2001 Ruling 2000-0058363 - QSBC shares - 55(3)(a)

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:

1) Whether cash and near cash investments would be considered assets used principally in an active business.

2) Application of subsection 55(2).

Position:

1. Yes

2. Dividends not subject to subsection 55(2) by virtue of paragraph 55(3)(a).

Reasons:

1. Cash and near cash are held due to contractual obligations with insurance companies as securities for bonds.

2. Paragraph 55(3)(a) satisfied.

XXXXXXXXXX 2000-005836

XXXXXXXXXX, 2001

Dear XXXXXXXXXX:

Re: XXXXXXXXXX ("Mr. A") - XXXXXXXXXX

XXXXXXXXXX ("Mrs. A") - XXXXXXXXXX

XXXXXXXXXX ("Son #1")- XXXXXXXXXX
XXXXXXXXXX ("Son #2")- XXXXXXXXXX
XXXXXXXXXX ("Opco") - XXXXXXXXXX
XXXXXXXXXX ("Holdco") - XXXXXXXXXX
XXXXXXXXXX (the "Trust")
XXXXXXXXXX. ("Trust Holdco")
Advance Income Tax Ruling

We are writing in response to your letter of XXXXXXXXXX, wherein you requested an advance income tax ruling on behalf of the above-referenced taxpayers. We acknowledge receipt of your correspondence dated XXXXXXXXXX and our telephone conversations and emails in connection herewith.

To the best of your knowledge, and that of the taxpayers involved, none of the issues contained herein is:

(i) dealt with in an earlier return of any such taxpayer or a related person;

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

(iii) under objection by any such taxpayer or a related person;

(iv) subject to a ruling previously issued by the Income Tax Rulings Directorate; or

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

DEFINITIONS

In this letter, unless otherwise expressly stated:

(a) "ACB" means "adjusted cost base" as that expression is defined in section 54 and subsection 248(1);

(b) "Act" means the Income Tax Act, R.S.C. 1985, c.1 (5th Supp.), as amended, and unless otherwise stated, every reference herein to a section, subsection, paragraph or subparagraph is a reference to the relevant provision of the Act;

(c) "active business" has the meaning assigned by subsection 248(1);

(d) "agreed amount" has the meaning assigned by subsection 85(1);

(e) "BCA" means the XXXXXXXXXX;

(f) "Canadian-controlled private corporation" has the meaning assigned by subsection 125(7);

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

(h) "Mrs. B" refers to XXXXXXXXXX;

(i) "Mr. C" refers to XXXXXXXXXX;

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

(k) "QSBC Shares" means qualified small business corporation shares as that expression is defined in subsection 110.6(1);

(l) "stated capital" has the meaning assigned to that term in the BCA;

(m) "taxable Canadian corporation" has the meaning assigned by subsection 89(1).

Our understanding of the facts, proposed transactions and purpose of the proposed transactions is as set forth below.

Facts

1. Mr A, Mrs. A, Son#1 and Son#2 are all residents in Canada. Mrs. A is the spouse of Mr. A, and Son #1 and Son #2 are the adult children of Mr. A and Mrs. A.

2. Holdco is a taxable Canadian corporation and a Canadian-controlled private corporation incorporated under XXXXXXXXXX the BCA on XXXXXXXXXX, and its issued and outstanding shares are as follows:

a) XXXXXXXXXX common shares;

b) XXXXXXXXXX preferred shares redeemable for an amount equal to the consideration for which they were issued, and which are entitled to a maximum, annual, and non-cumulative dividend of XXXXXXXXXX of the consideration for which they were issued;

c) XXXXXXXXXX preferred shares, redeemable and retractable for an amount equal to the consideration for which they were issued, and which are entitled to a maximum, monthly, non-cumulative dividend of XXXXXXXXXX of the consideration for which they were issued;

The holders of these shares are as follows:

SHAREHOLDER SHARES PUC ACB

Mr. A XXXXXXXXXX

Mr. A XXXXXXXXXX

Mr. A XXXXXXXXXX

Mrs. A XXXXXXXXXX

Son #1 XXXXXXXXXX
Son #2 XXXXXXXXXX

Mr. A controls Holdco by virtue of his ownership of the XXXXXXXXXX preferred shares.

The shares of Holdco are capital property in the hands of each of the shareholders.

3. As at XXXXXXXXXX (the "Balance Sheet Date"), the assets of Holdco were as follows:

a) cash and near cash in the amount $XXXXXXXXXX;

b) XXXXXXXXXX common shares of Opco with a fair market value of $XXXXXXXXXX;

c) a loan to Opco in the amount of $XXXXXXXXXX.

