2004 Ruling 2004-0065611R3 - Single-wing Butterfly

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 proceeds from sale of XXXXXXXXXX prior to the distribution may be considered to be a business asset.

Position: Yes.

Reasons: Transferee has entered into sufficient commitments to use proceeds to acquire another business asset.

XXXXXXXXXX 								2004-006561

XXXXXXXXXX, 2004

Dear XXXXXXXXXX:

Re: XXXXXXXXXX ("DC")
XXXXXXXXXX ("X")
XXXXXXXXXX ("Y")
Advance Income Tax Ruling Request

We are writing in response to your letters of XXXXXXXXXX in which you requested an advance income tax ruling on behalf of the above-noted taxpayers. We also acknowledge the information provided in various telephone conversations and subsequent correspondence. 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 taxpayers or related persons;

(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 related persons;

(iii) under objection by the taxpayers or related persons;

(iv) before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has expired; or

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

DEFINITIONS

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

(a) "A" and "B" are XXXXXXXXXX, X and Y's parents;

(b) "Aco" means XXXXXXXXXX;

(c) "Act" means the Income Tax Act (Canada), R.S.C. 1985 (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;

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

(e) "agreed amount" means the amount that the taxpayer and the corporation have jointly elected in prescribed form in respect of an eligible property;

(f) XXXXXXXXXX;

(g) "Bco" means XXXXXXXXXX;

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

(i) "capital dividend account" ("CDA") has the meaning assigned by subsection 89(1);

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

(k) "Cco" means XXXXXXXXXX;

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

(m) "depreciable property" has the meaning assigned by subsection 13(21);

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

(o) "distribution" has the meaning assigned by subsection 55(1);

(p) "dividend refund" has the meaning assigned by subsection 129(1);

(q) "dividend rental arrangement" has the meaning assigned by subsection 248(1);

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

(s) "eligible property" has the meaning assigned by subsection 85(1.1);

(t) "fair market value" ("FMV") 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, expressed in terms of cash;

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

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

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

(x) "refundable dividend tax on hand" ("RDTOH") has the meaning assigned by subsection 129(3);

(y) "related persons" has the meaning assigned by section 251;

(z) "series of transactions or events" includes the related transactions or events referred to in subsection 248(10);

(aa) "specified financial institution" has the meaning assigned by subsection 248(1);

(bb) "specified investment business" has the meaning assigned by subsection 125(7);

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

(dd) "taxable dividend" has the meaning assigned by subsection 89(1);

(ee) "taxable preferred share" has the meaning assigned by subsection 248(1); and

(ff) "undepreciated capital cost" ("UCC") has the meaning assigned by subsection 13(21).

FACTS

1. X and Y are brothers and Canadian residents. A and B are their parents.

2. DC is incorporated under the laws of XXXXXXXXXX. It is a taxable Canadian corporation and a CCPC. Its fiscal year ends on XXXXXXXXXX and it carries on the business of XXXXXXXXXX farming. The principal business address of DC is XXXXXXXXXX. It deals with the XXXXXXXXXX taxation services office and its taxation centre is XXXXXXXXXX.

3. DC's authorized share capital consists of XXXXXXXXXX voting common shares of no par value and XXXXXXXXXX non-voting preferred shares with a par value of $XXXXXXXXXX each. All of the shares of DC represent capital property to its shareholders. DC's issued share capital is held by X and Y as follows:

PUC
ACB

X:

XXXXX common shares
$XXXXXXX
$XXXXXXX

XXXXX preferred shares
$XXXXXXX
$XXXXXXX

Y:

XXXXX common shares
$XXXXXXX
$XXXXXXX

XXXXX preferred shares
$XXXXXXX
$XXXXXXX

4. DC does not have any RDTOH and will not have any such amount at the end of the taxation year in which the proposed transactions are completed. DC has a nominal balance in its CDA.

5. DC's assets consist of current assets (accounts receivable, prepaid expenses, and inventory), buildings, equipment and vehicles, XXXXXXXXXX, an investment in a XXXXXXXXXX co-operative, XXXXXXXXXX% of the issued shares of Aco, and a non-interest bearing loan receivable from Cco.

6. DC's liabilities consist of current liabilities (bank indebtedness, accounts payable, shareholders loans, and the current portion of its long-term debt) and its long-term debt, including a loan from the Farm Credit Corporation, an interest bearing loan payable from Cco, and an interest bearing loan from A and B.

