2002 Ruling 2001-0116073 - Certain Tax Consequences of buy/bump/sell

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 CCRA.

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

Principal Issues: 88(1)(d) bump, 69(11) on buy/bump/sell transaction, and interest deductibility on amount payable to acquire shares of Target.

Position: standard bump ruling, 69(11) does not apply in this situation, interest is deductible provided there is a legal obligation to pay interest, the interest is reasonable and the Target shares or substituted property continues to be used by Holdco for the purpose of gaining or producing income from a business or property.

Reasons: The law.

XXXXXXXXXX 2001-011607

XXXXXXXXXX, 2002

Dear XXXXXXXXXX:

Re: ADVANCE INCOME TAX RULING
XXXXXXXXXX ("Purchaser")

This is in reply to your letter of XXXXXXXXXX in which you request an advance income tax ruling on behalf of the above named taxpayer. We also acknowledge the information provided in subsequent correspondence and during our various telephone conversations in connection with your request (XXXXXXXXXX).

We understand that, to the best of your knowledge and that of Purchaser ("the taxpayer"), none of the issues involved in the ruling request:

(i) is identified in an earlier tax return of the taxpayer or of a related person;

(ii) is being considered by a tax services office or taxation center in connection with a previously filed tax return of the taxpayer or a related person;

(iii) is under objection by the taxpayer or a related person;

(iv) is before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has not expired; and

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

You advised that the proposed transactions described herein, will have no impact on the ability of the taxpayers or related persons to meet their outstanding tax liabilities.

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

DEFINITIONS

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

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

(b) "ACB" means the expression "adjusted cost base" which has the meaning assigned by section 54;

(c) "affiliated persons" has the meaning assigned by section 251.1;

(d) "Amalco" means a company formed on the amalgamation of Newco and Target;

(e) "arm's length" has the meaning assigned by subsection 251(1);

(f) "Cansub" means XXXXXXXXXX;

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

(h) "CBCA" means the Canada Business Corporations Act;

(i) "CCRA" means the Canada Customs and Revenue Agency;

(j) "Closing Date" means the date on which the Share Acquisition will be completed and is expected to be XXXXXXXXXX business days following the satisfaction of any pre-closing conditions, but no later than XXXXXXXXXX;

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

(l) "Finco" refers to a third-party entity which is not related to either Pubco or Purchaser;

(m) "ineligible property" has the meaning assigned by subparagraphs 88(1)(c)(iii) to (vi);

(n) "LP" means XXXXXXXXXX;

(o) "Master Lease Agreement" means the agreement dated XXXXXXXXXX between Target and Xco;

(p) "Newco" means a company to be incorporated under the XXXXXXXXXX as a wholly-owned subsidiary of Purchaser;

(q) XXXXXXXXXX;

(r) "paid-up capital" has the meaning assigned by subsection 89(1);

(s) "Price Adjustments" are the adjustments to the purchase price of the Target shares sold to Purchaser and Target US shares sold to Purchaser US in paragraph 39 herein and have the meaning assigned by XXXXXXXXXX the Share Purchase Agreement;

(t) "principal amount" has the meaning assigned by subsection 248(1);

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

(v) "Proposed Transactions" means the transactions described in paragraphs 23 to 44 of this letter;

(w) "public corporation" has the meaning assigned by subsection 89(1);

(x) "Pubco" means XXXXXXXXXX;

(y) "Purchaser" means XXXXXXXXXX;

(z) "Purchaser US" means XXXXXXXXXX;

(aa) "related persons" has the meaning assigned by subsection 251(2);

(bb) "Xco" means XXXXXXXXXX;

(cc) "Share Purchase Agreement" means the agreement between Purchaser and XXXXXXXXXX Vendorco XXXXXXXXXX dated XXXXXXXXXX;

(dd) "specified shareholder" has the meaning assigned by subparagraph 88(1)(c.2)(iii);

(ee) "Subco1" means XXXXXXXXXX;

(ff) "Subco2" means XXXXXXXXXX;

(gg) "substituted property" has the meaning assigned by paragraph 88(1)(c.3);

(hh) "Target" means XXXXXXXXXX;

(ii) "Target US" means XXXXXXXXXX;

(jj) "taxable Canadian corporation" has the meaning assigned in subsection 89(1);

(kk) "UCC" means the expression "undepreciated capital cost" as defined in subsection 13(21);

(ll) "Vendorco" means XXXXXXXXXX; and

(mm) "Vendorco US" means XXXXXXXXXX.

