Why have separate classes of shares in the capital of a corporation for new investors? Creating separate classes of shares creates its own problems both from a tax and non-tax perspective. Nonetheless, for tax purposes it is sometimes desirable to have different groups of investors subscribe for different classes of shares in the capital of a corporation.

Consider the position where Mike and John decide to form Opco to operate that lemonade stand business they’ve always wanted to run. On the incorporation of Opco under the Business Corporations Act (Ontario), each of Mike and John subscribe for 50 Common Shares in the capital of Opco at $1 per share. As a result, the tax cost and tax paid-up capital (”PUC”) of their shares is $100 in total.

Let’s move forward three years. Opco has been a success. Edgar, who is a friend of Mike and John, wants in. Mike and John are amenable—serving lemonade is hard work, and they could use the help and the extra capital—and so they agree to allow Edgar to subscribe for 50 Common Shares. Opco’s value, however, has increased so that its issued shares are worth $500 in total ($5 per share), and so it is only fair that Edgar pay more for his shares than $1 per share (the original subscription price paid by Mike and John). Edgar should pay $5 per share, or $250 in total, for his 50 Common Shares.

Let’s say that Edgar pays the required $250 in total for his 50 Common Shares. What are the tax consequences? The tax cost of Edgar’s shares is $250 in total or $5 per share, but their stated capital per share is only $2.33 because the stated capital of a share is the total stated capital of the class to which the share belongs divided by the number of issued shares of the class.

PUC is valuable because it can be returned to a shareholder tax free. The calculation of PUC begins with stated capital for corporate law purposes (not accounting purposes). If the stated capital of a class of shares issued by an Ontario corporation is $50, then, in general, the PUC will be $50 as well. Of course, the Income Tax Act (Canada) wouldn’t be the Income Tax Act (Canada) if it didn’t contain numerous rules that provide for adjustments to PUC to ensure that a taxpayer can’t artificially increase it. Nevertheless, if one is concerned only with subscriptions for shares, then stated capital and PUC are usually equal to each other.

The key point to note is that both stated capital and PUC are calculated by reference to a class of shares unlike tax cost or “adjusted cost base”, which is calculated by reference to the holder of the shares. PUC is averaged across all of the shares of a particular class rather than just all shares held by a particular individual. As a result, Edgar’s cost per share of his Common Shares in the capital of Opco is $5 ($250/50), but the PUC of each of his shares is only $2.33 (($250+$100)/150).

So what? This discrepancy is only likely to matter if Opco purchases Edgar’s shares for cancellation. On a sale to an arm’s-length third party, it is highly likely that the only relevant tax characteristic of Edgar’s shares will be their tax cost. He paid $250 for his shares. If he sells them for $500, he will realize a gain of $250. There’s no magic to that, and it’s the appropriate result. It’s what a rational person would expect.

A rational person will have a much harder time with a purchase for cancellation of shares that have attributes like Edgar’s. On a purchase for cancellation, the Act deems a shareholder to have received a dividend and proceeds of disposition. The deemed dividend is calculated first, and it is equal to the purchase price paid for the shares minus their PUC. If Edgar were to turn around and sell his shares back to Opco for the amount he paid ($250), he would be required to include in income a deemed dividend! The amount of the deemed dividend would be equal to $133.33 (50*($5 – $2.33)).

As for Edgar’s proceeds of disposition, the Act reduces them by the amount of the deemed dividend he received, so that on the purchase for cancellation he is deemed to receive proceeds equal to $2.33 per share ($5 – $2.66). That is, Edgar is deemed to realize a capital loss on the purchase for cancellation of his shares in an amount equal to the deemed dividend. The capital loss, however, cannot be used to reduce or eliminate the deemed dividend. Economically, when Edgar’s shares are purchased by Opco for $5 per share, he is simply receiving his money back. For tax purposes, he is treated as having received income![1]

The results described above are perverse. An experienced and intelligent Justice lawyer of my acquaintance once attempted to provide a policy justification for these rules. She didn’t convince me; I’m not sure she convinced herself. In any case, rational or not, these are the rules.

