2000 Ruling 2000-0055693 - 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.

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: standard split up butterfly - no new issues

Position:

Reasons:

XXXXXXXXXX 2000-005569

Attention: XXXXXXXXXX

XXXXXXXXXX, 2000

Dear Sirs:

Re: Advance income tax ruling
XXXXXXXXXX ("Aco")

We are writing in response to your letter of XXXXXXXXXX wherein you requested an advance income tax ruling in respect of the above taxpayer. We also acknowledge your letters of XXXXXXXXXX.

To the best of your knowledge, and that of the parties to this ruling, none of the issues contained in this advance income tax ruling:

1. is in an earlier return of the taxpayer or a related person;

2. is being considered by a tax services office or a taxation centre in connection with a previously filed tax return of the taxpayer or a related person;

3. is under objection by the taxpayer or a related person;

4. is before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has not expired; or

5. is the subject of a ruling previously issued by this Directorate.

Unless otherwise stated all references to a statute herein are to the Income Tax Act (Canada), R.S.C. 1985 (5th Supp.), c. 1, as amended, (the "Act").

Definitions

In this letter, the following terms have the meanings specified:

(a) "ACB" means "adjusted cost base" as that expression is defined in section 54;

(b) "agreed amount" in respect of a property means the amount that the transferor and transferee of the property have agreed upon in their election under either subsection 85(1) or subsection 97(2) in respect of the property;

(c) XXXXXXXXXX;

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

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

(f) "cost amount" has the meaning assigned by subsection 248(1);

(g) "distribution" has the meaning assigned by subsection 55(1);

(h) "dividend rental arrangement" has the meaning assigned by subsection 248(1);

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

(j) "financial intermediary corporation" has the meaning assigned by subsection 191(1);

(k) "legal paid-up capital" in respect of a share means the paid-up capital in respect of the share without reference to the Act;

(l) "PUC" means "paid-up capital" as that expression is defined in subsection 89(1);

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

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

(o) "RDTOH" means "refundable dividend tax on hand" as that expression is defined in subsection 129(3);

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

(q) "series of transactions or events" has the meaning assigned by subsection 248(10);

(r) "specified financial institution" and "restricted financial institution" have the meanings assigned by subsection 248(1);

(s) "specified investment business" has the meaning assigned by subsection 125(7);

(t) "specified person" has the meaning assigned by paragraph (h) of the definition "taxable preferred share" in subsection 248(1);

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

(v) "taxable dividend" has the meaning assigned by subsection 89(1).

Facts

1. Aco is a taxable Canadian corporation and a private corporation which was incorporated under the laws of the XXXXXXXXXX.

2. The authorized share capital of Aco is XXXXXXXXXX common shares, without par value; and XXXXXXXXXX common shares, without par value.

3. Aco's issued share capital consists XXXXXXXXXX common shares which are held as capital property by their holders as follows:

Shareholder Shares ACB PUC

XXXXXXXXXX ("Bco") XXXXXXXXXX

XXXXXXXXXX ("Cco") XXXXXXXXXX

XXXXXXXXXX ("Dco") XXXXXXXXXX

XXXXXXXXXX ("Eco") XXXXXXXXXX

XXXXXXXXXX ("Fco") XXXXXXXXXX

XXXXXXXXXX ("Gco") XXXXXXXXXX

XXXXXXXXXX ("Hco") XXXXXXXXXX

XXXXXXXXXX ("Ico") XXXXXXXXXX

XXXXXXXXXX ("Jco") XXXXXXXXXX

XXXXXXXXXX ("Kco") XXXXXXXXXX

XXXXXXXXXX ("Lco") XXXXXXXXXX

XXXXXXXXXX ("Mco") XXXXXXXXXX

XXXXXXXXXX ("Nco") XXXXXXXXXX
XXXXXXXXXX

4. The estimated fair market value of the shares of Aco exceeds the aggregate ACB of those shares. Each of the shareholders is a taxable Canadian corporation, a private corporation and resident in Canada.

