2003 Ruling 2003-0183723 - Share-For-Share Exchange

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 share exchange transaction satisfies the requirements of s. 85.1 and (2) whether application of allocation in proportion to patronage to liability of customer to purchase shares constitutes payment under s. 135(4) of the Act.

Position: (1) Yes and (2) Yes.

Reasons: Complies with requirements of relevant provisions as worded.

XXXXXXXXXX 2003-018372

XXXXXXXXXX, 2003

Dear XXXXXXXXXX:

Re: Request for Advance Income Tax Ruling
XXXXXXXXXX

This letter is in reply to your letter of XXXXXXXXXX in which you request an advance income tax ruling on behalf of the above named taxpayer. We acknowledge receipt of (i) your letter of XXXXXXXXXX in which you discuss the purposes of the proposed transactions described herein and the reasons for requesting an advance income tax ruling, (ii) your letter of XXXXXXXXXX and accompanying copies of various corporate documentation and (iii) your e-mail correspondence of XXXXXXXXXX and attached correspondence addressed to you by legal counsel for the above named taxpayer. We also acknowledge our various telephone conversations in connection with your request (XXXXXXXXXX).

We also understand that, to the best of your knowledge and that of the above named taxpayer, none of the issues involved in this ruling request:

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

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

(iii) is under objection by the taxpayer or a related person;

(iv) is before the Courts; and

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

Unless otherwise stated, all references to a statute are to the Income Tax Act (Canada), R.S.C. 1985, c. 1 (5th Supp.), as amended (the "Act"), and all references to monetary amounts are in Canadian dollars.

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

DEFINITIONS

(a) "ACO" means XXXXXXXXXX;

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

(c) "allocation in proportion to patronage" has the meaning assigned by subsection 135(4);

(d) "BCO" means XXXXXXXXXX;

(e) "Canadian corporation" has the meaning assigned by subsection 89(1);

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

(g) "cooperative corporation" has the meaning assigned by subsection 136(2);

(h) "customer" has the meaning assigned by subsection 135(4);

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

(j) "foreign affiliate" has the meaning assigned by subsection 95(1);

(k) "member cooperative" means a cooperative corporation that is a shareholder of ACO or BCO, as the case may be;

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

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

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

FACTS

1. BCO is a cooperative corporation incorporated under the XXXXXXXXXX. BCO files its Canadian federal income tax returns with the XXXXXXXXXX Taxation Centre and is serviced by the XXXXXXXXXX Tax Services Office.

2. BCO's authorized share capital consists of XXXXXXXXXX shares with a par value of $XXXXXXXXXX each (the "XXXXXXXXXX shares"). A XXXXXXXXXX share entitles its holder to receive dividends as and when declared by the directors of BCO and to receive the remaining property of BCO on its dissolution. Each XXXXXXXXXX share may be redeemed by BCO for its $XXXXXXXXXX par value. As at XXXXXXXXXX, there were XXXXXXXXXX shares issued and outstanding, all of which were held by directors and member cooperatives of BCO. The amount of issued and outstanding XXXXXXXXXX shares on that date included XXXXXXXXXX shares that were held by ACO.

3. ACO is a cooperative corporation incorporated under the XXXXXXXXXX, with authorized share capital of (i) an unlimited number of non-cumulative, non-voting preferred shares with a par value of $XXXXXXXXXX each and redeemable at par and (ii) an unlimited number of ACO Common Shares with a par value of $XXXXXXXXXX each (the "ACO Common Shares"). Each ACO Common Share may be redeemed by ACO at a price equal to its $XXXXXXXXXX par value.

4. At XXXXXXXXXX, ACO's issued and outstanding share capital consisted of XXXXXXXXXX ACO Common Shares, all of which were held by member cooperatives of ACO.

5. BCO and ACO are both Canadian corporations and taxable Canadian corporations.

6. BCO makes allocations in proportion to patronage in respect of all its customers of the taxation year at the same rate, with appropriate differences for different types or classes of goods, products or services, or classes, grades or qualities thereof. All of BCO's customers are member cooperatives of BCO.