Issuing separate classes of shares will avoid this problem. If Edgar, instead of subscribing for Common Shares in the capital of Opco, subscribes for Class 1 Common Shares (common shares of a different class), and no one else subscribes for shares of that class, then the tax cost and PUC of his shares will be equal to his purchase price. If, therefore, Opco repurchases Edgar’s shares immediately after he paid for them, he will not receive a deemed dividend or realize proceeds of disposition, and all will be right with the world.[2]

Issuing multiple classes of common shares has its own problems, however. If the different classes have different rights to dividends or liquidation amounts, then a shareholder agreement might be necessary to protect the minority shareholders. If the classes have identical rights, then the issue becomes whether the classes really are separate classes such that their stated capital and PUC can be computed separately (see blog.simpsonwigle.com/2007/10/classes-of-shares/). A cautious tax adviser, who decides to insert, say, a liquidation preference to ensure that classes can be distinguished, will need to consider the implications under Parts IV.1 and VI.1 of the Act. In short, the decision to issue multiple classes to avoid the complexities associated with Edgar’s circumstances will create their own complexities. The tired tax adviser, who is confident that Opco will never repurchase Edgar’s shares, might content herself with allowing him to subscribe for ordinary Common Shares in the capital of that corporation.

[2] All is not lost even if multiple shares weren’t used but it becomes necessary to repurchase shares. Extra steps, such as the incorporation of a holdco for the seller, can be taken to ensure that the shareholder doesn’t end up in Edgar’s predicament.

x = (10y – z)/9

where

x is the value of the bad assets to be removed from the corporation;

y is the value of the bad assets before anything is removed from the corporation; and

z is the value of all assets of the corporation before anything is removed from it.

The Court summarized the issue before it as follows:

At issue is whether non-resident corporations such as the appellant can be subjected to a penalty pursuant to subsection 162(2.1) of the Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.) (the Act) for failure to file their tax returns on time for a given taxation year, in circumstances where they have no taxes payable for that year. The Tax Court Judge [in Exida.com] found in the affirmative. In so doing, she declined to follow an earlier decision of her colleague Miller J. in Goar, Allison & Associates Inc. v. The Queen [2009 TCC 174] who had come to the opposite conclusion.

The Court disagreed with Justice Woods’ interpretation of subsection 162(2.1) as follows:

[28] […] As was found by the Tax Court Judge, the legislative history and context make it clear that the intention was to impose the higher of the “regular penalties” and the “alternative penalties” when a non-resident corporation has taxes payable and the higher of the “alternative penalties” when it has none (Reasons, para. 57). However, it is equally clear that those charged with implementing this last aspect of the legislative plan failed in their task. As noted, subsection 162(2.1) makes the application of the “alternative penalties” conditional upon the non-resident corporation being liable to the “regular penalties” under subsection 162(1) or (2), and no such liability can exist in circumstances where a non-resident corporation has no taxes payable. The question which arises in this appeal is whether this fundamental drafting error can be cured by the purposive interpretation proposed by the Tax Court Judge. In my respectful view, it cannot.

The Court, however, went on to dismiss the taxpayer’s appeal on the basis that the penalties provided by subsection 162(7) were applicable. That subsection reads as follows:

162. (7) Every person (other than a registered charity) or partnership who fails

(a) to file an information return as and when required by this Act or the regulations, or

(b) to comply with a duty or obligation imposed by this Act or the regulations is liable in respect of each such failure, except where another provision of this Act (other than subsection 162(10) or 162(10.1) or 163(2.22)) sets out a penalty for the failure, to a penalty equal to the greater of $100 and the product obtained when $25 is multiplied by the number of days, not exceeding 100, during which the failure continues.

The Court agreed with Justice Campbell in Goar that paragraph 162(7)(a) could not apply because the non-resident corporations had failed to file tax returns not “information returns”. The Court, however, held that paragraph 162(7)(b) could and did apply to taxpayer:

[38] In the present case, we have the advantage of knowing that the reason why no penalty can be imposed on a non-resident corporation pursuant to subsection 162(2.1) when no taxes are payable is that those charged with implementing the legislative plan failed in their task. The result, although unintended, is that no penalty is set out for the appellant’s failure to file its tax return on time under the Act.

[39] It follows that the first condition for the application of the residual penalty under paragraph 162(7)(b) is met. As otherwise, it is common ground that the appellants failed to file their tax returns on time in breach of the obligation created by paragraph 150(1)(a), all the elements required for the application of the residual penalty are present.

Does this mean that individuals who file late will now be subject to penalties even if they didn’t owe taxes or they had paid their taxes by the deadline? Traditionally, the CRA has not imposed penalties on such persons probably because section 162 calculates the penalty by reference to the taxes payable. The Court’s reasoning in Exida.com seems to permit the CRA to impose penalties under paragraph 162(7)(b) on individuals who don’t file even if they don’t owe tax.

