2007 Ruling 2007-0226581R3 - Intrnl reorg. - XXXXXXXXXX

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.

Principal Issues: Distribution of assets of a corporation prior to a divorce by the two shareholders.

Position: Favourable rulings issued.

Reasons: The law.

XXXXXXXXXX 2007-022658

XXXXXXXXXX, 2007

Dear XXXXXXXXXX:

RE: XXXXXXXXXX
Advance Income Tax Ruling Request

This is in reply to your letter of XXXXXXXXXX, as modified by your other correspondence, wherein you requested an advance income tax ruling on behalf of the taxpayers described in this ruling request. You have advised us that to the best of your knowledge and that of the taxpayers involved none of the issues involved in this ruling request are:

(i) in an earlier return of any of the taxpayers or a related person;

(ii) being considered by a tax services office ("TSO") or taxation centre ("TC") in connection with a previously filed tax return of any of the taxpayers or a related person;

(iii) under objection by any of the taxpayers or a related person;

(iv) before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has expired; or

(v) the subject of a ruling previously issued by the Income Tax Rulings Directorate.

The taxpayers have also represented that the proposed transactions described herein will not result in any taxpayer described herein being unable to pay its existing outstanding tax liabilities.

DEFINITIONS

In this letter, all monetary amounts are expressed in Canadian dollars unless otherwise indicated, and the following terms or expressions have the meaning specified:

(a) "Act" means the Income Tax Act, R.S.C. 1985 (5th Supp.) c.1, as amended from time to time and consolidated to the date of this letter and, unless otherwise expressly stated, every reference herein to a part, section or subsection, paragraph or subparagraph and clause or subclause is a reference to the relevant provision of the Act, and the Income Tax Regulations thereunder are referred to as the "Regulations";

(b) "adjusted cost base" has the meaning assigned by section 54;

(c) "agreed amount" means the amount agreed on by the transferor and transferee in respect of the transfer of an eligible property in a joint election filed pursuant to subsection 85(1);

(d) "BCA" means the Business Corporations Act of XXXXXXXXXX;

(e) "BN" refers to the tax identification number assigned by the CRA to a particular entity;

(f) "CRA" means the Canada Revenue Agency;

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

(h) "fair market value" means the highest price available in an open and unrestricted market, between informed prudent parties, acting at arm's length and with no compulsion to act, expressed in terms of cash;

(i) "forgiven amount" has the meaning assigned by subsections 80(1) and 80.01(1);

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

(k) "Holdco" means XXXXXXXXXX;

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

(m) "Paragraph" refers to a numbered paragraph in this advance income tax ruling;

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

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

(p) "Proposed Transactions" means the transactions described in Paragraphs 7 to 14;

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

(r) "related persons" has the meaning assigned by section 251;

(s) "restricted financial institution" has the meaning assigned by subsection 248(1);

(t) "series of transactions or events" includes the transactions or events referred to in subsection 248(10);

(u) "Shareholder A" means XXXXXXXXXX;

(v) "Shareholder B" means XXXXXXXXXX;

(w) "SIN" means social insurance number;

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

(y) "stated capital" has the meaning assigned by the BCA;

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

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

(bb) "taxation year" has the meaning assigned by subsection 249(1).

FACTS

1. Holdco was incorporated on XXXXXXXXXX , pursuant to the BCA. Holdco initially carried on XXXXXXXXXX business in XXXXXXXXXX under its former name of XXXXXXXXXX. On XXXXXXXXXX, Holdco changed its name to XXXXXXXXXX . Following the cessation of the XXXXXXXXXX business as described in Paragraph 3, Holdco changed its name to XXXXXXXXXX on XXXXXXXXXX. Holdco is a taxable Canadian corporation and has a XXXXXXXXXX taxation year. Holdco files its federal tax returns at the XXXXXXXXXX TC and otherwise deals with the XXXXXXXXXX TSO.

2. The only issued and outstanding shares of Holdco are XXXXXXXXXX Class A common shares ("Class A Shares"). Shareholder A and Shareholder B have owned the Class A Shares in equal proportions (i.e. XXXXXXXXXX Class A Shares each) since Holdco was incorporated. The aggregate paid-up capital of the Class A Shares is $XXXXXXXXXX. The Class A Shares are capital property to each of Shareholder A and Shareholder B and have a fair market value greater than their adjusted cost base and paid-up capital.