PROPOSED TRANSACTIONS

1. Each member cooperative of BCO (other than ACO) will dispose of its XXXXXXXXXX shares to ACO in exchange for ACO Common Shares having an equivalent par value (i.e., a holder of 1 XXXXXXXXXX share will receive XXXXXXXXXX ACO Common Shares pursuant to the exchange) (the "Share Exchange"). Upon completion of the Share Exchange, BCO will become a wholly-owned subsidiary of ACO.

2. BCO will continue to provide services to ACO and the member cooperatives of ACO that had been shareholders of BCO prior to the Share Exchange. ACO and its member cooperatives will be the only customers of BCO and will continue to be members of BCO for the purposes of the XXXXXXXXXX.

3. The by-laws of BCO will be amended to provide that the member cooperatives of ACO that are customers of BCO will be obligated to acquire ACO Common Shares subscribed for by BCO for the purposes of paying allocations in proportion to patronage to customers of BCO. The by-laws of BCO will further provide that in these circumstances, such member cooperatives will be required to purchase ACO Common Shares from BCO for an amount equal to their subscription price. This will create a liability due by those aforementioned member cooperatives to BCO.

4. Subsequent to the completion of the Share Exchange and after the amendments to BCO's by-laws contemplated by paragraph 3 have been made, the following transactions and events will take place on an annual basis (either at or near the end of a particular taxation year of BCO or the beginning of the following taxation year of BCO):

(a) BCO will declare an allocation in proportion to patronage to its customers in an amount not exceeding its taxable income for the taxation year determined without reference to paragraph 20(1)(u) and section 135 of the Act (a "Patronage Allocation");

(b) Concurrent with a Patronage Allocation, BCO will subscribe for ACO Common Shares with an aggregate par value equal to the amount of the Patronage Allocation (other than the portion thereof credited in favour of ACO) less the amount of any withholding tax that BCO would be required to deduct, withhold and remit to the Receiver General pursuant to subsection 135(3) of the Act in respect of the payment of the Patronage Allocation (other than the portion thereof credited in favour of ACO);

(c) With respect to each member cooperative of ACO, BCO will pay the Patronage Allocation credited in favour of the member cooperative by (i) transferring to the member cooperative the ACO Common Shares that the member cooperative is obligated to acquire from BCO pursuant to BCO's by-laws and applying the Patronage Allocation so credited to the member cooperative against the amount that the member cooperative is required to pay BCO for the ACO Common Shares so transferred and (ii) paying a cash amount that is equal to the amount that must be deducted and withheld by BCO on the payment of Patronage Allocation credited in favour of such member cooperative, which cash amount shall be immediately deducted and withheld by BCO and remitted forthwith to the Receiver General; and

(d) With respect to the Patronage Allocation credited in favour of ACO, BCO will pay the Patronage Allocation by (i) issuing XXXXXXXXXX shares to ACO and, at ACO's request, applying the Patronage Allocation so credited against the amount that ACO is required to pay for the issuance of such XXXXXXXXXX shares and (ii) paying a cash amount that is equal to the amount that must be deducted and withheld by BCO on the payment of Patronage Allocation credited in favour of ACO, which cash amount shall be immediately deducted and withheld by BCO and remitted forthwith to the Receiver General.

ADDITIONAL INFORMATION

1. Each member cooperative of BCO (other than ACO) will deal at arm's length with ACO immediately before the Share Exchange.

2. Each member co-operative of BCO that exchanges XXXXXXXXXX shares pursuant to the Share Exchange or persons with whom such member co-operative does not deal with at arm's length, or such member co-operative along with persons with whom such member co-operative does not deal at arm's length will not, immediately after the Share Exchange:

(a) control ACO; or

(b) beneficially own shares of the capital stock of ACO having a fair market value of more than 50% of the fair market value of all the outstanding shares of the capital stock of ACO.

