2001 Ruling 2001-0086313 - Transfer of Assets under 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: This is a transfer of assets among related companies under 55(3)(a). The purpose of the proposed transactions is primarily to transfer shares of XXXXXXXXXX (Tco) now held by Holdco to Subco, in order to apply capital losses or other available deductions against the capital gain that will be realized on the sale by Subco of some of its Tco shares in a secondary public offering. The purpose of the proposed PUC increase on the Tco shares is to decrease the capital gain that would otherwise be realized on the sale of such shares to the extent of Tco's safe income on hand in respect of the Tco shares held by Subco.

Position:

Paragraph 55(3)(a) applies to the dividends arising on the cross-redemptions.

Reasons:

All the taxpayers are related. The dispositions of the Tco shares on the public offering are at FMV and are not dispositions of shares of a dividend payor or recipient.

XXXXXXXXXX 								2001 - 008631

XXXXXXXXXX, 2001

Dear XXXXXXXXXX:

Re: XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
Advance Income Tax Ruling Request

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 also acknowledge receipt of your facsimiles as well as the information provided in various telephone conversations.

Throughout this letter, the taxpayers involved will be referred to as follows:

XXXXXXXXXX Pubco
XXXXXXXXXX Subco
XXXXXXXXXX Holdco
XXXXXXXXXX Tco
XXXXXXXXXX Vco
XXXXXXXXXX Xco
XXXXXXXXXX Yco
XXXXXXXXXX Zco

Subco's tax affairs have been administered by the XXXXXXXXXX Tax Services Office and its corporate tax returns have been filed at the XXXXXXXXXX Taxation Centre. Holdco's tax affairs have been administered by the XXXXXXXXXX Tax Services Office and its corporate tax returns have been filed at the XXXXXXXXXX Taxation Centre. Tco's tax affairs have been administered by the XXXXXXXXXX Tax Services Office and its corporate tax returns have been filed at the XXXXXXXXXX Taxation Centre. Pubco, Subco, Holdco and Tco are all resident in Canada for the purposes of the Act.

To the best of your knowledge, and that of any of the taxpayers, none of the issues involved in this ruling request is:

(i) involved in an earlier return of any of the taxpayers 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 of the taxpayers or a related person;

(iii) under objection by any of the taxpayers or a related person;

(iv) before the courts; or

(v) the subject of a ruling previously issued by the Income Tax Rulings Directorate.

The taxpayers have represented that the proposed transactions will not affect their ability to pay any of their outstanding tax liabilities.

DEFINITIONS

In this letter, unless otherwise expressly stated, the following terms have the meanings specified:

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

(b) "adjusted cost base" ("ACB") has the meaning assigned to that term by section 54;

(c) "agreed amount" in respect of a property means the amount that the transferor and the transferee of the property have agreed upon in an election under subsection 85(1);

(d) "arm's length" has the meaning assigned to that term by subsection 251(1);

(e) "CBCA" means the Canada Business Corporations Act and, where applicable, its predecessor statutes;

(f) "capital property" has the meaning assigned to that term by section 54;

(g) "eligible property" has the meaning assigned to that term by subsection 85(1.1);

(h) "FMV" means fair market value;

(i) XXXXXXXXXX;

(j) "paid-up capital" ("PUC") has the meaning assigned to that term by subsection 89(1);

(k) "private corporation" has the meaning assigned to that term by subsection 89(1);

(l) "proceeds of disposition" has the meaning assigned to that term by section 54;

(m) "public corporation" has the meaning assigned to that term by subsection 89(1);

(n) "related persons" has the meaning assigned to that term by subsection 251(2);

(o) "safe-income determination time" has the meaning assigned to that term by subsection 55(1);

(p) "safe income on hand" in respect of a particular share of a corporation at a particular time means the portion of the unrealized gain inherent in such share of the corporation at that time that cannot reasonably be considered to be attributable to anything other than income earned or realized (as determined pursuant to subsection 55(5)), to the extent that it is on hand, by any corporation after 1971 and before the safe-income determination time for the transaction, event or series of transactions or events that includes the proposed transactions described below;

(q) "series of transactions or events" includes the transactions or events referred to in subsection 248(10);

(r) "specified financial institution" ("SFI") has the meaning assigned to that term by subsection 248(1);

(s) "stated capital" and "stated capital account" have the meaning assigned to those terms by section 26 of the CBCA;

(t) "taxable Canadian corporation" ("TCC") has the meaning assigned to that term by subsection 89(1); and

(u) "taxable dividend" has the meaning assigned to that term by subsection 89(1).

