2004 Ruling 2004-0069751R3 - Buy, Bump and Sell Transactions

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: Bump on farm land owned by a farm corporation when the shares of the farm corporation are acquired by a land developer and the farm corporation is wound-up.

Position: Yes.

Reasons: The law.

XXXXXXXXXX 2004-006975

XXXXXXXXXX, 2004

Dear XXXXXXXXXX:

Re: XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
Advance Income Tax Ruling Request

This is in reply to your letter of XXXXXXXXXX, which revised your original ruling request dated XXXXXXXXXX, and your other correspondence, wherein you requested an advance income tax ruling on behalf of the above-noted taxpayers. 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 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, and the Income Tax Regulations thereunder are referred to as the "Regulations";

(b) "adjusted cost base" (also referred to as "ACB") as defined in section 54 and subsection 248(1);

(c) "BCA" means the Business Corporations Act XXXXXXXXXX;

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

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

(f) "CRA" means the Canada Revenue Agency;

(g) "DeveloperCo" means XXXXXXXXXX;

(h) "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, expressed in terms of cash;

(i) "Farmco1" means XXXXXXXXXX;

(j) "Farmco2" means XXXXXXXXXX;

(k) "Land" consists of the XXXXXXXXXX acres of farm land located in the XXXXXXXXXX;

(l) "Newco" means XXXXXXXXXX;

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

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

(o) "Parent" means XXXXXXXXXX;

(p) "Proposed Transactions" means the transactions described in Paragraphs 19 to 24;

(q) "PurchaseCo" means XXXXXXXXXX;

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

(s) "Sibling1" means XXXXXXXXXX;

(t) "Sibling1 Family Trust" means the XXXXXXXXXX;

(u) "Sibling1 Spouse" means XXXXXXXXXX;

(v) "Sibling2" means XXXXXXXXXX;

(w) "Sibling2 Family Trust" means the XXXXXXXXXX;

(x) "Sibling2 Spouse" means XXXXXXXXXX and

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

FACTS

1. Farmco1 is a taxable Canadian corporation that was established by Sibling1 on XXXXXXXXXX under the BCA. Farmco1's CRA business number is XXXXXXXXXX and it files its corporate income tax returns with the XXXXXXXXXX TC but otherwise deals with the XXXXXXXXXX TSO. Farmco1's principal asset is a 50% undivided interest in the Land that was used by it in a farming business, as described in Paragraph 3 below. Farmco1's 50% undivided interest in the Land is capital property to Farmco1 and its ACB is $XXXXXXXXXX .

2. Farmco2 is a taxable Canadian corporation that was established by Sibling2 on XXXXXXXXXX under the BCA. Farmco1's CRA business number is XXXXXXXXXX and it files its corporate income tax returns with the XXXXXXXXXX TC but otherwise deals with the XXXXXXXXXX TSO. Farmco2's principal asset is a 50% undivided interest in the Land that was used by it in a farming business as described in Paragraph 3 below. Farmco2's 50% undivided interest in the Land is capital property to Farmco2 and its ACB is $XXXXXXXXXX .

3. Until XXXXXXXXXX , each of Farmco1 and Farmco2 carried on the business of farming. In XXXXXXXXXX , the Land that was used by each of Farmco1 and Farmco2 in its respective farming business was leased to a local farmer who continues to use such Land in his farming business. Historically, the Land that is currently owned by Farmco1 and Farmco2 was originally purchased by XXXXXXXXXX (now deceased) in XXXXXXXXXX . In XXXXXXXXXX , the Land was sold by XXXXXXXXXX to his son, XXXXXXXXXX , who continued to farm the Land until XXXXXXXXXX , when he transferred an undivided equal interest in such Land to his two children, Sibling1 and Sibling2. In particular, XXXXXXXXXX sold an equal, undivided interest in 50% of the Land to Sibling1 and Sibling2 for $XXXXXXXXXX each, and transferred the remaining 50% of the Land to Sibling1 and Sibling2 by inter vivos gift each as to an equal, undivided interest. As a result of the sale and inter vivos gift, Sibling1 and Sibling2 acquired their respective 50% undivided interest in the Land each with an adjusted cost base of $XXXXXXXXXX .

4. On XXXXXXXXXX , each of Sibling1 and Sibling2 transferred their respective undivided 50% interest in the Land to Farmco1 and Farmco2, as the case may be, for shares issued by the particular corporation. In particular, Sibling1 transferred his 50% undivided interest in the Land to Farmco1 at a time when its fair market value was $XXXXXXXXXX and elected under section 85 to have the agreed amount equal to $XXXXXXXXXX . Sibling1 received XXXXXXXXXX Class "A" Common Shares of Farmco1 with a stated capital of $XXXXXXXXXX , and a promissory note in the amount of $XXXXXXXXXX . Similarly, Sibling2 transferred her 50% undivided interest in the Land to Farmco2 at a time when its fair market value was $XXXXXXXXXX and elected under section 85 to have the agreed amount equal to $XXXXXXXXXX . Sibling2 received XXXXXXXXXX Class "A" Common Shares of Farmco2 with a stated capital of $XXXXXXXXXX , and a promissory note in the amount of $XXXXXXXXXX .

