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.
Principal Issues: Whether 80(2)(g) applies
Position: Yes
Reasons:
No evidence supports a position that the Canco shares issued to Parentco were paid for other than by a forgiveness of debt owed to Parentco by Canco.
September 25, 2003
TORONTO WEST TSO HEADQUARTERS
Basic Files 1262-442-1-3 Corporate Financing
Section
Attention: D. Griffith Denise Dalphy, LL.B.
(613) 941-1722
2003-002235
Forgiveness of Debt
XXXXXXXXXX
This is in response to your memorandum dated May 30, 2003 wherein you enquired whether paragraph 80(2)(g) of the Income Tax Act (the "Act") would apply to the situation described below.
Facts
Our understanding of the facts is as follows:
1. On XXXXXXXXXX ("Parentco"), a US corporation, subscribed for XXXXXXXXXX Class A Special shares (issued from treasury) of XXXXXXXXXX ("Canco"), its Canadian subsidiary corporation, in consideration for the cancellation of $XXXXXXXXXX of indebtedness of Canco to Parent.
2. On XXXXXXXXXX, Parentco subscribed for XXXXXXXXXX new Class B Special shares (issued from treasury) of Canco. The agreement provided "1. XXXXXXXXXX".
3. On XXXXXXXXXX, a demand promissory note in the amount of $XXXXXXXXXX was issued by Canco to Parentco. The Resolution of the Directors stated
"XXXXXXXXXX ..."
4. On XXXXXXXXXX Resolutions of Shareholder of Canco dispensed with the appointment of auditors, pursuant to subsection 163(1) of the Canada Business Corporation Act, for Canco's financial years ended XXXXXXXXXX to an including XXXXXXXXXX.
5. On XXXXXXXXXX, Parentco subscribed for XXXXXXXXXX Class B Special shares (issued from treasury) of Canco for the aggregate price of "$XXXXXXXXXX in full payment of the subscription price".
6. On XXXXXXXXXX, Canco agreed to purchase all of the assets owned by XXXXXXXXXX for a price of approximately $XXXXXXXXXX.
7. On XXXXXXXXXX, Parentco subscribed for XXXXXXXXXX Class B Special shares of Canco (issued from treasury) for the aggregate price of "$XXXXXXXXXX in full payment of the subscription price".
8. On XXXXXXXXXX Canco issued an interest bearing promissory note in favour of Parentco in the principal amount of US $XXXXXXXXXX.
9. On XXXXXXXXXX, pursuant to a "Resolution of Directors" of Canco, the Class B special shares was increased by XXXXXXXXXX Class B special shares (for a total allocation of XXXXXXXXXX Class B special shares of Canco to Parentco. The "Resolution of Directors" provided:
" XXXXXXXXXX ....."
10. Ms Bette Anne Spears, of the CCRA's Regional Valuation Unit in Kitchener, advised that, using the adjusted equity approach, the fair market value of each Class B Special share is $XXXXXXXXXX, and that an earnings approach would result in a nominal value for the Class B Special shares.
11. The XXXXXXXXXX Balance Sheet of Canco shows amounts due to Shareholder as $XXXXXXXXXX.
The XXXXXXXXXX Balance Sheet of Canco shows amounts due to Shareholder as $XXXXXXXXXX.
The XXXXXXXXXX Balance Sheet of Canco shows amounts due to Shareholder as $XXXXXXXXXX.
12. The XXXXXXXXXX Balance Sheet of Canco shows amounts due to Shareholder as $XXXXXXXXXX.
13. The XXXXXXXXXX Balance Sheet of Canco shows amounts due to Shareholder as $XXXXXXXXXX.
14. The General Ledger for Canco for the Period Ending XXXXXXXXXX shows as Debits inter-company Balances to Parentco of $XXXXXXXXXX and $XXXXXXXXXX.
The General Ledger for Canco for the Period Ending XXXXXXXXXX shows as a Credit, $XXXXXXXXXX as a "XXXXXXXXXX".
15. An e-mail from Canco stated: "XXXXXXXXXX.
Canco was incorporated under the Canada Business Corporations Act (the "CBCA"), R.S.C. 1985, c. C-44, as amended.
Subsection 25 of the CBCA provides that a share cannot be issued until it has been paid for:
"25. (1) Issue of shares - Subject to the articles, the by-laws and any unanimous shareholder agreement and to section 28, shares may be issued at such times and to such persons and for such consideration as the directors may determine.
