22 June 2016 Internal T.I. 2016-0632821I7 F - 93(2.01) & Capital Contribution -- translation

Principal Issues: Whether the concept of “substituted shares” used in subsection 93(2.01) may be interpreted in such a way as to refer to shares owned by a taxpayer in respect of which the taxpayer made a capital contribution consisting of shares of another foreign affiliate.

Position: Yes.

Reasons: See below.

June 22, 2016

Concept of "substituted share" in subsection 93(2.01) -

Shares transferred by way of capital contribution

This is in response to your request of February 19, 2016 in which you asked our view regarding the application of the concept of "substituted share" in subsection 93(2.01) in respect of shares of a foreign affiliate ( "FA") of a taxpayer which are the subject to a capital contribution made in favour of another of its FAs without any additional shares being issued. Note that all references to a statute are to provisions of the Income Tax Act (Canada), R.S.C. 1985, c.1 (5th Supp.), as amended to the date of this letter.

Submitted Relevant Facts

Our understanding of the relevant facts submitted is summarized as follows:

1. Canco incorporated a société à responsabilité limitée under Luxembourg law ("Luxco1") in respect of which it subscribed to XXXXXXXXXX shares for $XXXXXXXXXX.

2. Luxco1 used the $XXXXXXXXXX in proceeds in order to acquire one-third of the shares of an FA ("NRco") which, at all relevant times, was a resident in a country with which Canada has a tax treaty and where it was carrying on an active business.

3. Canco also incorporated another société à responsabilité limitée under Luxembourg law ("Luxco2") in respect of which it subscribed to XXXXXXXXXX shares for $XXXXXXXXXX.

4. Canco thereafter made an interest-free loan of $XXXXXXXXXX to Luxco2 which, in turn, lent the same amount on an interest-bearing basis to NRco. Over the taxation years XXXXXXXXXX ending after the establishment of this financing structure,

a. the interest income realized by Luxco2 has been recharacterized pursuant to clause 95(2)(a)(ii)(B) as income from an active business, as that term is defined in subsection 95(1);

b. Luxco2 has paid to Canco dividends corresponding to its income realized from its exempt surplus, for a total of $XXXXXXXXXX, which dividends are exempt dividends as defined in subsection 93(3).

5. Subsequently, the shares of Luxco2 were contributed as capital contribution by Canco to Luxco1 without further shares being issued by the latter. The fair market value of the capital contribution was set at $XXXXXXXXXX, bringing the adjusted cost base of the shares of Luxco1 to $XXXXXXXXXX pursuant to paragraph 53(1)(c).

6. Canco then sold the shares of Luxco1 to a third party for $XXXXXXXXXX, realizing a capital loss of $XXXXXXXXXX.

7. Luxco1 did not pay dividends to Canco while its shares were held by the latter.

Question

You wish to confirm that the XXXXXXXXXX Luxco2 shares are shares for which the XXXXXXXXXX shares of Luxco1 were substituted in terms of the capital contribution made by Canco for the purposes of the application of the loss limitation rules in subsection 93(2.01), thus allowing the loss made by Canco on the disposal of XXXXXXXXXX shares of Luxco1 to be reduced by $XXXXXXXXXX.

Comments

We are generally of the view that the shares of an FA held by a taxpayer may be considered shares substituted for shares transferred by the taxpayer to the FA as a capital contribution. In this context, and applying subsection 93(2.01), we are of the view that the loss of $XXXXXXXXXX realized within the context of the relevant facts submitted should be reduced by $XXXXXXXXXX, leaving $XXXXXXXXXX.

Subsection 93(2.01) establishes a loss limitation rule which is intended to reduce the loss realized on the disposition of shares of an FA where exempt dividends, as described in subsection 93(3), have been paid on the shares which were disposed of or on substitute shares. This rule contains no purpose test. It applies without any requirement that the purpose of the payment of the dividends was to create such a loss.

The concept of "substituted share" in subsection 93(2.01) must in our view be given its ordinary meaning, taking into account inter alia that the interpretive rule in subsection 248(5) does not stipulate a definitive meaning for this concept for the purposes of the Act.

For your information, unless exempted, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency’s electronic library. A severed copy will also be distributed to the commercial tax publishers, following a 90-day waiting period (unless advised otherwise to extend this waiting period), for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should the taxpayer request a copy of this memorandum, they may request a severed copy using the Privacy Act criteria, which does not remove taxpayer identity. Requests for this latter version should be e-mailed to: ITRACCESSG@cra-arc.gc.ca. In such cases, a copy will be sent to you for delivery to the taxpayer.

We trust that our comments will be of assistance.

Dave Beaulne, CPA, CA
Manager
for the Director
International Operations Division
Income Tax Rulings Directorate
Legislative Policy
and Regulatory Affairs Branch