In Emory, the taxpayer undertook a transaction as summarized above. The Court made no finding on whether the taxpayer dealt at arm’s-length with the controlling shareholder (’B’ in the example above), but even if the Court had done so it would have made no difference. The taxpayer was deemed not to deal at arms length with Holdco because of paragraph 84.1(2)(b) of the Income Tax Act (Canada), which provides as follows:

(2) For the purposes of this section,

[…]

(b) in respect of any disposition described in subsection (1) by a taxpayer of shares of the capital stock of a subject corporation to a purchaser corporation, the taxpayer shall, for greater certainty, be deemed not to deal at arm’s length with the purchaser corporation if the taxpayer

(i) was, immediately before the disposition, one of a group of fewer than 6 persons that controlled the subject corporation, and

(ii) was, immediately after the disposition, one of a group of fewer than 6 persons that controlled the purchaser corporation, each member of which was a member of the group referred to in subparagraph (i);

Under subsection 84.1(2.2) a group of persons is deemed to be any collection of two or more persons, and “a corporation that is controlled by one or more members of a particular group of persons in respect of that corporation is considered to be controlled by that group of persons”.

As a result of these deeming rules, the taxpayer in Emory was deemed not to deal at arms length with Holdco because she was part of a group of two individuals who controlled Opco immediately before the transaction and part of the same group that controlled Holdco immediately after the transaction (where Holdco also controlled Opco immediately after the transaction). What was the result? Instead of being able to claim the capital gains exemption in respect of the entire proceeds received for her shares in Opco, Ms. Emory was treated as having received a deemed dividend in a total amount equal to $492,387. Ouch.

The taxpayer’s lawyer attempted to argue that the result flowing from the black letter of the law should not apply to his client, to which the Tax Court responded as follows:

1. Subparagraphs 84.1(2)(b)(i) and (ii) are not meaningless. Paragraph 84.1(2)(b) provides the framework for the expansion of the meaning of the term “arm’s length.” (¶30)
2. “I can understand why counsel would suggest that these rules could have inappropriate results. For many years, commentators have noted that section 84.1 is a trap for the unwary. See, for example, the article by Peter Bowen referred to above. However, Parliament has clearly provided for this result, presumably in order to limit the potential for abuse.” (¶32)
3. The CRA did not make public pronouncements respecting section 84.1 that conflict with the position it took in this case. (¶34)
4. The position taken in this case did not conflict with Silicon Graphics Ltd. v. The Queen, 2002 FCA 260: “The statutory provision that was relevant in Silicon Graphics was the definition of “Canadian-controlled private corporation” in subsection 125(7) of the Act. It did not contain deeming rules similar to those at issue here.” (¶36)
5. This interpretation did not render meaningless the word “particular” in s. 84.1(2.2)(c). (¶38)
6. The plain meaning interpretation of 84.1 was not counter to the purpose of section 84.1:
   

   [40] I also disagree with this submission. It is clear that section 84.1 is an anti-avoidance provision that is designed to prevent the tax-free extraction of corporate surplus. It is also clear, though, that the provision could potentially overreach its anti-avoidance objective in certain cases. This result was clearly intended by Parliament, in my view.

   [41] It is perhaps worth mentioning that section 84.1 would not have applied to the disposition by the appellant of shares of Sona if the appellant had not owned any shares in Ontario Inc. The fact that the appellant owned a small number of shares in Ontario Inc. has unfortunately resulted in the application of this section.

Emory is a perfect example of how the black letter of the Act will apply regardless of anyone’s conception of common sense. Arguably, the taxpayer had, in substance, sold her interest in Opco. Her ongoing indirect 5% interest could be seen as a portfolio investment. Such an argument, however, could not be advanced because the clear rules in the Act dictated a different result. Tax advisors beware!

In Pascoal v. The Queen, 2009 TCC 608, the Court relied on Dirienzo v. The Queen, 2000 DTC 2230, for the proposition that “the appropriate degree of care, skill and diligence required for a successful due diligence defence is much lower when the directors are family members.” The Court quoted the following passage from the case (per Bowman ACJTC, as he then was):

Do the conclusions stated above absolve the appellant of his responsibilities under section 227.1? On one view of the matter, it could be said that he did not exercise the degree of care, diligence and skill contemplated by subsection 227.1(3) because he exercised none at all. On the other hand, he was a mere nominal director with no powers, no responsibilities and no say in the way the corporation was run. It is all very well to adopt a hectoring, moralizing tone and say that if people take on the responsibility of corporate directorships they should be expected to assume all the consequences of such a position. I am not however concerned with what the situation would be in a perfect world. I have to make a determination of the facts as they exist in a highly imperfect world where malleable young family members are bullied by domineering patriarchs.

