2003 Ruling 2003-0029633 - Arm's Length Sale of Shares

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 a husband and wife are dealing at arm's length with a purchaser corporation that buys the shares of their wholly-owned corporation.

Position: Yes.

Reasons: Finding is dependent on the specific facts.

XXXXXXXXXX 2003-002963

XXXXXXXXXX, 2003

Dear XXXXXXXXXX:

Re: XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
Advance Income Tax Ruling

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 letters of XXXXXXXXXX, your facsimiles as well as the information provided in various telephone conversations.

Throughout this letter, the individual and corporate taxpayers will be referred to as follows:

      XXXXXXXXXX  R
      XXXXXXXXXX  S
      XXXXXXXXXX  D
      XXXXXXXXXX  E
      XXXXXXXXXX  F
      XXXXXXXXXX .      Numco
      XXXXXXXXXX .      Buyerco
      XXXXXXXXXX .      Opco
      XXXXXXXXXX  Investco
      XXXXXXXXXX .      Aco

R and S file their individual income tax returns at the XXXXXXXXXX Taxation Centre and their tax affairs are administered by the XXXXXXXXXX Tax Services Office. R and S are resident in Canada for the purposes of the Act.

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

(i) in an earlier return of R or S or a related person;

(ii) being considered by a tax services office or taxation centre in connection with a previously filed tax return of R or S or a related person;

(iii) under objection by R or S or a related person;

(iv) before the courts; or

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

R and S have confirmed that the proposed transactions described herein will not affect the ability of any taxpayer identified in this ruling to pay its outstanding tax liabilities.

Unless otherwise indicated, all references to monetary amounts are in Canadian dollars.

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 by section 54;

(c) "BCA" means the Business Corporations Act (XXXXXXXXXX) and, where applicable, its predecessor statutes;

(c) "Canadian-controlled private corporation" has the meaning assigned by subsection 125(7);

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

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

(f) "disposition" has the meaning assigned by subsection 248(1);

(g) "Paragraph" means a numbered paragraph in this advance income tax ruling; and

(h) "proposed transactions" means the transactions described in Paragraphs 28 and 29 below.

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

FACTS

1. R and S each own XXXXXXXXXX Class A shares in the capital of Numco. They also each own XXXXXXXXXX% of the shares of Investco. Investco owns XXXXXXXXXX Class D non-voting redeemable preferred shares in the capital of Numco that are redeemable for $XXXXXXXXXX, which is the balance maintained by Investco in the stated capital account under the BCA for the Class D preferred shares.

2. R and S are husband and wife and are not related to either D or E.

3. All of the shares of Numco owned by R and S are held as capital property.

4. Numco owns XXXXXXXXXX Class A shares in the capital of Opco, which represent all of the issued and outstanding shares of Opco.

5. R, D and E each own XXXXXXXXXX Class A shares in the capital of Buyerco, which represent all of the issued and outstanding shares of Buyerco.

6. Each of Numco, Opco and Buyerco is incorporated under the BCA and is a Canadian-controlled private corporation.

7. The shares of Numco are eligible for the capital gains exemption under section 110.6.

8. Prior to the involvement of any of the current shareholders in Buyerco, its predecessor by amalgamation was owned by F. F had acquired the business as a spin-off from another corporation (XXXXXXXXXX) which did not wish to continue to be involved in the XXXXXXXXXX business.

9. Prior to the acquisition by Buyerco by its current shareholders, D effectively made all of the day-to-day decisions of the business. The owner, F, was during this time a XXXXXXXXXX and played only a supervisory role in the management of the business.

10. Prior to R's involvement in Buyerco, R and S had been the owner-operators of Opco. They had started this corporation approximately XXXXXXXXXX years prior to their involvement in Buyerco. Prior to establishing Opco, R had been involved in the operation of a XXXXXXXXXX business with XXXXXXXXXX, a corporation of which he was not a shareholder.

11. R originally established Opco with two other shareholders, XXXXXXXXXX.

12. Prior to the purchase of Buyerco by its current shareholders, R had no involvement in Buyerco, although he would have known of its existence as a competitor to his business.

13. To facilitate the acquisition of Buyerco, an acquiring corporation, Aco, was established to act as purchaser. All of the shares of Aco were owned equally by the current shareholders of Buyerco. Aside from independent financing from the XXXXXXXXXX, each of the current shareholders of Buyerco or their related corporations provided $XXXXXXXXXX of financing to Aco.

14. Following completion of the acquisition of Buyerco, Aco and Buyerco were amalgamated pursuant to the provisions of the BCA to form Buyerco.

15. A shareholder agreement was put in place between R, D and E and insurance policies were obtained to fund the purchase obligations contained in the shareholder agreement. The amount of life insurance obtained for D and E is $XXXXXXXXXX each, while that for R is limited to $XXXXXXXXXX.

16. All of the day-to-day management decisions of Buyerco have been made by D since the date of its acquisition. D does consult with R from time-to-time in respect of various matters as both companies operate in the same business and deal with the same suppliers.