4. XXXXXXXXXX the Balance Sheet Date, the assets of Holdco were, in all material respects, always of the nature of assets referred to in subparagraphs 3a),3b) and 3c) above, although dollar amounts and specific assets varied from time to time within that period.

5. The common and preferred shares of Holdco, held by Mr. A and Mrs. A will, XXXXXXXXXX, not have been owned by anyone other than Mr. A and Mrs. A.

6. The fair market value of the XXXXXXXXXX common and XXXXXXXXXX preferred shares of Holdco was $XXXXXXXXXX at the Balance Sheet Date.

7. Opco is a taxable Canadian corporation and a Canadian-controlled private corporation incorporated under XXXXXXXXXX the BCA on XXXXXXXXXX and continued under XXXXXXXXXX the BCA on XXXXXXXXXX. Currently, the sole shareholder of Opco is Holdco which holds XXXXXXXXXX common shares with an ACB and paid-up capital of $XXXXXXXXXX.

8. As at the Balance Sheet Date, the assets of Opco were as follows:

a) cash and near cash in the amount of $XXXXXXXXXX;

b) other assets which are used in an active business with a fair market value of $XXXXXXXXXX; and

c) a short-term loan ("Loan") made on XXXXXXXXXX by Opco to the Trust in the amount of $XXXXXXXXXX.

9. XXXXXXXXXX the Balance Sheet Date, aside from the Loan, the assets of Opco were, in all material respects, always of the nature of assets referred to in subparagraphs 8a) and 8b) above, although dollar amounts and specific assets varied from time to time within that period.

10. Opco is a XXXXXXXXXX. To bid on and undertake XXXXXXXXXX projects of a certain size, Opco must provide bonds pursuant to which third parties, such as insurance companies, will guarantee its performance and insure against its possible default.

11. To provide such bonds, the insurance company typically requires that the XXXXXXXXXX company maintain sufficient working capital reserves and cash reserves. Opco is required to maintain such reserves in order to be bonded pursuant to the indemnity and security agreements it has signed with XXXXXXXXXX. As well, Holdco is bound pursuant to the same agreements to maintain working capital reserves to support its guarantee of the obligations of Opco. Although the bonding companies do not have fixed rules as to the kinds of investments that constitute working capital and cash reserves, industry practice and the relationship that Opco has maintained with these bonding companies and the brokerage firm that obtained the bonds have effectively dictated that only short-term instruments which are easily liquidated will qualify for these purposes. For these reasons, Opco and Holdco have typically held such investments in certificates of deposit, treasury bills or money market instruments.

12. The removal of cash from Holdco and Opco would severely destabilize the business of Opco, and as a result, Opco would no longer be able to bid on and undertake large XXXXXXXXXX projects, but rather would only be able to bid on small projects, which would be a fundamental change in the nature of their business.

13. From the date of organization of Opco until XXXXXXXXXX, Mr. A was the sole beneficial owner of the XXXXXXXXXX common shares in Opco directly. On XXXXXXXXXX, these shares were transferred by Mr. A to Holdco. Mr. A and Holdco effected an election under section 85 of the Act in respect of such transfer. Mr A received XXXXXXXXXX preferred shares in Holdco and elected a high paid-up capital for those shares, as was then allowed. The paid-up capital of the XXXXXXXXXX shares of Holdco still owned by Mr. A is $XXXXXXXXXX.

14. Over the years, Holdco has repurchased a number of XXXXXXXXXX shares at their redemption price. Mr. A reported a taxable capital gain with respect to each of the share repurchases equal to the difference between the ACB of the shares and the redemption price. While these capital gains may have been eligible for the capital gain deduction pursuant to subsection 110.6(2.1), the deduction has never been claimed because Mr. A was not aware that he was eligible for this deduction.

15. The Trust was established under the laws of XXXXXXXXXX. The Trust has the following attributes:

a) The settlor of the Trust was Mrs. B.

b) The Trust is resident in Canada.

c) The Trust is fully discretionary as to income and capital distributions.

d) The trustees are Mr. A, Mrs. A and Mr. C.

e) All decisions of the trustees from time to time are to be determined by a majority vote.

f) The sole income and capital beneficiaries of the Trust are Mr. A, Mrs. A, Son #1, Son #2 and the children of Son #1 and Son #2.

16. Trust Holdco is a taxable Canadian corporation and a Canadian-controlled private corporation incorporated under XXXXXXXXXX the BCA on XXXXXXXXXX. Currently, the sole shareholder of Trust Holdco is the Trust, holding XXXXXXXXXX common shares with a paid-up capital and ACB of $XXXXXXXXXX in the aggregate.