3. On XXXXXXXXXX, Holdco sold the majority of its assets that were used in its XXXXXXXXXX business to an arm's-length third party for fair market value consideration. The assets that were sold by Holdco consisted of equipment, leaseholds, inventory and goodwill. XXXXXXXXXX. None of the asset sales by Holdco resulted in the proceeds of disposition from such asset sales being less than the fair market value of the assets that were sold.

4. Holdco now carries on an investment business. Currently, the property of Holdco consists of cash, marketable securities, accounts receivable, XXXXXXXXXX% of the issued and outstanding shares of a private corporation ("Pco"), and a loan receivable from Pco of approximately $XXXXXXXXXX. The marketable securities consist solely of money market funds and GICs. Holdco's liabilities consist of accounts payable, income taxes payable and approximately $XXXXXXXXXX owing to its shareholders. No significant changes in the property or liabilities of Holdco are expected prior to the implementation of the Proposed Transactions. Holdco is expected to have a balance of RDTOH at the time the Proposed Transactions are implemented.

5. Pco owns the land and building where Holdco formerly carried on its XXXXXXXXXX business. Pco had leased such property to Holdco and to various other commercial tenants. Pco continues to lease the land and buildings to the current owner of the XXXXXXXXXX business and to the various other commercial tenants. Pco and the other shareholders of Pco are not related persons in respect of Holdco, Shareholder A or Shareholder B.

6. Shareholder A and Shareholder B are husband and wife, however they are presently living separate and apart by reason of a marital breakdown which has now culminated in divorce proceedings. To date, the pending divorce of Shareholder A and Shareholder B has not been finalized and Shareholder A and Shareholder B are still legally married. As part of a negotiated matrimonial property settlement, and subject to the receipt of a favourable advance income tax ruling from CRA concerning the Proposed Transactions, Shareholder A and Shareholder B have agreed that one-half of the net fair market value of Holdco's property will be transferred to a new corporation to be owned and controlled by Shareholder B. In addition, Shareholder B's Class A Shares in Holdco will be eliminated so that Shareholder A will be the sole shareholder of Holdco while Shareholder B will be the sole shareholder of Newco. Shareholder A and Shareholder B are residents of Canada for the purposes of the Act. Shareholder A and Shareholder B file their respective tax returns at the XXXXXXXXXX TC but otherwise deal with the XXXXXXXXXX TSO.

PROPOSED TRANSACTIONS

7. Shareholder B will incorporate a new taxable Canadian corporation ("Newco") under the BCA. Shareholder B will be the sole director and officer of Newco. No shares of Newco will be issued on the incorporation of Newco.

The authorized share capital of Newco will include a class of voting common shares ("Common Shares") and a class of non-voting retractable and redeemable preferred shares ("Preferred Shares").

The Preferred Shares will entitle a holder to non-cumulative dividends as the director may declare, but not exceeding a reasonable rate stated as a percentage of the aggregate redemption amount of such shares. The aggregate redemption amount for the Preferred Shares will be set by the director at the time of issuance and will be equal to the fair market value of the property received by Newco for the issuance of such shares less any debt issued or liabilities assumed by Newco on their issuance. The redemption amount will be subject to a price adjustment clause.

8. Shareholder B will transfer her XXXXXXXXXX Class A Shares of Holdco to Newco and as consideration therefor, Newco will issue a number of Common Shares having an aggregate fair market value equal to the fair market value of the Class A Shares that Newco received from Shareholder B.

For the purposes of the BCA, the increase to the stated capital of the Common Shares of Newco that are issued to Shareholder B as consideration for the Class A Shares of Holdco, will equal the paid-up capital of the XXXXXXXXXX Class A Shares of Holdco so transferred to Newco and for greater certainty, such amount will not exceed the amount determined as B for the purposes of paragraph 84.1(1)(a).

Shareholder B and Newco will jointly elect, in prescribed form and within the time limits referred to in subsection 85(6), to have the provisions of subsection 85(1) apply in respect of the transfer of the Class A Shares. The agreed amount in each joint election will be equal to the adjusted cost base of the XXXXXXXXXX Class A Shares to Shareholder B immediately before the transfer. For greater certainty, the agreed amount will not exceed the lesser of the amounts described in subparagraphs 85(1)(c.1)(i) and (ii).

9. Immediately following the transfer of the Class A Shares of Holdco by Shareholder B described in Paragraph 8, Holdco will transfer a portion of its property to Newco and Newco will assume a portion of Holdco's existing liabilities such that immediately thereafter, Newco will have acquired, a proportion of the net fair market value of all property owned by Holdco determined immediately before such transfers that:

(i) the aggregate fair market value of the Class A Shares owned by Newco immediately before the transfer,

is of

(ii) the aggregate fair market value of all of the outstanding shares of Holdco immediately before the transfer.

