Principal Issues: a) In particular situations, do shares which are issued to various shareholders in a freeze transaction, qualify as prescribed shares pursuant to subsection 6205(2) of the Income Tax Regulations (Regulations)?
b) In a situation where many shareholders proceed to a freeze, who will be the original holder pursuant to subsection 6205(2) of the Regulations?
Position: a) Question of fact. General comments.
b) Each author of a freeze.
Reasons: a) Application of subsections 6205(2)(a) and 6205(4)(c) of the Regulations.
b) Application of paragraph 6205(2)(a) of the Regulations.
APFF FEDERAL TAX ROUNDTABLE 11 OCTOBER 2013
APFF CONFERENCE 2013
Question 5
Prescribed shares
The ITA allows an individual resident in Canada to claim, subject to certain conditions, a capital gains deduction ("CGD") in a total amount of $375,000 throughout the individual’s lifetime (subject to a legislative amendment that will come into force in January 2014).
By virtue of subsection 110.6(8), an individual may be denied the opportunity to claim the CGD for a capital gain from the disposition of a property if it can reasonably be concluded that a significant part of the capital gain is attributable to the fact that dividends were not paid on a share, other than as prescribed by Regulation (a “Prescribed Share”).
A Prescribed Share, as defined in subsection 6205(2) ITR, must be issued under an arrangement whose main purpose was to permit any increase in the value of the property to accrue to other shares, and is, in general terms:
- a preferred freeze share issued pursuant to a freeze on the increase in the value of participating shares, if the new participating shares issued pursuant to the freeze are participating Prescribed Shares that are issued to:
- the freezor
- a person who does not deal at arm's length with the freezor;
- a trust whose beneficiaries include only the freezor or persons not dealing at arm's length with the freezor;
- employees;
- a combination of such persons;
- Or a share issued by certain mutual fund corporations.
Situation 1
Opco is controlled by three brothers and also has four equal four minority shareholders who deal at arm's length with each other and with the three brothers. Each shareholder (a "Shareholder") will effect a freeze transaction through exchanging the shares held in Opco for Opco Preferred Shares and, concurrently, trusts, each of which will only have beneficiaries who are not dealing at arm's length with the Shareholder, will subscribe for Opco participating shares in the same proportions as the Shareholder held in Opco immediately prior to the freeze transaction.
Situation 2
Opco is controlled by three brothers and also has four equal four minority shareholders who deal at arm's length with each other and with the three brothers. Each shareholder will incorporate a holding company and become its sole shareholder ("Newco"). Each of the shareholders will effect a share rollover of the shares held in Opco to Newco in consideration for the issuance of participating shares in Newco. As part of a Newco freeze transaction, each shareholder will exchange the participating Newco shares for Newco preferred shares and, concurrently, a trust, all of whose beneficiaries are not dealing at arm's length with the Newco shareholder, will subscribe for participating shares of Newco. Finally, each of the Newcos will be amalgamated with Opco and each of the trust Newco shareholders Trusts will receive participating shares of the amalgamated corporation ("Amalco") while each other Newco shareholder will receive preferred shares.
Questions to the CRA
a) Is the CRA of the view that the shares issued in the freeze transactions described in Situations 1 and 2 above qualify as Prescribed Shares?
b) In a particular situation where all of the shareholders of an operating corporation are arm's length persons and each of the shareholders freezes the shareholder’s interest, who must be considered the "Original Holder" within the meaning of clause 6205(2)(a)(ii)(A) ITR for the purposes of the Prescribed Share analysis?
CRA response to Question 5(a)
The question of whether or not a particular share is a Prescribed Share referred to in 6205(1) ITR or 6205(2) ITR is one of fact and this determination is based not only on the conditions of the share, but also on any agreement relating to the share.
Subsection 6205(1) ITR targets certain shares by specifying the conditions which they must satisfy.
In addition, as stated in response to Question 16 posed at the 2012 Roundtable of the Association de planification fiscale et financière conference ("APFF"), the purpose of subsection 6205(2) ITR is to grant the status of Prescribed Shares, for the purposes of subsection 110.6(8) of the Act, to shares issued under an arrangement the main purpose of which is to effect a total or partial freeze in favour of persons not dealing at arm's length with the freezor shareholder (the "Original Holder"), a trust that only has as beneficiaries the Original Holder or persons not dealing at arm's length with the Original Holder, or employees of the corporation or a combination of these persons and employees.
