2002 Ruling 2002-0163903 - Reorganization of Capital

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:

Whether subsection 86(1) applies to the proposed transactions?

Whether the proposed transactions result in the application of subsection 15(1)?

Position:

Yes.

No.

Reasons:

The proposed transactions result in a reorganization of capital.

Paragraph 15(1)(a) precludes the applicability of subsection 15(1).

XXXXXXXXXX 2002-016390

XXXXXXXXXX, 2002

Dear XXXXXXXXXX:

Re: XXXXXXXXXX ("ACO")
XXXXXXXXXX. ("BCO")
XXXXXXXXXX ("NRCO")
XXXXXXXXXX ("FCO")

This is in reply to your letter of XXXXXXXXXX, and your E-mails of XXXXXXXXXX, wherein you requested an advance income tax ruling on behalf of the above-noted taxpayers.

To the best of your knowledge, none of the issues involved in this ruling:

(i) is in an earlier return;

(ii) is being considered by a tax services office or taxation centre in connection with a previously filed tax return;

(iii) is under objection;

(iv) is before the courts; or

(v) is the subject of a previously issued ruling.

DEFINITIONS

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

"Act" means the Income Tax Act, R.S.C. 1985 (5th Supp.) c.1, as amended to the date hereof, and unless otherwise stated, all references to a statute are to the Act;

"adjusted cost base" has the meaning assigned by section 54;

"arm's length" has the meaning assigned by section 251;

"Company Act" means the Company Act, (XXXXXXXXXX);

"capital property" has the meaning assigned by section 54;

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

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

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

"Proposed Transactions" means the proposed transactions described in paragraphs 12 through 16 below;

"related persons" has the meaning assigned by subsection 251(1); and

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

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

FACTS

1. ACO is a taxable Canadian corporation incorporated under the Company Act.

2. ACO has a XXXXXXXXXX% interest as a joint venturer in the XXXXXXXXXX and is the XXXXXXXXXX% owner of the XXXXXXXXXX The other joint venturer in the XXXXXXXXXX, a taxable Canadian corporation which deals at arm's length with ACO.

3. ACO's authorized capital consists of:

- XXXXXXXXXX voting participating common shares with a par value of $XXXXXXXXXX each;
- XXXXXXXXXX non-voting Class A redeemable, retractable preferred shares with a par value of $XXXXXXXXXX each;
- XXXXXXXXXX non-voting Class B redeemable, retractable preferred shares with a par value of $XXXXXXXXXX each; and
- XXXXXXXXXX non-voting Class C preferred shares with a par value of $XXXXXXXXXX each.

ACO's articles (the "Articles") provide that no dividends can be paid on the common shares if the payment of such dividends would reduce ACO's net assets below $XXXXXXXXXX (plus the total redemption amount of ACO's issued Class C preferred shares. However, there are currently no Class C preferred shares outstanding).

The common, Class A and Class B preferred shares of ACO are entitled to such discretionary dividends as the directors may declare, subject to the above restriction on the payment of dividends on the common shares and subject to a restriction that the Class A and B preferred shares are entitled to equal dividends.

On a liquidation or windup, the Class A and B preferred shareholders of ACO have a priority to receive their redemption amount plus declared but unpaid dividends. The common shareholders of ACO will receive the balance.

4. BCO is a taxable Canadian corporation that was incorporated under the Company Act. BCO periodically purchases XXXXXXXXXX from arm's length purchasers for export to XXXXXXXXXX . BCO also purchases XXXXXXXXXX from arm's length purchasers for sale to FCO.

5. BCO owns XXXXXXXXXX non-voting Class A preferred shares of ACO. This represents all of ACO's issued and outstanding Class A preferred shares (the "ACO Class A Preferred shares"). The ACO Class A Preferred shares are redeemable and retractable for $XXXXXXXXXX per share. BCO's adjusted cost base of the ACO Class A Preferred shares is nominal. BCO holds the ACO Class A Preferred shares as capital property.

6. XXXXXXXXXX ("CCO") is a taxable Canadian corporation which was incorporated under the Company Act. CCO owns all the issued and outstanding common shares of BCO.

7. NRCO and FCO are both corporations that are resident in XXXXXXXXXX . Each of NRCO and FCO owns XXXXXXXXXX common shares of ACO.

8. FCO owns all the issued and outstanding shares of CCO.

9. NRCO owns XXXXXXXXXX non-voting Class B preferred shares of ACO. This represents all of ACO's issued and outstanding Class B preferred shares (the "ACO Class B Preferred shares"). The ACO Class B Preferred shares are redeemable and retractable for $XXXXXXXXXX per share. NRCO's adjusted cost base of the ACO Class B Preferred shares is $XXXXXXXXXX per share. NRCO holds the ACO Class B Preferred shares as capital property.

10. NRCO deals at arm's length with BCO and FCO and each of these companies deals at arm's length with ACO.

11. Under revised Generally Accepted Accounting Principles ("GAAP") reporting pursuant to the CICA Handbook, if the retraction right is in place on the ACO Class B Preferred shares on XXXXXXXXXX, the retraction amount of these shares will have to be shown as a liability on ACO's financial statements.

An exception to the new GAAP reporting rules will exempt the ACO Class A Preferred shares from having to be shown as a liability.

PROPOSED TRANSACTIONS

12. ACO will pass special resolutions to amend its Articles in order to:

- authorize XXXXXXXXXX new Class A common shares and XXXXXXXXXX new Class B common shares;

- rename the existing common shares as Class C common shares; and

- delete those provisions of the Articles providing for the retractability of the ACO Class A Preferred shares and the ACO Class B Preferred shares and add a right to convert the ACO Class A Preferred shares to newly authorized Class A common shares and to convert the ACO Class B Preferred shares to newly authorized Class B common shares, such that the newly authorized Class A and Class B common shares will have a fair market value equal to the lesser of $XXXXXXXXXX and XXXXXXXXXX% of the fair market value of all of ACO's issued shares after conversion.

13. NRCO and FCO will consent in writing to these resolutions.

14. BCO will consent in writing via a separate resolution of the Class A Preferred shareholders.

15. NRCO will consent in writing via a separate resolution of the Class B Preferred shareholders.

16. A certified copy of the special resolutions will be filed in the XXXXXXXXXX.

There will be no alteration in ACO's register of members or share certificates; i.e. BCO and NRCO will continue to hold the same share certificates after the completion of the Proposed Transactions.

ADDITIONAL INFORMATION

FCO does not have any current intention to dispose of the shares of CCO.

PURPOSE OF THE PROPOSED TRANSACTIONS

If the retraction rights are not removed before XXXXXXXXXX, new GAAP reporting rules will require ACO to show the retraction amount of the ACO Class B Preferred shares as a long-term liability on its balance sheet. ACO's accountants have projected that this will produce a balance sheet deficit, which will result in negative consequences for ACO.

This will adversely affect ACO's ability to borrow as well as the interest rate at which it can borrow and it may precipitate demands for repayment of existing loans.

RULINGS

Provided that the above statements constitute a complete and accurate disclosure of all the relevant facts, purposes of the proposed transactions and proposed transactions, we rule as follows:

A. Provided that BCO holds the ACO Class A Preferred shares as capital property and provided that NRCO holds the ACO Class B Preferred shares as capital property, subsection 86(1) will apply, and subsection 86(2) will not apply, to the reorganization of the capital of ACO as described in paragraph 12 above such that:

(i) the adjusted cost base to BCO of the ACO Class A Preferred shares will be unaffected by the Proposed Transactions;

(ii) the adjusted cost base to NRCO of the ACO Class B Preferred shares will be unaffected by the Proposed Transactions;

(iii) the PUC of the ACO Class A Preferred shares will be unaffected by the Proposed Transactions; and

(iv) the PUC of the ACO Class B Preferred shares will be unaffected by the Proposed Transactions.

B. No dividend will be deemed to arise pursuant to subsection 84(1) or (3) with respect to the reorganization of capital described in paragraph 12 above.

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

D. As a result of the proposed transactions, in and by themselves, subsection 245(2) will not be applied to redetermine the tax consequences confirmed in the rulings given.

These rulings are given subject to the limitations and qualifications set forth in Information Circular 70-6R5 issued on May 17, 2002, and are binding on the Canada Customs and Revenue Agency provided that the proposed transactions are completed before XXXXXXXXXX.

The above rulings are based on the Act in its present form 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

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 adjusted cost base, PUC or fair market value of any shares referred to herein; or

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

Yours truly,

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