6 May 1994 Internal T.I. 9321827 - WARRANTS RECEIVED BY NR AS PART OF POD (T2 FILE)

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 a series of exchanges of shares and warrants circumvented paragraph 212.1(1)(a) of the Act.

Position TAKEN:

No.

Reasons FOR POSITION TAKEN:

84(3) applied and resulted in the same deemed dividend as 212.1(1)(a)

				May 6, 1994

North York District Taxation Office Rulings Directorate
F. Webster Jim Wilson
Chief of Audit (416) 957-2123
Attention: Peter Schulman
International Tax Group
932182

XXXXXXXXXX

This is in reply to your memorandum dated July 22, 1993, in which you requested our comments in respect of a series of dispositions of shares and warrants in Canadian corporations by XXXXXXXXXX, a corporation resident in the United States.

XXXXXXXXXX

all Canadian-controlled private corporations. The shares of these XXXXXXXXXX Canadian companies do not derive their value or the greater part of their value directly or indirectly from real property situated in Canada as defined for the purpose of Article XIII of the Canada-U.S. Income Tax Convention ("Convention"). The series of transactions are as follows:

Transactions

XXXXXXXXXX

For the purposes of this inquiry, you have asked us to assume that XXXXXXXXXX meets the conditions described in subsections 212.1(3) and 186(4) of the Act and that subsection 212.1(1) of the Act would otherwise apply.

Our Comments

We have not been provided the necessary facts with respect to ACB, FMV and paid-up capital ("PUC") that would enable us to provide a definitive opinion regarding the tax implications to XXXXXXXXXX. Also, we do not have a clear understanding as to why the series of transactions have been set up in this manner. However, we can provide the following general comments.

With respect to transactions #1 through #3, on the understanding that XXXXXXXXXX meets the conditions described in subsections 212.1(3) and 186(4) of the Act, section 212.1 of the Act may apply. In particular, before the tax implications in transaction #4 can be determined (see comments below), it will be necessary to consider the application of section 212.1 of the Act with respect to transaction #3 and if such application would adjust the PUC of the preferred shares in XXXXXXXXXX

With respect to transaction #4, since the warrants received are considered non-share consideration, the FMV of the warrants form part of the proceeds of disposition of the preferred shares in XXXXXXXXXX for capital gains purposes. Also, the rules in subsections 84(3) and 84(5) of the Act ensure that a deemed dividend will arise to the extent by which the aggregate of the FMV of the warrants and the amount by which the PUC of the common shares in XXXXXXXXXX has increased by virtue of its issue of the common shares received by XXXXXXXXXX along with the warrants, exceeds the PUC of the preferred shares in XXXXXXXXXX that were surrendered by XXXXXXXXXX. The proceeds of disposition will be reduced by any deemed dividend under subsection 84(3) of the Act in accordance with paragraph 54(h)(x) of the Act.

Had the warrants been issued in a separate transaction, it is possible that no immediate tax implications would have arisen (see comments pertaining to transaction #6).

The deemed dividend computed under subsection 84(3) of the Act, at a minimum, will equal any deemed dividend that would have been computed under paragraph 212.1(1)(a) of the Act had the common shares and warrants described in transaction #4 been received by XXXXXXXXXX in transaction #3 as the consideration for the preferred shares in XXXXXXXXXX In this regard it should be noted that because of the existence of paragraph 212.1(1)(b) of the Act the PUC of the preferred shares in XXXXXXXXXX received in transaction #3 cannot exceed the PUC of the preferred shares in XXXXXXXXXX. Accordingly, we are not concerned that subsection 212.1(1) of the Act has been circumvented under this series of transactions. For example, by the end of the series of transactions, it would appear that XXXXXXXXXX received strictly shares in XXXXXXXXXX as its consideration for the sale of its shares in XXXXXXXXXX. Had subsection 212.1(1) of the Act applied under those circumstances, the affect, ignoring the application of subsection 15(1) of the Act, would have been limited to a PUC adjustment pursuant to paragraph 212.1(1)(b) of the Act. Under the current structure, XXXXXXXXXX would appear to be subject to Part XIII tax on a deemed dividend under subsection 84(3) of the Act. It should be noted that XXXXXXXXXX is also liable for the withholding on the dividend.

With respect to transaction #5, no immediate tax implications will arise (see comments pertaining to transaction #6). Subsection 49(3) of the Act provides that where a warrant is exercised the holder adds the ACB of the warrant to the cost of the shares acquired.

With respect to transaction #6, Interpretation Bulletins IT-96R4 and IT-116R2 summarize the Canadian tax treatment of the granting of options (i.e. an option is ordinarily in the form of a right or a warrant) and may be of some assistance to you. Subject to paragraph 15(1)(c) of the Act, a subsection 15(1) benefit will arise at the time the warrants are offered to the shareholders and will be based on the FMV of such warrants at that time. We cannot determine from the information provided whether the exception in paragraph 15(1)(c) of the Act has been met. If paragraph 15(1)(c) of the Act does apply, the issuance of the warrants does not give rise to any immediate tax consequences to the issuer or the holder of the warrant. Should you determine that a benefit has been conferred on XXXXXXXXXX by XXXXXXXXXX at the time the warrants were issued and paragraph 15(1)(c) does not apply, the amount of such benefit is added to the cost of the warrants pursuant to subsection 52(1) of the Act.

Other Issues

It seems peculiar that the preferred shares issued by XXXXXXXXXX in transaction #3 reflect a FMV significantly less than the FMV of the consideration received two days later upon the surrender of those shares by XXXXXXXXXX. You may wish to request an explanation from the taxpayer in this regard, particularly since transactions #3 and #4 may have applied to Canadian corporate shareholders. For example, we would be concerned if a capital gain (i.e. the capital gain that would have arisen had the consideration described in transaction #4 been received in transaction #3) has been converted into a deemed dividend.

In any event, if subsection 84(3) of the Act applies as set out above, there does not appear to be any advantage in this arrangement to XXXXXXXXXX at this time. Once the PUC and FMV of all the relevant shares and warrants at each particular time have been determined, we would be glad to give this matter another look.

for Director
Reorganizations and Foreign Division
Rulings Directorate
Legislative and Intergovernmental
Affairs Branch