13 December 2005 External T.I. 2005-0136041E5 - Stop-Loss Rules - 112(3)

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.

Principal Issues: Status of certain shares under the transitional provisions to subsection 112(3) of the Act which are contained in subsection 131(1) of S.C. 1998, c.19 (the "grandfathering rules").

Position: General comments.

Reasons: The law.

XXXXXXXXXX 2005-013604
Michael Cooke
December 13, 2005

Dear XXXXXXXXXX:

Re: Subsection 112(3) and the Stop-Loss Rules

This letter is in response to your letter dated June 8, 2005, concerning whether certain shares, in the circumstances described in your letter, would be subject to the transitional provisions to subsection 112(3) of the Income Tax Act (the "Act") which are contained in subsection 131(1) of S.C. 1998, c.19 (hereinafter referred to as the "grandfathering rules").

Briefly, in your letter you indicate that the shareholders of a taxable Canadian corporation ("Xco") entered into a shareholders' agreement (the "Agreement") prior to April 27, 1995. The Agreement called for, among other things, Xco to repurchase its shares owned by a shareholder of Xco when that person died. Contemporaneously with the execution of the Agreement, Xco obtained life insurance for the sole purpose of funding its obligation to repurchase its shares on the death of an individual who is a direct or indirect shareholder of Xco as contemplated under the terms of the Agreement.

You indicate that, subsequent to April 26, 1995, new individuals became shareholders of Xco and that all new shareholders of Xco must agree to be bound by and become party to the Agreement. You indicate that new shareholders are added to the Agreement by way of an amendment but that none of the amendments are considered to replace the Agreement such that the Agreement has remained in force on an uninterrupted basis since its original execution. You also indicate that subsequent to April 26, 1995, an individual who was a shareholder of Xco on April 26, 1995, transferred all his shares of Xco to his holding corporation ("Holdco") in exchange for new shares of Holdco and that a joint election was filed with respect to this transfer pursuant to subsection 85(1).

You ask that we confirm that:

1. The addition of new shareholders of Xco by way of amendment to the Agreement after April 26, 1995 would not, in and by itself, cause another person's shares of Xco to lose their status as "grandfathered shares" under the grandfathering rules.

2. The transfer of the individual's shares of Xco, that were subject to the grandfathering rules, to Holdco in exchange for new shares of Holdco pursuant to subsection 85(1) would result in those Holdco shares being subject to the grandfathering rules.

3. A person who acquired shares of Xco after April 26, 1995 would not be considered to own shares of Xco that are subject to the grandfathering rules.

Your request appears to relate to a completed transaction involving specific taxpayers. Confirmation of the income tax consequences of completed transactions involving specific taxpayers will only be provided by the Canada Revenue Agency ("CRA") where the request is made to the particular taxpayer's Tax Services Office and all the facts, including the identity of the taxpayers involved, are provided. Notwithstanding the above we are prepared to offer the following comments.

In Income Tax Technical News No. 12 dated February 11, 1998, the CRA set out general comments relating to the application of the grandfathering rules for the purpose of applying the stop loss rule in subsection 112(3). Generally, the grandfathering rules will apply to prevent the application of this stop loss rule on a disposition of a share by an individual after April 26, 1995, where inter alia:

(a) the disposition occurs pursuant to a written agreement made before April 27, 1995 ("grandfathered agreement"); or

(b) the share was owned by the individual (other than certain trusts) on April 26, 1995; the disposition was made to the corporation that issued the share; on April 26, 1995, a corporation, or a partnership of which a corporation is a member, was a beneficiary of a life insurance policy that insured the life of the individual or the individual's spouse; and it was reasonable to conclude on April 26, 1995 that a main purpose of the life insurance was to fund, directly or indirectly, in whole or in part, a redemption, acquisition or cancellation of the share by the corporation that issued the share.

For the purpose of the requirement that a main purpose for the acquisition of the life insurance policy must have been to fund, directly or indirectly, in whole or in part, a redemption, acquisition or cancellation of a share the policyholder must be able to provide documentary evidence to substantiate that this requirement was met on April 26, 1995. It should also be noted that if a taxpayer acquires a share (the "new share") in exchange for a share that was subject to the grandfathering rule in (b) (the "grandfathered share") and the new share was acquired as a result of a transaction to which section 51, 85, 86 or 87 of the Act applied, the new share will be deemed to be the same share as the grandfathered share.

For the purpose of the grandfathering rule in (a), if the original parties to a grandfathered agreement choose to revise the terms of their relationship by concluding a separate agreement so that the existing grandfathered agreement remains unchanged, the status of a particular share as a "grandfathered share" will continue. However, if the revisions contained in the separate agreement are considered to cancel, nullify or otherwise replace the existing grandfathered agreement the status of such a share as a grandfathered share will be lost.

Our comments are provided in accordance with the practice described in paragraph 22 of Information Circular 70-6R5.

Yours truly,

David Palamar
Manager
Corporate Reorganizations Section II
Reorganizations and Resources Division
Income Tax Rulings Directorate
Policy and Planning Branch

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