FACTS

Description of the Parties

1. Purchaser was incorporated under the laws of XXXXXXXXXX and is a resident of Canada for purposes of the Act. Purchaser is an indirect wholly-owned subsidiary of XXXXXXXXXX, a corporation incorporated under the laws of XXXXXXXXXX. Purchaser's address is XXXXXXXXXX. Its business number is XXXXXXXXXX, it is serviced by the XXXXXXXXXX Tax Services Office and files its tax returns at the XXXXXXXXXX Taxation Centre.

2. Purchaser US is an indirect wholly-owned subsidiary of XXXXXXXXXX incorporated under the laws of XXXXXXXXXX and is a non-resident of Canada for purposes of the Act.

3. LP is a limited partnership established under the laws of XXXXXXXXXX. The limited partners are Subco1 (as to XXXXXXXXXX%) and XXXXXXXXXX (as to XXXXXXXXXX%). The business of the partnership is XXXXXXXXXX Target utilizes the services provided by LP.

4. Cansub is a wholly-owned subsidiary of Purchaser incorporated under the XXXXXXXXXX . Cansub is the primary operating subsidiary of Purchaser.

5. Pubco is a public corporation incorporated under the laws of XXXXXXXXXX and is a resident of Canada for purposes of the Act.

6. Vendorco is an indirect wholly-owned subsidiary of Pubco incorporated under the laws of XXXXXXXXXX and is a resident of Canada for purposes of the Act.

7. Subco1 is a wholly-owned subsidiary of Pubco incorporated under the laws of XXXXXXXXXX and is a resident of Canada for purposes of the Act.

8. Subco2 is a wholly-owned subsidiary of Pubco incorporated under the laws of XXXXXXXXXX and is a resident of Canada for purposes of the Act.

9. Target is a wholly-owned subsidiary of Vendorco incorporated under the XXXXXXXXXX and is a resident of Canada for purposes of the Act.

10. Vendorco US is an indirect wholly-owned subsidiary of Pubco incorporated under the laws of XXXXXXXXXX and is a non-resident of Canada for purposes of the Act.

11. Target US is a wholly-owned subsidiary of Vendorco US incorporated under the laws of XXXXXXXXXX and is a non-resident of Canada for purposes of the Act.

12. Newco is to be incorporated under the XXXXXXXXXX as a wholly-owned subsidiary of Purchaser.

13. Xco is a wholly-owned subsidiary of Target incorporated under the XXXXXXXXXX and is a resident of Canada for purposes of the Act. The shares of the capital stock of Xco owned by Target represent capital property to Target.

14. The issued shares of Pubco, as of XXXXXXXXXX , were as follows:

? XXXXXXXXXX common shares
? XXXXXXXXXX preferred shares

The common shares are publicly traded on XXXXXXXXXX.

15. It is believed that, as of XXXXXXXXXX largest holders of Pubco common shares were as follows:

XXXXXXXXXX.

Business Activities

16. Purchaser and its Canadian subsidiaries are involved in the XXXXXXXXXX business.

17. XXXXXXXXXX.

18. XXXXXXXXXX.

19. XXXXXXXXXX.

20. As of XXXXXXXXXX, Pubco and related companies owed in aggregate $XXXXXXXXXX to Target and prior to the Proposed Transactions, Pubco and related companies repaid these various promissory notes owing to Target. Target used these proceeds to make a non-interest-bearing demand loan of $XXXXXXXXXX to Pubco ("Pubco Note"). As of XXXXXXXXXX, Pubco and related companies owed in aggregate $XXXXXXXXXX to Xco documented by various promissory notes.