Our understanding of the facts, proposed transactions and purpose of the proposed transactions is as follows:

FACTS

1. Pubco is a XXXXXXXXXX public corporation, the shares of which are listed on the XXXXXXXXXX.

2. Subco is a XXXXXXXXXX wholly-owned subsidiary of Pubco. Subco is also a taxable Canadian corporation and a XXXXXXXXXX corporation within the meaning assigned to that term by subsection 248(1). XXXXXXXXXX.

3. Holdco is a taxable Canadian corporation governed by the CBCA XXXXXXXXXX, but is neither a public corporation nor a private corporation. The issued and outstanding share capital of Holdco consists of XXXXXXXXXX Class A common shares, all of which are held by Subco as capital property. The ACB of the Holdco Class A common shares to Subco is greater than the PUC in respect of such shares.

4. Holdco is a holding company for various investments. Holdco's assets consist primarily of current assets including cash, intercompany receivables and Holdco's short-term investments (the "Current Assets"), shares of Vco, and other assets that consist primarily of shares of Tco, Xco, Yco and Zco (such other assets will be referred to herein as the "Investment Assets"). Holdco has only minimal liabilities that do not exceed the value of its current assets.

5. Tco is a taxable Canadian corporation governed by the CBCA XXXXXXXXXX, but is neither a public corporation nor a private corporation. Tco is in the business of XXXXXXXXXX.

The issued and outstanding share capital of Tco currently consists of XXXXXXXXXX common shares (the "Tco Common Shares") entitled to one vote each, fully participating with respect to dividends and entitled to receive the remaining property of the corporation upon winding-up or dissolution. Holdco holds XXXXXXXXXX% of such common shares as capital property. The remainder of the shares are owned by persons who deal at arm's length with Holdco, most of whom are individuals employed in management positions with Tco.

The safe income on hand in respect of all of the Tco shares held by Holdco is currently estimated to be approximately $XXXXXXXXXX.

6. Vco provides a range of XXXXXXXXXX services. XXXXXXXXXX. Yco XXXXXXXXXX for Subco and others. Zco formerly carried on a XXXXXXXXXX business but is now dormant.

PROPOSED TRANSACTIONS

7. Holdco will file Articles of Amendment pursuant to which the share capital of Holdco will be reorganized. In particular, the XXXXXXXXXX Holdco Class A common shares will be exchanged for XXXXXXXXXX Holdco new common shares ("the Holdco Common Shares"), and XXXXXXXXXX Holdco preferred shares (the "Holdco Preferred Shares"). The Holdco Preferred Shares will be non-voting, redeemable and retractable for an amount which, in aggregate, will be equal to the FMV of Holdco's Investment Assets. The stated capital of the Holdco Common Shares and the Holdco Preferred Shares will, in aggregate, not exceed the stated capital of the XXXXXXXXXX Holdco Class A common shares, and will be allocated between the Holdco Common Shares and Holdco Preferred Shares based on their proportionate FMV. Subsection 86(2.1) will apply to reduce the PUC of the Holdco Common Shares and the Holdco Preferred Shares to the extent that the stated capital of the Holdco Common Shares and the Holdco Preferred Shares, in aggregate, exceeds the PUC of the Holdco Class A common shares.

8. Subco will incorporate a new corporation ("Newco") under the CBCA and transfer all of the Holdco Preferred Shares to Newco. As consideration for such transfer, Newco will issue at least one Newco common share to Subco.

In respect of such transfer, Subco and Newco will elect, jointly and in prescribed form and within the time limits referred to in subsection 85(6), to have the rules in subsection 85(1) apply to the transfer of the Holdco Preferred Shares to Newco. The agreed amount specified in the election will be equal to the cost amount of the transferred Holdco Preferred Shares immediately before the transfer, which will not be greater than the fair market value of those shares. The amount that will be added to the stated capital account of the Newco common shares pursuant to subsection 26(3) of the CBCA will be equal to the agreed amount in respect of the Holdco Preferred Shares so transferred.

9. Holdco will transfer its Investment Assets to Newco. As consideration for such transfer, Newco will issue redeemable, retractable preferred shares ("Newco Preferred Shares") to Holdco having an aggregate redemption amount equal to the FMV of the Investment Assets so transferred.

