Principal Issues: An estate freeze has been implemented. A taxpayer has exchanged his common shares of the capital stock of a corporation for preferred shares of the capital stock of that same corporation. The price agreed upon and the value of the preferred shares received by the taxpayer were subject to a Price Adjustment Clause. The new common shares of the capital stock of the corporation were issued to a discretionary trust. In determining if there is a transfer by the taxpayer to the trust in the context of the application of the provisions of subsection 75(2) to a taxpayer, whether it is still possible to adjust the price and the value of the preferred shares received by the taxpayer pursuant to the Price Adjustment Clause.
Position: The CRA will review each case to determine the validity of the Price Adjustment Clause. The criteria used to determine the validity of the Price Adjustment Clause in the context of the application of subsection 75(2) are the usual criteria used for other purposes of the Act. Provided that (i) the Price Adjustment clause is valid, (ii) it is still possible to adjust the price of the common shares agreed upon, the value of the preferred shares received and the consideration given for the preferred shares redeemed or sold and (iii) the terms of the clause have effectively been implemented, the CRA will take that Price Adjustment clause into account when considering whether the conditions to apply subsection 75(2) are met. It is not necessary to specify that the clause will apply for the purposes of subsection 75(2).
Reasons: Previous position. In file 2010-0366301I7, the CRA did not accept to apply the Price Adjustment Clause not because of a change in our position but because the taxpayers did not implement the terms of the clause.
FEDERAL TAX ROUNDTABLE 5 OCTOBER 2012
2012 APFF CONFERENCE
Question 1
Price Adjustment Clause and Subsection 75(2)
The Canada Revenue Agency ("CRA") has stated on a number of occasions that an estate freeze of a corporation for the benefit of a discretionary family trust could trigger the application of subsection 75(2) in certain circumstances. Technical Interpretation 2009-0317641E5 states that this anti-avoidance measure should not generally apply where a trust subscribes for shares of a corporation in exchange for consideration equal to their fair market value ("FMV"). However, pursuant to the decision in Kieboom (92 DTC 6382), subsection 75(2) could apply where the shares of a corporation are not subscribed for consideration equal to their FMV.
In Technical Interpretation 2010-0366301I7, the CRA found subsection 75(2) to be applicable in the context of an estate freeze for the benefit of a trust. Citing Garron (2009 TCC 450), the CRA concluded that the undervaluation of common shares constitutes a transfer of share rights attributable to existing equity in the corporation by the former shareholder to the trust. According to the CRA, the price adjustment clause related to the issue of the freeze shares was of no assistance to the transferor because at no time were the original proceeds represented by the freeze shares adjusted pursuant to that clause.
Questions to the CRA
(a) Is it correct that, regardless of a taxpayer's efforts to ensure the establishment of the FMV of the shares of a corporation in the context of an estate freeze in favour of a discretionary family trust, the taxpayer will not be able to use a freeze price adjustment clause in the event of a CRA assessment under subsection 75(2)?
(b) Is the answer different if the freeze shares are still held by the freezor at the time of an assessment contemplated under subsection 75(2)?
(c) Is the answer different if the freeze shares were sold to an unrelated person as part of a sale of the shares of the corporation?
(d) Could a taxpayer wishing to proceed with an estate freeze in favour of a discretionary family trust protect against such a result by providing that the price adjustment clause is also applicable for the purposes of subsection 75(2)?
CRA Response
In Technical Interpretation 2010-0366301I7, the CRA concluded that the price adjustment clause attached to the preferred shares issued in an estate freeze could not apply and assist the freezor in the situation submitted to the CRA and described in that document because, in that situation, the taxpayer had not adjusted the price in accordance with the price adjustment clause and it was too late to do so. Accordingly, that document contains specific facts and the position taken with respect to the situation described therein is not indicative of a general conclusion with respect to the validity of a price adjustment clause and its application for the purposes of subsection 75(2).
It is therefore incorrect to conclude that a taxpayer will never be able to rely on a price adjustment clause in the event of a CRA assessment under subsection 75(2).
The CRA will review each situation in determining if a price adjustment clause is valid. In the case of an estate freeze, if the price adjustment clause is valid and the taxpayer makes the necessary changes to the price of the common shares, the redemption value of the freeze preferred shares received and the amount that would have been received for the redeemed freeze preferred shares (by arranging for the corporation to make a refund or payment for the difference, as the case may be), the CRA will consider the tax consequences of the freeze taking into account that clause. Those tax implications will include consideration of the conditions for the application of subsection 75(2). Therefore, it is not necessary for the price adjustment clause to specifically mention that it will also apply for the purposes of subsection 75(2).
The CRA uses the same criteria in determining the validity of the price adjustment clause for purposes of determining whether there is a transfer by the shareholder effecting the freeze to the discretionary trust in the context of a review of the conditions for the application of subsection 75(2) for the purposes of determining the other tax consequences of an estate freeze. The usual criteria include, among other things, the existence of records demonstrating the intention to freeze the common shares at fair market value, the determination of such value by a fair and reasonable method and the fact that the excess or deficiency in the price is in fact reimbursed or paid or the legal liability is adjusted.
If the CRA recognizes the price adjustment clause as valid in a particular situation, under the wording of such a clause, it may result in a retroactive adjustment to the redemption value of the freeze preferred shares. In the situation you submitted to us, the preferred freeze shares have not been redeemed. Consequently, even if an estate freeze occurred in a statute-barred year, the price adjustment clause that would result in a change in the redemption value of the freeze preferred shares would have an effect in respect of the years following the freeze during which those shares were redeemed.
The question of whether our response would be different with respect to the acceptance of a price adjustment clause in a situation where a taxpayer still holds the freeze preferred shares at the time of the possible application of this clause as compared to a situation where that taxpayer sold the freeze preferred shares to an unrelated third party before that time would depend on the circumstances surrounding those situations. For example, if the shares were sold to an unrelated third party, one of the questions to be asked is whether it is still possible to apply the terms of this price adjustment clause for an amendment to be made to the redemption value of preferred shares so sold.
Response prepared by: Sylvie Labarre
(613) 946-5357
2012-045389