guy Goulet, CA, M.Fisc.
(613) 957-9768
August 29, 2005
Dear Sir,
Subject: Request for technical interpretation - 6204(1)(b) of the Regulations
This is in response to your fax of April 15, 2005, in which you requested our opinion as to the interpretation of paragraph 6204(1)(b) of the Income Tax Regulations (Regulations) in the Particular Situation described below.
Unless otherwise indicated, all statutory references herein are to provisions of the Income Tax Act (the "Act").
Particular Situation
On the day before a third party acquired all of the shares in the capital stock of a Canadian-controlled private corporation (CCPC), two directors of the CCPC exercised their stock options and acquired a number of common shares in the capital stock of CCPC. The next day, immediately prior to the third-party acquisition, the common shares in the capital stock of Opco, which were newly-issued to the two directors, were purchased for cancellation by Opco so as to accord with the number of issued and outstanding common shares in its capital stock agreed to with the third party acquirer.
As a result of this disposition of shares, both directors were deemed to have received a benefit because of their employment pursuant to subsections 7(1) and 7(1.1). The amount of this benefit should be added to their cost in computing the adjusted cost base of their common shares of Opco's capital stock pursuant to paragraph 53(1)(j). Furthermore, pursuant to subsection 84(3), Opco was deemed to have paid, at the time of the purchase for cancellation of the common shares of its capital stock, a dividend equal to the amount by which the purchase price exceeded the paid-up capital of the common shares and the directors were deemed to have received at that time their respective share of that dividend. Finally, both directors sustained a capital loss on the disposition of their shares in an amount equal to the amount of the taxable benefit computed under section 7.
Your Questions
You would like us to answer the following questions:
1. Would the two directors be entitled to deduct in computing their taxable income one-half of the value of the section 7 deemed benefit under paragraph 110(1)(d)? In particular, would the common shares of the capital stock of Opco issued to the two directors be, at the time of their issuance, prescribed shares under section 6204 of the Regulations for purposes of paragraph 110(1)(d)?
2. Could subsection 248(28) apply to prevent the application of subsection 84(3) to the Particular Situation since a benefit under subsection 7(1) would have already been computed?
Your Comments
You are of the view that the two directors would be entitled to the paragraph 110(1)(d) deduction since, in your view, the common shares of the capital stock of Opco issued to the two directors would be prescribed shares under section 6204 of the Regulations at the time they were issued.
You indicated that, in your view, paragraph 6204(1)(b) of the Regulations refers to the terms and conditions of shares established under the articles of incorporation and that this excludes purchases for cancellation not provided for in the articles of incorporation, as is the case in the Particular Situation.
Our Comments
It appears to us that the situation described in your letter may be an actual situation involving taxpayers. The Canada Revenue Agency ("CRA") does not generally provide written opinions on proposed transactions otherwise than by way of advance ruling. Furthermore, it is the responsibility of the relevant Tax Services Office to determine whether completed transactions have received appropriate tax treatment. We can, however, offer the following general comments which may not be fully applicable in a particular situation.
For the purposes of paragraph 110(1)(d), a share is a prescribed share of the capital stock of a corporation at the date of its issue if at that date the conditions of subsection 6204(1) of the Regulations are satisfied. The condition set out in paragraph 6204(1)(b) of the Regulations is that the corporation or a specified person in relation to the corporation cannot reasonably be expected to, within two years after the time the share is sold or issued, as the case may be, redeem, acquire or cancel the share in whole or in part, or reduce the paid-up capital of the corporation in respect of the share, otherwise than as a consequence of a transaction described in subparagraph 6204(1)(b)(i), (ii) or (iii) of the Regulations.
The question of whether at the time of issuance of a share the condition set out in paragraph 6204(1)(b) of the Regulations is met is one that can only be resolved after a full analysis of all relevant facts and legal documents. In general, the CRA will not limit itself to analyzing only the rights and privileges of shares established under the articles of incorporation to answer this question. In the Particular Situation, it appears to us that this condition would not be met since at the time of issue it was reasonable to expect that the shares would be acquired and cancelled by the corporation. As a result, we are of the view that the two directors would not be entitled to deduct, in computing their taxable income, an amount computed under paragraph 110(1)(d).
Regarding your second question, it is our position that subsection 248(28) does not apply to a deemed dividend on the redemption, acquisition or cancellation by a corporation of shares of its capital stock for which a section 7 benefit is included in an employee's income. It is our view that in such a situation, the section 7 benefit and the dividend computed under subsection 84(3) result from two different events, namely, the exercise of a stock option by the employee and the redemption, acquisition or cancellation of the shares by the corporation.
We hope that our comments will be of assistance.
Best regards,
Ghislain Martineau
Manager
Financial Sector and Exempt Entities Section
Income Tax Rulings Directorate
Policy and Planning Branch