7. Aco is a taxable Canadian corporation and a CCPC. Its assets consist of cattle and other inventory, equipment, prepaid expenses and a XXXXXXXXXX% interest in another company, Bco. The other XXXXXXXXXX% of the issued shares of Aco and XXXXXXXXXX% of the issued shares of Bco are held by arm's length parties.

8. Cco, a taxable Canadian corporation and a CCPC, is owned by A and B. Cco, A and B rent farmland to DC, which does not own any land itself.

PROPOSED TRANSACTIONS

9. DC will incorporate a new subsidiary wholly-owned corporation under the XXXXXXXXXX ("Subco"). Subco will be a taxable Canadian corporation and a CCPC. The authorized share capital of Subco will consist of an unlimited number of no par value common shares. On incorporation, DC will subscribe for 1 common share of Subco for $XXXXXXXXXX.

10. Y will cause a new company ("Newco") to be incorporated under the XXXXXXXXXX. Newco will be a taxable Canadian corporation and a CCPC. The authorized capital of Newco will include:

(a) voting, common shares with a par value of $XXXXXXXXXX per share; and

(b) XXXXXXXXXX non-voting, no par value, redeemable and retractable preferred shares which will be entitled to receive, as and when declared, non-cumulative dividends not exceeding XXXXXXXXXX % per annum of the redemption amount. Each preferred share will be redeemable and retractable for an amount equal to the FMV of the consideration received by Newco for the issuance of the share. On dissolution of Newco, each preferred share will entitle its holder to receive a distribution of the net assets of Newco in an amount equal to the redemption amount plus unpaid, declared dividends in priority to any distribution to be made to the common shareholders of Newco. No dividends or other distributions will be paid on any shares ranking junior to the Newco preferred shares if the effect of such a dividend or other distribution would be to reduce the net realizable value of the assets of Newco to an amount less than the aggregate of the redemption amounts.

Upon incorporation, Y will subscribe for 1 common share of Newco for $XXXXXXXXXX.

11. DC will transfer a portion of each type of property owned by it at that time to Subco such that immediately following the transfers, the net FMV of each type of property so transferred by DC to Subco, will approximate that proportion of the net FMV of all property of DC of that type determined immediately before such transfers that:

(a) the aggregate FMV, immediately before the transfers, of all of the shares of the capital stock of DC owned by Y at that time,
is of

(b) the aggregate FMV, immediately before the transfer, of all of the issued and outstanding shares of the capital stock of DC at that time.

12. As consideration for the transfers of property described above in paragraph 11, Subco will issue to DC XXXXXXXXXX common shares of Subco.

13. DC and Subco will elect, jointly and in prescribed form and within the time limits referred to in subsection 85(6), to have the rules in subsection 85(1) apply to the transfer of each asset of DC, as described in paragraph 11 above, that is an eligible property, to Subco. The agreed amount specified in such elections in respect of each eligible property transferred that has a FMV in excess of its cost amount to DC will be an amount that is not less than:

(a) in the case of capital property (other than depreciable property of a prescribed class), an amount equal to the lesser of the amounts described in subparagraphs 85(1)(c.1)(i) and (ii);

(b) in the case of depreciable property of a prescribed class, an amount equal to the least of the amounts described in subparagraphs 85(1)(e)(i), (ii) and (iii);

(c) in the case of eligible capital property, an amount equal to the least of the amounts described in subparagraphs 85(1)(d)(i), (ii) and (iii); and

(d) in the case of inventory, the amount described in paragraph 85(1)(c.1).

In each case, the agreed amount will not exceed the FMV of the respective property. For the purposes of the joint election described herein, the reference to "the undepreciated capital cost to the taxpayer of all property of that class immediately before the disposition" found in subparagraph 85(1)(e)(i) shall be interpreted to mean that proportion of the UCC to the taxpayer of all of the property of that class that the FMV of the asset immediately before the disposition is of the FMV of all property of that class immediately before the disposition.

Furthermore, the reference to "4/3 of the taxpayer's cumulative eligible capital in respect of the business immediately before the disposition ..." in subparagraph 85(1)(d)(i) will be read to mean the proportion of 4/3 of the taxpayer's cumulative eligible capital that the fair market value of the eligible capital property immediately before the disposition is of the fair market value of all the eligible capital property of the business immediately before the disposition.

14. That portion of the XXXXXXXXXX acquired by Subco as part of the transfers described in paragraph 11 will be sold by Subco to arm's length parties for cash.

