2001 Ruling 2001-0097813 - Spin-off active business invested asssets

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: Standard 55(3)(a) spin-off of a company into two separate companies, XXXXXXXXXX operating company and an investment company.

Position: Favourable ruling given

Reasons: Meets conditions of 55(3)(a)

XXXXXXXXXX 2001-009781

Attention: XXXXXXXXXX

XXXXXXXXXX, 2001

Dear XXXXXXXXXX:

Re: Advance Tax Ruling
XXXXXXXXXX

This is in reply to your letter of XXXXXXXXXX in which you request an advance income tax ruling on behalf of the above named taxpayer. We also acknowledge the information provided in subsequent correspondence and during our various telephone conversations in connection with your request (XXXXXXXXXX).

We understand that, to the best of your knowledge and that of the taxpayers involved, none of the issues involved in the ruling request:

(i) is in an earlier return of the taxpayers or a related person;
(ii) is being considered by a tax services office or taxation center in connection with a previously filed tax return of the taxpayers or a related person;
(iii) is under objection by the taxpayers or a related person;
(iv) is before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has not expired; or
(v) is the subject of a ruling previously issued by the Directorate;

You advised that to the best of your knowledge the proposed transactions described herein, will not impact the ability of the taxpayers to pay their outstanding tax liabilities.

Our understanding of the facts, proposed transactions and the purpose of the proposed transactions is as follows:

DEFINITIONS

(a) XXXXXXXXXX;

(b) "Act" means the Income Tax Act, R.S.C. 1985, c.1 (5th Supp.), as amended to the date hereof, and unless otherwise stated, all references herein to a part, section, subsection, paragraph or subparagraph is a reference to the relevant provision of the Act;

(c) "ACB" means "adjusted cost base" as the expression is defined in section 54;

(d) "agreed amount" in respect of a property means the amount that the transferor and the transferee of the property have agreed upon in an election under subsection 85(1);

(e) "Canadian-controlled private corporation" has the meaning assigned by subsection 125(7);

(f) "Canadian corporation" has the meaning assigned by subsection 89(1);

(g) "capital dividend account" has the meaning assigned by subsection 89(1);

(h) "capital property" has the meaning assigned by section 54;

(i) "cost amount" has the meaning assigned by subsection 248(1);

(j) "DCo" means XXXXXXXXXX;

(k) "dividend rental arrangement" has the meaning assigned by subsection 248(1);

(l) "eligible property" has the meaning assigned by subsection 85(1.1);

(m) "financial intermediary corporation" has the meaning assigned by subsection 191(1);

(n) "FMV" means fair market value;

(o) "guarantee agreement" has the meaning assigned by subsection 112(2.2);

(p) "Mr. A" means XXXXXXXXXX, a Canadian resident individual;

(q) "Mrs. B" means XXXXXXXXXX, a Canadian resident individual and wife of Mr. A

(r) "Mr. C" means XXXXXXXXXX, a Canadian resident individual and adult son of Mr. A. and Mrs. B;

(s) "Ms. D" means XXXXXXXXXX, a Canadian resident individual and adult daughter of Mr. A. and Mrs. B;

(t) "XXXXXXXXXX properties" means all of the assets used by DCo in the business of XXXXXXXXXX;

(u) "paid-up capital" has the meaning assigned by subsection 89(1);

(v) "Pubco" means XXXXXXXXXX;

(w) "qualified small business corporation share" has the meaning assigned by subsection 110.6(1);

(x) "refundable dividend tax on hand" has the meaning assigned by subsection 129(3);

(y) "specified financial institution" has the meaning assigned by subsection 248(1);

(z) "specified investment business" has the meaning assigned by subsection 125(7);

(aa) "specified person" has the meaning assigned by paragraph (h) in the definition of "taxable preferred share" in subsection 248(1);

(bb) "subsidiary wholly-owned corporation" has the meaning assigned by subsection 248(1);

(cc) "stated capital account" has the meaning assigned by XXXXXXXXXX;

(dd) "taxable Canadian corporation" has the meaning assigned by subsection 89(1);

(ee) "taxable dividend" has the meaning assigned by subsection 89(1); and

(ff) "undepreciated capital cost" means the amount determined in subsection 13(21).

