2003 Ruling 2003-0046823 - Reverse Estate Freeze

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: Undoing an estate freeze due to the decline in the fair market value of the assets of the corporation. Is a benefit conferred?

Position: No.

Reasons: The law as applied to the specific facts in this case.

XXXXXXXXXX 2003-004682

XXXXXXXXXX , 2003

Dear XXXXXXXXXX:

Re: XXXXXXXXXX ("Holdings")
Advance Income Tax Ruling Request

This is in reply to your undated letter that we received on XXXXXXXXXX and your subsequent correspondence, wherein you requested an advance income tax ruling on behalf of the above-noted taxpayer. You have advised us that to the best of your knowledge and that of the taxpayers involved none of the issues involved in this ruling request are:

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

(ii) being considered by a tax services office ("TSO") or taxation centre ("TC") in connection with a previously filed tax return of the taxpayers or a related person;

(iii) under objection by the taxpayers 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 ruling previously issued by the Income Tax Rulings Directorate.

The taxpayers have also represented that the proposed transactions described herein will not result in any taxpayer described herein being unable to pay its existing outstanding tax liabilities.

DEFINITIONS

In this letter, unless otherwise specified, all monetary amounts are expressed in Canadian dollars and the following terms have the meanings specified below:

(a) "Act" means the Income Tax Act, R.S.C. 1986 (5th Supp.) c.1, as amended from time to time and consolidated to the date of this letter and, unless otherwise expressly stated, every reference herein to a part, section or subsection, paragraph or subparagraph and clause or subclause is a reference to the relevant provision of the Act, and the Income Tax Regulations thereunder are referred to as the "Regulations";

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

(c) "BCA" means XXXXXXXXXX and where applicable, its predecessor statutes;

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

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

(f) "fair market value" means the highest price available in an open and unrestricted market between informed, prudent parties acting at arm's length and under no compulsion to act;

(g) "Individual A" means XXXXXXXXXX;

(h) "Individual B" means XXXXXXXXXX;

(i) "Individual C" means XXXXXXXXXX;

(j) "Individual D" means XXXXXXXXXX;

(k) "Individual E" means XXXXXXXXXX;

(l) "Individual F" means XXXXXXXXXX;

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

(n) "Paragraph" refers to a numbered paragraph in this advance income tax ruling;

(o) "private corporation" has the meaning assigned by subsection 89(1);

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

(q) "Proposed Transactions" means the transactions described in Paragraphs 13 to 17;

(r) "Province" means XXXXXXXXXX;

(s) "taxable Canadian corporation" has the meaning assigned by subsection 89(1); and

(t) "taxable dividend" has the meaning assigned by subsection 89(1).

FACTS

1. Holdings is a private corporation and a taxable Canadian corporation that was incorporated under the laws of the Province on XXXXXXXXXX.

2. The authorized capital of Holdings is currently comprised of the following classes of shares:

? XXXXXXXXXX voting common shares ("Common Shares") without par value;

? XXXXXXXXXX non-voting Class A preferred shares ("Class A Shares") with a par value of $ XXXXXXXXXX each; and

? XXXXXXXXXX non-voting Class B preferred shares ("Class B Shares") without par value.

3. The terms of the Class A Shares provide that a holder thereof is entitled to non-cumulative dividends of XXXXXXXXXX% of the Class A Redemption Amount. The Class A Redemption Amount is defined as the amount of cash consideration paid for the Class A Shares and/or the fair market value of any consideration other than cash received by Holdings for the issuance of such Class A Shares and is subject to a price adjustment clause. No dividends can be paid on the Class A Shares nor can any of the Class A Shares be redeemed if such payment of a dividend or redemption of such shares, as the case may be, impairs the value of the remaining issued and outstanding Class A Shares. The holders of Class A Shares are entitled to the return of the Class A Redemption Amount on the winding-up of Holdings in priority over every other class of shares.

Currently, the Class A Redemption Amount for the issued and outstanding Class A Shares is $XXXXXXXXXX per share.