Proposed Transactions

17. A company ("Newco") will be incorporated under XXXXXXXXXX the BCA, with the following authorized share capital:

a) XXXXXXXXXX Common shares;

b) XXXXXXXXXX shares, but otherwise ranking pari pasu with the Common shares;

c) XXXXXXXXXX preferred shares, redeemable for an amount equal to the consideration for which the shares were issued, and which are entitled to a maximum, annual, non-cumulative dividend of XXXXXXXXXX of the consideration for which the shares were issued;

d) XXXXXXXXXX preferred shares, redeemable for an amount equal to the consideration for which the shares were issued, and which are entitled to a maximum, annual, non-cumulative dividend of XXXXXXXXXX of the amount of the consideration for which the shares were issued;

e) XXXXXXXXXX preferred shares, redeemable and retractable for an amount of $XXXXXXXXXX per share, and which are entitled to a maximum monthly, non-cumulative dividend of XXXXXXXXXX per share;

f) XXXXXXXXXX preferred shares, redeemable and retractable for an amount equal to the consideration for which the shares were issued, and which are entitled to a maximum annual, non-cumulative dividend of XXXXXXXXXX of the amount of the consideration for which the shares were issued;

g) XXXXXXXXXX preferred shares, redeemable and retractable for an amount equal to the consideration for which the shares were issued, and which are entitled to a maximum monthly, non-cumulative dividend of XXXXXXXXXX of the amount of the consideration for which the shares were issued.

Mr. A and Mrs. A will each subscribe for XXXXXXXXXX Common shares of Newco for a total subscription price of $XXXXXXXXXX each. In addition, Mr. A will subscribe for XXXXXXXXXX preferred shares for a total share subscription price of $XXXXXXXXXX.

18. Opco will declare a dividend in kind to Holdco, comprised of the Loan which has a fair market value of $XXXXXXXXXX, an amount equal to its principal amount.

19. Following the dividend described in paragraph 18 above, Mr. A will purchase the Loan from Holdco at its fair market value for cash consideration of $XXXXXXXXXX.

20. Mr. A and Mrs. A will each transfer their XXXXXXXXXX common shares of Holdco to Newco, each in consideration of XXXXXXXXXX preferred shares of Newco. In connection with the transfer, each of Mr. A and Newco and Mrs. A and Newco will jointly elect in prescribed form within the time limit referred to in subsection 85(6), to have the provisions of subsection 85(1) apply to the transfer. The agreed amount in respect of the transferred shares of Holdco, in each case, will be equal to their fair market value. Newco will add to the stated capital account maintained for its XXXXXXXXXX preferred shares an amount equal to the aggregate of the paid-up capital of the common shares of Holdco transferred.

21. Mr. A will transfer at fair market value XXXXXXXXXX preferred shares of Holdco to Newco, in consideration for XXXXXXXXXX preferred shares of Newco. In connection with the transfer, Mr. A and Newco will jointly elect, in prescribed form within the time limit referred to in subsection 85(6), to have the provisions of subsection 85(1) apply to the transfer. The agreed amount in respect of the transferred shares of Holdco, in each case, will be equal to their ACB. Newco will add to the stated capital account maintained for its XXXXXXXXXX preferred shares an amount equal to the paid-up capital of the XXXXXXXXXX preferred shares of Holdco transferred.

22. Following the transfers described in 20 and 21 above, Holdco will purchase for cancellation the XXXXXXXXXX common shares and will redeem the XXXXXXXXXX preferred shares held by Newco for an amount equal to the fair market value of such shares, using the cash received from Mr. A, as described in paragraph 19 above, and the balance with cash and near cash held by Holdco.

23. Newco will subscribe for XXXXXXXXXX preferred shares of Trust Holdco, for a subscription price of $XXXXXXXXXX per share.

24. Mr. A will transfer XXXXXXXXXX preferred shares of Holdco to each of Son #1 and Son #2 for $XXXXXXXXXX, leaving Mr. A with 2 XXXXXXXXXX preferred shares of Holdco.

25. Following the transfer described in 24 above Holdco will purchase for cancellation the XXXXXXXXXX preferred shares held by Mr. A for an amount equal to $XXXXXXXXXX.

Purposes of the Proposed Transactions

26. To effect a business succession by which Mr. A's sons, Son #1 and Son #2, will assume control of the commercial operations of Opco and Holdco. The transaction described in paragraph 24 above effects the transfer of the voting control of Holdco to Son #1 and Son #2. This transaction also ensures that Mr. A retains 2 XXXXXXXXXX preferred shares in Holdco which he will use as a tie-breaker vote in case of any dispute between Son #1 and Son #2 concerning the affairs of Holdco and/or Opco. The specific number of 2 XXXXXXXXXX preferred shares has been chosen so that 1 XXXXXXXXXX preferred share will devolve to each of Mr. A's sons upon his death.