Facts

1. DCo is a Canadian-controlled private corporation incorporated under the laws of XXXXXXXXXX. The taxation year-end of DCo is XXXXXXXXXX . DCo deals with the XXXXXXXXXX Tax Services Office and files its corporate income tax returns at the XXXXXXXXXX Taxation Centre.

2. Mr. A, Mrs. B, Mr. C, and Ms. D are all residents of Canada, are all related to each other and do not deal with each other at arm's length.

3. Mr. C is Ms. D's brother; consequently, pursuant to subparagraph 55(5)(e)(i), they are deemed to be dealing at arm's length for purposes of section 55.

4. The issued and outstanding share capital of DCo is as follows:

Paid-up Capital ($)
XXXXXXXXXX Class A voting common shares XXXXXXXXXX
XXXXXXXXXX Class B voting common shares XXXXXXXXXX
XXXXXXXXXX Class C non-voting common shares XXXXXXXXXX

5. The holders of the issued and outstanding common shares of DCo and their ACB are as follows:

Name

Number and Class

ACB
$
Mr. A XXXXXXXXXX Class A XXXXXXXXXX
Mrs. B XXXXXXXXXX Class A XXXXXXXXXX
XXXXXXXXXX Class B XXXXXXXXXX
Mr. C XXXXXXXXXX Class C XXXXXXXXXX
Ms. D XXXXXXXXXX Class C XXXXXXXXXX

6. The shares of DCo represent capital property to each of the shareholders.

7. DCo is in the business of XXXXXXXXXX. DCo also owns life insurance policies on the lives of Mr. A and Mrs. B. DCo also holds cash and an investment in Pubco, a public company.

8. A list of DCo's assets and liabilities and their estimated FMVs at XXXXXXXXXX is summarized as follows:

Working capital $XXXXXXXXXX
XXXXXXXXXX properties XXXXXXXXXX
Life insurance - Cash surrender value net of policy loans XXXXXXXXXX
Investment in Pubco XXXXXXXXXX

9. There is no goodwill associated with the XXXXXXXXXX business carried on by DCo.

10. As at XXXXXXXXXX, DCo's refundable dividend tax on hand ("RDTOH") was $XXXXXXXXXX.

11. The shares of DCo held by each of Mr. A, Mrs. B, Mr. C and Ms. D are not qualified small business corporation shares.

PROPOSED TRANSACTIONS

12. The directors of DCo will resolve to split the common shares of DCo on a XXXXXXXXXX basis. As a result of the directors' resolution, the issued and outstanding common shares of DCo will be held as follows:

Name
Number and Class
% of outstanding common shares

Mr. A XXXXXXXXXX Class A common shares XXXXXXXXXX

Mrs. B XXXXXXXXXX Class A common shares XXXXXXXXXX

Mrs. B XXXXXXXXXX Class B common shares XXXXXXXXXX

Mr. C XXXXXXXXXX Class C common shares XXXXXXXXXX

Ms. D XXXXXXXXXX Class C common shares XXXXXXXXXX

13. Mr. A will incorporate a new corporation ("Newco") under the XXXXXXXXXX. Newco will be a taxable Canadian corporation.

14. Newco's authorized share capital will consist of an

a) unlimited number of Class A voting common shares,

b) unlimited number of Class B voting common shares,

c) unlimited number of Class C non-voting common shares, and

d) unlimited number of Class F non-voting, retractable, redeemable preferred shares. The redemption value of the Class F shares will be determined at the time the shares are issued and defined as being an amount equal to the FMV of the consideration received by Newco for the issuance of such shares.

15. Mr. A will subscribe for 1 Class A common share of Newco for $XXXXXXXXXX.

16. Mr. A will transfer, at FMV, Class A common shares of DCo to Newco having a FMV equal to XXXXXXXXXX% of the amount by which the FMV of DCo's XXXXXXXXXX properties exceeds the debt of DCo that is allocable to the XXXXXXXXXX operations (such debt will not exceed the cost amount of the assets), and will receive, as sole consideration therefor, XXXXXXXXXX Class A common shares of Newco having a FMV equal to the FMV of the DCo shares transferred.