5. XXXXXXXXXX (A Corporate Partnership) (the "Partnership") was formed on XXXXXXXXXX with each of its XXXXXXXXXX unit holders contributing a nominal $XXXXXXXXXX cash per XXXXXXXXXX unit, for a total contribution of $XXXXXXXXXX for the XXXXXXXXXX units.

6. On XXXXXXXXXX, Aco transferred substantially all of its assets, including goodwill, to the Partnership in exchange for the assumption of certain liabilities of Aco, the issuance of a promissory note by the Partnership and XXXXXXXXXX units of the Partnership. An election under subsection 97(2) was jointly filed by Aco and the Partnership such that the XXXXXXXXXX units had a nominal ACB of $XXXXXXXXXX.

The transfer of assets from Aco to the Partnership would have proceeded irrespective of whether or not a reorganization pursuant to paragraph 55(3)(b) was contemplated in the future. The Partnership was formed in order to allow for the ease of entry of new participants into the business and the retirement of existing participants from the business. By forming the partnership and transferring the assets into the Partnership, new participants could buy into the business without necessarily investing significant amounts of money. For instance, key employees may be able to become partners in the Partnership with nominal amounts invested and then participate in the income of the Partnership on the basis of an allocation of income, without necessarily having any interest in the existing value of the business at the time of entry into the Partnership. Retiring partners may continue to hold their Partnership interests but receive no further income or growth allocations in the Partnership after ceasing active participation in the Partnership, with payout of their capital accounts over time. The ability to bring new partners in at different times depending on their circumstances was important as the fair market value of the business had increased substantially and many new potential partners simply did not have the financial resources to be able to buy into the existing equity. Accordingly, it is your view that the transfer of assets was not in contemplation of the proposed reorganization described below since it does not form part of the series of transactions or events connected with implementing the proposed reorganization described below.

7. The Partnership carries on the business of XXXXXXXXXX. The Partnership employs approximately XXXXXXXXXX employees.

8. The Partnership's assets include working capital (consisting of cash, accounts receivable and rights arising from the prepayment of certain expenses), long-term notes receivable from its partners and employees, investments (consisting of shares of XXXXXXXXXX ("Oco"), XXXXXXXXXX ("Pco"), XXXXXXXXXX ("Qco"), XXXXXXXXXX ("Rco"), XXXXXXXXXX ("Sco"), XXXXXXXXXX ("Tco"), XXXXXXXXXX, ("Uco"), as well as its nominee corporation, XXXXXXXXXX ("Vco")), capital assets used in the business and goodwill of the business.

9. Aco carries on the business of XXXXXXXXXX as well as being a XXXXXXXXXX unit holding partner of the Partnership. Aco employs approximately XXXXXXXXXX employees.

10. Since XXXXXXXXXX, Aco's only issued and outstanding shares have been the XXXXXXXXXX common shares. As well, since that time these shares have been held by the XXXXXXXXXX unit holders of the Partnership in approximately the same proportion as their XXXXXXXXXX unit holdings, with no change in these proportions other than the changes described in paragraph 14 below, except that XXXXXXXXXX ("Wco") through its XXXXXXXXXX% owned subsidiary, XXXXXXXXXX ("Xco"), owns XXXXXXXXXX units of the Partnership while Cco, another XXXXXXXXXX% owned subsidiary of Wco, owns XXXXXXXXXX common shares of Aco.

11. Prior to XXXXXXXXXX, Aco redeemed certain XXXXXXXXXX and all of its XXXXXXXXXX common shares and certain XXXXXXXXXX common shares were transferred by various parties, in order to arrive at the same allocation of XXXXXXXXXX common shareholdings as the anticipated XXXXXXXXXX unit holdings of the Partnership. The pre-XXXXXXXXXX redemption of shares by Aco would have proceeded irrespective of whether or not a reorganization pursuant to paragraph 55(3)(b) was contemplated in the future. The purpose of the redemptions was clearly defined at the time and had no effect on the proposed reorganization described below. Accordingly, it is your view that the transfers of assets were not in contemplation of the proposed reorganization described below since they do not form part of the series of transactions or events connected with the proposed reorganization described below.