In respect of such transfer, Holdco and Newco will elect, jointly and in prescribed form and within the time limits referred to in subsection 85(6), to have the rules in subsection 85(1) apply to the transfer of the Investment Assets to Newco. Each of the Investment Assets is an eligible property and capital property to Holdco. The agreed amount in respect of each transferred Investment Asset will be equal to the cost amount of that asset immediately before the transfer, which will not be greater than the fair market value of that asset. The amount that will be added to the stated capital account of the Newco Preferred Shares pursuant to subsection 26(3) of the CBCA will be equal to the agreed amount in respect of the Investment Assets so transferred.

10. Immediately after the transfer described in paragraph 9 above, Newco will redeem all of the Newco Preferred Shares issued by it to Holdco for an amount equal to the aggregate redemption amount of such shares. Newco will pay the aggregate redemption amount by issuing a non-interest-bearing demand promissory note (the "Newco Note") to Holdco having a principal amount and FMV equal to the aggregate redemption amount of the Newco Preferred Shares so redeemed. Holdco will accept the Newco Note as full payment of the aggregate redemption amount of the Newco Preferred Shares so redeemed.

11. Immediately after the redemption of the Newco Preferred Shares described in paragraph 10 above, Holdco will redeem all of the Holdco Preferred Shares held by Newco for an amount equal to the aggregate redemption amount of such shares, which amount will be equal to the aggregate redemption amount of the Newco Preferred Shares redeemed as described in paragraph 10 above. Holdco will pay the aggregate redemption amount by issuing a non-interest-bearing demand promissory note (the "Holdco Note") to Newco having a principal amount and FMV equal to the aggregate redemption amount of the Holdco Preferred Shares so redeemed. Newco will accept the Holdco Note as full payment of the aggregate redemption amount of the Holdco Preferred Shares so redeemed.

12. Immediately following the issuance of the demand promissory notes described in paragraphs 10 and 11 above, the obligations under the Newco Note held by Holdco and the Holdco Note held by Newco will be settled by way of set-off, one against the other.

13. Subco, as sole shareholder of Newco, will resolve to wind up Newco. Under the terms of the winding-up of Newco, Newco will assign and distribute to Subco all of its property which will consist of the Investment Assets acquired by it from Holdco. Following the distribution of all of its property, filing of final tax returns and receipt of the relevant clearance certificates and consents, Articles of Dissolution will be filed and Newco will be dissolved.

14. A cash dividend will be paid on the Tco Common Shares.

15. Tco will file Articles of Amendment to create a new class of shares (the "Tco New Common Shares") having attributes substantially identical to the existing Tco Common Shares, except that each Tco New Common Share will be convertible into one Tco Common Share and voting rights and dividend rights will attach to fractional interests in the Tco New Common Shares. Under the CBCA, no voting rights or dividend rights attach to fractional shares unless the Articles provide otherwise. No voting rights or dividend rights attach to fractional interests in the existing Tco Common Shares. The Articles of Amendment will also amend the terms and conditions of the Tco Common Shares to provide that the holder thereof is entitled to convert each such share, on a one-for-one basis, into a Tco New Common Share.

16. Subsequent to the filing of the Articles of Amendment, Subco will exercise the conversion right attached to its Tco Common Shares with the result that all such shares will be converted into Tco New Common Shares on a one-for-one basis.

17. There will be a series of resolutions increasing the stated capital maintained for the Tco New Common Shares in increments, so that the aggregate increase will equal the remaining estimated safe income on hand in respect of the Tco New Common Shares held by Subco, after deducting Subco's share of the cash dividend described in paragraph 14 above.

18. Subco will then exercise its right to convert each Tco New Common Share back into a Tco Common Share.

19. Tco will file further Articles of Amendment which will eliminate any conversion right attaching to the Tco Common Shares and eliminate from the authorized capital any unissued Tco New Common Shares. As a result, the authorized and issued shares of Tco will, once again, consist of only a single class of common shares, namely the Tco Common Shares.

20. Subco will offer a portion of the Tco Common Shares it holds to the public, XXXXXXXXXX Certain Tco Common Shares, held by XXXXXXXXXX, will also be sold under such prospectus. Application will be made to list the Tco Common Shares on the XXXXXXXXXX Stock Exchange (the "XXXXXXXXXX") and a preliminary prospectus was filed with the relevant provincial securities commissions on XXXXXXXXXX. After the closing of the offering, which is anticipated to occur XXXXXXXXXX, Tco will be a public corporation. It is anticipated that after the closing, Subco will hold approximately XXXXXXXXXX% of the Tco Common Shares, existing management will hold approximately XXXXXXXXX% of the Tco Common Shares, and the remaining XXXXXXXXXX% of the Tco Common Shares will be held by the public.