4. The terms of the Class B Shares provide that a holder thereof is entitled to non-cumulative dividends, at the discretion of the directors, of XXXXXXXXXX% of the Class B Redemption Amount, with the consent of holders of Class A Shares and Class B Shares. The Class B Redemption Amount is defined as the fair market value of any consideration received by Holdings for the issuance of such Class B Shares and is subject to a price adjustment clause. The holders of Class B Shares are entitled to the return of the Class B Redemption Amount on the winding-up of Holdings after payment to the holders of Class A Shares of the amount to which they are entitled (other than declared and unpaid dividends). No shares are to be issued by Holdings that rank in priority to or pari passu with Class B Shares while such Class B Shares are outstanding and no dividends on, or redemptions and repurchases of, Common Shares or any other class of junior shares issued by Holdings is permitted if the result of the payment of such dividends, or redemption, or repurchase would render Holdings incapable of redeeming the Class B Shares.

Currently, the Class B Redemption Amount for the issued and outstanding Class B Shares is $XXXXXXXXXX per share.

5. The number of issued and outstanding shares of Holdings, along with the amount of each holder's aggregate ACB and aggregate PUC of such shares, is currently as follows:

Shareholder
Type of Share
ACB
PUC

Common Shares

Individuals A & B (jointly)
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
Individual C
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
Individual D
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
Individual E
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
Individual F
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX

Class A Shares

Individuals A & B (jointly)
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX

Class B Shares

Individuals A & B (jointly)
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX

6. Individual A and Individual B are the parents of Individual C, Individual D and, Individual E, none of whom are minors. Individual F is the spouse of Individual E. Collectively, Individual C, Individual D, Individual E and Individual F are referred to as the "Children". Each of the individuals referred to above is a resident of Canada for the purposes of the Act and each such individual holds their respective shares of Holdings as capital property.

7. As a consequence of the death of Individual A's brother in XXXXXXXXXX, Individual A received a portfolio of marketable securities from his brother's estate and one common share of Holdings (representing a XXXXXXXXXX% interest in Holdings). On XXXXXXXXXX, Holdings repurchased its only other issued and outstanding common share that was owned by Individual A's sister. Immediately thereafter, Individual A transferred a portfolio of marketable securities to Holdings in exchange for a non-interest bearing demand promissory note ("Holdings Note 1") having a principal amount of $XXXXXXXXXX. Individual A then gifted XXXXXXXXXX% of the Holdings Note 1 (i.e. $XXXXXXXXXX in total) to the Children.

8. Pursuant to an estate freeze carried out on XXXXXXXXXX, Individual A exchanged the only issued and outstanding common share of Holdings for XXXXXXXXXX Class A Shares of Holdings having a Class A Redemption Amount of $XXXXXXXXXX per share (or $XXXXXXXXXX in the aggregate). Immediately thereafter, each of the following individuals then subscribed for new common shares of Holdings for $XXXXXXXXXX per share.

Individual # of Shares

Individual A XXXXXXXXXX
Individual C XXXXXXXXXX
Individual D XXXXXXXXXX
Individual E XXXXXXXXXX
Individual F XXXXXXXXXX

9. On XXXXXXXXXX the common shares of Holdings were subdivided on a XXXXXXXXXX for XXXXXXXXXX basis without any additional payment by any holder such that the Common Shares were held as follows:

Individual # of Shares

Individual A XXXXXXXXXX
Individual C XXXXXXXXXX
Individual D XXXXXXXXXX
Individual E XXXXXXXXXX
Individual F XXXXXXXXXX

10. On XXXXXXXXXX, Individual A transferred certain marketable securities having an aggregate fair market value of $XXXXXXXXXX to Holdings. As consideration for such transfer, Holdings issued to Individual A XXXXXXXXXX Class B Shares with an issue price of $XXXXXXXXXX per share (or $XXXXXXXXXX in the aggregate) and a demand, non-interest-bearing promissory note ("Holdings Note 2") with a principal amount of $XXXXXXXXXX.

11. On XXXXXXXXXX, Individual A transferred XXXXXXXXXX% joint ownership of his XXXXXXXXXX Common Shares, XXXXXXXXXX Class A Shares and XXXXXXXXXX Class B Shares of Holdings and the outstanding principal amount owing by Holdings on the Holdings Note 2 to Individual B by way of inter vivos gift as an estate planning step.