In addition to the assumption of a portion of Holdco's liabilities by Newco, Newco will issue a number of its Preferred Shares to Holdco having an aggregate fair market value and redemption amount equal to the amount by which the aggregate fair market value of the properties of Holdco that are transferred to Newco exceeds the aggregate fair market value of liabilities of Holdco that are assumed by Newco in respect of such transfers.

In respect of the above-described property transfers, Holdco 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 each eligible property that is transferred by Holdco to Newco. The agreed amount in respect of each eligible property so transferred will be as follows:

(i) in the case of capital property (other than depreciable property of a prescribed class) and inventory, an amount not less than the lesser of the amounts described in subparagraphs 85(1)(c.1)(i) and (ii);

(ii) in the case of depreciable property of a prescribed class, an amount not less than the least of the amounts described in subparagraphs 85(1)(e)(i), (ii) and (iii); and

(iii) in the case of eligible capital property, an amount not less than the least of the amounts described in subparagraphs 85(1)(d)(i), (ii) and (iii).

In each case, the agreed amount will not exceed the fair market value of the respective property, nor will it be less than the amount permitted under paragraph 85(1)(b). The amount of Holdco's liabilities to be assumed by Newco and to be allocated to property that will be the subject of an election under subsection 85(1) will not exceed the total of the agreed amounts elected for all such properties.

For the purposes of the BCA, Newco will add to the stated capital account maintained for its Preferred Shares an amount equal to the amount by which the aggregate cost of the properties acquired by it from Holdco (determined pursuant to subsection 85(1) where relevant) exceeds the aggregate amount of the liabilities, if any, assumed by Newco as consideration therefor. For greater certainty, the increase to the paid-up capital of the Preferred Shares so issued by Newco will not exceed the maximum amount that could be added to the paid-up capital of such share, having regard to subsection 85(2.1).

10. Newco will redeem its Preferred Shares held by Holdco by issuing a demand promissory note ("Newco Note") having a principal amount and fair market value equal to the aggregate redemption amount and fair market value of the Preferred Shares. Holdco will accept the Newco Note as full payment for the fair market value of the Preferred Shares.

11. Following the share redemptions described in Paragraph 10, Newco will cause its first taxation year to end.

12. Holdco will purchase for cancellation the XXXXXXXXXX Class A Shares held by Newco by issuing a demand promissory note (the "Holdco Note") having a principal amount and fair market value equal to the aggregate fair market value of the Class A Shares so purchased for cancellation. Newco will accept the Holdco Notes as full payment for the purchase price of the Class A Shares.

13. The principal amount owing by Holdco to Newco under the Holdco Note and the principal amount owing by Newco to Holdco under the Newco Note will be set-off in full against each other and each such note will be marked paid in full and cancelled.

14. Shareholder B will tender her resignation as a director and officer of Holdco.

ADDITIONAL INFORMATION

15. It is expected that sometime after the Proposed Transactions are completed (but for greater certainty not before) that the divorce between Shareholder A and B will be finalized. XXXXXXXXXX.

16. The Proposed Transactions will occur in the order presented unless otherwise indicated, with the exception of the filing any applicable election forms in respect of the Proposed Transactions described in Paragraphs 8 and 9, which will be filed on or before the applicable due date.

17. Other than as described herein, no significant transactions have been completed prior to the date of this letter nor are there any other transactions currently being contemplated that would form part of the series of transactions or events that includes the Proposed Transactions.

18. There are no plans or intentions for Shareholder A or for Shareholder B to dispose of any shares of Holdco or Newco (other than as described in this letter) and specifically, there are no present intentions for any arm's length parties to acquire any interest in either Holdco or Newco.

19. Neither Holdco nor any corporation to which Holdco is related is a specified financial institution or a restricted financial institution.

20. None of the shares in the capital of Holdco or of Newco, has been, or will be, at any time during the implementation of the Proposed Transactions:

(a) the subject of any undertaking that is guarantee agreement;

(b) a share that is issued or acquired as part of a transaction or series of transactions or events of the type described in subsection 112(2.5); or

(c) the subject of a dividend rental arrangement.

PURPOSE OF THE PROPOSED TRANSACTIONS

21. The purpose of the Proposed Transactions is to allow the property of Holdco to be divided equally on a tax-free basis between Shareholder A and Shareholder B prior to the divorce and pursuant to a negotiated property settlement arising from the divorce proceedings.

