2002 Ruling 2002-0116653 - Section 86 Share Exchange86

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: Whether section 86 applies to share exchange

Position: Yes

Reasons: All the requirements of section 86 are satisfied

XXXXXXXXXX 2002-011665

XXXXXXXXXX, 2002

Dear XXXXXXXXXX:

Re: XXXXXXXXXX
Advance Income Tax Ruling

This is in reply to your letter of XXXXXXXXXX in which you requested advance income tax rulings on behalf of the above named taxpayers. We acknowledge your facsimiles of XXXXXXXXXX, and the information provided in our various telephone conversations in connection with your request.

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

(i) is in an earlier return of the taxpayer or a related person;

(ii) is being considered by a tax services office or taxation centre in connection with a previously filed tax return of the taxpayer or a related person;

(iii) is under objection by the taxpayer or a related person;

(iv) is before the courts and no judgment has been previously issued; or

(v) is the subject of a ruling previously issued by the Income Tax Rulings Directorate to the taxpayer or a related person.

DEFINITIONS

In this letter, unless otherwise noted: (i) all statutory references are to the Income Tax Act, R.S.C. 1985, c.1 (5th Supp.), as amended (the "Act"), and (ii) all references to monetary amounts are in Canadian dollars.

In this letter:

(a) "ACB" means "adjusted cost base" which has the meaning assigned by section 54 and subsection 248(1);

(b) "agreed amount" in respect of an asset means the amount that the transferor and the transferee of the asset agree upon in their election under subsection 85(1) in respect of that asset;

(c) "BCA" means the Business Corporations Act (XXXXXXXXXX);

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

(e) "CBCA" means the Canada Business Corporations Act;

(f) "Canco" means XXXXXXXXXX;

(g) "Common Shareholders" means the owners of the common shares of Canco after the transfer described in paragraph 15 below and prior to the share exchange described in paragraph 17 below;

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

(i) "Holdco" means the corporation to be incorporated as described in paragraph 14 below;

(j) "Individual A" means XXXXXXXXXX;

(k) "Individual B" means XXXXXXXXXX;

(l) "Individual C" means XXXXXXXXXX;

(m) "Individual D" means XXXXXXXXXX;

(n) "Individual E" means XXXXXXXXXX;

(o) "Individual F" means XXXXXXXXXX;

(p) "Individual G" means XXXXXXXXXX;

(q) "Individual H" means XXXXXXXXXX;

(r) "Individual I" means XXXXXXXXXX;

(s) "Preferred Shareholders" means the beneficial owners of the Class A preferred shares of Canco after the transfer described in paragraph 15 below and prior to the share exchange described in paragraph 17 below;

(t) "private corporation" has the meaning assigned by subsection 89(1);

(u) "proceeds of disposition" has the meaning assigned by section 54;

(v) "PUC" means "paid-up capital" which has the meaning assigned by subsection 89(1);

(w) "related person" has the meaning assigned by section 251;

(x) "stated capital" means stated capital as that expression is used in the BCA or CBCA, as the context requires;

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

(z) "USCo" means XXXXXXXXXX.

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

FACTS

1. The personal information of the Individuals is as follows:

Individual		Address				SIN	 	

Individual A		XXXXXXXXXX 			XXXXXXXXXX 	

	Individual B		XXXXXXXXXX 			XXXXXXXXXX 

	Individual C		XXXXXXXXXX 			XXXXXXXXXX 

	Individual D		XXXXXXXXXX 			XXXXXXXXXX 

	Individual E		XXXXXXXXXX 			XXXXXXXXXX 

Individual F		XXXXXXXXXX 			XXXXXXXXXX 

	Individual G		XXXXXXXXXX 			XXXXXXXXXX 

	Individual H		XXXXXXXXXX 			XXXXXXXXXX 

Individual I XXXXXXXXXX XXXXXXXXXX

2. Individual A is a resident of Canada for the purposes of the Act. Individual A deals with the XXXXXXXXXX Tax Services Office and files his returns with the XXXXXXXXXX Taxation Centre. Individual A is not related to Individuals B, C, D, E, F, G, H or I.

3. Individuals B, C, D, E, F, G, H and I are non-residents of Canada for the purposes of the Act. Individuals C, D and E are siblings and are related persons. Individual B is the brother-in-law of Individuals C, D and E and is related to each. Individuals F, G and H are siblings and are related persons. Individuals C, D and E are cousins of Individuals F, G and H.