15. Immediately after the sale described in paragraph 14 above, the XXXXXXXXXX common and XXXXXXXXXX preferred shares of DC held by Y will be transferred to Newco. As consideration for the transferred shares, Newco will issue XXXXXXXXXX common shares to Y. Y and Newco will elect jointly, in prescribed form within the time provided by subsection 85(6), to have the rules of subsection 85(1) apply to the transfer. The agreed amount specified in the election will be equal to the ACB to Y of the transferred shares immediately before the transfer, which amount will not exceed the FMV of those shares.

16. Immediately after the transfer of Y's shares of DC to Newco described above in paragraph 15 and immediately before the transfers of property described in paragraph 19 below, the property owned by DC will be determined on a consolidated look-through basis by including the appropriate pro-rata share of the assets of Subco and Aco, and all such property will be classified into the following three types of property for the purposes of the definition of "distribution" in subsection 55(1) and paragraph 55(3)(b):

(a) cash or near-cash property comprising all of the current assets of DC, including cash, accounts receivable, inventory and prepaid expenses;

(b) business property comprising all of the assets of DC, other than cash or near-cash property, any income from which would, for the purposes of the Act, be income from a business (other than a specified investment business) carried on by DC. For greater certainty, the loan receivable from the XXXXXXXXXX cooperative will be treated as a business property as it essentially represents the holdback the XXXXXXXXXX cooperative retains on the purchase of XXXXXXXXXX. The proceeds from the sale of the XXXXXXXXXX described in paragraph 14 above will also be treated as business property; and

(c) investment property comprising all of the assets of DC, other than cash or near-cash property, any income from which would, for the purposes of the Act, be income from property or a specified investment business. For greater certainty, the loan receivable from Cco will be treated as an investment property and the shares of Aco will, in part, be treated as an investment property reflecting Aco's investment in Bco.

17. In determining the net FMV of each type of property owned by DC, immediately before the transfers of property described in paragraph 19 below, the liabilities of DC and Subco and Aco, will be allocated to and deducted in the calculation of the net FMV of each type of property of DC as follows:

(a) current liabilities of DC (including the current portion of long-term debt) will be allocated to each cash or near-cash property of DC in the proportion that the FMV of each such property is of the FMV of all cash or near-cash property owned by DC. The allocation of current liabilities will not exceed the aggregate FMV of all cash or near-cash property of DC;

(b) accounts receivable, inventories and prepaid expenses that are initially classified in accordance with paragraph (a) as cash or near-cash property, that will relate to a business carried on by DC, Newco or Subco and that will be collected, sold or consumed by such corporation in the ordinary course of its business will then be reclassified as business property and the net FMV thereof, determined after the allocation of current liabilities described in (a) will be included in the net FMV of business property and will not be included in the net FMV of cash or near-cash property;

(c) liabilities, other than current liabilities, of DC that relate to a particular property will then be allocated to the particular property (and effectively to the type of property to which the property belongs) to the extent of its FMV. The liabilities pertaining to a type of property but not to a particular property will then be allocated to that type of property, but not in excess of the net FMV of such type of property after the allocation of liabilities to a particular property as described herein; and
(d) if any liabilities ("excess DC unallocated liabilities") remain after the allocations described in steps (a) and (c) above are made, such excess DC unallocated liabilities will then be allocated to the cash or near cash property and business property, if any, of DC based on the relative net FMV of each type of property prior to the allocation of such remaining liabilities, but after the allocation of the liabilities described in clauses (a) and (c) above.

18. For greater certainty, for the purposes of the classification of the types of property, in determining the net FMV of each type of property:

(a) any tax accounts, such as balances of any capital losses, non-capital losses, investment tax credits, CDA or RDTOH, will not be considered to be a property or liability, as the case may be;

(b) no amount will be considered to be a liability unless it represents a true legal liability which is capable of quantification; and

(c) the amount of any deferred income taxes in the financial statements will not be considered a liability.

19. Immediately following the determination of the net FMVof DC's three types of property, as described in paragraphs 16 to 18 above, DC will transfer to Newco all of the shares of Subco (XXXXXXXXXX common shares) and, if necessary, investment property which is additional to the cash or near cash property which is represented by the common shares of Subco, such that the net FMV of each type of property so transferred to Newco (after allocating and deducting, in the manner described in paragraph 17 above, the liabilities of DC which are to be assumed by Newco as described herein) will approximate that proportion of the net FMV of all property of DC of that type determined immediately before such transfer that:

(a) the aggregate fair market value, immediately before the transfer, of all of the shares of the capital stock of DC owned by Newco at that time;
is of

(b) the aggregate fair market value, immediately before the transfer, of all of the issued and outstanding shares of the capital stock of DC at that time.

