XXXX V.A. Sider (613)995-1178
April 7, 1982
XXXX
We are writing in response to your letter of March 11, 1982 wherein you requested a technical interpretation on the application of subsection 55(2) of the Income Tax Act of Canada (the "Act").
In your letter you outlined a plan which is much like an estate freeze and which is designed to allow the employees of a company to share in its future growth. The basic components of this plan are described below:
1. The present owner of a Canadian-controlled private corporation ("OPCO") incorporates a holding company ("HOLDCO").
2. The owner transfers 100% of the common shares of OPCO to HOLDCO on a tax-free basis using section 85 of the Act. Common shares of HOLDCO are received as the only consideration.
3. The common shares of OPCO are converted on a tax-free basis under section 86 of the Act into preferred shares of OPCO having a fair market value and paid-up capital equal to the fair market value and paid-up capital of OPCO's common shares.
4. HOLDCO subscribes for 50% of a new issue of common shares of OPCO and OPCO's employees subscribe for the other 50%.
5. HOLDCO and the employees enter into a unanimous shareholders agreement whereby it is agreed that OPCO's preferred shares held by HOLDCO will be redeemed as and when possible, based on accumulating retained earnings of OPCO.
You have asked whether, upon redemption of the OPCO preferred shares held by HOLDCO, the provisions of paragraph 55(2)(b) of the Act would apply to the resulting deemed dividends and, if so, would the "safe income" attributable to the preferred shares be equivalent to the "safe income" formerly attributable to the owner's common shares of OPCO.
In our view paragraph 55(2) (b) of the Act would apply to the dividends resulting from the redemption of the preferred shares, and the safe income originally attributable to the owner's common shares of OPCO would flow through on a pro-rata basis to the preferred shares of OPCO. It is our opinion that the owner is in effect disposing of part of his interest in OPCO and that therefore the application of subsection 55(2) in these circumstances is proper.
Yours truly,
ORIGINAL SIGNED BY ORIGINAL SIGNÉ PAR R.D. WEIL
for Director General Corporate Rulings Directorate Legislation Branch