Assume that Holdco owns all of the issued shares of Opco, and Opco proposes to merge with another corporation (Targetco) to form Amalco, which will carry on the businesses of the two predecessor corporations. For now, the shareholders of Holdco and Targetco will continue as shareholders of Holdco. We could complete this transaction on a tax-deferred basis by having the Targetco shareholders sell their shares to Holdco for shares in the capital Holdco. Each of the Targetco shareholders would file an election under section 85 of the Income Tax Act (the “ITA”) to ensure that their sale of shares occurred on a tax-deferred basis. Targetco and Opco could then complete a horizontal short-form amalgamation to form Amalco, which would be a wholly-owned subsidiary of Holdco.

The same result, however, could be achieved more simply using a triangular amalgamation. Subparagraph 175(1)(b)(iii) of the Ontario Business Corporations Act provides for an amalgamation of two corporations where shareholders of a predecessor corporation receive securities of “any body corporate other than the amalgamated corporation.” Opco and Targetco could amalgamate pursuant to a long-form amalgamation. The amalgamation agreement would provide for the issue of shares in the capital Holdco to Targetco shareholders (probably using the same ratios that would have appeared in the section 85 rollover agreements). In general, subsection 87(9) of the ITA permits an amalgamation like this to occur on a tax-deferred basis for the corporations involved and for the shareholders, including the shareholders of Targetco.

Why use this mechanism? The legal documentation would be simpler for one thing. Instead of multiple share purchase agreements and a short-form amalgamation, the lawyer can prepare one amalgamation agreement and long-form articles of amalgamation (which have their own advantages over the short-form variety). The accountant’s life is made easier too because the rollovers under section 87 of the ITA do not require the filing of any elections. In addition, if a shareholder of Targetco happens to be a non-resident, it may be possible to avoid having to obtain a certificate for the shareholder under section 116 of the ITA (cf. ¶45 of IT-474R2 and ¶¶31-32 of IC72-17R5).

Lawyers accustomed to implementing estate freezes are familiar with the very particular “suggestions” they will receive from accountants about the characteristics of the shares to be used to effect the freeze. The purpose of a freeze, of course, is to permit an existing shareholder to exchange an asset with growth potential—Common Shares of Opco, let’s say—for another asset whose value will not increase even if the value of the issued shares of Opco as a whole do. Mr. Pappas, to effect an estate freeze, might exchange his Common Shares in the capital of Opco for Special Shares with a value that is fixed at an amount equal to the value the Common Shares. Opco will issue new Common Shares to the individuals whom Mr. Pappas wishes to benefit by implementing the freeze so that any future growth will accrue to them.

The trick is to ensure that Mr. Pappas’ Special Shares will have a value equal to the value of the old Common Shares and that that value will not increase in the future. If the value of the Special Shares is less than the value of the old Common Shares, then that value might inhere in the new Common Shares, in which case Mr. Pappas will have conferred a benefit on the new Common Shareholders, which is a Bad Thing from a tax perspective. On the other hand, if Mr. Pappas’ Special Shares can increase in value or if that value can exceed the redemption amount of the Special Shares, then the freeze will have been thwarted. Growth in the value of Opco’s shares will continue to accrue in the hands of Mr. Pappas, although he doesn’t need the growth, and his tax bill on death will increase.

How, then, to ensure that the Special Shares keep the desired value? The Canada Revenue Agency (the “CRA”) requires that freeze shares be

• redeemable at the option of the issuer for a fixed amount
• redeemable at the option of the holder (‘retractable’) for a fixed amount
• entitled to dividends at a ‘reasonable’ rate
• entitled to a preference on liquidation
• freely transferable
• protected by a non-impairment clause, which ensures that shares cannot be redeemed or dividends paid that would prevent the issuer redeeming the freeze shares

Historically, the CRA has pretended indifference about whether freeze shares need have voting rights. Before addressing voting rights, however, let us consider the issue of the dividend rights that attach to freeze shares.

Dividends

Freeze shares, if they are retractable (which they should be), need not be entitled to cumulative dividends. The holder of a fixed-value share that is not retractable would (or should) insist on cumulative dividends to compensate the holder for money that is tied up in the issuer’s capital. Put another way, a share would not have a value equal to its redemption amount if cumulative dividends weren’t payable. On the other hand, given that a freeze shareholder, in theory, can retract the shares and demand their value at any time, cumulative dividends should not be necessary.