For the purpose of this paragraph, the expression "approximate that proportion" means that the discrepancy from that proportion, if any, would not exceed 1%, determined as a percentage of the FMV value of each type of property which Newco will receive as compared to what Newco would have received had it received its pro rata share of the net FMV of that type of property.

20. As consideration for the transfers described above in paragraph 19 of the Subco shares and, if necessary any other property, Newco will issue to DC a number of preferred shares having an aggregate FMV and redemption amount equal to the aggregate FMV of the property transferred to Newco. Newco will add to the stated capital account maintained for its preferred shares an amount not exceeding the cost to Newco (as determined under section 85, where relevant) of the property transferred less any liabilities it assumes.

21. In respect of the transfers described in paragraph 19 above, DC and Newco will jointly elect, in prescribed form and within the time referred to in subsection 85(6), to have the rules in subsection 85(1) apply to the transfer of each property transferred by DC to Newco that is an eligible property. The agreed amount in each such election in respect of a particular eligible property transferred will not be less than:

(a) in the case of capital property (other than depreciable property of a prescribed class), an amount equal to the lesser of the amounts described in subparagraphs 85(1)(c.1)(i) and (ii); and

(b) in the case of eligible capital property, an amount equal to the least of the amounts described in subparagraphs 85(1)(d)(i), (ii) and (iii).

In each case, the agreed amount will not exceed the FMV of the respective property, nor will it be less than the amount of any liabilities assumed by Newco as consideration for the transfer of such property.

22. Newco will redeem all of its preferred shares held by DC for their aggregate redemption amount which, for greater certainty, will equal the aggregate FMV of such shares. As payment of the redemption amount, Newco will issue to DC a non-interest bearing demand promissory note (the "Newco Note") having a principal amount and FMV equal to the redemption amount of the preferred shares so redeemed. DC will accept the Newco Note as full payment of the redemption amount of the preferred shares.

23. Following the redemption of the preferred shares of Newco described in paragraph 22 above, DC will purchase for cancellation and redeem all of the DC common shares and preferred shares owned by Newco for FMV consideration. DC will pay the purchase price and the redemption price for such shares by issuing to Newco a non-interest bearing demand promissory note (the "DC Note") having a principal amount and FMV equal to the aggregate FMV of the shares purchased and redeemed. Newco will accept the DC Note as full payment of the purchase price and redemption price of the shares.

24. The Newco Note and the DC Note will be set off against one another and cancelled in full satisfaction of Newco's and DC's mutual debt obligations.

25. Subco and Newco will be amalgamated.

ADDITIONAL INFORMATION

26. Y will move his portion of the XXXXXXXXXX farming business carried on by DC from XXXXXXXXXX to XXXXXXXXXX. Y has entered into a Letter of Intent with X committing Subco to acquiring a license with the XXXXXXXXXX allowing for participation in the XXXXXXXXXX for the purposes of accumulating quota for the commencement of XXXXXXXXXX production once building of new XXXXXXXXXX production facilities are complete. Such quota will be purchased by Subco with the proceeds from the sale of XXXXXXXXXX contemplated in paragraph 14. Y has also entered into an Agricultural Real Estate Purchase Contract in respect of farmland in XXXXXXXXXX which is conditional upon the necessary permits being granted for a XXXXXXXXXX facility before XXXXXXXXXX. The purchase is expected to close on XXXXXXXXXX .

27. Except as described herein, no property has been or will be acquired or disposed of by DC and no liabilities have been or will be incurred by DC in contemplation of or subsequent to the proposed transactions.

28. None of the proposed transactions will have any impact on outstanding tax liabilities, if any, of any of the taxpayers referred to in this ruling request.

29. None of the shares of DC or Newco will be at any time during the implementation of the proposed transactions described herein:

(a) the subject of any undertaking or agreement that is referred to in subsection 112(2.2) as a "guarantee agreement";

(b) issued or acquired as part of a transaction, event or series of transactions or events of the type described in subsection 112(2.5); or

(c) the subject of a "dividend rental arrangement" as that term is defined in subsection 248(1).

30. None of DC and Newco is or will be a specified financial institution or a restricted financial institution at any time before the completion of the proposed transactions. None of DC and Newco is or will not, at any time before the completion of the proposed transactions, be a corporation described in any of paragraphs (a) to (f) of the definition of "financial intermediary corporation" in subsection 191(1) of the Act.

PURPOSE OF PROPOSED TRANSACTIONS

31. The purpose of the proposed transactions is to distribute, on a tax-free basis, a portion of the assets of DC to a new company owned XXXXXXXXXX% by Y in order to separate his business interests from those of his brother.

