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A.A. Cameron (613) 957-2116
JUN 27 1988
Dear Sirs:
Re: Shares issued to employees
This is in reply to your letter of November 16, 1987 in which you requested a technical interpretation concerning the following hypothetical fact situations which were presented to us as follows:
"Situation 1
1. Company A is a Canadian-controlled private corporation.
2. In recognition of employment services, Company A issued preferred shares to certain arm's length employees. The preferred shares had the following attributes:
- non-voting, non-participating - par value 1 cent - redemption value $100
3. The shares were issued prior to May 23, 1985.
Situation 2
1. The facts are as in situation 1, except the shares were issued to the employees subsequent to May 23, 1985.
Questions
1. If the shares were held by the employees for two years and then Company A redeems the shares, what are the income tax consequences to the employee in situations 1 and 2 above?
2. If an affiliated company to Company A redeemed the preferred shares, would the proposed Part 11.1 tax apply in situations 1 and 2 above?
3. Would Revenue Canada be willing to provide an advanced ruling or a comfort letter in respect of the proposed Part II.1 tax if the response to question 2 as is applies to situation 2 is that the Part II.1 tax does not apply?"
We will respond to your questions in the same order in which they were presented.
1. (a) Assuming the Class A Shares were acquired by the employees prior to May 23, 1985
In our opinion, provided that Company A was a Canadian-controlled private corporation (a "C.C.P.C.") at the time it agreed to issue the Class A Shares to the employees, the employees were dealing at arm's length with Company A immediately after that time, and the employees have not disposed of the Class A Shares within two years from the date they acquired them, the provisions of subsection 7(1.1) of the Income Tax Act ("the Act") as it read prior to May 23, 1985 would be applicable. Consequently, no benefit would arise to the employee pursuant to subsection 7(1) of the Act, a dividend in the amount of $99.99 would be deemed to have been received on each Class A Share pursuant to subsection 84(3) of the Act, the provisions of subparagraph 54(h)(x) would operate to reduce the employee's proceeds of disposition for each Class A Share by the amount of the above-mentioned deemed dividend, and the employee would realize a capital gain of one cent in respect of each Class A Share redeemed. Where the disposition of the Class A Shares occurred in a taxation year subsequent to 1984, and provided that for the purposes of subsection 110.6(3) of the Act the employee was resident in Canada throughout that taxation year, the employee would be able to include the amount of the capital gain arising on the disposition in the calculation of his annual gains limit for the purposes of subsection 110.6(3) of the Act.
(b) Assuming the Class A Shares were acquired by the employees subsequent to May 22, 1985
In our opinion, provided that Company A was a C.C.P.C. at the time it agreed to issue the Class A Shares to the employees and the employees were dealing at arm's length with Company A immediately after that time, the provisions of subsection. 7(1.1) of the Act would be applicable. Consequently paragraph 7(1)(a) of the Act would deem a benefit to have been received by the employee by virtue of his employment, in the taxation year in which he disposed of the Class A Shares, equal to the value of those shares at the time he acquired them. The provisions of subsection 84(3) and subparagraph 54(h)(x) of the Act will operate as detailed under alternative(a) above, however, the provisions of paragraph 53(1)(j) would operate to add the amount of the benefit included in the employee's income by virtue of paragraph 7(1)(a) to his adjusted cost base of the Class A Shares with the result that the employee would have a capital loss on the disposition of his Class A Shares. Provided all the requirements of paragraph 39(1)(c) of the Act are satisfied this capital loss, subject to all the reductions referred to in that paragraph, could be a business investment loss to the employee. Pursuant to paragraph 110(1)(d.1) of the Act (assuming that paragraph 110(1)(d) of the Act is not relevant based upon this hypothetical fact situation) the employee would be able to deduct in calculating his taxable income an amount equal to one-half of the benefit included in his income for that year pursuant to paragraph 7(1)(a) of the Act.
In our opinion the provisions of subsection 4(4) of the Act will not operate to delete either the inclusion in an employee's income arising under section 7 of the Act or the amount of the deemed dividend pursuant to subsection 84(3) of the Act.
2. In our opinion, under both situations, the provisions of subsection 183.1(1) of the Act (as presently enacted) would apply upon the acquisition of the Class A Shares by an affiliate of Company A unless the acquisition could be exempted by virtue of paragraph 183.1(4)(c) of the Act. However, since the Class A Shares would not appear to qualify as "prescribed shares" under the definition contained in draft subsection 6207(1) of the Income Tax Regulations, this exemption would likely not be available.
We note that the Notice of Ways and Means Motion to amend the Act which was tabled in the House of Commons on June 13, 1988 proposes to amend section 183.1 of the Act. The proposed amendment, as presently drafted, has no application to the above situations.
However, other proposed provisions of the Act may have application.
3. The Department is prepared to provide advance income tax rulings, with respect to proposed transactions, based on the Act at a particular time. Additional comments and/or opinions, if appropriate, will generally be included in advance income tax rulings with respect to proposed changes to the Act once draft legislation is available.
The comments expressed above reflect our interpretation of how the provisions of the Act referred to herein would generally apply to the hypothetical fact situations outlined above. The application of these, or other, provisions of the Act to the facts of a particular fact situation may yield results which differ from those described above.
Yours truly,
for Director Reorganizations and Non-Resident Division Specialty Rulings Directorate Legislative and Intergovernmental Affairs Branch