12. Since the time of the estate freeze described in Paragraph 8 and the transactions described in Paragraphs 10 and 11 above, the fair market value of Holdings' assets have suffered a significant decline due to adverse market conditions. Holdings also currently owes approximately $XXXXXXXXXX in the aggregate to its shareholders under the Holdings Note 1 and Holdings Note 2. As a result, based on the current fair market value of Holdings assets, Holdings is unable to repay all its outstanding liabilities and is insolvent such that the current fair market value of all of Holdings issued and outstanding shares is nominal. The decline in the fair market value of Holdings' issued and outstanding shares has not been caused by the removal of assets of the corporation.

PROPOSED TRANSACTIONS

13. The authorized capital of Holdings will be reorganized under the BCA such that a new class of preferred shares ("Class C Shares") with a par value of $XXXXXXXXXX per share will be authorized. The Class C Shares will have rights identical to those of the existing Class B Shares except that the Class C Shares will be voting.

14. Individual A and Individual B will jointly acquire all XXXXXXXXXX issued and outstanding Common Shares of Holdings that are currently held by the Children for an aggregate purchase price equal to the fair market value of those shares which is anticipated to be nominal.

15. Individual A and Individual B will then exchange all their jointly owned XXXXXXXXXX Common Shares, XXXXXXXXXX Class A Shares and XXXXXXXXXX Class B Shares of Holdings for 1 jointly-owned newly-issued Class C Share of Holdings having a par value and PUC of $XXXXXXXXXX and a redemption amount (the "Class C Redemption Amount") equal to the aggregate fair market value of the exchanged shares. No joint election under section 85 will be made in respect of this exchange.

16. Individual A and Individual B and each of the Children will then subscribe for newly issued common shares of Holdings in the same ratio as their previous ownership of Common Shares described in Paragraph 8 for nominal consideration.

17. Holdings will then redeem the 1 Class C Share for the Class C Redemption Amount.

PURPOSE OF THE PROPOSED TRANSACTIONS

18. Individual A would like to rationalize his affairs for purposes of estate planning. The proposed reorganization of capital would recognize the economic reality that Holdings is currently insolvent and that the Common Shares, Class A Shares and Class B Shares have a nominal fair market value. The proposed reorganization would re-establish the intention of the initial estate freeze transactions of providing for future growth to rest with the holders of the Common Shares.

RULINGS GIVEN

Provided that the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, proposed transactions and the purpose of the Proposed Transactions, and provided that the Proposed Transactions are completed in the manner described above, our rulings are as set forth below.

A. Provided Individual A and Individual B jointly own the XXXXXXXXXX Common Shares, XXXXXXXXXX Class A Shares and XXXXXXXXXX Class B Shares of Holdings as capital property, the provisions of subsection 86(1) will apply and for greater certainty, subsection 86(2) will not apply, to the exchange of all such shares of Holdings for one Class C Share of Holdings as described in Paragraph 15 of the Proposed Transactions.

B. Subsection 246(1) will not apply to the acquisition of the XXXXXXXXXX Common Shares of Holdings by Individual A and Individual B from the Children as described in Paragraph 14 of the Proposed Transactions.

C. Subsection 245(2) will not be applied, as a result of the Proposed Transactions, in and by themselves, to redetermine the tax consequences confirmed in the rulings given above.

The above rulings are given subject to the limitations and qualifications set out in IC 70-6R5 and are binding on the CCRA provided that the proposed transactions are completed by XXXXXXXXXX. These 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 into law, could have an effect on the rulings provided herein.

OTHER COMMENTS

Nothing in this letter should be construed as implying that the CCRA has confirmed, reviewed or has made any determination in respect of:

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

(b) any other tax consequence relating to the facts, Proposed Transactions or any transaction or event taking place either prior to the Proposed Transactions or subsequent to the Proposed Transactions, whether described in this letter or not, other than those specifically described in the rulings given above.

Yours truly,

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