21 November 2011 External T.I. 2011-0418971E5 - subsection 88(1.7)

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: A public corporation ("Pubco") would not be controlled by any person or group of persons. An acquiring corporation would acquire control of Pubco as a result of a transaction with arm's length persons. Whether the exception provided within brackets in subsection 88(1.7) would apply in such a context.

Position: Generally yes.

Reasons: Textual, contextual and purposive interpretation of subsection 88(1.7) and paragraphs 88(1)(c) and (d).

XXXXXXXXXX
									U. Chalupa
 									2011-041897
									(613) 957-2124

November 21, 2011

Dear XXXXXXXXXX ,

Re: Subsection 87(1.7) of Income Tax Act

This is in reply to your email dated August 31, 2011 in which you requested Canada Revenue Agency's (the "CRA") comments on the exception provided within brackets in subsection 88(1.7) of the Income Tax Act (the "Act").

Unless otherwise stated, every reference herein to a part, section, subsection, paragraph or subparagraph is a reference to the relevant provision of the Act.

In your email, you briefly described the following situation:

• A corporation (hereinafter "Purchaser") would like to acquire all of the issued and outstanding shares of the capital stock of a public corporation (hereinafter "Pubco").
• The shares of the capital stock of Pubco would be widely held. No shareholder of Pubco would have a controlling interest in Pubco.
• Pubco would own a subsidiary wholly-owned corporation (hereinafter "Subco"). Prior to the offer made by Purchaser to acquire Pubco, Subco would have regularly paid taxable dividends to Pubco. However, Pubco would have never paid any dividend to its shareholders.
• Subco would own an asset (hereinafter the "Asset") eligible for the "bump" pursuant to paragraphs 88(1)(c) and 88(1)(d).
• Purchaser would incorporate a new corporation (hereinafter "Acquisitionco") which would acquire all of the issued and outstanding shares of the capital stock of Pubco from arm's length persons.
• Purchaser would then proceed with a reorganisation where Pubco would be wound-up into Acquisitionco. Acquisitionco would elect to increase or "bump" the cost of the shares of the capital stock of Subco pursuant to paragraphs 88(1)(c) and 88(1)(d).
• Subco would then be wound-up into Acquisitionco. Acquisitionco would elect to increase or "bump" the cost of the Asset pursuant to paragraphs 88(1)(c) and 88(1)(d).

You asked whether the exception provided within brackets in subsection 88(1.7) would apply in the situation described above. If this is the case, and in the context of applying subparagraph 88(1)(d)(i.1), Acquisitionco (the "parent" for purposes of subsection 88(1)) would be considered to have dealt at arm's length with Pubco (the corporation receiving the dividends from Subco, the "subsidiary" for purposes of subsection 88(1) with respect to the second winding-up) at the time the dividends where received by Pubco. Subsection 88(1.7) reads as follows:

For the purposes of paragraphs (1)(c) and (d), where a parent of a subsidiary did not deal at arm's length with another person (other than a corporation the control of which was acquired by the parent from a person with whom the parent dealt at arm's length) at any time before the winding-up of the subsidiary, the parent and the other person are deemed never to have dealt with each other at arm's length, whether or not the parent and the other person coexisted.
[Emphasis added.]

Your comments:

You are of the opinion that, despite the fact that Pubco would not be controlled by any person or group of persons prior to its acquisition by Acqusitionco, the exception provided within brackets in subsection 88(1.7) should still apply in the circumstances described above since Acquisitionco would acquire control of Pubco as a result of a transaction with persons with whom Acquisitionco dealt at arm's length. Consequently, Acquisitionco would not be deemed to never have dealt at arm's length with Pubco. Otherwise, if the exception provided within brackets in subsection 88(1.7) is interpreted too restrictively, the taxable dividends paid by Subco to Pubco prior to its acquisition of control by Acquisitionco would technically fall under subparagraph 88(1)(d)(i.1) with respect to the winding-up of Subco into Acquisitionco and would reduce the amount of the "bump-up" of the tax cost of the Asset held by Subco at the time of the winding-up. Such a result would appear to be contrary to the tax policy underlying subparagraph 88(1)(d)(i.1) and subsection 88(1.7).

Our comments:

We are generally in agreement with your comments. Based on a textual, contextual and purposive interpretation of subsection 88(1.7) and paragraphs 88(1)(c) and (d), we agree that the exception provided within brackets in subsection 88(1.7) should apply in the scenario described above. Consequently, Acquisitionco would be considered to have dealt at arm's length with Pubco at the time the dividends paid by Subco would be received by Pubco. Thus, the amount of these dividends should not reduce the amount of the "bump-up" of the tax cost of the Asset held by Subco at the time of the winding-up.

Finally, it should be noted that our comments are limited to the interpretation of the exception provided within brackets in subsection 88(1.7) in the context of the scenario described above and that a review of all the relevant facts and circumstances would be required to confirm the availability of the "bump-up" of the tax cost of property pursuant to paragraphs 88(1)(c) and (d) in a particular situation. Consequently, nothing in this letter should be construed as implying that the CRA has agreed to, reviewed or made any determination in respect of the availability of the "bump-up" in a particular situation.

We trust that the foregoing will be of assistance to you.

Yours truly,

Stéphane Prud'Homme, LL.B, M. Fisc.
Manager
Mergers and Acquisitions Section
Reorganizations and Resources Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch