XXXX
J.D. Brooks (613) 957-2118
Attention: XXXX
April 24, 1986
Dear Sirs:
Re: Section 86 of the Income Tax Act (the "Act")
This is in reply to your letter of February 7, 1986 in which you requested our opinion on the application of subsection 86(1) of the Act.
You presented a hypothetical situation involving XYZ Company, a Canadian controlled private corporation. The share capital of XYZ Company consists of common shares and a class of special shares ("Class B shares") which are non-participating and which provide for a 5% cumulative dividend per annum. The sole owner of the Class B shares is an individual, Mr. X. The redemption amount of the Class B shares is $100,000 and no dividend has been paid on these shares for three (3) consecutive years. The Class B shares constitute capital property of Mr. X.
The share capital of XYZ Company will be reorganized such that the Class B shares will be exchanged for shares of a new class, i.e. Class D shares, which will have a redemption value of $115,000, i.e. an amount equal to the redemption value of the Class B shares plus $15,000 representing the cumulative dividends in arrears. The paid-up capital of the Class D shares will be equal to the paid-up capital of the Class B shares given up in exchange. It is assumed that the Class B shares rank in preference to common shares as to dividend entitlement prior to the reorganization.
The wording of your question suggests that the transactions described may relate to a specific taxpayer. If that is the case, it would be appropriate for you to request an advance income tax ruling. The guidelines for advance ruling applications are set out in Information Circular 70-6R, published by the Department on December 18, 1978. Nevertheless we offer the following general opinion.
In our opinion, the provisions of subsection 86(1) of the Income Tax Act (the "Act") would apply in your example, subject to the provisions of subsections 86(2) and (3). Subsection 86(2) may apply if, having regard to the facts of a particular case, it is reasonable to consider that a benefit is conferred by holders of a class of shares on related persons who own shares of another class, such as the common shares in this example. A benefit could be considered to arise in your example if as a result of the reorganization the common shareholders become entitled to dividends prior to the time at which they would have otherwise been entitled to dividends. If the common shares are owned by persons not related to the preference shareholder, subsection 245(2) might have application.
These comments represent an expression of opinion and are not binding on the Department, as explained in paragraph 24 of Information Circular 70-6R.
Yours truly, for Director Reorganizations and Non-Resident Division Specialty Rulings Directorate Legislative and Intergovernmental Affairs Branch