The CRA has also stated that the dividend rate[1] of a freeze share should be reasonable. Sometimes we receive instructions for incorporation that include a request to create shares with a fixed redemption amount and a right to receive unlimited dividends. Although it is possible to create a class of shares with such rights, we generally advise against it if they are to be used in a freeze. We are concerned that the fair market value of such a share will not be equal to its redemption amount, especially if the share will be held by a controlling shareholder.

In many estate freezes, the likes of Mr. Pappas will insist on retaining voting control of Opco. Mr. Pappas might wish to benefit the new Common Shareholders, but he is probably not ready to turn over control of Opco to them, especially if his comfortable retirement depends in part on protecting the value of his freeze shares (Mr. Pappas’ Special Shares). What is the position, then, if Mr. Pappas’ Special Shares are entitled to unlimited dividends, and he controls Opco?

In Winram v. M.N.R., [1972] D.T.C. 6187 (F.C.T.D.), Gibson J. considered the liability of an estate for estate tax where the deceased died owning nine of the 1,000 issued shares of a corporation. The issued capital of the corporation consisted of 990 Class B shares, which were participating and non-voting and 10 Class A shares, which were participating and voting. The deceased held nine of the latter shares at his death; his wife held the remaining issued shares. It appears the estate took the position that the nine Class A shares were worth only 9/1000 of the entire value of the corporation. The Minister assessed on the basis that the value of the nine Class A shares was much greater than that. The Minister contended that, because the husband could control the issuer, he could divert dividends to himself and, in effect, take all of the value of the corporation for his own benefit. As a result, the Minister argued, the value of his shares was significantly higher than the value ascribed to them by the estate.

The trial judge found in favour of the Minister. First, the judge noted the following about the governance of the corporation:

Until the date of death of the deceased and at all material times prior thereto also, the Articles of Association of the company provided at Article 3 that no share might be transferred except with the consent of the Board of Directors “who (might) . . . in their absolute discretion refuse to register the transfer of any share”; at Article 6 that the holders of non-voting shares did not have the right to vote; at Article 17 as amended that in the case of an equality vote that the Chairman had a second or casting vote; at Article 18 that “a Director interested in any contract or arrangement under consideration may be counted to make up the quorum although he shall not vote thereon”; and at Article 20 that dividends might be declared by ordinary resolution and that “dividends so declared may be equal for each class of share or not equal and dividends may be declared on one class of share without dividends being declared on another class of share”.

The judge’s decision is neatly summarized in the headnote of the case:

The wife of the deceased could not, by wilfully refusing to attend a properly called directors’ meeting, prevent the deceased from transferring the nine class A shares of which he was the owner, or from declaring dividends whereby the company would pay out 9/10 of the surplus to himself. Even if she did attend such a meeting, the deceased, because of his casting vote, could take these steps. Such action would not have been an abuse of his power in respect of the class B shareholders as they did not have an inalienable right to any part of the dividends declared, nor would it have been a breach of the deceased’s fiduciary duty as a director for he would have also been acting in his capacity as a shareholder and would therefore be free of any constructive trust. Also, any dividends declared on class A voting shares at a properly called directors’ meeting would not have been an abuse by the majority of the class A holders over the rights of the minority of class A holders.

Winram dealt with two classes of shares, both of which were fully participating. Perhaps the court would have arrived at a different conclusion if the deceased’s shares had been redeemable and retractable for a fixed amount. Moreover, the decision has been distinguished in another case involving similar circumstances (see Shepp v. The Queen, [1999] D.T.C. 510 (T.C.C.)). Finally, one wonders whether a similar result would obtain today in respect of shares of an issuer governed by the Ontario Business Corporations Act, with its oppression remedy.

But why wonder about the status of Winram, especially given that, according to one tax commentator,[2] some CRA valuators still believe that shares without voting control, where another class of shares with control have a right to unlimited dividends, should be considered to have nominal value? It would seem prudent simply to ensure that the freeze shares have a dividend cap. If the freezor wishes to continue to share in the value of the corporation going forward, it would be better to implement an estate “gel” or leave the freezor with some portion of the Common Shares.

