2013 Ruling 2012-0463611R3 - Foreign Divisive Reorganization

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: 1. What is the distributing corporation's proceeds of disposition of the property being transferred to the transferee corporation? 2. What is the transferee corporation's cost of the property it acquires from the distributing corporation? 3. What is the cost of the shares of the transferee corporation to each of its shareholders? 4. Does the divisive reorganization give rise to FAPI? 5. Does the divisive reorganization result in benefits under subsections 15(1), 56(2) or 246(1)? 6. Does 95(6) apply? 7. Does GAAR apply?

Position: 1.The fair market value of the property transferred. 2. The fair market value of the shares issued by the transferee corporation on acquisition of the property. 3. The fair market value of the shares acquired. 4. No 5. No 6. No 7. No

Reasons: 1. The distributing corporation's proceeds of disposition of the property transferred will be determined by reference to the terms of the Division. Subparagraph 69(1)(b)(i) will apply so that the distributing corporation's proceeds of disposition will be equal to the fair market value of the transferred property. 2. The cost of the property acquired by the transferee corporation from the distributing corporation will be determined by reference to general principles of cost determination. 3. General principles of cost determination. 4. No income arises that is described in the definition of FAPI. 5. Conditions precedent to the application of subsections 15(1), 56(2) and 246(1) are not met. 6. Conditions precedent to the application of 95(6) are not met. 7. There is no avoidance transaction.

XXXXXXXXXX
2012-046361

XXXXXXXXXX, 2013

Dear XXXXXXXXXX:

Re: XXXXXXXXXX ("Canco")
Advance Income Tax Ruling

This is in response to your XXXXXXXXXX request for an advance income tax ruling on behalf of Canco.

To the best of your knowledge and that of Canco, none of the proposed transactions included in this ruling is:

(i) dealt with in an earlier return of Canco or a related person;

(ii) being considered by any tax services office or taxation centre in connection with a tax return previously filed by Canco or a related person;

(iii) under objection by Canco or by a related person; or

(iv) before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has not expired.

The rulings given herein are based solely on the facts, proposed transactions and the purpose of the proposed transactions described below. Facts and proposed transactions described in the documents submitted with your request that are not set out below do not form part of the facts and proposed transactions on which this ruling is based and any reference to these documents is provided solely for the convenience of the reader.

Definitions

The following terms have the meanings specified below:

a) "Act" means the Income Tax Act, R.S.C. 1985 (5th supp.), c.1, as amended, and unless otherwise stated, all statutory references herein are to the Act;

b) "active business" has the meaning defined in subsection 95(1);

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

d) "calculating currency" has the meaning defined in subsection 95(1);

e) "Canco" means XXXXXXXXXX;

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

g) "controlled foreign affiliate" has the meaning assigned by subsection 95(1);

h) "corporation" has the meaning assigned by subsection 248(1);

i) "CRA" means the Canada Revenue Agency;

j) "designated treaty country" has the meaning assigned by subsection 5907(11) of the Regulations;

k) "Dividend" means the dividend paid by FA2 to FA1 as described in paragraph 17;

l) "Division" means the divisive reorganization of FA1 described in paragraphs 19 and 20;

m) "exempt surplus" has the meaning assigned by subsection 5907(1) of the Regulations;

n) "excluded property" has the meaning assigned by subsection 95(1);

o) "FA1" means XXXXXXXXXX;

p) "FA2" means XXXXXXXXXX;

q) "FA Loans" means particular loans receivable owed to FA1 from other foreign affiliates of Canco as described in paragraph 18;

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

s) "foreign accrual property income" ("FAPI") has the meaning assigned by subsection 95(1);

t) "foreign affiliate" has the meaning assigned by subsection 95(1);

u) "Foreign Country" means XXXXXXXXXX;

v) "Foreign Country2" means XXXXXXXXXX;

w) "Forsub" means XXXXXXXXXX;

x) "Forsub2" means XXXXXXXXXX;

y) "IFRS" means International Financial Reporting Standards;

z) "Newco" means the corporation described in paragraph 20;

aa) "non-resident" has the meaning assigned by subsection 248(1);

bb) "Other Property" means all property of FA1, other than the FA Loans and shares of the capital stock of FA2. At the date of this Ruling, Other Property includes, (i) cash on deposit with FA2 of approximately $XXXXXXXXXX in the currency of the Foreign Country ("FC") (which cash is employed by FA2 in its active business); (ii) a book deferred tax asset which is not considered "property" within the meaning assigned by subsection 248(1); and (iii) certain poorer quality loans that were transferred from FA2 to FA1 XXXXXXXXXX with a book value (and assumed FMV) of approximately FC$XXXXXXXXXX;

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

dd) "Regulations" means the Income Tax Regulations, C.R.C. 1977, c. 945, as amended;

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

ff) "taxable surplus" has the meaning assigned by subsection 5907(1) of the Regulations; and

gg) "underlying foreign tax" has the meaning assigned by subsection 5907(1) of the Regulations.