Paragraph 6205(2)(a) ITR generally defines Prescribed Shares in the context of a freeze as those issued under an arrangement the main purpose of which is to permit any increase in the value of the property of the particular corporation to accrue to other shares that would, at the time of their issue, be Prescribed Shares if this paragraph was read without reference to subsection 6205(2) ITR.
The information provided for Situations 1 and 2 is not sufficient to determine whether the new participating shares are Prescribed Shares as defined in subsection 6205(1) ITR on the date of their issuance. For the purposes hereof, we therefore have assumed that the participating shares issued by Opco in Situation 1 and those issued by each Newco in Situation 2, are Prescribed Shares on the date of their issuance as defined in subsection 6205(1) ITR.
Since, in both situations, the preferred shares do not meet the conditions of subsection 6205(1) ITR, they would be Prescribed Shares only if all the conditions described in subsection 6205(2) ITR are satisfied.
For the purposes of this question, we have also assumed that there are no other shares issued respectively by Opco and Newco in Situations 1 and 2, other than the preferred shares and the participating shares.
Situation 1
We have assumed that each Original Holder of Opco is not an employee of Opco and that each person who has a beneficial interest in each of the trusts deal at arm's length with that shareholder. We have also taken as given that the freeze transactions described in Situation 1 were effected pursuant to an arrangement whose main purpose was to permit an increase in the value of Opco's assets to accrue to the new participating shares issued to each of the trusts.
Under clause 6205(2)(a)(ii)(A), and on the facts provided, 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.
In our view, the conditions in clause 6205(2)(a)(ii)(A), at the level of the holding of the participating shares of Opco issued as part of the freeze transaction described in Situation 1, are not satisfied. In fact, 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.
Consequently, the preferred shares issued to each Original Holder would not qualify as Prescribed Shares by virtue of paragraph 6205(2)(a) ITR.
Situation 2
The CRA can only make a final determination on this issue in the context of a full review of all facts and documents, either during an audit or as part of an advance ruling request. However, we can make the following general comments.
For the purposes of our response, we have assumed that no Original Holder or beneficiary of the trusts is an employee of Opco or Newco. In addition, we have assumed that at the time of the rollover of the shares of the capital stock of Opco to each Newco, each Original Holder is the sole holder of all the shares of the capital stock of each of the Newcos.
If the freeze transactions described in Situation 2 are effected pursuant to an arrangement whose main purpose was to permit any increase the value of the property of each Newco to accrue to the new participating shares of each Newco, each preferred freeze share issued by each Newco to each Original Holder could qualify as a Prescribed Share if the participating shares are held by a trust all of whose beneficiaries do not deal at arm's length with each Original Holder who is the originator of the freeze and the sole holder of the preferred freeze shares issued by each Newco. In addition, the participating shares must satisfy the conditions of subsection 6205(1).
Under paragraph 6205(4)(c), where each Newco and Opco amalgamate, the corporation resulting from the amalgamation (the "New Corporation") will be deemed to be the same corporation as, and a continuation of, each of the predecessor corporations, and any share of the capital stock of the New Corporation issued on the merger or amalgamation as consideration for a share of the capital stock of a predecessor corporation is deemed to be the same share as that of the predecessor corporation for which it was issued. In other words, in the event of an amalgamation, paragraph 6205(4)(c) creates a presumption under which preferred shares issued by the New Corporation to each Original Holder qualify as a Prescribed Share.
However, this presumption would not apply if the preferred shares issued by the New Corporation are not Prescribed Shares on the date of their issuance and if, depending on the situation:
(i) the terms and conditions of that share are not identical to those of the share of the predecessor corporation for which it was issued,
(ii) at the time of its issue the fair market value of that share is not the same as that of the share of the predecessor corporation for which it was issued.
Based on the facts that you have provided, there is some uncertainty as to whether the above conditions are satisfied. Thus, 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.
We query whether this result - that the preferred shares issued by the New Corporation to each Original Holder would be Prescribed Shares - is in line with tax policy. We wish to consult with the Department of Finance respecting this situation.
CRA response to question 5(b)
Under subclause 6205(2)(a)(ii)(A)(I) ITR, the Original Holder is the person to whom the particular share was issued pursuant to paragraph 6205(2)(a). Therefore, every person to whom a corporation issues the particuoar shares (the freeze shares) as part of a total or partial freeze would be considered an Original Holder.
Lucie Allaire
(613) 957-2046
2013-049651j