12. Aco owns life insurance policies on the lives of each of the partners of the Partnership, with a cash surrender value of these policies totaling approximately $XXXXXXXXXX as at XXXXXXXXXX, and which is expected to be approximately $XXXXXXXXXX at XXXXXXXXXX.

13. As a result of the income allocations by the Partnership, and drawings (contributions) by Aco from (to) the Partnership, since XXXXXXXXXX, the XXXXXXXXXX units of the Partnership held by Aco have an ACB of approximately $XXXXXXXXXX.

14. There have been several changes in the XXXXXXXXXX unit holdings of the Partnership since formation and in the common shareholdings of Aco since XXXXXXXXXX. All of these changes were the result of persons buying into, or retiring from, the business and would have proceeded irrespective of whether or not a reorganization pursuant to paragraph 55(3)(b) was contemplated in the future. The purpose of the transactions was clearly defined at the time and had no effect on the proposed reorganization described below. Accordingly, it is your view that the transfers of assets were not in contemplation of the proposed reorganization described below since they do not form part of the series of transactions or events connected with the proposed reorganization described below.

15. Aco has no RDTOH balance and will not have any RDTOH balance at XXXXXXXXXX.

Proposed Transactions

16. Each of the shareholders of Aco will amend their authorized share capital to include a class of shares as follows:

XXXXXXXXXX preferred shares without par value which will be voting, be redeemable and retractable at an amount per share equal to the fair market value of consideration received at the time of their issuance, as set by the Board of Directors at the time of issuance, have a price adjustment clause with regard to the fair market value, and be entitled to non-cumulative dividends, as declared by the directors from time to time on shares which are issued and outstanding. In the event of wind-up or liquidation, these shares will be participating to the extent of their redemption value plus declared but unpaid dividends, and will rank in preference to all other classes of shares. Notwithstanding that the preferred shares will be subject to a price adjustment clause, for the purposes of subsection 191(4), the directors will specify an amount per share not to exceed the fair market value of consideration for which the share was issued. The amount so specified will not be described by reference to a formula or be subject to change thereafter.

17. Aco will transfer its life insurance policies to the Partnership in exchange for cash equal to the estimated fair market value of the life insurance policies, which is equal to the cash surrender values of the policies.

18. Immediately before the transfers of property described in paragraph 19 below, the assets of Aco will be determined and will be classified into three types of property for purposes of paragraph 55(3)(b) as follows:

(a) cash or near cash property, being the current assets of Aco including cash, accounts receivable, inventory, rights arising from the prepayment of certain expenses, and income and other taxes recoverable;

(b) investment property, being all the assets of Aco, other than cash or near-cash property, any income from which would, for the purposes of the Act, be income from property or a specified investment business; and

(c) business property, being all the assets of Aco, other than cash or near-cash property and investment property, any income from which would, for the purposes of the Act, be income from a business other than a specified investment business.

19. Aco will transfer, at fair market value, a portion of its cash or near cash, investment and business property to each of its shareholders. As a result of the transfers, the fair market value of the cash or near cash, investment and business property received by each of the shareholders will be equal to the proportion of the fair market value of all the cash or near cash, investment and business property of Aco before the transfer that:

(a) the fair market value, immediately before the transfer, of all the shares of the capital stock of Aco owned by the shareholder at that time

is of

(b) the fair market value, immediately before the transfer, of all the issued shares of the capital stock of Aco at that time

As consideration, each shareholder will issue voting preferred shares to Aco, with the aggregate redemption amount equal to the value of the assets received. The number of preferred shares so issued will be such that they are greater than 10% , but less than 50%, of all of the outstanding voting shares of each shareholder.