Facts

1. Canco is a taxable Canadian corporation and a XXXXXXXXXX. The shares of Canco are traded on the XXXXXXXXXX.

2. Forsub is a resident of Foreign Country2 for purposes of the Act.

3. Canco directly and indirectly owns XXXXXXXXXX% of the voting shares of Forsub.

4. Forsub2 is a resident of Foreign Country2 for purposes of the Act;

5. Forsub owns XXXXXXXXXX% of the voting shares of Forsub2.

6. FA1 is a company formed under the corporate laws of the Foreign Country and is a resident of Foreign Country for purposes of the Act. Canco directly owns XXXXXXXXXX% of the issued and outstanding shares in FA1, with Forsub2 owning the XXXXXXXXXX% remainder. FA1 is a controlled foreign affiliate of Canco. FA1 is primarily a holding company and does not carry on an active business. Immediately prior to the Division described in paragraphs 19 and 20, FA1 owns Other Property, FA Loans (as described below) and approximately XXXXXXXXXX% of the shares of FA2. FA1 has approximately FC$XXXXXXXXXX of taxable surplus, with nominal underlying foreign tax. The primary source of the taxable surplus is from active business income earned in Foreign Country in taxation years prior to Foreign Country becoming a designated treaty country.

7. FA2 is a successor corporation formed under the corporate laws of the Foreign Country XXXXXXXXXX. FA2 is a resident of Foreign Country for purposes of the Act. FA2 is a controlled foreign affiliate of Canco. FA2 was not incorporated (directly or indirectly) by Canco. Canco acquired indirect interests in FA2 (or its predecessor(s)) at various increments over time. Canco has always owned its interests in FA2 (or its predecessor(s)) through FA1 as described above. XXXXXXXXXX. FA1 and FA2 each prepare statutory financial statements in accordance with generally accepted accounting principles under IFRS, and report their results in FC.

8. The ACB of the shares of FA1 held by Canco is approximately CAN$XXXXXXXXXX. Pursuant to the corporate laws of the Foreign Country, the legal paid-up capital of the shares of FA1 held by Canco and Forsub2 is approximately FC$XXXXXXXXXX. The FMV of the shares of FA1 is significantly in excess of their ACB and legal paid-up capital.

9. Pursuant to the tax laws of the Foreign Country, the total Foreign Country tax cost of the FA1 shares to Canco and Forsub2 is approximately FC$XXXXXXXXXX.

10. FA1's ACB in the shares of FA2 is approximately FC$XXXXXXXXXX. The FMV of the shares of FA2 is in excess of their ACB.

11. For Foreign Country accounting purposes, FA1's investment in FA2 is recorded at a cost of FC$XXXXXXXXXX.

12. At the time of the Division, the FMV and ACB to FA1 of the FA Loans will be approximately FC$XXXXXXXXXX.

13. At the time of the Division, for Foreign Country accounting purposes, the FA Loans will be recorded in FA1's books at a cost of approximately FC$XXXXXXXXXX.

14. For Foreign Country accounting purposes, the Other Property is recorded in FA1's books at a cost of approximately FC$XXXXXXXXXX.

15. FA1's book equity is approximately FC$XXXXXXXXXX, consisting of share capital of FC$XXXXXXXXXX, retained earnings of FC$XXXXXXXXXX and other book equity items (including reserves, inflation and goodwill amortization) of FC$XXXXXXXXXX. FA1 carries no significant liabilities.

16. Pursuant to the tax laws of the Foreign Country, corporations who are resident in Foreign Country are subject to two categories of tax. XXXXXXXXXX.

Proposed Transactions

17. FA2 will pay a dividend ("Dividend") of approximately FC$XXXXXXXXXX to FA1. The actual amount of the Dividend will depend on the resources available at the time to FA2, and may vary by as much as FC$XXXXXXXXXX in either direction.

18. FA1 will then loan money to other foreign affiliates of Canco equal in aggregate to the amount of the Dividend (the "FA Loans"). All of the interest in respect of the FA Loans, if paid or payable to FA1, would be included in FA1's exempt surplus.

