Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.
Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.
Principal Issues: Whether ss.248(28) would apply in a taxation year to a situation where a ss.84(1) deemed dividend is received on a share that it mark-to-market property.
Position: Ss. 248(28) may apply in some cases to reduce the profit computed under section 142.5 by all or part of the amount included in income for the year under ss. 84(1). .
Reasons: It remains a question of fact to be determined in each case, whether there has been any double inclusion in income to which ss. 248(28) would apply. It would also be necessary to determine on the facts, how much of the ss 84(1) deemed dividend is reflected in the profit computed under ss.142.5(1) as there are generally other factors which would affect the FMV of shares in addition to the receipt of deemed dividends
XXXXXXXXXX 1999-000700
Alison M. Campbell
April 11, 2001
Dear XXXXXXXXXX:
Re: Deemed Dividends on Mark-to-Market Property
This is in your reply to your letter of October 4, 1999, wherein you requested our comments on the application of section 142.5 and subsections 84(1) and 248(28), where there is a step-up in the paid up capital of preferred shares held as mark-to-market property by a financial institution. It appears that your question may relate to specific transactions that you are contemplating. The specific tax consequences of a proposed transaction can only be confirmed by way of an advance income tax ruling prepared in accordance with the guidelines set out in IC 70-6R2. We can however, provide the following general comments that may be of assistance to you, but are not binding on the Agency.
Where at the end of a taxation year, a taxpayer holds shares that are mark-to-market property as defined in subsection 142.2(1), the taxpayer will be deemed to have disposed of the shares immediately before the end of the taxation year for proceeds equal to the fair market value of the shares pursuant to subsection 142.5(2). Any resulting profit or loss would be included in the taxpayer's income for the year under subsection 142.5(1).
Where, during a taxation year, the issuing corporation increases the paid up capital of a share that is mark-to-market property to the shareholder with the result that the taxpayer is deemed to have received a dividend pursuant to subsection 84(1), it is your view that unless subsection 248(28) applies an amount will be included twice in computing the income of the taxpayer.
In our 1998 document number 9803947, we stated that where subsection 84(3) applied, to deem a dividend to have been received by a financial institution on the redemption of a mark-to-market share, subsection 248(28) would apply to reduce the amount of the proceeds used in computing the profit under subsection 142.5(1) by the amount of the subsection 84(3) deemed dividend.
It will be a question of fact in each particular situation, whether the same amount is being included in income twice when subsection 84(1) and section 142.5 both apply in a taxation year in respect of a share. There are several factors that would need to be considered in assessing the applicability of subsection 248(28) to each situation where subsection 84(1) deemed dividends have been realized on shares that are mark-to-market property.
1. It is our view that subsection 248(28) would only apply with respect to the amount of the increase in value of the share being included in income under section 142.5 that is attributable to the deemed dividend being included in income under subsection 84(1). While the FMV of shares would generally be expected to increase when the redemption amount of shares is increased, the amount of any increase or decrease in the FMV of shares would also be affected by other factors such voting, dividend entitlement, trading, and liquidation rights. Therefore, it would be necessary to determine the amount of any FMV increase that is attributable to a subsection 84(1) dividend, before determining the amount of any adjustment under subsection 248(28) in computing income under subsection 142.5(1).
2. There would only ever be one year in which subsection 84(3) and section 142.5 would both apply in respect of a share; the year the share is redeemed. However, the circumstances where subsection 84(1) deemed dividends may be realized on a mark-to-market share is more complicated as there may be several years, during which the share is held, that a deemed dividend under subsection 84(1) is realized and subsection 142.5(1) also applies. This fact must be taken into account in determining the application of subsection 248(28) in such a situation.
3. Paragraph 142.5(2)(b) provides for the cost amount of a share that is a mark-to-market property to be readjusted each year based on the FMV of the share at the end of the immediately preceding taxation year. Therefore, to the extent the FMV at the end of a taxation year reflects a deemed dividend under subsection 84(1) during the year, that portion of the subsection 84(1) dividend would also be reflected in the cost base of the share at the beginning of the following taxation year. Again, this fact must be considered in determining the appropriate application of subsection 248(28) in situation similar to the one you described.
Based on the foregoing comments, our general view would be that to the extent a subsection 84(1) deemed dividend included in income in a year or a preceding year is reflected in the profit otherwise computed under subsection 142.5(1) for a taxation year, the profit included in income under subsection 142.5(1) for the year would be reduced. It is possible that in situations where these types of shares are outstanding over several taxation years, it will be necessary to track maintain an annual tracking of the amount of deemed dividends from prior years that were not reflected in the FMV of the share in the year in which they arose, but may be the reason for an increase in the FMV of the share in a subsequent year. For illustration purposes consider the following hypothetical example.
Original Cost and PUC of Share $ 0
Subsection 84(1) Deemed Dividend - Yr 1 $ 50
Subsection 84(1) Deemed Dividend - Yr 2 $ 75
FMV at End of Year 1 $ 30
FMV at End of Year 2 $120
Redeemed in Year 3 for $125
Assuming the only factor affecting the FMV of the share is its redemption amount and the fact that the share is not redeemable until year 3, a deemed dividend of $50 would be included in computing income of the shareholder and the profit to be included in income under section 142.5 for Year 1 would be nil. This is because subsection 248(28) would apply to reduce the inclusion of the $30 of mark-to-market profit by $30 of deemed dividends. The $20 of deemed dividends not reflected in Year 1 would then have to be tracked forward to Year 2.
In year 2, the profit otherwise to be included in income under subsection 142.5 of $90 ($120-$30), would be reduced by $90 on the application of subsection 248(28). The $90 is the portion of the total deemed dividends from Year 1 and Year 2 of $125 that at the end of Year 2 is reflected in the FMV. It excludes the $30 of the Year 1 deemed dividend that was reflected in the Year 1 FMV, which is reflected in the cost of the share in Year 2 for the purposes of computing the mark-to-market profit on the share. At the end of Year 2 there is $5 of deemed dividend that has not yet been reflected in the FMV of the share and $120 of deemed dividend that is reflected in the cost of the share for the purposes of computing mark-to-market profit.
On redemption in year 3, there would be no deemed dividend on the shares under subsection 84(3) since the redemption amount is equal to the PUC of the share. The mark to market gain computed before considering subsection 248(28) would be $5 ($125 - $120). This income amount would then be reduced to nil by applying subsection 248(28) to remove from double inclusion in income of the taxpayer the $5 of deemed dividends already included in income in a prior year and now reflected in the FMV of the share.
As is clear from this simplistic example, the use of subsection 248(28) in this situation is cumbersome and may not provide an appropriate result in all circumstances. Furthermore, it would have to be established that the increase in fair market value of the shares was solely the result of the increases in paid up capital. Accordingly, we will bring the issue to the attention of the Department of Finance to discuss the possibility of a legislative amendment, so that subsection 248(28) would not be required in these circumstances.
We trust our comments will be of assistance to you.
Yours truly,
F. Lee Workman
Manager
Financial Institutions Section
Income Tax Rulings Directorate
Policy and Legislation Brach
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