Federal Court Of Appeal Rules That Retractable Preferred Shares Are Not “Capital” For Purposes Of The Large Corporations Tax Under Part 1.3 Of The Income Tax Act

Article by David Spiro, 2007, Blake, Cassels & Graydon LLP

Originally published in Blakes Bulletin on Tax, June 2007

In a decision released on June 11, 2007 (Attorney General of Canada v. Ford Credit Canada Limited, 2007 FCA 225), the Federal Court of Appeal held that retractable preferred shares (shares that oblige the issuer to redeem them at the request of the holder) are not "capital" for purposes of the Large Corporations Tax (LCT) that was imposed by Part I.3 of the Income Tax Act (the Act) for years prior to 2006. Although LCT was effectively repealed as of January 1, 2006, corporations and financial institutions that had issued retractable preferred shares before that date should consider challenging any assessment or reassessment that included the amount of those retractable preferred shares in capital for LCT purposes.

In this decision, the Federal Court of Appeal rejected the longstanding policy of the Canada Revenue Agency that Generally Accepted Accounting Principles (GAAP) do not displace the legal meaning of terms used in Part I.3 of the Act. This policy has been reiterated on numerous occasions by officials of the Minister of National Revenue (the Minister) and is clearly reflected in Interpretation Bulletin IT-532:

11. . . . the balance sheet nomenclature used to describe or characterize a particular balance sheet item may be based upon its accounting substance rather than its legal form. It is the CCRA's position that the legal nature governs irrespective of the accounting treatment or nomenclature used to describe or characterize a particular transaction or event. The reporting of certain leases as sales or financing transactions (CICA Handbook, Section 3065) and the reporting of certain preferred shares with various debt characteristics as debt (CICA Handbook, Section 3860) are but two examples where the accounting characterizations may not reflect the legal nature of the transactions.

12. Preferred shares that have been characterized as liabilities and reflected on the balance sheet in an amount equal to the redemption amount of the shares would, for the purposes of Part I.3, be considered to retain their legal character as shares of the capital stock of a corporation. . . .

By way of background, the Canada Revenue Agency reassessed Ford Credit for its 2001 to 2003 taxation years on the basis that CAD 1.17 billion of retractable preferred shares should be included in its capital for purposes of Part I.3 tax. In...