2016-0634551E5 Ss 191(4) and PAC

Principal Issues: i) Whether a PAC that is included in the terms or conditions of a taxable preferred share will negate the amount specified in subsection 191(4). (ii) How would the operation of the PAC affect the amount of original deemed dividends and additional deemed dividends that will qualify as excluded dividends for the purposes of subsection 191(4).

Position: (i) No. (ii) If the PAC becomes operative to increase the original redemption amount to an amount in excess of the specified amount, the additional dividends arising will not qualify as excluded dividends; however, the original deemed dividends will continue to qualify as excluded dividends. If the PAC operates to reduce the redemption amount to an amount less than the specified amount, the entire amount of the original deemed dividends will be disqualified as excluded dividends.

Reasons: (i) The 1989 Conference Report and document # 9309585 did not state a PAC would negate the specified amount. (ii) Where the PAC operates to increase the redemption amount, the excess amount calculated under subsection 191(5) will apply to deny excluded dividend treatment to the additional dividends. If the PAC operates to reduce the redemption amount, the condition stipulated in the mid-amble of subsection 191(4), that the specified amount does not exceed the FMV of property received as consideration on the issuance of the shares, will not be met.

Author: Ferrari, Rob
Section: 84(3), 191(4), 191(5)

XXXXXXXXXX                                                                                   2016-063455
                                                                                                           R. Ferrari
May 4, 2016

Dear XXXXXXXXXX:

Re:  Subsection 191(4) and Price Adjustment Clause

We are writing in response to your enquiry that we received on February 29, 2016, with respect to the impact of a price adjustment clause (“PAC”) on the “specified amount” for the purpose of subsection 191(4) of the Income Tax Act (the “Act”).

We understand that in the hypothetical scenario described, the terms and conditions of taxable preferred shares (the “shares”) specify an amount for which the shares are to be redeemed, acquired or cancelled for the purposes of subsection 191(4).  The specified amount would equal, but would not exceed the fair market value of the consideration for which the shares are issued and the consideration received for the issuance of the shares would not include a taxable preferred share.  The terms and conditions of the shares also separately contain a PAC in respect of the redemption price of the shares, based on the fair market value of the consideration for which such shares were issued.

The submission requests confirmation that the inclusion of a PAC in the terms of the shares will not cause the denial of the specified amount for the purposes of subsection 191(4).  Further, if the shares have been redeemed and deemed dividends arose under subsection 84(3), which were deemed to be excluded dividends, you ask how the subsequent operation of the PAC would impact the amount of the dividends that would qualify as excluded dividends.

Our Comments

This technical interpretation provides general comments about the provisions of the Act and related legislation (where referenced). It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination. The income tax treatment of a particular transaction proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R7, Advance Income Tax Rulings and Technical Interpretations.

Paragraph 84(3)(a) may deem a corporation to have paid a dividend on the redemption, acquisition or cancellation of shares in an amount by which the amount paid on the redemption exceeds the paid-up capital of those shares.  Part V1.1 of the Act provides for a tax on corporations paying certain dividends on taxable preferred shares and short-term preferred shares in excess of the corporation’s dividend allowance.  An exception to Part VI.1 tax is provided for “excluded dividends” as defined in subsection 191(1), which includes, inter alia, dividends that are paid to a shareholder that has a "substantial interest" in the corporation as defined in subsection 191(2).  Where the conditions of subsection 191(1) are not otherwise met, relief from Part VI.1 tax may also be available under subsection 191(4), which deems certain deemed dividends to be excluded dividends.

Paragraph 191(4)(a) contemplates the circumstances, as described in your submission, in which a share of the capital stock of a corporation is issued.  In such cases, the mid-amble of subsection 191(4) describes the following conditions that are required to be met:

“…the terms or conditions of the share or the agreement in respect of the share specify an amount in respect of the share, including an amount for which the share is to be redeemed, acquired or cancelled (together with, where so provided, any accrued and unpaid dividends thereon) and where paragraph (a) applies, the specified amount does not exceed the fair market value of the consideration for which the share was issued.”

Where the above conditions are met and deemed dividends arise on a redemption, acquisition or cancellation of a share to which subsection 84(2) or 84(3) applies, paragraph 191(4)(d) deems the dividends to be excluded dividends for the purposes of, inter alia, Part VI.1, unless the share was issued for consideration that included a taxable preferred share.  Subsection 191(5) stipulates a limitation with respect to the amount that may qualify as excluded dividends, which reads as follows:

“Subsection 191(4) does not apply to the extent that the total of:

(a)   the amount paid on the redemption, acquisition or cancellation of the share, and
(b)   all amounts each of which is an amount (other than an amount deemed by subsection 84(4) to be a dividend) paid, after the particular time and before the redemption, acquisition or cancellation of the share, on a reduction of the paid-up capital of the corporation in respect of the share exceeds the specified amount referred to in subsection (4).”

We have assumed that the amount referred to in paragraph 191(5)(b) is not relevant to your enquiry.  With respect to the specified amount, the CRA has indicated that for the purposes of subsection 191(4) of the Act, the terms or conditions of the share or agreement in respect of the share must specify an actual dollar amount, and where no amount has been specified, the specified amount will be the amount for which the share is to be redeemed, acquired or cancelled.  Accordingly, the specified amount is not permitted to be based on a formula that relates to some other share, nor will the specified amount be adjusted if the PAC becomes operative.  These positions were confirmed at the 1989 Revenue Canada Round Table - Question 20 and in technical interpretation 9309585.

In the circumstances you have described, the terms and conditions of the shares will separately contain a PAC with respect to the redemption amount.  In such cases, the CRA accepts that the shares being the subject to the potential operation of a PAC will not, in and of itself, negate the amount that was specified for the purposes of subsection 191(4).

If in the circumstances described above, the PAC became operative after the redemption of the shares to increase the redemption to an amount in excess of the specified amount, the excess would not qualify as an excluded dividend by virtue of subsection 191(5).  However, the operation of the PAC would not, in and of itself, result in the original deemed dividend being disqualified as an excluded dividend.  On the other hand, if the PAC were to become operative to reduce the redemption amount to an amount that is less than the specified amount, the requirement in subsection 191(4), that the specified amount not exceed the fair market value of the consideration for which such shares were issued, would not be met.  As a result, the entire amount of the original deemed dividend would be disqualified as an excluded dividend for the purposes of subsection 191(4).

We trust our reply will be of assistance.

Yours truly,

G. Moore
For Director
Reorganizations Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

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