Voting Rights

Historically, the CRA has accepted that freeze shares need not have voting rights except to the extent necessary to protect the value of the shares.[3] But, as already discussed above, the owner who implements a freeze will often wish to retain control of the issuer to protect the owner’s investment. In fact, it is not uncommon for the freezor to retain voting control through the use of “thin-voting shares”. Thin-voting shares are shares that do not participate significantly in the earnings or assets of a corporation but that confer voting rights on the holder.

If the freezor retains voting control, however, what of the dreaded “control premium”, the extra amount that a third party might pay to obtain control of a corporation? The CRA, at the 2007 Canadian Tax Foundation National Tax Conference, when asked about thin-voting shares, responded that “It is the opinion of the CRA that a hypothetical purchaser would be willing to pay some amount for the voting control of a company.” That is, it would seem that the CRA might consider taking the position that thin-voting shares, although they purport to be worth, say, only $100 in total because they are redeemable and retractable for that amount, should be valued for some (unspecified) higher amount because of their voting rights. The use of thin-voting shares could undermine an estate freeze, in other words.

The statement ought to apply to more than just thin-voting shares. The underlying principle would seem to be equally applicable to any kind of voting control. Why pick on thin-voting shares only? What if Mr. Pappas took back only Special Shares with substantial value, but they also have voting rights that give him control of Opco? Will his Special Shares be worth more than their redemption amount? And what about de facto control? Mr. Pappas’ Special Shares might not have votes, but his retraction of the shares, soon after the completion of the freeze, might render Opco insolvent, which would likely give Mr. Pappas de facto of the corporation. Does that make the Special Shares worth more than their redemption amount?

Frankly, this is deep water for a tax lawyer without any valuation training, and it is difficult to provide advice in this context. The tax lawyer might be permitted to ask some policy questions of the CRA, however, viz. just what does it think it is doing? The estate freeze is a staple of tax planning for the owner-managed business. Why make the matter more complicated and fraught than it already is, especially given that the very concept of a freeze is a dodgy one from a valuation perspective anyway? After all, it seems likely that a hypothetical purchaser would be willing to pay some amount—more than a nominal amount—for Common Shares issued in connection with a freeze. In a freeze, the Common Shares are acquired for a nominal amount, but they give one the opportunity to share in the growth of some very valuable assets. Who wouldn’t pay something for that bet, something more than the nominal amount for which the shares are issued? Why ignore that fact and then pick on thin voting shares?

Conclusion

In estate freezes, getting the share provisions—the dividend entitlements and the voting rights, among others—getting the provisions right counts for a lot, and so the lawyer needs to work carefully with the accountant on this task, even where the CRA’s guidance on the subject has been less than helpful.

[2] David Louis, CCH Tax Topics, October 16, 2008.

[3] For this reason some lawyers prefer to insert a clause that requires the issuer of freeze shares to obtain the consent of their holder before implementing any reorganization of capital that might adversely affect the value of the shares. Query whether such a clause is necessary in light of section 170 of the OBCA (for example).

As stated in Income Tax Technical News No. 38, the CRA does not have an established position on valuing different types of property, including shares, as the valuation is dependent on the facts and circumstances of each situation. Information Circular 89-3 (IC 89-3), Policy Statement on Business Equity Valuations, outlines the valuation principles and policies that the CRA considers and follows in the evaluation of securities and intangible property of closely held corporations for income tax purposes. In determining the fair market value of a class of shares, the CRA determines the fair market value of the corporation ‘‘as a whole’’ or ‘‘en bloc’’ and then allocates the value to each class of shares in isolation. The fair market value of each class is determined according to the rights and restrictions of each class and voting control is a right that may have significant value. [Emphasis added.]

The CRA’s position is that non-participating controlling shares have some value and may therefore bear a premium. However, in the context of an estate freeze of a Canadian-controlled private corporation, where the freezor, as part of the estate freeze, keeps controlling non-participating preference shares in order to protect his economic interest in the corporation, the CRA generally accepts not to take into account any premium that could be attributable to such shares for the purposes of subsection 70(5) of the Income Tax Act at the freezor’s death.

David Louis, in reporting on this development in the October 1 issue of CCH’s Tax Topics, noted the following about this statement:

• The CRA reiterates its view that voting power is valuable.
• The CRA’s new position appears to accommodate only subsection 70(5) freezes, which leaves open the possibility that the concession will not be extended to freezes executed for the purposes of income splitting or exemption multiplication.

In addition, the CRA seems to believe that the voting control should exist to protect the freezor’s economic interest. Query whether, to satisfy the CRA on this point, the voting control must diminish and terminate if the freezor’s economic interest diminishes and terminates.

Some of the controversy continues.