21. Xco owns XXXXXXXXXX preferred shares of Subco2 redeemable for $XXXXXXXXXX.

22. As of XXXXXXXXXX, Xco owed $XXXXXXXXXX to Target ("Xco Debt") and $XXXXXXXXXX to Pubco.

PROPOSED TRANSACTIONS

Pre-Closing Transactions ("Pubco Reorganization")

23. Target will transfer all of its XXXXXXXXXX ("XXXXXXXXXX Assets") to Xco in exchange for (a) the assumption by Xco of liabilities of Target related to these assets, if any, not exceeding the UCC of the assets transferred, and (b) the issuance of XXXXXXXXXX common shares of Xco. Xco and Target will jointly elect in prescribed form and within the time referred to in subsection 85(6) to have the provisions of subsection 85(1) apply to the transfer of any of the XXXXXXXXXX Assets that is an eligible property and that has a fair market value in excess of its cost amount. The agreed amount will be equal to the cost amount of the XXXXXXXXXX Assets transferred, consistent with the limitations set out in subsection 85(1). A GST election for nil consideration will be made by Target and Xco.

24. The Master Lease Agreement will be amended to reflect the terms to be agreed to by the Purchaser and Pubco prior to the Closing Date. The amendment will be set out as a schedule to the agreement respecting the transfer of the XXXXXXXXXX Assets.

25. Subco1 will transfer the "XXXXXXXXXX Assets" (which has the meaning assigned to that term by the Share Purchase Agreement) to Xco. The consideration for the XXXXXXXXXX Assets will be cash and the assumption of the obligations related to customer and third party contracts forming part of the XXXXXXXXXX Assets and the consideration for the associated goodwill will be the issuance of one preferred share. A joint election will be made and filed pursuant to section 22 of the Act. Subco1 and Xco will jointly elect in prescribed form and within the time referred to in subsection 85(6) to have the provisions of subsection 85(1) apply to the transfer of any of the goodwill. The agreed amount will be equal to the cost amount of the XXXXXXXXXX Assets transferred, consistent with the limitations set out in subsection 85(1).

26. Employees of Subco1 identified as being employees of the XXXXXXXXXX will be transferred to Target and a service contract entered into between Target and Xco with respect to the services of such Employees.

27. Pubco will repay in full the short-term promissory note it issued to Xco on XXXXXXXXXX. All accrued interest on the loan at the date of repayment will also be paid by Pubco to Xco. The promissory note issued by Pubco to Xco will be cancelled.

28. Pubco will make a partial repayment of $XXXXXXXXXX on the Pubco Note.

29. Target will make a contribution of capital to Xco in the amount of $XXXXXXXXXX.

30. Pubco will repay in full the outstanding $XXXXXXXXXX principal amount on the Pubco Note. The promissory note issued by Pubco to Target will be cancelled.

31. Xco will redeem its preferred share held by Subco1 at its redemption amount. All accrued dividends, if any, on the preferred share to the date of redemption will also be paid.

32. To the extent of safe income, Target will pay a dividend(s) or trigger a deemed dividend to Vendorco.

33. Target will complete a return of capital to Vendorco in such amount as Pubco may determine.

34. Subco2 will redeem its XXXXXXXXXX preferred shares held by Xco at their redemption amount. All accrued dividends on the preferred shares to the date of redemption will also be paid.

35. Xco will use the redemption proceeds of the XXXXXXXXXX preferred shares of Subco2 and accrued dividends thereon to repay in full to Pubco the outstanding principal amount in respect of its XXXXXXXXXX% loan from Pubco of XXXXXXXXXX and the outstanding principal amount in respect of its XXXXXXXXXX% loan from Pubco of XXXXXXXXXX. All accrued interest on the loans at the date of repayment will also be paid by Xco to Pubco. The promissory notes issued by Xco to Pubco will be cancelled.

36. Target will transfer the Excluded Assets (which has the meaning assigned to that term in the Share Purchase Agreement and includes XXXXXXXXXX) to Vendorco and Vendorco will assume any obligations of Target related to the Excluded Assets. This transfer of Excluded Assets net of related obligations will be effected by way of a dividend in kind having an estimated fair market value of $XXXXXXXXXX.