17. Mrs. B will transfer, at FMV, Class A common shares of DCo to Newco having a FMV equal to XXXXXXXXXX% of the amount by which the FMV of DCo's XXXXXXXXXX properties exceeds the debt of DCo that is allocable to the XXXXXXXXXX operations (such debt will not exceed the cost amount of the assets), and will receive, as sole consideration therefor, XXXXXXXXXX Class A common shares of Newco having a FMV equal to the FMV of the DCo shares transferred.

18. Mrs. B will transfer, at FMV, Class B common shares of DCo to Newco having a FMV equal to XXXXXXXXXX% of the amount by which the FMV of DCo's XXXXXXXXXX properties exceeds the debt of DCo that is allocable to the XXXXXXXXXX operations (such debt will not exceed the cost amount of the assets), and will receive, as sole consideration therefor, XXXXXXXXXX Class B common shares of Newco having a FMV equal to the FMV of the DCo shares transferred.

19. Mr. C will transfer, at FMV, Class C common shares of DCo to Newco having a FMV equal to XXXXXXXXXX% of the amount by which the FMV of DCo's XXXXXXXXXX properties exceeds the debt of DCo that is allocable to the XXXXXXXXXX operations (such debt will not exceed the cost amount of the assets), and will receive, as sole consideration therefor, XXXXXXXXXX Class C common shares of Newco having a FMV equal to the FMV of the DCo shares transferred.

20. Ms. D will transfer, at FMV, Class C common shares of DCo to Newco having a FMV equal to XXXXXXXXXX% of the amount by which the FMV of DCo's XXXXXXXXXX properties exceeds the debt of DCo that is allocable to the XXXXXXXXXX operations (such debt will not exceed the cost amount of the assets), and will receive, as sole consideration therefor, XXXXXXXXXX Class C common shares of Newco having a FMV equal to the FMV of the DCo shares transferred.

The purpose of the share transfers in paragraphs 16 to 20 is to enable Newco to become a shareholder of DCo.

21. Newco will add to the stated capital account maintained for each class of its common shares an amount equal to the paid-up capital of each class of common shares of DCo transferred by each of Mr. A, Mrs. B, Mr. C and Ms. D pursuant to paragraphs 16 to 20 above.

22. Each of Mr. A, Mrs. B, Mr. C and Ms. D will jointly elect with Newco in prescribed form and within the time referred to in subsection 85(6) to have the provisions of subsection 85(1) apply to the transfer of shares described in paragraphs 16 to 20 above. The agreed amount will be equal to the cost amount of the shares transferred, consistent with the limitations set out in subsection 85(1).

23. DCo and Newco will enter into a purchase and sale agreement to transfer, at FMV, all of the XXXXXXXXXX properties of DCo to Newco. In consideration for the XXXXXXXXXX properties, Newco will:

(a) assume debt of DCo that is allocable to the XXXXXXXXXX operations, but not exceeding the aggregate of the agreed amounts in the joint election under subsection 85(1) described in paragraph 25 below; and

(b) issue to DCo Class F preferred shares having an aggregate redemption value ("Redemption Amount"), retraction amount and FMV equal to the FMV of the XXXXXXXXXX properties transferred to Newco, as described herein, less the amount of debt of DCo assumed by Newco as described in (a) above.

24. After the transfer described in paragraph 23, the FMV of the Class F preferred shares of Newco owned by DCo will be equal to the aggregate FMV of the Class A, Class B, and Class C common shares of DCo owned by Newco.

25. DCo and Newco will jointly elect in prescribed form and within the time referred to in subsection 85(6) to have the provisions of subsection 85(1) apply to the transfer of any of the XXXXXXXXXX properties that is an eligible property and has a FMV in excess of its cost amount. The agreed amount will be equal to the cost amount of the assets transferred, consistent with the limitations set out in subsection 85(1). Where the property is a "XXXXXXXXXX" as that phrase is defined in subsection XXXXXXXXXX the agreed amount will be an amount that is not less than $XXXXXXXXXX and not greater than the FMV of the property.

