21 November 2011 External T.I. 2011-0422191E5 F - Price adjustment clause and redemption of shares -- translation

21 November 2011 External T.I. 2011-0422191E5 F - Price adjustment clause and redemption of shares

Principal Issues: In the course of an estate freeze, preferred shares are issued to a taxpayer in consideration for common shares. The redemption value of those shares would be equal to the fair market value of the common shares acquired by the corporation. The rights, privileges and restrictions of the preferred shares described in the articles of incorporation would contain a price adjustment clause. Pursuant to that price adjustment clause, the redemption value of the preferred shares would be adjusted to reflect the fair market value of the consideration if the amount considered to be the fair market value is changed. If the preferred shares are redeemed before an upward adjustment to the redemption value, the corporation would pay an additional amount to the taxpayer. What would be the tax treatment of such additional payment made by the corporation in favour of the taxpayer?

Position: In such a case, the CRA's position is that the additional payment made by the corporation in favour of the taxpayer, as a result of the price adjustment clause becoming operative, would be treated as a dividend. Such a dividend would have to be included in the shareholder's income in the year of receipt under subsection 84(3) of the Act.

Reasons: Previous positions.

XXXXXXXXXX
									2011-042219
									Sylvie Labarre, CA

November 21, 2011

Dear Sir,

Subject: Price adjustment clause and redemption of shares

This is in response to your e-mail of September 23, 2011 in which you asked us for our opinion as to when a taxpayer should add an amount received as a result of a price adjustment clause to the taxpayer’s income.

Unless otherwise stated, all references to a statutory section or included provision in this letter are to a section of the Act or one of its provisions.

The question was posed in the following context.

In the course of an estate freeze in the 20X0 year, a corporation issued to a taxpayer preferred freeze shares of its capital stock in consideration for participating shares. The redemption value of such preferred shares was equal to the fair market value of the participating shares it received as consideration therefor. A price adjustment clause was contained in the rights, privileges, conditions and restrictions for the preferred shares contained in the articles of the corporation. Pursuant to that price adjustment clause, the redemption value of the preferred shares that was determined at the time of the issue was to be adjusted if the fair market value of the participating shares given in consideration differed from the value originally determined by the taxpayer and the corporation. In addition, the price adjustment clause provided that if the redemption price of the freeze preferred shares was adjusted upward subsequent to the redemption of shares, the corporation was to pay to the holder of the redeemed shares the difference per share between the redemption price as adjusted and the amount actually received upon redemption (the "additional payment").

The corporation redeemed all of the freeze preferred shares of its capital stock, held by the taxpayer, and paid the taxpayer the initially established redemption value in 20X2. Following the redemption of the freeze preferred shares, the CRA contested the initial fair market value. It was a few years before the dispute was settled. Following the settlement of the dispute in 20X7, the amount established as the fair market value of the participating shares given as consideration for the issue of the freeze preferred shares was adjusted upward. The parties applied the redemption price adjustment clause of the freeze preferred shares and the corporation made an additional payment to the taxpayer in 20X7 as the freeze preferred shares had been redeemed in 20X2.

Question

You wish to know if the additional payment received in 20X7, pursuant to the application of the price adjustment clause, would be taxed in the year of the redemption (in 20X2) or in the year of receipt of that additional payment ( in 20X7). You also wish to know if the payer should take into account the additional payment in the year of the payment of that amount.

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 (the "CRA") not to issue a written opinion regarding proposed transactions otherwise than through advance rulings. Furthermore, when it comes to determining whether a completed transaction has received appropriate 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 may, however, under certain circumstances, not apply to your particular situation.

You referred to the CRA's response to Question 4.6 of the APFF Federal Tax Roundtable that was held at the 1998 APFF Conference. In 1998, the question was asked in a context similar to that described above. The CRA then indicated that it considered the additional payment made pursuant to the price adjustment clause as a dividend, for both the payor and the recipient, for the following reasons:

1. The payment arises from a right relating to a share.
2. The payment is made as a result of a redemption of shares under subsection 84(3) and is incidental to such redemption.
3. To treat the payment as a capital payment would change the nature of the payment otherwise made and the income otherwise realized.
4. This position favours the uniform treatment of shareholders and corporations with respect to the application of subsection 84(3).

The CRA has not changed that position since 1998. Although the clarification has not been made publicly, our Directorate's position is that this inclusion as a dividend pursuant to subsection 84(3) would take place in the year of receipt of the additional payment. In addition, and for the purposes of subsection 129(1), the dividend would be considered to have been paid by the payer in the taxation year in which the additional payment was actually made.

Consequently, in the situation presented above, the taxpayer should include in the calculation of the taxpayer’s income for the 20X7 taxation year, a dividend equal to the additional payment received in 20X7.

These comments are not advance income tax rulings and are not binding on the CRA with respect to a particular situation.

Best regards,

Stéphane Prud'Homme, Notary, M.Fisc.
for the Director
Corporate Reorganization and Resource Industry Division
Income Tax Rulings Directorate
Legislative Policy
and Regulatory Affairs Branch