RULINGS

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. Subject to the application of subsection 69(11), subsection 85(1) will apply to the transfer of each eligible property by DC to Subco, as described in paragraph 11, in respect of which an election under subsection 85(1) is made, such that the agreed amount in respect of each transfer of each eligible property will be deemed to be DC's proceeds of disposition and Subco's cost thereof pursuant to paragraph 85(1)(a). For greater certainty, paragraph 85(1)(e.2) will not apply to the transfers.

B. Subsection 85(1) will apply to the transfer by Y of his shares of DC to Newco, as described in paragraph 15, in respect of which an election under subsection 85(1) will be made. The agreed amount in respect of each transfer will be deemed to be the Y's proceeds of disposition and Newco's cost thereof pursuant to paragraph 85(1)(a). For greater certainty, paragraph 85(1)(e.2) will not apply to the transfer.

C. Subject to the application of subsection 69(11), subsection 85(1) will apply to the transfer of each eligible property by DC to Newco, as described in paragraph 19, in respect of which an election under subsection 85(1) is made, such that the agreed amount in respect of each transfer of eligible property will be deemed to be DC's proceeds of disposition and Newco's cost thereof pursuant to paragraph 85(1)(a). For greater certainty, paragraph 85(1)(e.2) will not apply to the transfers.

D. On the redemption by Newco of its preferred shares held by DC, described in paragraph 22 above, and on the purchase for cancellation and redemption by DC of its common shares and preferred shares held by Newco, as described in paragraph 23 above:

(a) by virtue of subsection 84(3):

(i) Newco will be deemed to have paid, and DC will be deemed to have received, a taxable dividend at that time equal to the amount, if any, by which the amount paid to redeem the preferred shares exceeds the PUC of those shares immediately before the redemption; and

(ii) DC will be deemed to have paid, and Newco will be deemed to have received, a taxable dividend at that time equal to the amount, if any, by which the amount paid in respect of the purchase for cancellation of the common shares and the redemption of the preferred shares exceeds the PUC of those shares immediately before the purchase or the redemption, as the case may be;

(b) the taxable dividends deemed to have been received by each of Newco and DC as described in (a) above:

(i) will be included in the particular recipient's income pursuant to section 82 and paragraph 12(1)(j);

(ii) will be excluded from the proceeds of disposition of the shares so redeemed or purchased for cancellation by virtue of paragraph (j) of the definition of "proceeds of disposition" in section 54; and

(iii) will be deductible in computing the taxable income of the particular recipient for the year in which the dividend is deemed to have been received pursuant to subsection 112(1) and such deduction will not be denied by any of the provisions of subsections 112(2.1), (2.2), (2.3) or (2.4); and
(c) provided that each of DC and Newco is not entitled to a dividend refund in respect of its taxation year in which it is deemed to pay the dividend referred to in (a) above, DC and Newco will not be subject to Part IV tax under subsection 186(1) in respect of such dividend.

E. The taxable dividends described in ruling D.(a) above will not be subject to tax under Part IV.1 or Part VI.1.

F. Provided that, as part of the series of transactions or events that include these proposed transactions, there is not:

(a) a disposition of property in the circumstances described in subparagraph 55(3.1)(b)(i);

(b) an acquisition of control in the circumstances described in subparagraph 55(3.1)(b)(ii);

(c) an acquisition of property in the circumstances described in subparagraph 55(3.1)(b)(iii);

(d) an acquisition of property in the circumstances described in paragraph 55(3.1)(c); or

(e) an acquisition of property in the circumstances described in paragraph 55(3.1)(d);

which has not been described herein, by virtue of paragraph 55(3)(b), subsection 55(2) will not apply to the taxable dividends referred to in ruling D. (a) above and, for greater certainty, subsection 55(3.1) will not apply to deny the exemption under paragraph 55(3)(b).

G. The settlement of the Newco Note and the DC Note will not give rise to a "forgiven amount" within the meaning of subsection 80(1) or 80.01(1).

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

I. As a result of the proposed transactions described herein, 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 out in Information Circular 70-6R5 dated May 17, 2002 and are binding on the Canada Revenue Agency provided that the proposed transactions are completed before XXXXXXXXXX.

COMMENTS

Nothing in this ruling should be construed as implying that the Canada Revenue Agency has agreed to or reviewed:

(a) the determination of the adjusted cost base, paid-up capital or FMV of any shares or other property 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 above.

Yours truly,

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

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