Principal Issues: Whether the transitional rule under subparagraph 131(11)(b) of the Income Tax Amendments Act, 1997 (Bill C-28/ Royal Assent June 18, 1998), as amended, (the "Transitional Rules") relating to application of subsections 112(3) to (3.2) of the ITA applies to preferred shares received by an individual as a stock dividend on grandfathered shares of the capital stock of a corporation?
Position: No.
Reasons: The preferred shares were not owned by the individual on April 26, 1995 and the criteria of paragraph 131(12) of the Transitional Rules are not met.
2004-008880
XXXXXXXXXX Guy Goulet, CA, M. Fisc,
(613) 957-9768
September 23, 2004
Dear Sir,
Subject: Subsection 112(3.2) of the Income Tax Act
This is in response to your letter of July 28, 2004, requesting our views on the application of the transitional relief provided in paragraph 131(11)(b) of the Income Tax Amendments Act, 1997 (Bill C-28 assented to on June 18, 1998), as amended (the "1998 Act"), in respect of the application of subsection 112(3.2) of the Income Tax Act (the "Act").
In your letter, you described a situation where common shares of the capital stock of a particular corporation held by a particular individual satisfy all the conditions for transitional relief under paragraph 131(11)(b) of the 1998 Act. You informed us that the particular corporation would like to pay a dividend by issuing preferred shares to shareholders holding common shares of its capital stock (a stock dividend).
You wish to know whether the preferred shares of the capital stock of the particular corporation that would be received by the particular individual as a stock dividend on the common shares would satisfy the condition for transitional relief in subparagraph 131(11)(b)(i) of the 1998 Act, that condition being that the relief applies to the disposition of a share of the capital stock of a corporation disposed of to the corporation only if, on April 26, 1995, the share was held by an individual.
You indicated that paragraph 248(5)(b) deems a share received as a stock dividend on another share of the capital stock of a corporation to be property substituted for that other share. Consequently, you argue that the preferred shares that would be received by the individual as a stock dividend should satisfy the transitional relief condition in subparagraph 131(11)(b)(i) of the 1998 Act since they are deemed to be substituted property for shares that do satisfy that condition.
Finally, you referred to technical opinion 2003-0013545 Grandfathering Rules for Subsection 112(3.2), which states that shares issued as a result of a stock split benefit from the protection that was afforded to the old shares and will not be affected by the limitations in subsection 112(3.2) to the extent that the old shares satisfy the conditions for transitional relief. In your view, from an economic perspective, a stock dividend is equivalent to a stock split. Therefore, you believe that shares issued as part of a stock dividend should receive the same tax treatment as shares issued as a result of a stock split with respect to the interpretation of transitional relief for the purposes of subsection 112(3.2).
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 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 be fully applicable in a particular situation.
In the situation presented, we do not believe that the preferred shares of the capital stock of the particular corporation that would be received by the particular individual as a stock dividend on the common shares of the capital stock of the particular corporation would qualify for transitional relief. Our conclusion is based on the following observations.
For transitional relief to apply to a disposition of a share of the capital stock of a corporation to the corporation, all of the conditions in subparagraphs 131(11)(b)(i) to (iv) of the 1998 Act must be satisfied The condition in subparagraph 131(11)(b)(i) of the 1998 Act is that "on April 26, 1995, the share was owned by an individual (other than a trust) or by a particular trust under which an individual (other than a trust) was a beneficiary. In addition, subsection 131(12) of the 1998 Act provides that "For the purposes of paragraph (11)(b) and this subsection, a share of the capital stock of a corporation acquired in exchange for another share in a transaction to which section 51, 85, 86 or 87 of the Act applies is deemed to be the same share as the other share."
In the situation presented, it is clear that the preferred shares of the capital stock of the particular corporation that would be received by the particular individual as a stock dividend on the common shares of the capital stock of the particular corporation were not held by the particular individual on April 26, 1995, notwithstanding that the preferred shares would be deemed to be substituted property for the common shares under paragraph 248(5)(b). In addition, subsection 131(12) of the 1998 Act could not apply to deem the preferred shares to be the same shares as the common shares because the preferred shares would not have been acquired by the particular individual in exchange for another share in a transaction to which section 51, 85, 86 or 87 of the Act applies.
Finally, we remind you that when all the conditions listed in Interpretation Bulletin IT-65, Stock Splits and Consolidations, are satisfied, the CRA's position is to consider that no disposition or acquisition of shares has occurred on a stock split. However, there is an acquisition of shares when a share is received by a shareholder as a stock dividend on another share of the capital stock of a corporation. We refer you to paragraph 3 of Interpretation Bulletin IT-88R2 Stock Dividends for more details on the distinction between a stock dividend and a stock split.
We hope that our comments will be of assistance.
Best regards,
Maurice Bisson, CGA
for the Director
Corporate Reorganizations and Resource Industries Division
Income Tax Rulings Directorate
Policy and Planning Branch