17. From time-to-time, transactions are done between the corporations where one corporation has a customer requiring a particular piece of equipment which is only available from the inventory of the other corporation. All such transactions between the corporations are completed at cost so that no profit is recognized on the transfer of products between the two. For the XXXXXXXXXX period from XXXXXXXXXX, Opco's purchases from Buyerco amounted to $XXXXXXXXXX, while Buyerco's purchases from Opco amounted to $XXXXXXXXXX. During the same period, the sales of each corporation would have been close to $XXXXXXXXXX. For the XXXXXXXXXX fiscal year, Opco's sales amounted to $XXXXXXXXXX, while Buyerco's sales amounted to $XXXXXXXXXX.

18. There are no other transactions between the corporations and, in particular, there are no capital loans advanced by either of the corporations to the other.

19. The loans from the XXXXXXXXXX to R, D and E for the acquisition of Buyerco have been retired and the guarantees given in respect thereof have been recovered. The loans payable to the individuals have been retired in part. D has received $XXXXXXXXXX in repayment of the loan he advanced in order to allow him to repay loans he received from his family members while loans owing to Investco and to E's professional corporation have been retired to the extent of $XXXXXXXXXX respectively, leaving a balance of $XXXXXXXXXX owing by Buyerco.

20. Buyerco and Opco operate independently. They do not have common customers although they do compete for customers in the same marketplace. There is a physical separation between their respective offices of approximately XXXXXXXXXX. They both operate in premises rented from third parties and there is no connection between the landlords of these premises or between the landlords and the lessees (other than through the lease agreements).

21. The operations of Buyerco and Opco are financially independent from each other and there are no intercorporate loans of a capital nature, although, as indicated in Paragraph 17 above, there may, from time-to-time, be a small amount of trade credit outstanding between the two corporations where one sells the other a piece of equipment requested by a customer of the other. There are no intercorporate guarantees between the corporations. The corporations deal with different banks and both corporations have their own independent credit facilities with those banks.

22. Both corporations have net incomes before tax which require that bonuses be declared annually to reduce their taxable income to the small business limit. Neither corporation is financially dependent on the other.

23. There are no management contracts between the two corporations, although S provides accounting services to both Opco and Buyerco. S has previously worked in a professional accounting office and has significant experience in bookkeeping and preparation of financial statements and tax returns. The annual financial statements and tax returns of Buyerco are reviewed by an independent firm of chartered accountants.

24. R and S are of similar age and are planning their retirement. XXXXXXXXXX R no longer feels able to spend as much as six days a week in the operation of Opco and for that reason has decided to sell the shares of Opco in the near future and retire to a retirement property that R and S have purchased.

25. R and S have XXXXXXXXXX children, one of whom is actively involved in the day-to-day business and affairs of Opco. It is the desire of R and S that this child be able to continue her involvement in the business. The sale of the shares of Opco to Buyerco for cash would allow R and S to equalize the distribution of their estates among their XXXXXXXXXX children. The shares of Buyerco would be left to the child interested in the XXXXXXXXXX business and the other XXXXXXXXXX children would receive cash.

26. Each of the shareholders of Buyerco have, and exercise, separate interests. No instrument or other right exists between the three shareholders of Buyerco which allows one to influence the actions of the others. The three shareholders believe that Buyerco will benefit economically by purchasing Opco because they believe that the combined entity will be able to branch out into other products and services which either of them, separately, may not be able to undertake.

27. R and S have made it clear that they will only sell the shares of Opco to Buyerco if the capital gain exemption would be available to them on the sale. Otherwise, they would have a significant disadvantage compared to a sale to a third party.

PROPOSED TRANSACTIONS

28. Numco will repurchase its XXXXXXXXXX Class D redeemable preferred shares held by Investco for $XXXXXXXXXX.

29. R and S will each sell their XXXXXXXXXX Class A shares in the capital of Numco to Buyerco for $XXXXXXXXXX each, and will claim a deduction under section 110.6 on their income tax returns for the year of the sale.

PURPOSE OF PROPOSED TRANSACTIONS

30. R and S are close to retirement. They have XXXXXXXXXX children, one of whom is actively engaged in the business operated by Opco. They wish to realize the cash value of their shares of Opco through a sale to Buyerco. Upon completion of the sale of Opco to Buyerco, R will continue to hold a one-third indirect interest in Opco, as well as a one-third direct interest in Buyerco. Ultimately, R and S intend to leave their interest in Buyerco to the child that is active in the business of Opco and Buyerco and provide for their other XXXXXXXXXX children from the cash proceeds of the Opco sale.

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. Subsection 84.1(1) will not apply to the sale by R and S of their respective 50 Class A shares of Numco to Buyerco and, in particular, paragraph 84.1(2)(b) will not apply to deem either R or S not to deal at arm's length with Buyerco.

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

The above rulings are given subject to the limitations and qualifications set out in Information Circular 70-6R5 dated May 17, 2002 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, reviewed or has made any determination in respect of:

(a) the fair market value or adjusted cost base of any property or the paid-up capital of any shares referred to herein; and

(b) any other tax consequences relating to the facts and proposed transactions described herein other than those specifically described in the rulings given above, including, without limiting the generality of the foregoing, any entitlement to a deduction under section 110.6.

Yours truly,

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

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