Author: T. Murphy
May 22, 1992
1992 VANCOUVER DISTRICT OFFICE ROUND TABLE
DISTRESS PREFERRED SHARES
QUESTION 28
Will Revenue Canada confirm that preferred shares meeting the conditions in subparagraph (e)(iii) of the definition of term preferred share in subsection 248(1) ("distress preferred shares") will not, in general, be subject to subsection 112(2.4) by virtue of subsection 112(2.5)?
DEPARTMENT'S POSITION
Subsection 112(2.4) will not generally apply to dividends received on distress preferred shares by virtue of subsection 112(2.5).
ANALYSIS
Subsection 112(2.4) denies a deduction under subsection 112(1) in respect of dividends received on collateralized preferred shares unless subsection 112(2.5) applies. Subsection 112(2.5) provides that subsection 112(2.4) will apply only where the share was issued or acquired as part of a transaction or event or as part of a series of transactions or events that enabled any corporation to earn investment income, or any income substituted therefor, and the amount of taxes payable is less than the amount of taxes that would be payable if such investment income were the only income of the corporation for the year.
The reference in subsection 112(2.5) to any corporation requires an examination of the tax position of both the issuer and the investor with respect to the issuance of the distress preferred shares. As distress preferred shares are issued in exchange or substitution for a debt obligation which was used by the issuing corporation (or a corporation with which it does not deal at arm's length) in the financing of its business carried on in Canada immediately before the shares were issued, the transaction does not enable the issuing corporation to earn investment income, or any income substituted therefor.
While the transaction will enable the investor corporation to earn investment income, the taxes payable on its income for the year will not be less than the amount of taxes that would be payable for the year if the dividends were the only source of income to the investor, as before the application of subsection 112(2.4) the amount of taxes payable for the year would be nil because of the subsection 112(1) deduction.
As the conditions in subsection 112(2.5) are satisfied, subsection 112(2.4) will not apply to deny a deduction for the dividends received by the investor corporation under subsection 112(1).