19. FA1 will undergo a divisive reorganization pursuant to the corporate laws of the Foreign Country (the "Division").

20. Pursuant to the corporate laws of the Foreign Country, FA1's shareholders (Canco and Forsub2) will adopt, publish and file such resolutions and other legal acts or instruments as may be necessary or appropriate to effect the Division. In accordance with the corporate laws of the Foreign Country, the Division will be a legal division of FA1 into two legal entities, with the result that:

a. Newco will be created under, and governed by, the corporate laws of the Foreign Country as a limited liability corporation. Newco will be a non-resident of Canada and a resident of the Foreign Country for purposes of the Act. Newco will be a resident of the Foreign Country under the residency principles of the tax laws of the Foreign Country.

b. The deed of formation of Newco will specify that the shares of FA2, the Other Property and liabilities of FA1 will be retained by FA1, while the FA Loans will be assigned by FA1 to Newco at the time of the Division.

c. By operation of the corporate laws of the Foreign Country, Canco and Forsub2's approval of the Division will result in Canco and Forsub2 becoming the shareholders of Newco with Canco having a XXXXXXXXXX% ownership interest in Newco and Forsub2 having a XXXXXXXXXX% ownership interest in Newco. The deed of formation will also include a provision that limits the liability of each of Canco and Forsub2 to the amount of their respective capital contribution to Newco.

d. Other than the shares of Newco, none of FA1, Canco or Forsub2 will receive any property as a result of the Division.

21. At the time of the Division, FA1's assets will consist of shares of FA2, the FA Loans and the Other Property.

22. At the time of the Division, the FA Loans will be excluded property to FA1.

23. The FMV and ACB to FA1 of the FA Loans at the time of the Division will be equal to the amount of the Dividend, estimated to be approximately FC$XXXXXXXXXX.

24. In the opinion of the taxpayer, the ACB of the FA Loans to Newco will be equal to the total FMV of the shares of Newco issued on the Division to Canco and Forsub2. Therefore, no gain or loss will be realized on the subsequent repayment of any such FA Loans, other than a gain or loss attributable to the fluctuation of the value of the currency in which a particular FA Loan is denominated relative to the calculating currency of Newco.

Additional information

25. Contemporaneously with the assignment of the FA Loans to Newco, pursuant to the corporate laws of the Foreign Country, the legal paid up capital of the shares of FA1 will be reduced by an amount equal to the legal paid up capital of the shares of FA1 immediately before the Division multiplied by the proportion that the book value of the FA Loans transferred by FA1 to Newco at the time of the Division is to the book value of all the property of FA1 immediately before the Division. The legal paid up capital of the shares of FA1 held by Canco and Forsub2 will be reduced pro rata based on their respective ownership percentages in FA1 immediately before the Division.

26. Contemporaneously with the assignment of the FA Loans to Newco, pursuant to the tax laws of the Foreign Country, the tax cost of the shares of FA1 held by Canco and Forsub2 will be reduced by an amount equal to the legal paid up capital of the shares of FA1 immediately before the Division multiplied by the proportion that the book value of the FA Loans transferred by FA1 to Newco at the time of the Division is to the book value of all the property of FA1 immediately before the Division. The Foreign Country tax cost of the shares of FA1 held by Canco and Forsub2 will be reduced pro rata based on their respective ownership percentages in FA1 immediately before the Division.

27. Pursuant to the corporate laws of the Foreign Country, the legal paid up capital of the shares of Newco will be equal to the legal paid up capital of the shares of FA1 immediately before the Division multiplied by the proportion that the book value of the FA Loans transferred by FA1 to Newco at the time of the Division is to the book value of all the property of FA1 immediately before the Division. The legal paid up capital of the shares of Newco held by Canco and Forsub2 will be pro rata based on their respective ownership percentages in FA1 immediately before the Division.

28. Pursuant to the tax laws of the Foreign Country, the tax cost of the shares of Newco to Canco and Forsub2 will be equal to the legal paid up capital of the shares of FA1 immediately before the Division multiplied by the proportion that the book value of the FA Loans transferred by FA1 to Newco at the time of the Division is to the book value of all the property of FA1 immediately before the Division. The Foreign Country tax cost of the shares of Newco held by Canco and Forsub2 will be pro rata based on their respective ownership percentages in FA1 immediately before the Division.

29. Under the tax laws of the Foreign Country, the Division will not result in a redemption, disposition or cancellation of the shares of FA1, nor will it result in a dividend payment by FA1 or Newco or any other form of distribution by FA1 to Canco or Forsub2.

30. Pursuant to the tax laws of the Foreign Country, the tax cost of the FA Loans to Newco will be equal to the Foreign Country tax cost of the FA Loans to FA1 immediately before the Division. The Foreign Country tax cost of the property retained by FA1 (i.e. the shares of FA2 and the Other Property) will not be affected by the Division.

31. No income or profit, as computed under the tax laws of the Foreign Country, will arise as a consequence of FA1's assignment of the FA Loans to Newco, nor will such laws impose income tax as a result of the reduction of the capital account of FA1.

32. The total FMV of the shares of Newco issued on the Division to Canco and Forsub2 will be equal to the FMV of the FA Loans assigned by FA1 to Newco.