20. In respect of the transfers described in paragraph 19 above, Aco and each of its shareholders will jointly elect pursuant to subsection 85(1), in prescribed form and within the time referred to in subsection 85(6), to transfer the XXXXXXXXXX units of the Partnership at an agreed amount which will be equal to the lesser of the amounts described in subparagraphs 85(1)(c.1)(i) and (ii).

The fair market value of each property transferred will equal or exceed the agreed amount in respect therefor. There will not be any liabilities assumed by any of the shareholders as consideration for the transferred properties. The amount that will be added to the legal paid-up capital of the preferred shares issued on the transfers described in paragraph 19 above will be equal to the fair market value of the properties so received.

21. Each of the shareholders of Aco will redeem, at their redemption amount, its preferred shares held by Aco. As payment of the redemption amount, each of the shareholders of Aco will assume a pro rata amount of the liabilities of Aco, with the remainder of the redemption amount being paid by the issuance of a demand non-interest-bearing demand promissory note having a principal amount and fair market value equal to the redemption amount of the preferred shares of that particular shareholder less the amount of the liabilities so assumed by the shareholder (the "Shareholders' Notes").

22. Aco will purchase for cancellation, at fair market value, all of its common shares owned by its shareholders. In consideration, Aco will issue to each of its shareholders a non-interest-bearing demand promissory note having a principal amount and fair market value equal to the fair market value of the Aco shares so purchased from that shareholder (the "Aco Notes").

The purchases for cancellation will take place in three stages:

(a) Aco will purchase for cancellation the common shares held by the shareholders holding greater than XXXXXXXXXX common shares of Aco, being Cco, Dco and Jco. These shareholders hold, in aggregate, XXXXXXXXXX shares which will leave XXXXXXXXXX issued and outstanding common shares after these purchases for cancellation.

(b) Immediately thereafter, Aco will purchase for cancellation the common shares held by the shareholders holding greater than XXXXXXXXXX common shares of Aco, being Eco, Fco, Gco and Hco. These shareholders hold, in aggregate, XXXXXXXXXX shares which will leave XXXXXXXXXX issued and outstanding common shares after these purchases for cancellation.

(c) Immediately thereafter, Aco will purchase for cancellation the remaining common shares held by the remaining shareholders, being Bco, Ico, Kco, Lco, Mco and Nco.

23. The Shareholders' Notes and the Aco Notes will then be offset and all such notes will be cancelled.

24. Aco will then be wound up pursuant to the requirements of the XXXXXXXXXX and struck from the register.

Subsequent Transactions

25. After the final income tax return of Aco is filed, an income tax clearance certificate will be requested and to the extent that there is a liability reassessed after the wind-up of Aco, each of the former shareholders of Aco will be required to contribute funds on a pro rata basis for the payment of any amounts owing.

26. It is intended that a change in the fiscal period of the Partnership from XXXXXXXXXX to XXXXXXXXXX will be requested.

Additional Information

27. Except as described herein, no property has, or will, become property of Aco and no liabilities have been, or will be, incurred by Aco in contemplation of and before the proposed transactions described above, except as described herein.

28. Except as described herein, none of the parties will dispose of any property to a partnership or an unrelated person as part of a series of transactions that includes the proposed transactions.

29. None of the parties is contemplating an acquisition of control of any corporation referred to above except as described herein.

30. None of the shares of Aco or any of the shareholders of Aco has been, or will be, at any time during the implementation of the proposed transactions described herein:

(a) the subject of any undertaking that is referred to in subsection 112(2.2) as a "guarantee agreement";

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

(c) the subject of a dividend rental arrangement as that term is defined in subsection 248(1).

31. None of Aco or any of the shareholders of Aco is or will be at the time of the proposed transactions, a "specified financial institution" within the meaning of subsection 248(1).