26. Pursuant to a director's resolution, Newco will redeem its Class F preferred shares owned by DCo and will issue in consideration therefor to DCo a demand non-interest-bearing promissory note (the "Newco Note") acknowledging an indebtedness equal to the aggregate redemption amount of the Class F preferred shares, as described in paragraph 23. DCo will accept the Newco Note in full satisfaction of the aggregate redemption amount of the Class F preferred shares.

27. Concurrent with the transaction described in paragraph 26, DCo will purchase for cancellation the Class A, Class B, and Class C common shares owned by Newco and in consideration therefor will issue to Newco a demand non-interest-bearing promissory note (the "DCo Note") acknowledging an indebtedness equal to the aggregate FMV of such Class A, Class B, and Class C common shares purchased for cancellation. Newco will accept the DCo Note in full satisfaction of the aggregate purchase price of the Class A, Class B, and Class C common shares.

28. The DCo Note and the Newco Note will be set off against each other and cancelled in full satisfaction of the obligations under each note.

OTHER INFORMATION

29. It is our understanding that:

a) none of the shares of DCo or Newco referred to in this advance income tax ruling request have been or will be subject to a guarantee agreement;

b) none of the shares of DCo or Newco referred to in this advance income tax ruling request have been or will be subject to a dividend rental arrangement;

c) none of the shares of DCo or Newco referred to in this advance income tax ruling request have been or will be issued or acquired as part of a transaction or event or series of transactions or events of the type described in subsection 112(2.5); and

d) neither DCo nor Newco is or will be at any time before the completion of the proposed transactions described herein, a financial intermediary corporation.

30. As part of the series of transactions that includes the proposed transaction, there will be no:

a) disposition of property in the circumstances described in subparagraph 55(3)(a)(i) except as permitted by clause 55(3)(a)(i)(A) and (B);

b) significant increase in the total direct interest in any corporation in the circumstances described in subparagraph 55(3)(a)(ii) except as permitted;

c) disposition of property in the circumstances described in subparagraph 55(3)(a)(iii);

d) disposition of property in circumstances described in subparagraph 55(3)(a)(iv); or

e) significant increase in the total of all direct interests in the circumstances described in subparagraph 55(3)(a)(v).

PURPOSE OF THE PROPOSED TRANSACTIONS

The XXXXXXXXXX operations of DCo are to be separated from the other assets held by DCo in order to provide DCo with the opportunity to take on greater risk in the XXXXXXXXXX
XXXXXXXXXX

RULINGS REQUESTED AND GIVEN

Provided that the preceding statements constitute a complete and accurate disclosure of all the relevant facts, proposed transactions, and purpose of the proposed transactions and provided further that the proposed transactions are carried out as described above, our rulings are as follows:

A. Provided that the requisite elections are filed in the prescribed form and within the prescribed time period, the provisions of subsection 85(1) will apply to:

i) the transfer of Class A common shares of DCo by Mr. A, as described in paragraph 16, with the result that the amounts agreed upon with respect to such shares will be deemed to be Mr. A's proceeds of disposition of the property and Newco's cost of the property pursuant to paragraph 85(1)(a);

ii) the transfer of Class A common shares of DCo by Mrs. B as described in paragraph 17 with the result that the amounts agreed upon with respect to such shares will be deemed to be Mrs. B's proceeds of disposition of the property and Newco's cost of the property pursuant to paragraph 85(1)(a);

iii) the transfer of Class B common shares of DCo by Mrs. B as described in paragraph 18 with the result that the amounts agreed upon with respect to such shares will be deemed to be Mrs. B's proceeds of disposition of the property and Newco's cost of the property pursuant to paragraph 85(1)(a);

iv) the transfer of Class C common shares of DCo by Mr. C as described in paragraph 19 with the result that the amounts agreed upon with respect to such shares will be deemed to be Mr. C's proceeds of disposition of the property and Newco's cost of the property pursuant to paragraph 85(1)(a);

v) the transfer of Class C common shares of DCo by Ms. D as described in paragraph 20 with the result that the amounts agreed upon with respect to such shares will be deemed to be Ms. D's proceeds of disposition of the property and Newco's cost of the property pursuant to paragraph 85(1)(a); and
vi) the transfer by DCo to Newco as described in paragraph 23 of each XXXXXXXXXX property that is an eligible property, with the result that the amounts agreed upon with respect to the XXXXXXXXXX properties will be deemed to be DCo's proceeds of disposition of the property and Newco's cost of the property pursuant to paragraph 85(1)(a).