27. To repurchase the XXXXXXXXXX preferred shares held by Mr. A, so that Mr. A effectively will be bought out.

28. The purpose of the transactions described in paragraphs 18 and 19 above is to allow Mr. A to transfer the sum of money to Holdco which will be necessary to purchase for cancellation the XXXXXXXXXX common shares and XXXXXXXXXX preferred shares held by Newco and the XXXXXXXXXX preferred shares held by Mr. A.

29. The purpose of the transactions described in paragraph 23 above is to fund Trust Holdco with amounts required for its operations and further investments.

Rulings Requested and Given

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

A. For the purposes of the definition of the terms "small business corporation" and "qualified small business corporation share" in subsections 248(1) and 110.6(1) of the Act, respectively, the cash and near cash property referred to in paragraphs 3a) and 8a) above will, to the extent that the retention of such amounts is necessary for Opco to obtain the bonds which are required for it to bid on various construction projects, be considered to be assets used principally in an active business.

B. Subject to the provisions of subsection 110.6(8) and provided that at the time of the transfer of the Holdco common shares to Newco described in paragraph 20 above, such shares are qualified small business corporation shares, Mr. A and Mrs. A will each be entitled to a deduction to the extent permitted by subsection 110.6(2.1) in respect of the capital gain realized on the disposition of such shares.

C. The application of subsection 84.1(1) to the transfer of the XXXXXXXXXX common shares of Holdco by Mr. A and Mrs. A to Newco described in paragraph 20 above will not result in a reduction of the paid-up capital of the Newco XXXXXXXXXX preferred shares pursuant to the provisions of paragraph 84.1(1)(a) or result in a dividend being deemed to be paid to Mr. A or Mrs. A pursuant to the provisions of paragraph 84.1(1)(b).

D. On the purchase for cancellation/redemption by Holdco of the Holdco shares held by Newco as described in paragraph 22:

(a) paragraphs 84(3)(a) and (b) will apply to deem Holdco to have paid, and Newco to have received, a dividend equal to the amount by which the amount paid on the redemption of those shares exceeds the paid-up capital thereof immediately prior to the redemption;

(b) paragraph (j) of the definition of "proceeds of disposition" in section 54 will apply to exclude the amount of such deemed dividend from the proceeds of disposition which Newco would otherwise be considered to have received as a result of such redemption.

E. Provided that as part of the series of transactions or events that includes the proposed transactions described herein, there is no disposition of property or increase in interest in a corporation, described in any of subparagraphs 55(3)(a)(i) to (v), then, by virtue of paragraph 55(3)(a) of the Act, the provisions of subsection 55(2) will not apply to the deemed dividends referred to in Ruling D above. For greater certainty, the proposed transactions described in paragraphs 17 to 25 herein, in and by themselves, will not be considered to result in any disposition of property or any increase in interest in a corporation described in any of subparagraphs 55(3)(a)(i) to (v).

F. With respect to the deemed dividends described in Ruling D above, Newco, the recipient of the dividend therein described, will by virtue of subsections 186(2) and 186(4) be connected with Holdco such that Newco shall not be subject to tax under Part IV in respect of such dividend except as provided for in paragraph 186(1)(b).

G. By virtue of subsection 256(7), no person or group of persons will, as a result of the proposed transactions described above, acquire control of either Holdco or Opco for purposes of subsection 249(4).

H. Subsection 245(2) will not be applied as a result of the Proposed Transactions, in and of themselves, to redetermine any of the tax consequences confirmed in the rulings granted herein.

The above rulings are given subject to the limitations and qualifications set out in Information Circular 70-6R4 dated January 29, 2001 and are binding on the Canada Customs and Revenue Agency provided that the proposed transactions are completed by XXXXXXXXXX.

The above rulings are based on the law as it presently reads and do not take into account any proposed amendments to the Act which, if enacted, could have an effect on the rulings provided herein.

Nothing in this letter should be considered as confirmation of the income tax consequences of any of the transactions described in this letter other than as specifically described. For greater certainty, other than their potential impact on the rulings provided above, we are not commenting on any tax consequences relating to the transactions described in paragraphs 18 and 19 above.

In addition, nothing in this letter should be construed as confirmation, express or implied, of the fair market value or adjusted cost base of any property or the paid-up capital of any share.

Yours truly,

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