6 March 2008 Internal T.I. 2008-0269711I7 - Prescribed Shares - Flow-Through Share

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: Whether a share issued under a flow-through share agreement which included an indemnity clause similar to that considered in the JES Investments case would be a prescribed share

Position: Yes

Reasons: Conclusion of FCA in the JES Investments case

										March 6, 2008

	Brett Evers	HEADQUARTERS
	A/Manager								Income Tax Rulings
	Income Tax Section (Group 2)	  				Directorate
	Technical Applications & Valuations Division		Ted Harris
	Compliance Programs Branch					(613) 957-2114

	Attention:  David Shugar
										2008-026971

Prescribed Shares for Purposes of the Flow-Through Share Rules

We are writing in response to your memorandum of February 27, 2008 wherein you requested our opinion as to whether the type of indemnity clause contained in paragraph 10 of the Share Subscription and Renunciation Agreement (the "Indemnity Clause") between Deena Energy Inc. and JES Investments Ltd. described in paragraph 8 of the Federal Court of Appeal's decision in The Queen v. JES Investments Ltd. 2007 DTC 5608 would cause any share issued under such an agreement to be a prescribed share by virtue of subparagraph 6202.1(1)(c)(i) of the Income Tax Regulations (the "Regulations").

The Indemnity Clause, which was at issue in the JES Investments case, read as follows:

The Corporation hereby agrees to indemnify and save harmless the Subscriber from and against any liability, loss, damage, cost or expense which the Subscriber may sustain or incur arising out of or in any way connected with the expenditure of the Subscription Amount.

Legislation

Subparagraph 6202.1(1)(c)(i) of the Regulations provides that a share will be a prescribed share for purposes of the "flow-through share" definition in subsection 66(15) of the Act if, at the time of its issue,

(c) any person or partnership has, either absolutely or contingently, an obligation (other than an excluded obligation in relation to the share) to effect any undertaking, either immediately or in the future, with respect to the share or the agreement under which the share is issued (including any guarantee, security, indemnity, covenant or agreement and including the lending of funds to or the placing of amounts on deposit with, or on behalf of, the holder of the share or, where the holder is a partnership, the members thereof or specified persons in relation to the holder or the members of the partnership, as the case may be) that may reasonably be considered to have been given to ensure, directly or indirectly, that;

(i) any loss that the holder of the share and, where the holder is a partnership, the members thereof or specified persons in relation to the holder or the members ownership or disposition of the share or any other property is limited in any of the partnership, as the case may be, may sustain by reason of the holding, respect, or

(ii) the holder of the share and, where the holder is a partnership, the members thereof or specified persons in relation to the holder or the members of the partnership, as the case may be, will derive earnings, by reason of the holding, ownership or disposition of the share or any other property.

The definition of "excluded obligation" in subsection 6202.1(5) of the Regulations provides that:

"excluded obligation", in relation to a share issued by a corporation, means

(a) an obligation of the corporation

(i) with respect to eligibility for, or the amount of, any assistance under the Canadian Exploration and Development Incentive Program Act, the Canadian Exploration Incentive Program Act, the Ontario Mineral Exploration Program Act, 1989, Statutes of Ontario 1989, c. 40, or the Mineral Exploration Incentive Program Act (Manitoba), Statutes of Manitoba 1990-91, c. 45, or

(ii) with respect to the making of an election respecting such assistance and the flowing out of such assistance to the holder of the share in accordance with any of those Acts,

(a.1) an obligation of the corporation, in respect of the share, to distribute an amount that represents a payment out of assistance to which the corporation is entitled

(i) under section 25.1 of the Income Tax Act, Revised Statutes of British Columbia, 1996, c. 215, and

(ii) as a consequence of the corporation making expenditures funded by consideration received for shares issued by the corporation in respect of which the corporation purports to renounce an amount under subsection 66(12.6) of the Act, and

(b) an obligation of any person or partnership to effect an undertaking to indemnify a holder of the share or, where the holder is a partnership, a member thereof, for an amount not exceeding the amount of any tax payable under the Act or the laws of a province by the holder or the member of the partnership, as the case may be, as a consequence of

(i) the failure of the corporation to renounce an amount to the holder in respect of the share, or

(ii) a reduction, under subsection 66(12.73) of the Act, of an amount purported to be renounced to the holder in respect of the share.

Your Opinion

It is your opinion that the Indemnity Clause would not qualify as an "excluded obligation" and would, therefore, run afoul of subparagraph 6202.1(1)(c)(i) of the Regulations such that any share issued under that Agreement would be a prescribed share and, therefore, not a flow-through share.

Our Comments

In concluding that the shares issued by Deena pursuant to the Agreement were prescribed shares, Ryer, J.A. made the following comments in paragraph 18 of the reasons for judgment in the JES decision:

I realize that the taxpayer would not have supported this interpretation of clause 10 of the Agreement if Deena had fulfilled all of its obligations under the Agreement since the taxpayer's intention, at the time that the Agreement was entered into, was to acquire shares that qualified as flow-through shares. However, the intention that a share should qualify as a flow-through share cannot prevent that share from constituting a prescribed share if the requirements of section 6202.1 of the ITR are met and as I have concluded, the rights of the taxpayer under clause 10 of the Agreement are of the type specified by subparagraph 6202.1(1)(c)(i) of the ITR.

In view of these comments and the fact that the Indemnity Clause is not in respect of amounts described in the definition of "excluded obligation" referred to above, we agree with your opinion that the rights of an investor under this type of indemnity clause are of the nature described in subparagraph 6202.1(1)(c)(i) of the Regulations, such that any share issued under a "flow-through share agreement" that contains such a clause would be a prescribed share and, therefore, not a flow-through share.

We trust that these comments will be of assistance.

for Director
Reorganizations and Resources Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch