2002 Ruling 2002-0126853 - PATRONAGE DIVIDENDS

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:

1. Whether a corporation is entitled to claim a deduction for patronage dividends under subsection 135(1).

2. Will the corporation be considered to have made payment when the patronage dividends are set-off against the customers' advance accounts?

Position:

1. Yes, subject to the limitation in subsection 135(2) and provided the requirements of section 135 are otherwise met.

2. Yes, the customers have authorized in writing the set-off.

Reasons:

1. Based on the information provided.

2. See definition of "payment" in subsection 135(4) and paragraph 10(b) of IT-362R.

XXXXXXXXXX 							2002-012685

XXXXXXXXXX , 2002

Dear XXXXXXXXXX:

Re: Advance Income Tax Ruling
XXXXXXXXXX

This is in reply to your letter of XXXXXXXXXX in which you requested an advance income tax ruling on behalf of the above-noted taxpayer. We also acknowledge additional information provided in your letters of XXXXXXXXXX.

You advise that to the best of your knowledge and that of the taxpayer referred to above, none of the issues involved in the ruling request is:

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

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

iii. under objection by the taxpayer or a related person;

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

v. the subject of a previous ruling issued by the Directorate.

In this letter, unless otherwise indicated, all statutory references are to the provisions of the Income Tax Act, R.S.C. 1985, 5th Supplement, c.1, as amended, (the "Act"), and all the following terms have the meanings specified:

a) "ACO" means XXXXXXXXXX,

b) "BCO" means XXXXXXXXXX,

c) "CCO" means XXXXXXXXXX,

d) "DCO" means XXXXXXXXXX, and

e) "CCRA" means Canada Customs and Revenue Agency.

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

FACTS

1. ACO is a corporation incorporated under the Business Corporation Act (XXXXXXXXXX) by Articles of Incorporation dated XXXXXXXXXX and is a taxable Canadian corporation within the meaning of 89(1). It is authorized to issue an unlimited number of common shares but you advise that no shares have been issued.

2. ACO has not yet established its fiscal year-end. Its office is located in XXXXXXXXXX. Its tax services office is the XXXXXXXXXX TSO and its taxation centre is the XXXXXXXXXX Tax Centre.

3. BCO is a taxable Canadian corporation and a public corporation within the meaning of subsection 89(1). BCO directly and through controlled direct and indirect subsidiaries carries on business in Canada as a XXXXXXXXXX.

4. DCO is a taxable Canadian corporation within the meaning of subsection 89(1). DCO is a wholly-owned indirect subsidiary of XXXXXXXXXX whose shares are listed on the XXXXXXXXXX Stock Exchange. DCO and its wholly-owned direct and indirect Canadian subsidiaries (collectively called the "DCO Group") carry on XXXXXXXXXX businesses in Canada.

5. BCO and DCO deal with each other at arm's length within the meaning of subsection 251(1).

6. XXXXXXXXXX.

7. CCO is a taxable Canadian corporation within the meaning of subsection 89(1). CCO directly and indirectly through subsidiary corporations also carries on business in Canada as a XXXXXXXXXX. CCO is entitled to XXXXXXXXXX from XXXXXXXXXX derived from business with CCO's XXXXXXXXXX in accordance with the terms of the typical CCO XXXXXXXXXX agreement.

8. BCO is the controlling shareholder of CCO.

PROPOSED TRANSACTIONS

9. ACO's articles of incorporation will be amended to change the designation of the common shares to Class A Voting Common Shares ("Class A Voting shares") and to create an unlimited number of Class B Voting Common Shares ("Class B Voting shares"), an unlimited number of Class 1 Equity Non-Voting Shares ("Class 1 Equity shares"), and an unlimited number of Class 2 Equity Non-Voting Shares ("Class 2 Equity shares").

10. Each of BCO and CCO will hold one Class A Voting share of ACO. The holder of each Class A Voting share will be entitled to that number of votes equal to XXXXXXXXXX divided by the number of Class A Voting shares issued and outstanding from time to time. The Class A Voting shares will be held in a voting trust of which BCO will be the trustee and will be authorized to vote the shares on behalf of the Class A Voting shareholders. The Class A Voting shares in aggregate will represent XXXXXXXXXX votes. The Class A Voting shares will have a fixed value of $XXXXXXXXXX and will be non-participating.

11. Each of the XXXXXXXXXX corporations comprising the DCO Group will hold one Class B Voting share of ACO. The holder of each Class B Voting share will be entitled to that number of votes equal to XXXXXXXXXX divided by the number of Class B Voting shares issued and outstanding from time to time. The Class B Voting shares will be held in a voting trust of which DCO will be the trustee and will be authorized to vote the shares on behalf of the Class B Voting shareholders. The Class B Voting shares in aggregate will represent XXXXXXXXXX votes. The Class B Voting shares will have a fixed value of $XXXXXXXXXX and will be non-participating.

12. In addition to the one Class A Voting share, BCO will also hold one Class 1 Equity share of ACO. Under the terms and conditions of the Class 1 Equity shares, BCO will be entitled to receive dividends at the discretion of the directors to the exclusion of the holders of any other class of shares. The directors' discretion will be subject to the terms of the Shareholders' Agreement which provide for the payment of dividends on the Class 1 Equity shares calculated based on the volume of business conducted by ACO with BCO's XXXXXXXXXX.

13. In addition to the one Class A Voting share, CCO will also hold one Class 2 Equity share of ACO. Under the terms and conditions of the Class 2 Equity shares, CCO will be entitled to receive dividends at the discretion of the directors to the exclusion of the holders of any other class of shares. The directors' discretion will be subject to the terms of the Shareholders' Agreement which provide for the payment of dividends on the Class 2 Equity shares calculated based on the volume of business conducted by ACO with CCO's XXXXXXXXXX.

14. BCO's XXXXXXXXXX and CCO's XXXXXXXXXX will not hold any shares of ACO.

15. In compliance with the Price Discrimination Enforcement Guidelines under the Competition Act (Canada) relating to buying groups, ACO will purchase and acquire title to XXXXXXXXXX products, including XXXXXXXXXX (the "Products") and will be liable as principal and responsible to various suppliers ("Suppliers") for payment of the price of Products acquired. ACO will XXXXXXXXXX. ACO's customers will be BCO and BCO's XXXXXXXXXX, CCO and CCO's XXXXXXXXXX, and the DCO Group.

16. XXXXXXXXXX.

17. ACO's revenue will consist of:

a) revenue from the sales of Products to its customers,

b) membership fees, and

c) rebates, allowances or similar cash amounts paid to it by its Suppliers in accordance with the various supply arrangements and the volume of Products purchased by ACO from each Supplier ("rebate revenue").

18. ACO will enter into a Services Agreement with BCO pursuant to which BCO will provide comprehensive management and administrative services relating to ACO's operation in exchange for a service fee in the amount of approximately $XXXXXXXXXX per annum. The service fee is intended to cover ACO's operating costs with the exception of head office costs such as annual audit and legal fees and bad debts.

19. Under the terms of the XXXXXXXXXX Agreements between ACO and each of DCO and BCO, DCO (on behalf of itself and the other members of the DCO Group) and BCO (on behalf of itself and CCO) will agree to pay to ACO an annual membership fee. Subject to adjustments as contemplated in the Agreements, DCO will pay a membership fee in the amount of $XXXXXXXXXX plus XXXXXXXXXX % of audit and legal fees, and BCO will pay a membership fee in the amount of $XXXXXXXXXX plus XXXXXXXXXX% of audit and legal fees.

20. In circumstances where a customer of ACO fails to pay a Supplier on ACO's behalf for the price of Products as required, ACO will be required to pay the Supplier directly and will incur a bad debt if the amount is not ultimately recovered from the customer. Such bad debts will be funded through additional membership fees from DCO or BCO, as the case may be, depending on whether the defaulting customer is a member of the DCO Group or is an affiliate, XXXXXXXXXX or affiliate XXXXXXXXXX of BCO. In aggregate, membership fees to be paid to ACO will approximate ACO's operating costs including bad debts.

21. Under the terms of the Shareholders' Agreement, ACO will distribute as patronage dividends its rebate revenue for each year to its voting shareholders pro rata strictly in accordance with the sales volumes for each Product sold to each voting shareholder. Each voting shareholder's rebate entitlement is hereinafter referred to as the "Voting Shareholder Entitlement".

22. In addition to the patronage dividends, BCO and CCO may receive taxable dividends on their equity shares. As noted in 12 and 13 above, the taxable dividends will be calculated as provided for in the terms of the Shareholders' Agreement. In particular, such dividends will be calculated by reference to ACO's rebate revenue with respect to the purchases by each shareholder's XXXXXXXXXX and any income tax payable by ACO on the rebate revenue. The amount of the dividend in respect of each shareholder is hereinafter referred to as the "Equity Shareholder Entitlement".

23. As contemplated in the Shareholders' Agreement, ACO will make advances to the shareholders after the end of each of the XXXXXXXXXX fiscal periods in each year on account of and in an amount based on ACO's estimate of the Voting Shareholder Entitlement and Equity Shareholder Entitlement for each shareholder. Within XXXXXXXXXX days of the end of each fiscal year, ACO will calculate each Voting Shareholder Entitlement and Equity Shareholder Entitlement for the particular fiscal year and on or before the date that is XXXXXXXXXX days following the end of the particular fiscal year will pay such Entitlement to each shareholder as a patronage dividend or as a taxable dividend, as the case may be and as more particularly described in 24 and 25 below, and will set-off the amount of such Entitlement against advances made to each shareholder during the fiscal year.

24. On or before the date that is XXXXXXXXXX days following the end of the particular fiscal year, each of the holders of voting shares, including each of the DCO Group corporations, BCO, but only insofar as its Voting Shareholder Entitlement is concerned, and CCO, but only insofar as its Voting Shareholder Entitlement is concerned (collectively referred to as the "Voting Shareholders"), will be paid their respective Voting Shareholder Entitlement as a patronage dividend. To effect payment of each patronage dividend, the directors will declare the patronage dividend to be paid to the particular Voting Shareholder, and the advance account of the particular Voting Shareholder will be reduced as follows:

a) Firstly, the particular Voting Shareholder will be required to repay to ACO an amount equal to 15% of the patronage dividend (the "Withheld Amount") which amount will be forthwith remitted by ACO on behalf of the Voting Shareholder to the Receiver General as required pursuant to subsection 135(3), and the Withheld Amount will be deducted from the Voting Shareholder's advance account.

b) Secondly, the remaining 85% of the patronage dividend will be paid to the Voting Shareholder by way of set-off against its advance account.

All adjustments to advance accounts will be made on or before the date that is XXXXXXXXXX days following the end of the particular fiscal year.

25. Each of the holders of equity shares, including BCO, but only as to its Equity Shareholder Entitlement, and CCO, but only as to its Equity Shareholder Entitlement, will be paid their respective Equity Shareholder Entitlements by way of set-off against their shareholder advance accounts. ACO will pay the Equity Shareholder Entitlement to the Equity Shareholders as an ordinary taxable dividend on or before the date that is XXXXXXXXXX days following the end of the particular fiscal year.

PURPOSE OF THE PROPOSED TRANSACTIONS

26. The purpose for the establishment of ACO is to consolidate the purchasing power of ACO's members XXXXXXXXXX.

RULINGS GIVEN

Provided that the preceding statements constitute a complete and accurate disclosure of all the proposed transactions, and purpose of the proposed transactions, and provided further that the proposed transactions are carried out as described above, we confirm that:

A. At the time the Voting Shareholder advance accounts are adjusted to effect a set-off of the patronage dividends against the Voting Shareholder advances as described in 24 above, ACO will be considered to have made payment to the Voting Shareholders within the meaning of paragraph (b) of the definition of "payment" in subsection 135(4).

B. Provided that for a particular taxation year ACO held out the prospect that amounts would be credited to the Voting Shareholders in accordance with subsection 135(5), ACO will be entitled to deduct pursuant to paragraph 20(1)(u) and subsection 135(1), subject to the limitation in subsection 135(2), in computing its income for the year patronage dividends paid by ACO within the year or within 12 months thereafter to the Voting Shareholders as described in 24 above and such patronage dividends will be included in computing the income of the Voting Shareholders for the taxation year in which such amounts are paid pursuant to subsection 135(7).

These rulings are given subject to the limitations and qualifications set out in Information Circular 70-6R4, issued by the CCRA on January 29, 2001, and are binding provided that the proposed transactions are completed by XXXXXXXXXX with respect to patronage dividends declared and paid in respect of ACO's 2003 taxation year.

Yours truly,

XXXXXXXXXX

Manager
Financial Institutions Team
Financial Industries Division
Income Tax Rulings Directorate
Policy and Legislation Branch