25 May 2000 External T.I. 2000-0021445 - Exemption from 55(2)

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 Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues: Whether paragraph 55(3)(a) will apply to exempt the proposed transactions from the applicability of subsection 55(2).

Position: No.

Reasons: The proposed transactions do not meet the tests in paragraph 55(3)(a)

XXXXXXXXXX 						2000-002144
F. Francis
Attention:  XXXXXXXXXX 

May 25, 2000

Dear Sirs:

This is in reply to your letter of April 18, 2000, wherein you requested our comments on the applicability of subsection 55(2) of the Income Tax Act (the "Act") to the following situation:

• Opco is a Canadian-controlled private corporation. Three adult siblings ("A", "B" and "C") each own one-third of the common shares of Opco and the mother of the three siblings ("Mother") owns non-voting preferred shares having a redemption and retraction amount based on an estate freeze completed several years ago.
• Opco owns two pieces of real property used in the business which the shareholders wish to separate into a separate company controlled by Mother.
• A new company ("Realtyco") will be incorporated. A, B and C will each own one-third of the common shares of Realtyco and Mother will own sufficient voting preferred shares (having a nominal redemption value) to give her voting control of Realtyco.
• A stock dividend will be declared on the common shares of Opco in order to issue sufficient preferred shares (the same class of non-voting preferred shares that Mother already owns) to A, B and C so that the number of preferred shares outstanding, including Mother's preferred shares, will have a redemption value equal to the equity in the real properties.
• The owners of the preferred shares will transfer those shares to Realtyco in exchange for non-voting preferred shares of Realtyco pursuant to subsection 85(1) of the Act.
• The real properties will be transferred from Opco to Realtyco in accordance with subsection 85(1) of the Act with Opco receiving non-voting preferred shares of Realtyco with a redemption amount equal to the redemption amount of the preferred shares referred to above.
• The preferred shares owned by Realtyco will be redeemed for a Promissory Note and the preferred shares owned by Opco will be redeemed for another Promissory Note. The Promissory Notes will be set-off and extinguished.

You request our view as to whether the foregoing series of transactions would be exempt from the provisions of subsection 55(2) of the Act by virtue of the exemption under paragraph 55(3)(a).

In a phone conversation of April 28, 2000, (XXXXXXXXXX/Francis), you enquired as to whether our response would differ if, as part of the series, the preferred shares of Opco owned by Mother were exchanged for voting preferred shares such that Mother controlled Opco.

OUR COMMENTS

It appears that the opinion you seek relates to specific proposed transactions and, therefore, we bring to your attention Information Circular 70-6R3 issued on December 30, 1996. Confirmation of tax consequences with respect to proposed transactions involving specific taxpayers will only be provided in response to a request for an advance income tax ruling. Consequently, we will only provide the following general comments.

The exemption under paragraph 55(3)(a) of the Act does not apply if, as part of the transaction or event or series of transactions or events, there was at any particular time a significant increase in the total direct interest in any corporation of one or more persons who were unrelated persons immediately before the particular time. Subparagraph 55(5)(e)(i) of the Act deems A, B and C not to be related to each other and to be dealing with each other at arm's length. Consequently, none of A, B and C is related to Opco. Under paragraph 55(3.01)(a) of the Act, for purposes of paragraph 55(3)(a), an unrelated person means a person to whom the dividend recipient is not related. Under the above-described series of transactions, Realtyco and Opco are dividend recipients. Therefore, A, B and C are unrelated persons who will significantly increase their total direct interest in Realtyco as part of the series of transactions or events described herein. Consistent with the foregoing comments, it is our view that the above series of transactions would be subject to the application of subsection 55(2) of the Act.

If, as part of the series of transactions or events, the preferred shares owned by Mother were exchanged for voting preferred shares, it is our view that this would result in a significant increase in the interest in Opco by Mother, an unrelated person immediately before that time. Consequently, the series of transactions would be subject to the application of subsection 55(2) of the Act.

We trust the above comments are of assistance to you.

Yours truly,

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