PURPOSE OF THE PROPOSED TRANSACTIONS

21. The purpose of the proposed transactions described in paragraphs 7 through 13 is to transfer the Tco Common Shares now held by Holdco to Subco, which may be in a better position to apply capital losses or other available deductions against the capital gain that will be realized on the sale of Tco Common Shares in a public offering. The purpose of the proposed transactions in paragraphs 14 to 18 is to decrease the capital gain that would otherwise be realized on the sale of such shares to the extent of the safe income on hand in respect of the Tco Common Shares held by Subco.

RULINGS 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. The provisions of subsection 86(1) will apply to the exchange of shares described in paragraph 7 above, such that:

(a) the cost to Subco of the Holdco Preferred Shares will be equal to that proportion of the aggregate ACB of the Holdco Class A common shares that the FMV of the Holdco Preferred Shares is of the aggregate FMV of the Holdco Common Shares and the Holdco Preferred Shares; and

(b) the cost to Subco of the Holdco Common Shares will be an amount equal to the remaining ACB of the Holdco Class A common shares;

and for greater certainty:

(c) paragraph 86(2) will not apply to such exchange; and

(d) subsection 84(1) will not deem a dividend to be paid on such reorganization of the share capital of Holdco.

B. The provisions of subsection 85(1) will apply to:

(a) the transfer of the Holdco Preferred Shares held by Subco to Newco, as described in paragraph 8 above; and

(b) the transfer of the Investment Assets by Holdco to Newco, as described in paragraph 9 above;

such that the agreed amounts in respect of each such transfer will be deemed to be the transferor's proceeds of disposition of the property and the transferee's cost thereof, and the transferor's cost of the shares received as consideration for the disposition. For greater certainty, paragraph 85(1)(e.2) will not apply to the transfers referred to herein.

C. As a result of the redemption by Newco of the Newco Preferred Shares held by Holdco as described in paragraph 10 above and the redemption by Holdco of the Holdco Preferred Shares held by Newco as described in paragraph 11 above:

(a) by virtue of paragraphs 84(3)(a) and 84(3)(b):

(i) Newco will be deemed to have paid, and Holdco will be deemed to have received, a taxable dividend equal to the amount by which the amount paid to redeem the Newco Preferred Shares held by Holdco exceeds the PUC thereof, immediately before such redemption; and

(ii) Holdco will be deemed to have paid, and Newco will be deemed to have received, a taxable dividend equal to the amount by which the amount paid to redeem the Holdco Preferred Shares held by Newco exceeds the PUC thereof, immediately before such redemption;

(b) the taxable dividends deemed to be received by Holdco and Newco as a result of the redemptions referred to in Ruling C(a) above will be included in each corporation's income pursuant to paragraph 12(1)(j), and will be deductible by each corporation in computing its taxable income pursuant to subsection 112(1), unless the provisions of subsection 112(2.1), 112(2.2), 112(2.3) or 112(2.4) apply to deny the application of the subsection 112(1) deduction in respect of such dividends;

(c) the dividends deemed to have been received by Holdco and Newco as a result of the redemptions referred to in Ruling C(a) above will be excluded from the proceeds of disposition of such shares by virtue of paragraph (j) of the definition of "proceeds of disposition" in section 54; and

(d) by virtue of paragraph 191(2)(a), Holdco will have a substantial interest in Newco immediately before the redemption of the Newco Preferred Shares held by Holdco, as described in paragraph 10 above, and Newco will have a substantial interest in Holdco immediately before the redemption of the Holdco Preferred Shares held by Newco, as described in paragraph 11 above. Consequently, neither Holdco nor Newco will be subject to Part IV.1 tax under section 187.2 or to Part VI.1 tax under section 191.1 in respect of:

(i) the dividend deemed to have been paid by Newco to Holdco upon the redemption of the Newco Preferred Shares since each such dividend will be an "excepted dividend" within the meaning of paragraph (b) of the definition of "excepted dividend" in section 187.1 where Holdco is the recipient of the particular dividend, and will be an "excluded dividend" within the meaning of paragraph (a) of the definition of "excluded dividend" in subsection 191(1) where Newco is the payer of the particular dividend, or

(ii) the dividend deemed to have been paid by Holdco to Newco upon the redemption of the Holdco Preferred Shares since each such dividend will be an "excepted dividend" within the meaning of paragraph (b) of the definition of "excepted dividend" in section 187.1 where Newco is the recipient of the particular dividend, and will be an "excluded dividend" within the meaning of paragraph (a) of the definition of "excluded dividend" in subsection 191(1) where Holdco is the payer of the particular dividend.