4. USCo is a corporation that is a non-resident of Canada for the purposes of the Act. USCo's head office is located at XXXXXXXXXX. Some of the individuals described in paragraph 9 below own common shares of USCo.

5. Canco was incorporated pursuant to the provisions of the CBCA, and is a private corporation and a taxable Canadian corporation. The head office of Canco is located at XXXXXXXXXX. Canco's year-end is XXXXXXXXXX. Canco's business number is XXXXXXXXXX, and it deals with the XXXXXXXXXX Tax Services Office and files its tax returns with the XXXXXXXXXX Taxation Centre.

6. The authorized share capital of Canco, and a summary of the rights, restrictions and conditions attaching to these shares is as follows:

a) an unlimited number of Class A preferred shares, which entitle the holder to cumulative dividends with a variable rate determined from time to time by the Board of Directors, and which are non-voting, non-participating, redeemable, retractable;

b) an unlimited number of Class B preferred shares, which entitle the holder to a XXXXXXXXXX% non-cumulative dividend, and which are non-voting, non-participating, redeemable and retractable; and

c) an unlimited number of common shares, which entitle the holder to dividends as declared by the Board of Directors and which are voting and subject to the rights, privileges, restrictions and conditions attaching to any other class of shares of the corporation with respect to the receipt of the remaining property of the corporation on dissolution.

The Class A preferred shares were created by Certificate of Amendment dated XXXXXXXXXX pursuant to section 177 of the CBCA and were issued in XXXXXXXXXX on the conversion of debt into equity.

7. The issued share capital of Canco consists of XXXXXXXXXX common shares and XXXXXXXXXX Class A preferred shares. There are no issued and outstanding Class B preferred shares.

8. Information relating to the XXXXXXXXXX issued and outstanding common shares of Canco is as follows:

Shareholder		Number		ACB		PUC

Individual A		XXXXXXXXXX
	USCo			XXXXXXXXXX 

9. Individual B is the bare trustee, and registered owner, of all the issued and outstanding Class A preferred shares. Information relating to the beneficial ownership of the XXXXXXXXXX issued and outstanding Class A preferred shares of Canco is as follows:

Shareholder		Number		ACB		PUC

Individual A		              XXXXXXXXXX
Individual B		              XXXXXXXXXX
Individual C		              XXXXXXXXXX
Individual D		             XXXXXXXXXX
Individual E		   	XXXXXXXXXX
Individual F	  	  	 XXXXXXXXXX
Individual G	  	  	 XXXXXXXXXX
Individual H	  	   	XXXXXXXXXX
Individual I		     	XXXXXXXXXX 

10. All of the shareholders described in paragraphs 8 and 9 above hold their shares as capital property for the purposes of the Act.

11. Currently, Canco is in a deficit position and may not declare dividends under the provisions of the CBCA. The cumulative dividends in arrears on the Class A preferred shares as at XXXXXXXXXX were $XXXXXXXXXX. Dividends have never been declared on the Class A preferred shares and the Board of Directors has no intention of declaring any dividends prior to the proposed transactions.

12. Canco does not have any non-capital or net capital loss carryforwards.

PROPOSED TRANSACTIONS

13. Canco's Board of Directors will pass a directors' resolution to authorize a current valuation of the common and preferred shares of Canco.

14. Individual A will incorporate Holdco under the provisions of the BCA. Holdco will be a private corporation and a taxable Canadian corporation. The share capital of Holdco will consist of common shares and preferred shares.

15. Individual A will transfer his XXXXXXXXXX common shares and XXXXXXXXXX preferred shares of Canco to Holdco for a purchase price equal to their aggregate fair market value. Holdco will satisfy the purchase price by issuing common and preferred shares of Holdco to Individual A. The Board of Directors of Holdco will limit the amount to be added to the stated capital of the common and preferred shares issued to an amount equal to the aggregate PUC of the respective common and preferred shares of Canco so transferred.

16. Individual A and Holdco 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 the common and preferred shares of Canco described in this paragraph. The agreed amount in respect of each transfer of eligible property will be an amount equal to the lesser of the amounts described in subparagraphs 85(1)(c.1)(i) and (ii). For greater certainty, the agreed amount will not exceed the fair market value of the respective property transferred or be less than the amount described in paragraph 85(1)(b).