(2) Shares non-assessable - Shares issued by a corporation are non-assessable and the holders are not liable to the corporation or to its creditors in respect thereof.
(3) Consideration - A share shall not be issued until the consideration for the share is fully paid in money or in property or past services that are not less in value than the fair equivalent of the money that the corporation would have received if the share had been issued for money.
(4) Consideration other than money - In determining whether property or past services are the fair equivalent of a money consideration, the directors may take into account reasonable charges and expenses of organization and reorganization and payments for property and past services reasonably expected to benefit the corporation.
(5) Definition of "property" - For the purposes of this section, "property" does not include a promissory note or a promise to pay, that is made by a person to whom a share is issued, or a person who does not deal at arm's length, within the meaning of that expression in the Income Tax Act, with a person to whom a share is issued."
There is no indication in the evidence that we have seen that Parentco paid for the shares of Canco other than by a forgiveness of the debt owed to Parentco by Canco. While we agree that if Parentco paid cash for the Canco shares, and then Canco used this money to repay its indebtedness to Canco, paragraph 80(2)(g) of the Act would not apply, it would seem in this case that one transaction (shares paid for by debt forgiveness) was effected and not two transactions (shares paid for in cash, then the cash used to repay debt). However, even if the evidence that you may discover supports two separate transactions, it is our position that the general anti-avoidance rule could be considered to challenge the transactions in this situation.
As you pointed out in your analysis of this issue, in 1995, in #9518785, we were asked for a technical interpretation in a "hypothetical" situation where a Canadian corporation ("Canco") is indebted to its U.S. parent ("Parentco") and, to avoid the application of paragraph 80(1)(g) of the Act, the Canco proposed to carry out two courses of action which result in either the parent of Parentco or a subsidiary of Parentco subscribing for shares in Canco. Canco would then use the funds received on the issuance of its shares to repay part of its debt to Parentco. We opined that subsection 245(2) of the Act (the general anti-avoidance rule" "GAAR") would be applied to deny the tax benefit and to treat the settlement of the debt.
While in 2002-0141005, we stated:
"Your concern regarding the potential application of the GAAR relates to a previous technical interpretation (No. 9518785) that described a situation whereby a subsidiary corporation ("subco") was indebted to its parent ("parentco"). To avoid the application of Section 80, parentco or a subsidiary of parentco would subscribe for shares in subco, who would use the funds to repay the debt owing. The technical interpretation concluded by stating that the transaction described therein would be an avoidance transaction and subsection 245(2) would apply. As stated earlier, it is the CCRA's practice to comment on the application of subsection 245(2) only after reviewing all the facts and circumstances of a transaction in the context of an advance tax ruling and that technical interpretations should not be provided in respect of the GAAR. Accordingly we wish to inform you that technical interpretation 9518785 will be withdrawn."
The above technical interpretation did not mean that GAAR would not be applied in such a situation; it simply meant that the application of GAAR cannot be determined unless it is the context of an advance income tax ruling where all of the relevant facts and evidence can be examined. In fact, the law firm that submitted the request that was the subject of 2002-0141005 subsequently submitted an advance income tax ruling request 2002-017008. It was determined by the GAAR Committee that GAAR would be applied. At the same time, the GAAR Committee considered a similar request (2002-17627) concerning proposed transactions submitted by XXXXXXXXXX. Because the GAAR Committee's opinion was unfavourable, they also withdrew their request.
In summary, it would appear that paragraph 80(2)(g) of the Act would apply on the issuances of Class A and Class B Special shares by Canco, and, in the alternative, arguments to apply GAAR could be developed to afford the result that would have occurred if paragraph 80(2)(g) of the Act had applied. You may wish to consult tax avoidance in this regard.
We hope this opinion will be of assistance. We would like to thank you for the analysis and documentation that you provided to us. It was particularly helpful.
For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the CCRA's electronic library. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, they can be provided with the electronic library version, or they may request a copy severed using the Privacy Act criteria, which does not remove client identity. You should make requests for this latter version to Mrs. Jackie Page at (819) 994-2898. A copy will be sent to you for delivery to the client.
Steve Tevlin
Manager
Corporate Financing Section
Financial Industries Division
Income Tax Rulings Directorate
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