Section 51

Canco indirectly controlled ULC which was the sole member (holding common membership units) of LLC. ULC also held non-interest-bearing Notes which were convertible into "Shares" (membership interests) at a specified price per share. The Notes were converted into "Preferred Shares" of LLC having a fair market value equal to the "fair market value of LLC as a whole (i.e., the remaining equity interests in LLC had no value at that time)."

The Directorate found that the exchange did not occur pursuant to the terms of the Notes given the number of Preferred Shares which were issued. Accordingly, s. 51 did not apply, so that the loss which otherwise was realized on the exchange was denied. It also stated: "We have not considered the application of GAAR to the conversion, but you may wish to consider it further."

The Directorate further noted that "in 58563 [see below]… CRA stated that subsection 51(1)… applied to a conversion made pursuant to the holder's right to convert even if the issuer had the option to repurchase the shares in the meantime."

Given that a conversion from one class or series into another class or series under s. 91 of the Quebec Business Corporations Act generally will not entail any change to the corporation's authorized capital, s. 51 rather than 86 usually will apply.

CRA's position in IT-291R3, that an election under s. 85(1) potentially is available even if the shares to be issued are not yet part of the transferee's authorized capital, is inapplicable to s. 51(1) because the wording of s. 51(1) is clear as to the simultaneous nature of the exchange.

A shareholder of a mutual fund corporation redeems his shares in accordance with their terms in exchange for shares of another class of the same corporation. CRA stated:

Subject to the application of subsections 51(4) and 245(2), subsection 51(1) would apply to deem the exchange not to be a disposition of the convertible shares and …there would not be an "amount paid by the corporation in the year on the redemption of shares of its capital stock" for the purposes of factor A in the definition "capital gains redemptions" in subsection 131(6).

Where a debt obligation provides that it is convertible at the option of the holder into another debt obligation of the same issuer provided that the issuer has first given notice to the holders allowing them to make such a conversion, the rollover will be available on such a conversation because s. 51.1 applies at the point of conversion and, at that time, the terms of the debt obligation provides that the rollover is available. CRA stated:

Section 51.1...applies at a point in time, namely at the time of conversion. So long as the right to make the exchange is part of the terms of the debt obligation at that time the rollover will be available provided, of course, that the conditions in paragraphs 51.1(a) and (c) are also satisfied. Thus, a right of exchange which is part of the terms of the obligation from its inception or which becomes a term of the obligation at any time prior to the moment of exchange will satisfy paragraph 51.1(b)... .

An employee, who holds 100 common shares of an employer corporation (the "Old Shares") with an adjusted cost base and paid-up capital of $500 ($5 per share) and a fair market value of $1,500 ($15 per share), will satisfy the exercise price of $10 per share ($300 in aggregate) for an employee stock option to acquire 30 treasury common shares (the "New Shares") of the employer corporation by exchanging 20 Old Shares having an aggregate fair market value of $300. Will such exchange be considered a disposition? CRA stated:

Subject to subsection 51(4) of the Act, section 51 will apply to any situation where a share of the capital stock of a corporation is acquired by a taxpayer in exchange for a capital property that is another share of the particular corporation and no other consideration is received for the old shares.

After being asked whether "the right of exchange must be absolute for purposes of subsection 51(1)," a specific example was described. Preferred shares were redeemable at the option of the company upon giving at least 30 days' notice to the holder and were convertible by the holder into common shares upon 30 days' notice by the holder. In addition, the corporation, without a requirement to give a notice, could during the 30-day period preceding a redemption [sic], proceed with a redemption of shares which were the subject of a conversion notice.

CRA stated (TaxInterpretations translation):

Subsection 51(1)...is applicable when a taxpayer has acquired shares of the capital stock of a corporation in exchange for capital property of the taxpayer which was a share, an obligation or note of the corporation, the terms of which conferred on the holder such right of exchange. We are of the view that the provisions of section 51 of the Act are applicable when the taxpayer has received shares in exchange for a convertible security after having required such exchange in accordance with the right of exchange attached to the convertible security - even if the corporation had the opportunity to redeem such security before such exchange was effected.