D. The cost to Holdco of the Newco Note will be equal to the FMV of the Newco Note at the time of receipt.

E. The cost to Newco of the Holdco Note will be equal to the FMV of the Holdco Note at the time of receipt.

F. The settlement of the Newco Note and the Holdco Note by way of set-off of one against the other, described in paragraph 12 above, will not give rise to a "forgiven amount" within the meaning of subsection 80(1) or section 80.01.

G. As a result of the winding up of Newco, as described in paragraph 13 above:

(a) by virtue of paragraph 88(1)(a), Newco will be deemed to have disposed of the Investment Assets held by it to Subco for an amount equal to the ACB of such assets immediately before the winding-up;

(b) by virtue of paragraph 88(1)(c), the cost to Subco of the Investment Assets acquired by it on the winding-up of Newco will be equal to the ACB to Newco of such assets immediately before the winding-up; and

(c) by virtue of paragraph 88(1)(b), Subco will be deemed to have disposed of the shares of Newco for an amount equal to the ACB of such shares immediately before the winding-up.

H. Section 51 will apply to the conversion by Subco of the Tco Common Shares into Tco New Common Shares, as described in paragraph 16 above, with the result that such conversion will be deemed not to be a disposition of such Tco Common Shares and the cost to Subco of the Tco New Common Shares acquired on such conversion will be the ACB to Subco of the Tco Common Shares immediately before such conversion.

I. As a result of the increases in stated capital of the Tco New Common Shares, as described in paragraph 17 above:

(a) by virtue of subsection 84(1), Tco will be deemed to have paid, and Subco will be deemed to have received, a taxable dividend on the Tco New Common Shares held by Subco equal to the increases in the stated capital;

(b) the taxable dividends deemed to be received by Subco as a result of the increases in stated capital referred to in Ruling I(a) above will be included in Subco's income pursuant to paragraph 12(1)(j), and will be deductible by Subco in computing its taxable income XXXXXXXXXX unless the provisions of subsection 112(2.1), 112(2.2), 112(2.3) or 112(2.4) apply to deny the application of the XXXXXXXXXX deduction in respect of such dividends;

(c) by virtue of paragraph 53(1)(b), the increases in stated capital referred to in Ruling I(a) above will be added in computing the ACB of the Tco New Common Shares held by Subco; and

(d) subsection 55(2) will not apply to the taxable dividends referred to in Ruling I(a) above, provided that the amount of any such incremental addition to the stated capital of the Tco New Common Shares, together with the cash dividend received by Subco, as described in paragraph 14 above, and the aggregate amount of all preceding stated capital increases, described in paragraph 17 above, does not exceed the safe income on hand of Tco in respect of such shares, and for such purposes, the safe income on hand of Tco will include any amount that would have been included in the safe income on hand of Tco if the Tco Common Shares had continued to be held by Holdco and had not been converted or reconverted.

J. Section 51 will apply to the conversion by Subco of the Tco New Common Shares back into Tco Common Shares, as described in paragraph 18 above, with the result that such conversion will be deemed not to be a disposition of such Tco New Common Shares and the cost to Subco of the Tco Common Shares acquired on such conversion will be the ACB to Subco of the Tco New Common Shares immediately before such conversion.

K. Provided that, as part of the series of transactions or events that includes the proposed transactions, there is not a disposition of property or an increase in interest described in any of subparagraphs 55(3)(a)(i) to (v), then by virtue of paragraph 55(3)(a), subsection 55(2) will not apply to the taxable dividends referred to in Ruling C(a) above and, for greater certainty, the proposed transactions described in paragraphs 7 to 20 above will not be considered to result in any of the events described in subparagraphs 55(3)(a)(i) to (v), in and by themselves.

L. The provisions of subsections 15(1), 56(2), 69(4), 69(11) and 246(1) will not apply to the proposed transactions described herein, in and by themselves.

M. Subsection 245(2) will not be applied to the proposed transactions, in and by themselves, to re-determine the tax consequences confirmed in the rulings given.

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.

COMMENTS

1. Nothing in this ruling should be construed as implying that the Canada Customs and Revenue Agency has agreed to or reviewed:

(a) the determination of the fair market value or ACB of any particular asset or the paid-up capital or safe income on hand in respect of any shares referred to herein; or

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

Yours truly,

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

??