3. Each member cooperative of BCO will not, in its return of income for any taxation year in which it disposes of XXXXXXXXXX shares in exchange for ACO Common Shares pursuant to the Share Exchange, include in computing its income for that year any portion of the gain or loss, otherwise determined, from such disposition.

4. ACO will not make a joint election with any of the member co-operatives pursuant to subsection 85(1) or (2) of the Act in respect of the Share Exchange.

5. Each member cooperative of BCO that will exchange XXXXXXXXXX shares for ACO Common Shares pursuant to the Share Exchange will not be a foreign affiliate of a taxpayer resident in Canada at the end of the taxation year of such member cooperative in which the Share Exchange occurs.

6. Each member cooperative of BCO will hold its XXXXXXXXXX shares as capital property immediately before the disposition of such shares pursuant to the Share Exchange.

PURPOSE OF THE PROPOSED TRANSACTIONS

BCO and ACO are both key organizations in the cooperative movement in XXXXXXXXXX. BCO provides XXXXXXXXXX to local cooperatives while ACO provides a broad range of support services such as XXXXXXXXXX. While the two organizations serve the same cooperatives, they operate independently of each other with separate Boards of Directors and separate management. A study was conducted which indicated that substantial cost savings could be realized if the two organizations worked more closely with each other, particularly with respect to governance. It was decided that the separate legal existence of ACO and BCO should be retained, however much of the savings could be realized if BCO became a wholly-owned subsidiary of ACO. Accordingly, it is proposed that each member cooperative of BCO will dispose of its shares in BCO to ACO in exchange for shares of ACO.

BCO will continue to provide XXXXXXXXXX to the member cooperatives that had previously been its shareholders. Furthermore, BCO will declare a patronage allocation to its customers annually. BCO's practise has been to effect the patronage payment by crediting the amount to the customer's obligation to purchase additional shares of BCO. However, this would be inconsistent with the objective of leaving BCO as a wholly-owned subsidiary of ACO. Therefore, it is proposed that the patronage payment be effected as described herein.

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 and the Additional Information will be true in all respects, we confirm that:

A. Subsection 85.1(1) of the Act will apply (and will not be precluded from applying pursuant to subsection 85.1(2) of the Act) to the disposition by each member cooperative of BCO of its XXXXXXXXXX shares to ACO in exchange for ACO Common Shares pursuant to the Share Exchange so that:

(i) each member cooperative of BCO shall be deemed to have disposed of its XXXXXXXXXX shares for proceeds of disposition equal to the adjusted cost base to it of such shares immediately before that disposition;

(ii) each member cooperative of BCO shall be deemed to have acquired the ACO Common Shares at a cost to that member cooperative equal to the adjusted cost base to it of the XXXXXXXXXX shares immediately before that disposition; and

(iii) the cost to ACO of each exchanged XXXXXXXXXX share after that disposition shall be deemed to be the lesser of (i) its fair market value immediately before that disposition and (ii) its paid-up capital immediately before that disposition.

B. The application of an amount to the liability of the member cooperatives of BCO to purchase ACO Common Shares as contemplated by paragraph 4(c) of the Proposed Transactions will constitute "payment" within the meaning assigned by subsection 135(4) of the Act.

C. Provided that for a particular taxation year BCO held out the prospect that amounts would be credited to its customers in accordance with subsection 135(5) of the Act and subject to the limitation in subsection 135(2) of the Act, BCO will be entitled to deduct in computing its income for the year, pursuant to paragraph 20(1)(u) and subsection 135(1) of the Act, the Patronage Allocations that are paid in the manner contemplated in paragraph 4(c) of the Proposed Transactions so long as such payments are made within the particular taxation year or within 12 months thereafter.

The Rulings given are 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 before XXXXXXXXXX.

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, paid-up capital or fair market value of any shares referred to herein;

(b) the determination of whether any particular amount credited to a customer of BCO in accordance with paragraph 4(a) of the Proposed Transactions is an allocation in proportion to patronage; or

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

Yours truly,

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