37. Employees of Subco1 providing XXXXXXXXXX services in support of Target and identified by and agreed to by Purchaser and Pubco as employees to be transferred to Target will be transferred to Target.

Acquisition of Target by Purchaser

38. Purchaser will raise $XXXXXXXXXX (the "Acquisition Debt") by borrowing money from both XXXXXXXXXX (or related corporations) and third-party financial institutions.

39. Purchaser will acquire, solely for cash consideration of $XXXXXXXXXX, all of the issued and outstanding shares of Target (the "Share Acquisition"), being XXXXXXXXXX common shares (the "Acquired Shares"), from Vendorco. Purchaser US will acquire, solely for cash consideration of $XXXXXXXXXX, all of the issued and outstanding shares of Target US from Vendorco US. The Share Purchase Agreement identifies a number of potential purchase Price Adjustments. A bid letter dated XXXXXXXXXX and an exclusivity letter dated XXXXXXXXXX have been executed confirming the parties' mutual understanding concerning the Share Acquisition.

40. The Share Acquisition will be subject to a number of pre-closing conditions, inter alia, the parties' obtaining, prior to the Closing Date, all required third-party consents to the transaction and making all necessary filings and obtaining all necessary consents or approvals under applicable antitrust legislation and applicable securities legislation. The Share Purchase Agreement was signed on XXXXXXXXXX. The Closing Date is expected to be in XXXXXXXXXX.

41. At the Closing Date, Target will enter into a Transitional Services Agreement (the "TS Agreement") with Pubco in respect of future services to be provided by each company and its affiliates. The services to be provided deal with various XXXXXXXXXX services. The fees for such services are to be set at a reasonable, negotiated amount as set out in the TS Agreement. The TS Agreement is attached as a schedule to the Share Purchase Agreement.

The transitional services are to be provided for a term commencing on the Closing Date and ending at the end of the transition period. A specific transition period is provided for each type of service in the TS Agreement.

Target will enter in a new agreement with LP (the "LP Agreement") in connection with XXXXXXXXXX. The terms of the LP Agreement are currently under negotiation. The LP Agreement will be a schedule attached to the Share Purchase Agreement.

Amalgamation of Newco and Target

42. Newco will be incorporated under the XXXXXXXXXX as a wholly-owned subsidiary of Purchaser.

43. Immediately following the Share Acquisition on the Closing Date, Purchaser will sell the Acquired Shares to Newco. The consideration will consist of an interest-bearing demand promissory note ("Newco Note") having a principal amount of $XXXXXXXXXX and Newco common shares. Purchaser and Newco will jointly elect in prescribed form and within the time referred to in subsection 85(6) to have the provisions of subsection 85(1) apply to the transfer of the Acquired Shares. The agreed amount will be determined within the limitations set out in subsection 85(1). The interest rate on the Newco Note will exceed the interest rate on the Acquisition Debt.

44. Immediately thereafter, also on the Closing Date, Newco and Target will amalgamate, pursuant to Articles of Amalgamation filed under the XXXXXXXXXX, to form "Amalco". By virtue of the amalgamation, all of the property and liabilities of Newco and Target will become property and liabilities of Amalco. Purchaser will receive shares of Amalco in exchange for its Newco shares. The Target shares held by Newco will be cancelled.

ADDITIONAL INFORMATION

45. Amalco intends to sell, for cash consideration, all of the issued shares of Xco (the "Xco Shares") and the Xco Debt to Finco. Amalco has not entered into a letter of intent or other agreement with Finco. Accordingly, no party, including Finco will have any absolute or contingent right, either immediately or in future, to acquire the Xco Shares on or before the Closing Date. Finco will therefore not be related to Target at any time prior to the Share Acquisition. XXXXXXXXXX.

46. Amalco will distribute cash proceeds received from the sale of the Xco Shares and Xco Debt to Purchaser by way of a reduction in intercompany debt.