17. After the transfer described in paragraph 15 above, Canco will file articles of amendment to:

a) create an unlimited number of a new class of common shares (the "New Common Shares"), designated as Class A common, with the following characteristics:

i. voting;

ii. entitle the holder to receive any dividend declared by the Board of Directors; and

iii. are subject to the rights, privileges, restrictions and conditions attaching to any other class of shares of the corporation to receive the remaining property of the corporation on dissolution;

b) create an unlimited number of a new class of preferred shares (the "New Preferred Shares") with the following characteristics:

i. retractable at the option of the holder;

ii. redeemable at the option of the corporation;

iii. have a fixed redemption value equal to the fair market value of the common shares to be exchanged;

iv. entitle the holder to dividends equal to XXXXXXXXXX% of the paid-up capital of the new preferred shares;

v. have dividend restrictions on the other classes of shares to ensure that there are sufficient funds to redeem the preferred shares at their redemption amount;

vi. cumulative if the fair market value of the corporation's net assets falls below the redemption amount of the preferred shares or if the corporation is unable to redeem the shares if the retractable feature is exercised;

vii. voting with respect to the rights attached to the preferred shares; and

viii. have a preference on liquidation;

c) change all of the existing issued and outstanding common shares into New Preferred Shares on a share for share basis; and

d) change all of the existing issued and outstanding Class A preferred shares into New Common Shares on a share for share basis.

The existing issued common shares and the Class A preferred shares will then be cancelled. The fair market value of the New Preferred Shares and the New Common Shares received by each shareholder, as the case may be, will be equal to the fair market value of the common shares and Class A preferred shares so exchanged.

The non-resident shareholders will apply for a clearance certificate under section 116 in respect of the disposition of their common or Class A preferred shares, as the case may be, on the share exchange.

18. After the share exchanges described in paragraphs 17c) and d) above, Canco will:

a) add to its stated capital in respect of the New Common Shares an amount equal to the aggregate PUC of the Class A preferred shares so exchanged immediately before the reorganization; and

b) add to its stated capital in respect of the New Preferred Shares an amount equal to the aggregate PUC of the common shares so exchanged immediately before the reorganization.

ADDITIONAL INFORMATION

19. There have been no significant transactions completed by the taxpayers prior to the time of this ruling and it is not anticipated that there will be any significant transactions after the completion of the proposed transactions.

20. Individual A is transferring his Canco shares to Holdco to facilitate future estate planning transactions. At the time of this ruling, however, no specific transactions are contemplated.

21. The proposed transactions are not expected to have any impact on the outstanding tax liabilities, if any, of the taxpayers identified in the ruling.

PURPOSE OF THE PROPOSED TRANSACTIONS

The purpose of the share exchange is to transfer direct control of Canco to the financiers of the business, being the preferred shareholders described in paragraph 9 above, and to allow the future capital appreciation of Canco to accrue to them.

RULINGS

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

A. The provisions of section 86 will apply to the exchange by the Common Shareholders of the common shares of Canco for New Preferred Shares of Canco, as described in paragraph 17c) above. As a consequence, the cost to each Common Shareholder of the New Preferred Shares will be deemed by paragraph 86(1)(b) to be equal to the ACB of the common shares to each Common Shareholder before the exchange. The proceeds of disposition of the common shares will be deemed by paragraph 86(1)(c) to be the cost of the New Preferred Shares to each Common Shareholder.

B. The provisions of section 86 will apply to the exchange by the Preferred Shareholders of the Class A preferred shares of Canco for New Common Shares of Canco, as described in paragraph 17d) above. As a consequence, the cost to each Preferred Shareholder of the New Common Shares will be deemed by paragraph 86(1)(b) to be equal to the ACB of the Class A preferred shares to each Preferred Shareholder before the exchange. The proceeds of disposition of the Class A preferred shares will be deemed by paragraph 86(1)(c) to be the cost of the New Common Shares to each Preferred Shareholder.

C. Subsection 245(2) will not be applied to the proposed transactions, in and by themselves, to redetermine the tax consequences confirmed in the rulings given.

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

COMMENTS

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

a) the determination of the ACB, PUC or fair market value of any shares referred to herein; or

b) any tax consequences relating to the facts and proposed transactions described herein other than those specifically described in the rulings given above.

Yours truly,

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