Principal Issues: In the course of an estate freeze, preferred shares are issued to a taxpayer in consideration for common shares. The redemption value of those shares would be equal to the fair market value of the common shares acquired by the corporation. The rights, privileges, conditions and restrictions of the preferred shares described in the articles of incorporation would contain a price adjustment clause. Pursuant to that price adjustment clause, the redemption value of the preferred shares would be adjusted to reflect the fair market value of the consideration if the amount considered to be the fair market value is changed. If the preferred shares are redeemed before an upward adjustment to the redemption value, the corporation would pay an additional amount to the taxpayer. What would be the tax treatment of such additional payment made by the corporation in favour of the taxpayer?
Position: In such a case, the CRA's position is that the additional payment made by the corporation in favour of the taxpayer, as a result of the price adjustment clause becoming operative, would be treated as a dividend. Such a dividend would have to be included in the shareholder's income in the year of receipt under subsection 84(3) of the Act.
Reasons: Previous position.
Canadian Tax Foundation
2011 Roundtable
November 29, 2011
Receipt of an additional deemed dividend
Question 9
In the course of an estate freeze, a taxpayer transfers the participating shares of the capital stock of a corporation to that corporation, in consideration for its issuance of freeze preferred shares of its capital stock. The redemption value of these freeze preferred shares is equal to the fair market value of the participating shares received as consideration. The articles of the corporation include a price adjustment clause in the rights, privileges, conditions and restrictions attached to the freeze preferred shares. Under this price adjustment clause, the redemption value of the freeze preferred shares that is determined at the time of issue must be adjusted if the Canada Revenue Agency determines a fair market value of the participating shares given in consideration is different from the value originally established by the taxpayer and the corporation. In addition, the price adjustment clause provides that, should the redemption price of the preferred shares be adjusted upward following the redemption of shares, the corporation must pay to the holder of the redeemed shares the difference per share between the redemption price as adjusted and the amount actually received upon redemption ("additional payment").
The taxpayer then redeemed the freeze preferred shares, about 5 years ago.
Subsequently, there was a dispute over the determination of the redemption value of the freeze preferred shares. After a certain period of time, the fair market value was determined to be higher than that initially determined.
Once the value of the freeze preferred shares has been determined, the price adjustment clause takes effect to redetermine the amount that should have been paid upon the redemption of the shares. As a result, the corporation making the redemption must make an additional payment to the taxpayer.
We understand that the nature of the additional payment received by the taxpayer as a result of the effect of the adjustment clause will be that of a deemed dividend for any amount in excess of the paid-up capital of the shares redeemed. Indeed, at the 1998 APFF Federal Round Table (at question 4.6), it was stated that any additional payment made to an individual under a price adjustment clause will be considered a deemed dividend by virtue of 84(3) and not a supplementary addition to the proceeds of disposition.
Questions
- At what time will the supplementary deemed dividend be deemed by virtue of 84(3) to be paid by the corporation to the taxpayer and at what point will it be deemed to be received by the taxpayer?
- In the year the redemption was made? (Five years ago in 2006)
- In the year the additional payment was made? (i.e., 2011)
b) In the event that the answer is 2006 and the year is statute-barred, what steps should the taxpayer take? On the other hand, if the corporation that repurchased shares in 2006 had a refundable dividend tax on hand balance, what steps must it take to recover the dividend refund?
CRA Response
In such a case, the situation would be similar to that indicated in Question 4.6 of the APFF Federal Tax Round Table which took place at the association's 1998 conference. Thus, in this context, the CRA would apply the position taken in 1998 which is still valid. In 1998, the CRA indicated that it considered the additional payment made pursuant to the price adjustment clause [TaxInterpretations translation]:
"as a dividend, for both the payor and the recipient, for the following reasons:
- The payment arises from a right relating to a share.
- The payment is made as a result of a redemption of shares under subsection 84(3) and is incidental to such redemption.
- To treat the payment as a capital payment would change the nature of the payment otherwise made and the income otherwise realized.
- This position favours the uniform treatment of shareholders and corporations with respect to the application of subsection 84(3)."
The position of the CRA is that this inclusion as a dividend pursuant to subsection 84(3) would take place in the year of receipt of the additional payment. Furthermore, and for the purposes of subsection 129(1), the dividend would be considered to have been paid by the payer in the taxation year in which the additional payment was actually made.
Consequently, in the situation presented above, the taxpayer should include in the computation of the taxpayer’s income for the 2011 taxation year a dividend equal to the additional payment received in 2011.
Sylvie Labarre
2011-042636
November 29, 2011