47. Purchaser will reduce its Acquisition Debt by the amount of the debt repayment received from Amalco.

48. XXXXXXXXXX.

49. Amalco has no plans to dispose of any property acquired from Target, as a result of the amalgamation, or any substituted property to Pubco, any company related to Pubco or any direct or indirect shareholder of Pubco.

PURPOSE OF THE PROPOSED TRANSACTIONS

Purchaser, through its subsidiary Cansub and its other Canadian subsidiaries, has developed a business plan to expand its XXXXXXXXXX business in XXXXXXXXXX. The acquisition of Target provides Purchaser with an established, well-known business in the XXXXXXXXXX marketplace.

The Proposed Transactions allow Purchaser to dispose of XXXXXXXXXX assets of Target. XXXXXXXXXX By disposing of such assets to Finco, Purchaser is able to reduce its overall investment cost. The purposes of the amalgamation of Newco and Target are to allow Amalco to take advantage of the cost base "bump" provided for in paragraph 88(1)(d) and to allow for the future deduction of interest on Newco's debt from the income earned by Target.

RULINGS REQUESTED AND GIVEN

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

A. Provided that no property acquired by Amalco on the vertical amalgamation of Target and Newco or "any other property acquired by any person in substitution therefor" (within the meaning of that phrase for the purposes of clause 88(1)(c)(vi)(B)) is acquired by any person described in any of subclauses 88(1)(c)(vi)(B)(I), (II) or (III) (on the assumption that the "subsidiary" referred to in those subclauses is Target and the "parent" is Newco or Amalco, as the context requires) as part of the series of transactions or events that includes the acquisition of control of Target by Purchaser and the amalgamation of Target and Newco, pursuant to paragraphs 88(1)(c) and (d) of the Act, the cost to Amalco of the Xco Shares to Amalco, will be deemed to be the amount deemed by paragraph 88(1)(a) of the Act to be the proceeds of disposition of the Xco Shares to Target, plus, subject to the provisions of subparagraphs 88(1)(d)(ii) and (iii) of the Act, such portion of the amount, if any, by which

(a) the aggregate of the adjusted cost base to Newco of its shares of Target immediately before the amalgamation of Target and Newco,

exceeds

(b) the aggregate of the amounts determined under subparagraphs 88(1)(d)(i) and (i.1) of the Act,

as is designated by Amalco in respect of the Xco Shares in its first return of income under Part I of the Act for its first taxation year.

For greater certainty, the acquisitions of property described in the Proposed Transactions will not, in and of themselves, cause any property to be ineligible property.

B. The provisions of subsection 69(11) will not deem the proceeds of disposition on the pre-closing transfer of XXXXXXXXXX Assets from Target to Xco to be fair market value.

C. The Provisions of subsection 69(11) will not deem a disposition of the property acquired by Amalco on the amalgamation of Newco and Target for proceeds of disposition equal to fair market value of such property.

D. Provided that the property of Target acquired by Amalco on the amalgamation of Newco and Target or any property substituted therefor, is used and continues to be used thereafter by Amalco for the purpose of gaining or producing income, other than exempt income, from property or from a business and the property or property substituted therefor is not an interest in a life insurance policy, Amalco will be entitled, pursuant to subparagraph 20(1)(c)(ii), to deduct in computing its income for a taxation year from business or property the amount paid in the year or payable in respect of the year (depending on the method regularly followed by Amalco in computing its income) as interest on the Newco Note to the extent that the amount paid or payable is reasonable and is paid pursuant to a legal obligation to pay interest.

E. The Provisions of subsection 245(2) will not be applied as a result of the Proposed Transactions, in and of themselves, to redetermine the tax consequences described herein.

OTHER COMMENTS

Nothing in this ruling should be construed as implying that Canada Customs and Revenue Agency is making a determination or ruling in respect of:

(a) the cost or fair market value of any particular asset;

(b) the paid-up capital of any shares referred to herein; or

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

In particular we make no comment on the determination of safe income in paragraph 32 or the tax consequences relating to the Pubco Reorganization transactions in paragraphs 23 to 37.

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

Yours truly,

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