32. None of the taxpayers referred to herein has any outstanding tax liabilities that could be affected by the proposed transactions described herein.

33. The federal tax account numbers of the parties referred to herein are as follows:

Corporate Taxation Centre /
Name Account Number Tax Service Office

Aco XXXXXXXXXX
Bco XXXXXXXXXX
Cco XXXXXXXXXX
Dco XXXXXXXXXX
Eco XXXXXXXXXX
Fco XXXXXXXXXX
Gco XXXXXXXXXX
Hco XXXXXXXXXX
Ico XXXXXXXXXX
Jco XXXXXXXXXX
Kco XXXXXXXXXX
Lco XXXXXXXXXX
Mco XXXXXXXXXX
Nco XXXXXXXXXX
Oco XXXXXXXXXX
Pco XXXXXXXXXX
Qco XXXXXXXXXX
Rco XXXXXXXXXX
Sco XXXXXXXXXX
Tco XXXXXXXXXX
Uco XXXXXXXXXX
Vco XXXXXXXXXX
Wco XXXXXXXXXX
Xco XXXXXXXXXX

Purpose of the Proposed Transactions

The purpose of the proposed transactions is to simplify the corporate structure by eliminating Aco and transfer the employment services directly to the Partnership, thus eliminating the additional administrative effort and costs associated with maintaining Aco; to simplify the planning and administration of each of the Partner Companies by allowing for one allocation of income from the Partnership, rather than an allocation of income from the Partnership and dividend payments to each of the Partner Companies from Aco out of after-tax earnings; and to simplify and facilitate succession planning for the business of the Partnership.

Rulings Provided

Provided that the foregoing statements constitute a complete and accurate disclosure of all the relevant facts, proposed transactions and purpose of the proposed transactions, and provided that the proposed transactions are completed in the manner described above, we confirm the following:

A. Provided that Aco and each of its shareholders jointly file an election pursuant to subsection 85(1), in the prescribed form and within the prescribed time, in respect of the transfers of the XXXXXXXXXX units of the Partnership described in paragraph 19 above, the provisions of subsection 85(1) will apply to the transfer such that the agreed amount in respect of each such transfer will be deemed to be the proceeds of disposition to transferor and the cost thereof to transferee pursuant to paragraph 85(1)(a). For greater certainty, paragraph 85(1)(e.2) will not apply in respect of the transfers described herein.

B. The provisions of subsection 85(2.1) will apply to reduce the PUC of the preferred shares issued by each shareholder of Aco in respect of the transfers of the XXXXXXXXXX units of the Partnership by Aco to each of its shareholders as described in paragraph 19 above to an amount which will be equal to the aggregate of the agreed amounts, as determined in paragraph 20 above, in respect of the properties transferred to each shareholder.

C. As a result of the redemption by each of the shareholders of Aco of their preferred shares held by Aco, as described in paragraph 21 above, and the purchase for cancellation by Aco of the Aco Shares held by each of its shareholders as described in paragraph 22 above, the amount, if any, by which the amount paid on the redemption or purchase for cancellation exceeds the PUC of such shares immediately before the purchase or redemption will be deemed, by virtue of paragraphs 84(3)(a) and 84(3)(b), to be a dividend paid by Aco and each of its shareholders, as the case may be, and a dividend received by Aco and each of its shareholders, as the case may be.

D. To the extent that a dividend that is deemed to be received by Aco and each of its shareholders, as described in ruling C above is a taxable dividend, such dividend will, pursuant to subsection 112(1), be deductible in computing the taxable income of the recipient for the year in which the dividend is deemed to have been received and, for greater certainty, the provisions of subsections 112(2.1) to (2.4) will not apply to deny the subsection 112(1) deduction in respect of such dividends and the provisions of subsection 112(3) will apply to reduce any loss which may otherwise arise to the recipient as a result of the purchase for cancellation or redemption.