RULINGS

Provided that the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, proposed transactions and the purposes of the Proposed Transactions, and provided that the Proposed Transactions are completed in the manner described above, our rulings are as set forth below.

A. Provided the appropriate joint elections are filed in the prescribed form and manner within the time specified in subsection 85(6), the provisions of subsection 85(1) will apply to the transfer:

(a) of the Holdco Class A Shares owned by Shareholder B to Newco as described in Paragraph 8; and

(b) of any eligible property owned by Holdco to Newco as described in Paragraph 9;

such that the agreed amount in respect of each such transfer of eligible property will be deemed to be the transferor's proceeds of disposition of the particular property and the transferee's cost thereof pursuant to paragraph 85(1)(a). For greater certainty, paragraph 85(1)(e.2) will not apply to the transfers referred to above.

B. As a result of the redemption by Newco of the Preferred Shares described in Paragraph 10 and the purchase for cancellation by Holdco of the XXXXXXXXXX Class A Shares described in Paragraph 12, by virtue of subsection 84(3):

(a) Newco will be deemed to have paid, and Holdco will be deemed to have received, a taxable dividend equal to the amount by which the amount paid by Newco in respect of its redemption of the Preferred Shares owned by Holdco exceeds the paid-up capital of such class of shares immediately before the redemption; and

(b) Holdco will be deemed to have paid, and Newco will be deemed to have received, a taxable dividend equal to the amount by which the amount paid by Holdco in respect of the repurchase of the XXXXXXXXXX Class A Shares of Holdco owned by Newco exceeds the paid-up capital attributable to such common shares immediately before the purchase for cancellation; and

(c) The taxable dividends described in described in (a) and (b) above:

(i) will be included in computing the income, pursuant to subsection 82(1) and paragraph 12(1)(j), of the person deemed to have received such dividend;

(ii) will be deductible by the recipient pursuant to subsection 112(1) in computing its taxable income in the year in which such a dividend is deemed to have been received, and, for greater certainty, will not be prohibited by subsections 112(2.1), (2.2), (2.3) or (2.4);

(iii) will be excluded in determining the POD to the recipient of the shares so redeemed, purchased or cancelled pursuant to paragraph (j) of the definition of "proceeds of disposition" in section 54;

(iv) will, by virtue of subsection 112(3), reduce the loss, if any, in respect of the disposition of the shares on which the dividend is deemed to be received;

(v) will not be subject to tax under Part IV except to the extent that such payer corporation is entitled to a dividend refund for its taxation year in which it paid such dividend; and

(vi) will not be subject to tax under Part IV.1 or VI.1.

C. By virtue of paragraph 55(3)(a), the provisions of subsection 55(2) will not apply to any of the taxable dividends referred to in Ruling B, 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 described herein. For greater certainty, the Proposed Transactions described herein, in and by themselves, will not be considered to result in a disposition or increase in interest described in subparagraphs 55(3)(a)(i) to (v) with respect to the dividends deemed to be received by Holdco or Newco described in Ruling B.

D. The mutual set-off and cancellation of the Newco Note and the Holdco Note as described in Paragraph 13 will not give rise to a forgiven amount.

E. The provisions of subsections 15(1), 56(2), 69(1), and 246(1) will not apply to any of the Proposed Transactions described herein, in and by themselves.

F. Subsection 245(2) will not apply to the Proposed Transactions, in and by themselves, to re-determine the income tax consequences confirmed herein.

The above rulings are subject to the limitations and qualifications set out in Information Circular 70-6R5 dated May 17, 2002 and are binding on CRA provided that the Proposed Transactions, except for the Proposed Transactions are completed by XXXXXXXXXX. The above rulings are based on the law as it presently reads and do not take into account any proposed amendments to the Act and the Regulations which, if enacted into law, could have an effect on the rulings provided herein.

OTHER COMMENTS

Unless otherwise confirmed in the above rulings, nothing in this letter should be construed as implying that the CRA has confirmed, reviewed or has made any determination in respect of:

(a) the paid-up capital of any share or the adjusted cost base or fair market value of any property referred to herein;

(b) any other tax consequence relating to the facts, Proposed Transactions or any transaction or event taking place either prior to the Proposed Transactions or subsequent to the Proposed Transactions, whether described in this letter or not, other than those specifically described in the rulings given above, including whether any of the Proposed Transactions would also be included in a series of transactions or events that include other transactions or events that are not described in this letter.

Yours truly,

XXXXXXXXXX
Manager
Corporate Reorganizations Section II
Reorganizations and Resources Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch