2002 Ruling 2001-0107263 - Sale of Shares by Employee/Shareholders

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: Application of GAAR to set up Subco to purchase Employees' shares.

Position: Favourable ruling given; GAAR not applicable.

Reasons: Consistent with past rulings given

XXXXXXXXXX 2001-010726

XXXXXXXXXX, 2002

Dear XXXXXXXXXX:

Re: ADVANCE INCOME 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 taxpayers ("the taxpayers"). We also acknowledge the information provided in subsequent correspondence and during our various telephone conversations in connection with your request.

We understand that, to the best of your knowledge and that of the taxpayers, none of the issues involved in this 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 Income Tax Rulings Directorate.

You advised that to the best of your knowledge, the proposed transactions described herein, will have no impact on the ability of the taxpayers or related persons to pay their outstanding tax liabilities.

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

DEFINITIONS

1. In this letter, the following terms have the meanings specified:

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

(b) "arm's length" has the meaning assigned by subsection 251(1);

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

(d) "CCRA" means the Canada Customs and Revenue Agency;

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

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

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

(h) "taxable Canadian corporation" has the meaning assigned by subsection 89(1).

2. In addition, certain persons will be referred to as follows:

(a) "Holdco1" means XXXXXXXXXX, a taxable Canadian corporation and a Canadian-controlled private corporation;

(b) "Opco" means XXXXXXXXXX, a taxable Canadian corporation and a Canadian-controlled private corporation;

(c) "Opco Group" means Opco and the subsidiaries of Opco;

(d) "Holdco2" means XXXXXXXXXX, a taxable Canadian corporation and a Canadian-controlled private corporation which does not deal at arm's length with Opco;

(e) "Holdco3" means XXXXXXXXXX, a taxable Canadian corporation which deals at arm's length with Opco;

(f) "Employees" means the directors, officers and employees, other than Individual A, of the companies in the Opco Group who hold common shares of Opco, and "Employee" means any of them; and

(g) "Individual A" means XXXXXXXXXX, an individual resident in Canada for the purposes of the Act.

FACTS

3. Opco was incorporated under the Business Corporations Act (XXXXXXXXXX) on XXXXXXXXXX. Opco's business number is XXXXXXXXXX. Opco files its T2 corporation income tax returns at the XXXXXXXXXX Taxation Centre and is serviced by the XXXXXXXXXX Tax Services Office.

4. The authorized share capital of Opco consists of an unlimited number of common shares and an unlimited number of preference shares. There are currently XXXXXXXXXX common shares outstanding (the "Common Shares"). Holdco1 holds XXXXXXXXXX Common Shares (XXXXXXXXXX%), Holdco2 holds XXXXXXXXXX Common Shares (XXXXXXXXXX%), the Employees hold XXXXXXXXXX Common Shares (XXXXXXXXXX%), and Holdco3 holds the remaining XXXXXXXXXX Common Shares (XXXXXXXXXX %). There are currently no preference shares issued or outstanding.

5. The Common Shares are not qualified small business corporation shares.

6. Opco is a profitable enterprise that carries on an active business in Canada and through subsidiaries in several other countries. In each of XXXXXXXXXX, Opco paid dividends on the Common Shares of $XXXXXXXXXX, respectively.

7. XXXXXXXXXX.

8. Opco is not currently and has never been a public corporation. The Common Shares and the Preference Shares are not currently and have never been purchased and sold in the manner in which shares are normally purchased and sold by any member of the public in the open market.

9. Holdco1 was incorporated under the Business Corporations Act (XXXXXXXXXX) on XXXXXXXXXX. Holdco1's business number is XXXXXXXXXX. Holdco1 files its T2 corporation income tax returns at the XXXXXXXXXX Taxation Centre and is serviced by the XXXXXXXXXX Tax Services Office.

10. Holdco1 and Opco are both controlled by Individual A for the purposes of the Act.

11. Each of the Employees deals at arm's length with Individual A, Holdco1 and all companies in the Opco Group and will deal at arm's length with Subco (as defined below in paragraph 18) at all times.

12. In the XXXXXXXXXX, the Employees acquired XXXXXXXXXX preference shares of Opco (the "XXXXXXXXXX Shares") pursuant to a stock option plan. In XXXXXXXXXX, all the XXXXXXXXXX Shares were exchanged for Common Shares and cancelled. Since XXXXXXXXXX, the Employees have acquired additional Common Shares pursuant to a stock option plan and from current and former employees of the Opco Group who participated in the stock option plan and predecessor plans.

13. The Employees, Opco and Individual A are currently parties to a shareholders' agreement dated XXXXXXXXXX (the "Shareholders' Agreement") in respect of Common Shares held by the Employees. Section XXXXXXXXXX of the Shareholders' Agreement prohibits the Employees from transferring Common Shares, except as expressly provided in the Shareholders' Agreement.