E. The amount of a deemed dividend described in ruling C above will be excluded from the proceeds of disposition of the share so redeemed or purchased for cancellation, as the case may be, by virtue of paragraph (j) of the definition of "proceeds of disposition" in section 54.

F. The dividends that are deemed to be received by Aco and each of its shareholders, as described in ruling C above, will not be subject to tax under Part IV except as provided in paragraph 186(1)(b).

G. Provided that the amount paid by each of the Aco shareholders on the redemption of the preferred shares held by Aco is equal to the amount specified in respect of such shares as described in paragraph 16 above, the dividends deemed to have been received and paid as described in ruling C above will not be subject to tax under Parts IV.1 and VI.1 because each of those dividends will be dividends deemed by paragraph 191(4)(d) to be an "excluded dividend" and an "excepted dividend".

H. The Aco shares will not, as a result of the implementation of the proposed transactions described above, in and by themselves, be taxable preferred shares.

I. By virtue of the provisions of paragraph 55(3)(b), the provisions of subsection 55(2) will not apply to the dividends that are deemed to be received by Aco and each of its shareholders, as described in ruling C above, provided that, as part of the series of transactions or events that includes the proposed transactions described herein, there is no:

(i) disposition of property in the circumstances described in subparagraph 55(3.1)(b)(i);

(ii) acquisition of property in the circumstances described in subparagraph 55(3.1)(b)(ii);

(iii) acquisition of property in the circumstances described in subparagraph 55(3.1)(c); or

(iv) acquisition of property in the circumstances described in subparagraph 55(3.1)(d),

which has not been described herein and, for greater certainty, subsection 55(3.1) will not apply to deny the application of paragraph 55(3)(b).

J. The extinguishments of the Shareholders' Notes and the Aco Notes as described in paragraph 23 above will not give rise to a "forgiven amount" for purposes of subsections 80(1) and 80.01(1).

K. Provided that the cost to Aco of the Shareholders' Notes and the cost to each of the Aco shareholders of the Aco Notes will, in each case, upon the issuance thereof, be equal to the principal amount of the particular note, no amount will be included in the income of Aco and the Aco shareholders upon payment of the principal amount of the particular note.

L. The provisions of subsections 15(1), 56(2), 69(1), 69(4) and 246(1) will not apply as a result of the proposed transactions described herein, in and by themselves.

M. Subsection 245(2) will not be applied as a result of the proposed transaction, in and by themselves, to redetermine the tax consequences confirmed herein.

The above rulings are based on the Act in its present form and do not take into account any proposed amendments to the Act.

The above rulings are given subject to the limitations and qualifications set out in Information Circular 70-6R3 dated December 30, 1996 issued by Revenue Canada ("IC 70-6R3") and are binding on the Canada Customs and Revenue Agency ("the CCRA") provided the proposed transactions described herein are completed by XXXXXXXXXX.

Comments

1. Nothing in this ruling should be construed as implying that the CCRA has agreed to or reviewed:

(a) the determination of the ACB or fair market value of any property referred to herein or the PUC of any shares referred to herein;

(b) the determination of any of the balances of the RDTOH referred to herein; and

(c) any tax consequences relating to the facts, proposed transactions and subsequent transactions described herein, other than those specifically described in the rulings given above.

2. You have advised in paragraph 16 above, that the redemption price of the preferred shares will be subject to a price adjustment clause. Nothing in this letter should be construed as confirming that, for the purposes of any of the rulings given herein, any adjustment to the fair market value of the properties transferred and redemption amount of the shares issued as consideration, will be effective retroactively to the time of the transfer and issuance of shares. In addition, any such adjustment could affect the ruling given in Ruling I above. Furthermore, the rulings in this letter are not intended to apply to the operation of a price adjustment clause, since its coming into effect will be due to the circumstances that do not constitute proposed transactions that are seriously contemplated. The general position of the Agency with respect to price adjustment clauses is as stated in Interpretation Bulletin IT-169.

Yours truly,

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