23 September 2002 External T.I. 1999-0010175 - Liquidation; Anti-Circulatory Rules

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 CCRA.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.

Principal Issues: (1) Whether paragraph 95(2)(e.1) applies to the liquidation of a foreign trust. (2) How anti-circularity provisions of paragraphs 5904(3)(b) and 5905(11)(a) of the Regulations to the Act apply to incestuous shareholdings?

Position: (1) No position taken under current legislation; "No", under current proposed legislation. (2) Depends on the facts but generally they apply to down stream dividends only.

Reasons: (1) Fundamental changes to section 94 as proposed. (2) Paragraphs 5904(3)(b) and 5905(11)(a) of the Regulations were enacted only to break the circle where there are circular shareholding structures in foreign affiliates.

XXXXXXXXXX 1999-001017
Suzanie Chua
September 23, 2002

Dear XXXXXXXXXX:

Re: Liquidation of a Foreign Trust and Paragraph 95(2)(e.1)
Circular Shareholdings in Foreign Affiliates

We refer to your letters with respect to the liquidation of a foreign trust and to the computation of surplus entitlement percentage of a corporation resident in Canada in respect of a foreign affiliate. We refer to a telephone conversation between you and Ken Major with respect to your letters and mutual agreement that no definitive reply will be issued by us on the application of paragraph 95(2)(e.1) of the Income Tax Act (the "Act") to your facts. The first hypothetical situation you described with respect to the liquidation of a foreign trust is as follows:

1. CancoA owns 100% of the shares of two foreign affiliates FA1 and FA2.

2. FA1 and FA2 are residents of Country B.

3. A trust (the "Trust"), also a resident of Country B, owns all the shares of another corporation resident in Country B ("FA3").

4. The beneficiaries of the Trust are FA1 and FA2 and each has an equal interest in the Trust.

5. The Trust is liquidated and the tax laws of Country B provide a rollover in respect of the capital property distributed to FA1 and FA2 on the liquidation of the Trust.

6. Paragraph 94(1)(d) of the Act applies to the Trust.

You request our view whether the provisions of paragraph 95(2)(e.1) of the Act could apply to the liquidation of the Trust. You are concerned that as no surpluses would be computed for the Trust in reference to CancoA, CancoA would not have a surplus entitlement percentage in the Trust of not less than 90% that is required in order for paragraph 95(2)(e.1) of the Act to apply.

The second hypothetical situation you described with respect to the computation of surplus entitlement percentage and participating percentage is as follows:

1. CancoB a corporation resident in Canada owns 75% of the shares of a foreign affiliate ("FAB1").

2. FAB1 owns 100% of the shares of a second foreign affiliate of CancoB ("FAB2").

3. FAB2 owns 100% of the shares of a third foreign affiliate of CancoB ("FAB3").

4. FAB3 owns the other 25% of the shares of FAB1.

5. FAB3 has two classes of shares outstanding.

You point out that by virtue of the shares held by FAB3 in FAB1, each of the affiliates will have an "equity percentage" as defined in subsection 95(4) of the Act, in the other. As a result of this, what would be the correct interpretation of paragraphs 5902(2)(a), 5904(3)(b) and 5905(11)(a) of the Regulations (the "Anti-circularity Provisions") is unclear.

Comments

The situation outlined in your letter appears to involve either actual proposed transactions or an existing business arrangement involving identifiable taxpayers. Confirmation as to the income tax consequences of proposed transactions will only be given in the context of an advance income tax ruling. The procedures for making a request for an advance income tax ruling are outlined in Information Circular 70-6R5, dated May 17, 2002, issued by the Canada Customs and Revenue Agency ("the CCRA"). If the arrangement described already exists, assistance in determining its Canadian tax results may be obtained from a Tax Services Office of the CCRA. We can, however, offer the following general comments.

With respect to your first inquiry regarding the liquidation of a foreign trust, in light of the proposed amending legislation to current section 94 of the Act whereunder the issue does not arise, we will not comment on your inquiry except to say that under the current proposed legislation, it appears that paragraph 95(2)(e.1) of the Act has no application to the liquidation of a foreign trust in the circumstances you described. If you are contemplating winding up a particular arrangement before the coming into force of the proposed law, we would be pleased to consider the issue in reference to a detailed set of facts in the context of a ruling request.

With respect to your second inquiry, the overall scheme of the relevant calculations in sections 5902, 5904 and 5905 of the Regulations is to assess the amount of surplus that a share in a particular foreign affiliate would be entitled to if all the underlying foreign affiliates were to pay dividends up the chain of affiliates until the surplus reached the particular foreign affiliate and the particular affiliate paid a dividend on its shares, including the particular share. In our view, the purpose of the Anti-circulatory Provisions is to enable one to determine the starting point for the computation in a structure where circular shareholdings exist and clarify that the starting point is the lowest tier affiliate and downstream notional dividends are to be excluded from the computation. In the above example, we are of the view that the Anti-circularity Provisions would merely prevent the inclusion of notional dividends paid from FAB1 to FAB3 in the computation. They would not prevent the inclusion in the computation of upstream notional dividends from FAB3 to FAB2 and FAB2 to FAB1. It is our view that the surplus entitlement percentage of the shares of FAB1 owned by CancoB in respect of each of the three foreign affiliates would be 75%. As it would appear that in the above case the amount of the net surplus of each affiliate would not impact the proportion of the dividend received by a particular affiliate from another, paragraph 5904(3)(b) of the Regulations would not change the calculation of the PP of CancoB's shares in FA1 in respect of any of the affiliates. The participating percentage of CancoB's shares in FA1 in respect of each of the three affiliates would be 100%. In other circumstances, where any person acquires shares in a foreign affiliate and the principal purpose for the acquisition is the avoidance, reduction or deferral of the payment of tax, we would consider those shares not to have been acquired, pursuant to subsection 95(6) of the Act.

The foregoing comments are given in accordance with the practice referred to in paragraph 22 of Information Circular 70-6R5 and are not binding on Revenue Canada.

We trust these comments will be of assistance.

Yours truly,

for Director
International and Trusts Division
Income Tax Rulings Directorate
Policy and Legislation Branch