Situation 1
Opco is controlled by three brothers and its shares are held also by four minority shareholders (the "First Shareholders") who deal at arm's length with each other and the three brothers, and are later assumed by CRA not to be employees. Each shareholder (an "Original Shareholder") implements an estate freeze under which the Original Shareholder's shares of Opco are exchanged for preferred shares of Opco and a family trust subscribes for Opco participating shares. Are the preferred shares prescribed shares?
Response
In indicating that the preferred shares did not qualify as prescribed shares, CRA stated (Tax Interpretations translation):
Under clause 6205(2)(a)(ii)(A) ... in order for Opco preferred shares, issued to each Original Holder, to be Prescribed Shares, it is in particular necessary that the participating shares issued by Opco be owned by a person who did not deal at arm's length with each Original Holder or a trust none of whose beneficiaries were other than an Original Holder or persons who did not deal at arm's length with each Original Holder.
...[Instead] the trusts that hold Opco's participating shares do not deal on a non-arm's length basis with each Original Holder. The same applies for the beneficiaries of each of the trusts, who do not deal on a non-at arm's length basis with each of Opco's Original Holders.
Situation 2
The estate freeze of each Original Holder implemented differently.
Each Original Holder transfers its Opco shares to a Newco of which he or she is the sole shareholder in consideration for Newco shares, exchanges its shares of Newco for Newco preferred shares and the family trust subscribes for Newco participating shares. The four Newcos and Opco then amalgamate with the Original Holders and trusts receiving replacement preferred and participating shares, respectively, from Amalco (the "New Corporation"). Are the preferred shares prescribed shares?
Response
After summarizing the purpose requirement in Reg. 6205(2)(a)(i), and the requirement in Reg. 6205(2)(a)(i)(III) that each beneficiary not deal at arm's length with the Original Holder , and noting that each participating share would be required to satisfy Reg. 6205(1), and before noting the requirements of Reg. 6205(4)(c)(i) and (ii), CRA noted (Tax Interpretations translation) that, respecting the amalgamation, Reg. 6205(4)(c) " creates a presumption under which preferred shares issued by the New Corporation to each Original Holder qualify as a Prescribed Share."
CRA went on to state that although "there is some uncertainty ... it is possible that the presumption provided in paragraph 6205(4)(c) ITR may apply to the preferred shares of the capital stock of the New Corporation issued to each Original Holder so that they qualified as Prescribed Shares." In a live case, CRA would consult with Finance.