33. All or substantially all of the interest earned by Newco from lending activities undertaken by it after the Division will be included in computing its exempt surplus.

34. The Division will not result in the application of subsection 40(3) to Forsub2 in respect of its shares of FA1.

35. The Division will not result in the application of subsection 40(3) to Canco in respect of its shares of FA1.

Purpose of the Proposed Transactions

The purpose of the proposed transactions is to reorganize the corporate structure in the Foreign Country to allow for the income producing FA Loans to be held in a corporate chain that is separate from the current FA1 and FA2 chain, thereby setting up a separate "Finco" to carry on inter-affiliate funding. In particular, the structure following the proposed transactions should permit more flexibility to repatriate profits or capital from the Foreign Country in a tax efficient manner compared to the structure existing prior to the proposed transactions. XXXXXXXXXX.

XXXXXXXXXX. Inter-affiliate loans made by FA2 may result in unwanted restrictions and scrutiny and would require disclosure in respect of the release of public financial statements. As well, the FA Loans will carry varying degrees of risks (for example, monetary, credit and foreign country risk). FA2 enjoys relatively stable profits and there is a desire to separate the risks and potential economic losses from the FA Loans in such manner that they will not impact Canco's ability to eventually repatriate exempt surplus earned by FA2.

Rulings

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

A. The Division will not result in a "disposition" (as that term is defined in subsection 248(1)) of the shares of FA1 by Canco or Forsub2.

B. Subparagraph 53(2)(b)(ii) will apply, at the time the shares of Newco are received by Forsub2 and Canco, to reduce the ACB of the shares of FA1 held by each of Forsub 2 and Canco. The total amount of the reduction will be equal to the FMV, at the time of the Division, of the shares of Newco received by Canco and Forsub2, respectively. Forsub2 and Canco's reduction in the ACB of their respective shares of FA1 will be in proportion to their share ownership in FA1 at the time of the Division.

C. The ACB to Canco and Forsub2 of the shares of Newco issued to each of them will be equal to the FMV of those shares at the time of the Division.

D. Paragraph 69(1)(b) will apply, such that the proceeds of disposition to FA1 of the FA Loans transferred to Newco will be equal to the FMV of the FA Loans at the time of the Division.

E. The ACB to Newco of the FA Loans assigned by FA1 to Newco at the time of the Division (as described in paragraph 20) will be equal to the FMV of the FA Loans at the time of the assignment.

F. Subsections 15(1), 56(2) and 246(1) will not apply to the proposed transactions.

G. Subsection 95(6) will not apply to the proposed transactions.

H. Subsection 245(2) will not apply, as a result of the proposed transactions, in and by themselves, to re-determine the tax consequences described in the Rulings given above.

These rulings are given subject to the limitations and qualifications set out in Information Circular 70-6R5, issued by the CRA on May 17, 2002, and are binding on the CRA provided that the proposed transactions are entered into before XXXXXXXXXX.

The above-noted rulings are based on the Act in its present form and do not take into account any proposed amendments to the Act which, if enacted, could have an effect on the rulings provided herein.

Opinions

Provided that the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, additional information, proposed transactions and the purpose of the proposed transactions and provided further that the draft amendments to the Act that were released by the Minister of Finance and tabled in the House of Commons in a detailed Notice of Ways and Means Motion (implemented by Bill C-48) on October 24, 2012 (the "Draft Legislation") are, in respect of the proposed amendment to subsection 15(1), paragraph 53(2)(b), the proposed addition of subsections 90(2) and 90(3), and paragraph 15(1.4)(e), enacted in substantially the same form as proposed in the Draft Legislation, our opinions are as follows:

a) the assignment of the FA Loans by FA1 will be a pro rata distribution in respect of the shares of FA1 and the amount of the FMV of the FA Loans will be deemed to be a dividend pursuant to proposed subsection 90(2) of the Draft Legislation;

b) the Division will not result in a reduction to the ACB of the shares of FA1, held by each Canco and Forsub2, under proposed paragraph 53(2)(b) of the Draft Legislation; and

c) the Division will not result in a shareholder benefit under proposed paragraph 15(1.4)(e) of the Draft Legislation by virtue of the exception in that provision for dividends.

Caveats

Nothing in this ruling should be construed as implying that the CRA has considered, examined, agreed to or ruled on:

(a) whether any particular corporation described in this ruling is a foreign affiliate of Canco;

(b) whether any property described in the facts or the proposed transactions is excluded property of any person;

(c) the ACB or FMV of any property described in the facts or proposed transactions; or

(d) any tax consequences relating to the facts and proposed transaction described herein other than those specifically described in the Rulings and Opinions given above.

Yours truly,

for Director
International Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch