5-920241
24(1) M. Querry
(613) 957-8953
Attention:19(1)
May 15, 1992
Dear Sirs:
Re: Subsection 110.6(8) of the Act and Regulation 6205 - Prescribed Shares
We are writing in response to your letter dated January 21, 1992 in which you requested our views on the application of the above-referenced provisions to the following hypothetical situation. We apologize for the delay in our reply.
Four unrelated individuals, Messrs A, B, C and D, are the shareholders of a Canadian controlled private corporation carrying on an active business in Canada ("Opco"). Messrs. A, B and C would like to freeze their present interest in Opco and pass the ongoing growth in the business on to their children, while Mr. D would like his wife to have an equity interest.
Each of Messrs. A, B, C and D sells his shares of Opco to Newco in return for fixed value preferred shares having a fair market value ("FMV") and redemption amount equal to the FMV of the common shares of Opco at the time of the transfer. Common shares of Newco are purchased from treasury as follows:
Mr. E - (son of Mr. A) - 25%
Mr. F - (son of Mr. B) - 25%
Mr. G - (son of Mr. C) - 12.5%
Mrs. H - (daughter of Mr. C) - 12.5% 25%
Mrs. D - (wife of Mr. D) - 12.5%
Mr. D 12.5% 25%
Messrs. E and F are employed on a full time basis by Opco while Mr. G, Mrs. H and Mrs D are not.
Your concern is whether, at the conclusion of the transactions, the preferred shares held by Messrs A, B, C and D (or any one of them) constitute prescribed shares as defined in paragraph 6205(2)(a) of the Income Tax Regulations (the "Regulations").
Our comments
It is our view that any of the preferred shares are not prescribed shares pursuant to paragraph 6205(2)(a) of the Regulations unless the common shares that are issued as part of the arrangement are issued to persons who did not deal at arm's length with each of the original holders at the time of the issue of the preferred shares or at the end of the arrangement. Depending on the particular circumstances, the preferred shares of one shareholder could satisfy the requirements in subsection 6205(2) of the Regulations while the other preferred shares of another shareholder could not.
Paragraph 251(1)(b) of the Income Tax Act provides that it is a question of fact whether or not persons who are not related to each other are dealing at arm's length at a particular time. Please refer to paragraphs 10 to 14 of Interpretation Bulletin IT-419 for the Department's views on the criteria to be applied in determining whether unrelated persons are dealing at arm's length.
It is also our view that a share is not a prescribed share where it is issued as part of an arrangement whereby the increase in the value of the issuing corporation will accrue to "other shares" that are issued to both persons described in clause 6205(2)(a)(ii)(A) and to persons described in clause 6205(2)(a)(ii)(B) of the Regulations.
We trust our comments will be of assistance.
Yours truly,
Maurice Bisson for DirectorBusiness and General DivisionRulings DirectorateLegislative and IntergovernmentalAffairs Branch