B. The provisions of paragraph 85(1)(e.2) will not apply to any of the transfers described in paragraphs 16, 17, 18, 19, 20 and 23 above.

C. The provisions of subsection 84(3) will apply on the redemption of Class F preferred shares (as described in paragraph 26 above) to deem Newco to have paid and DCo to have received a dividend at that time on such shares equal to the amount, if any by which the amount paid on the redemption exceeds the paid-up capital of the Class F preferred shares immediately before the redemption.

D. The provisions of subsection 84(3) will apply on the purchase for cancellation of the Class A, Class B, and Class C common shares (as described in paragraph 27 above) to deem DCo to have paid and Newco to have received a dividend at that time on such shares equal to the amount, if any, by which the amount paid on the purchase for cancellation exceeds the paid-up capital of those Class A, Class B, and Class C common shares immediately before the purchase for cancellation.

E. The deemed dividends referred to in rulings C and D above, to the extent they are taxable dividends, will;

a) be deductible by DCo and Newco, respectively, in calculating their taxable income pursuant to subsection 112(1) and for greater clarity such deduction will not be prohibited by any of subsections 112(2.2), (2.3), and (2.4); and,

b) be excluded from the determination of proceeds of disposition of the shares redeemed or purchased for cancellation pursuant to paragraph (j) of the definition of "proceeds of disposition" in section 54.

F. The taxable dividends described in Rulings C and D above will not be subject to tax under subsection 186(1), except as provided in paragraph 186(1)(b).

G. The taxable dividends referred to in Rulings C and D above:

(a) will not be subject to tax under Part IV.1 because the dividends will be excepted dividends pursuant to paragraph (c) of the definition of "excepted dividend" in section 187.1; and

(b) will not be subject to tax under Part VI.1 of the Act on the basis that each of the recipients will have a substantial interest, within the meaning assigned by paragraph 191(2)(a), in the payer corporation at the time such taxable dividends are paid and, therefore, such dividends will be "excluded dividends" within the meaning of paragraph 191(1)(a).

H. Provided that there is no disposition or increase in interest described in any of subparagraphs 55(3)(a)(i) to (v) as part of a series of transactions or events that includes the Proposed Transactions, then by virtue of paragraph 55(3)(a), the provisions of subsection 55(2) will not apply to the taxable dividends described in Rulings C and D above.

I. Neither the provisions of subsections 80(2) nor 80.01(2) will apply to the extinguishment of the Newco Note or the DCo Note, as described in paragraph 28 above.

J. The provisions of 15(1), 56(2), 69(1), 69(4) and 246(1) will not apply as a result of the proposed transactions, in and by themselves.

K. Subsection 245(2) will not be applied as a result of the proposed transactions, in and by themselves, to redetermine the tax consequences requested to be confirmed in the rulings requested.

Other comments

Nothing in this letter should be construed as implying that Canada Customs and Revenue Agency has agreed to or reviewed:

(a) the determination of the adjusted cost base or FMV of any property or the paid-up capital of any shares referred to herein, or

(b) any tax consequences arising from any of the facts or proposed transactions described herein other than those specifically referred to in the rulings given above.

The rulings are given subject to the limitations and qualifications set out in Information Circular 70-6R4 dated January 29, 2001 and is binding on the Canada Customs and Revenue Agency provided that the proposed transactions are completed before XXXXXXXXXX.
Yours truly,

for Director
Reorganizations and Resources Division
Income Tax Rulings Directorate
Policy and Legislation Branch