14. Section XXXXXXXXXX of the Shareholders' Agreement provides that an Employee is entitled to require Opco to purchase some or all of the Common Shares held by him or her. Sections XXXXXXXXXX provide that, in the event of such a purchase, Opco will make two payments to the Employee in the following amounts (the aggregate of such amounts will be referred to herein as the "Total Price"):

(a) the share price most recently determined in accordance with Schedule XXXXXXXXXX to the Shareholders' Agreement (the "Basic Price"); and

(b) an additional amount equal to the portion of any dividend subsequently declared on the Common Shares that relates to the part of the last XXXXXXXXXX fiscal period of Opco during which the Employee held the Common Shares, provided that any such dividend is declared within XXXXXXXXXX of the date of purchase (the "Price Adjustment").

15. Section XXXXXXXXXX of the Shareholders' Agreement provides that Opco shall purchase, at an amount equal to the Total Price, all of the Common Shares owned by an Employee that ceases to be an active director, officer or employee of Opco or one of its affiliates.

16. Section XXXXXXXXXX provides that an Employee is entitled to offer to sell his or her Common Shares to the other parties to the Shareholders' Agreement at any time for an amount equal to the Total Price.

17. The paid-up capital of the Common Shares is currently $XXXXXXXXXX per share. The Basic Price of the Common Shares as most recently determined as at XXXXXXXXXX is $XXXXXXXXXX per share.

PROPOSED TRANSACTIONS

18. Holdco1 will incorporate a corporation ("Subco") pursuant to the Business Corporations Act (XXXXXXXXXX). Holdco1 will subscribe for XXXXXXXXXX common shares of Subco, which will constitute all the outstanding shares of Subco, in consideration for which it will pay a nominal amount to Subco.

19. Subco will become a party to the Shareholders' Agreement. At the same time, the parties will agree to amend the Shareholders' Agreement to add a provision entitling the Employees to require Subco to purchase some or all of their Common Shares on substantially the same terms as the Employees are currently entitled to require Opco to purchase some or all of their Common Shares. The purchase price for any such purchase by Subco will be calculated in the same manner as the Total Price, as described in paragraph 14, above.

20. From time to time, some or all of the Employees will notify Subco of their intention to exercise their right pursuant to the Shareholders' Agreement (as amended) to have Subco purchase some or all of their Common Shares (the "Subject Common Shares").

21. Upon receipt of each such notice, Opco will loan money to Subco in an amount equal to the Basic Price of the Subject Common Shares (such loan will be referred to herein as the "Debt").

22. Immediately thereafter, Subco will purchase, as principal for its own account and not as an agent for Opco, the Subject Common Shares from the Employees for a purchase price equal to the Total Price.

23. Immediately after each such purchase, Opco will purchase for cancellation the Subject Common Shares from Subco for a purchase price equal to the Total Price. The portion of such purchase price that relates to the Basic Price will be satisfied by the cancellation of the Debt.

24. In the event that a Price Adjustment subsequently becomes owing in respect of the Subject Common Shares, Opco will pay to Subco the amount of the Price Adjustment, as part of the amount paid for the purchase of the Subject Common Shares.

Opco will pay such amount at the same time that it pays a dividend to the holders of Common Shares. Immediately thereafter, Subco will pay to the Employees from whom it purchased the Subject Common Shares the amount of the Price Adjustment, as part of the amount paid for the purchase of the Subject Common Shares.

PURPOSE OF PROPOSED TRANSACTIONS

25. 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. Subsection 84(3) of the Act will not apply to deem the Employees to receive a dividend as a result of the purchase by Subco of Subject Common Shares from the Employees and the subsequent purchase for cancellation of those shares by Opco as described in paragraphs 22 and 23, above.

B. Provided that Opco does not become a corporation described in subsection 183.1(1)(a) or (b) of the Act, subsection 183.1(2) will not apply to impose a tax on Opco in respect of (i) all or any part of the amount paid by Subco to purchase the Subject Common Shares from the Employees as described in paragraphs 22 and 24, above, or (ii) all or any part of the amount paid by Opco to Subco to purchase the Subject Common Shares for cancellation as described in paragraphs 23 and 24, above.

C. The proposed transactions described herein do not give rise to an employment benefit to the Employees under section 6 of the Act, other than any benefit which might arise by virtue of section 7 of the Act.

D. Subsection 245(2) of the Act will not apply to redetermine the tax consequences confirmed in rulings A to C, above, solely as a result of the proposed transactions described herein.

These rulings are based on the Act as it currently reads and do not take into account any future amendments, whether currently proposed or not, to the Act.

Nothing in this letter should be construed as confirmation of the tax consequences of any of the transactions described in this letter other than as specifically described. In particular, we make no comment as to whether the Total Price amount determined by the formula as the purchase price for each share, as described in paragraph 14 above, is equivalent to the fair market value of each such share.

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