5. The current issued and outstanding share capital of Farmco1 and the fair market value of each class of shares held by each of the shareholders of Farmco1 is as follows:

Shareholder
Number and Class
FMV

Sibling1
XXXXXXXXXX Preferred
XXXXXXXXXX
Sibling1 Spouse
XXXXXXXXXX Common
XXXXXXXXXX
Family Trust1
XXXXXXXXXX Common
XXXXXXXXXX
Parent
XXXXXXXXXX Preferred
XXXXXXXXXX

The fair market value of the issued and outstanding shares of Farmco1 described above is based on the expected fair market value of such shares after the removal of certain miscellaneous assets which are not being acquired by PurchaseCo as described below. Accordingly, the only asset which will remain in Farmco1 at the time that all of the issued and outstanding shares of Farmco1 are transferred to PurchaseCo as set out in the Proposed Transactions described below, will be its 50% undivided interest in the Land.

6. The issued and outstanding share capital of Farmco2 and the fair market value of such class of shares held by each of the shareholders of Farmco2 is as follows:

Shareholder
Number and Class
FMV

Sibling2
XXXXXXXXXX Preferred
XXXXXXXXXX
Sibling2 Spouse
XXXXXXXXXX Common
XXXXXXXXXX
Family Trust2
XXXXXXXXXX Common
XXXXXXXXXX
Parent
XXXXXXXXXX Preferred
XXXXXXXXXX

The fair market value of the issued and outstanding shares of Farmco2 described above is based on the fair market value of such shares after the removal of certain miscellaneous assets which are not being acquired by PurchaseCo as described below. The only asset which will remain in Farmco2 at the time that all of the issued and outstanding shares of Farmco2 are transferred to PurchaseCo, as set out the Proposed Transactions described below, will be its 50% undivided interest in the Land.

7. Sibling1 and Sibling1 Spouse are married and are both residents of Canada for purposes of the Act. Sibling2 and Sibling2 Spouse are married and are both residents of Canada for purposes of the Act. Parent is the surviving parent of Sibling1 and Sibling2 and is a resident of Canada for purposes of the Act.

8. Sibling1, Sibling1 Spouse and Parent are trustees of Sibling1 Family Trust, which Parent settled on XXXXXXXXXX . The beneficiaries of Sibling1 Family Trust are the four children of Sibling1 and Sibling1 Spouse.

9. Sibling2 and Sibling2 Spouse and Parent are trustees of Sibling2 Family Trust, which Parent settled on XXXXXXXXXX . The beneficiaries of Sibling2 Family Trust are the four children of Sibling2 and Sibling2 Spouse.

10. DeveloperCo is a taxable Canadian corporation that was incorporated under the BCA. DeveloperCo's CRA business number is XXXXXXXXXX and it files its corporate income tax returns with the XXXXXXXXXX TC but otherwise deals with the XXXXXXXXXX TSO. DeveloperCo is a bare trustee for XXXXXXXXXX corporate joint venture participants (the "JVPs"). The JVPs carry on the business of real estate development and are interested in acquiring the Land owned by Farmco1 and Farmco2 for the purpose of development and resale.

11. PurchaseCo is a taxable Canadian corporation that was incorporated under the BCA. PurchaseCo's CRA business number is XXXXXXXXXX and it files its corporate income tax returns with the XXXXXXXXXX TC but otherwise deals with the XXXXXXXXXX TSO. PurchaseCo carries on the business of real estate investing and sales, and is interested in acquiring the Land owned by Farmco1 and Farmco2 for the purpose of resale. PurchaseCo owns all of the issued XXXXXXXXXX common shares of Newco, which has been incorporated for the purposes of the Proposed Transactions. Newco's CRA business number is XXXXXXXXXX .

12. DeveloperCo, PurchaseCo and Newco all deal at arm's length with each of Farmco1 and Farmco2 and each such corporation's shareholders. Furthermore, DeveloperCo, PurchaseCo and Newco do not, and will not, have any ownership interest in Farmco1 or Farmco2 immediately prior to the commencement of the Proposed Transactions.

13. Residential development in the City of XXXXXXXXXX has occurred on lands adjacent to and in the vicinity of the Land. Houses have been built on much of the surrounding areas and the City of XXXXXXXXXX has approved a Neighbourhood Area Structure Plan ("NASP") (as discussed in more detail below) that contemplates the Land being zoned for residential use.

14. As part of the development process that has occurred in the vicinity of the Land, adjacent third party land owners (the "Third Party Owners"), who are unrelated to each of Farmco1 and Farmco2 and each such corporation's shareholders, commenced the process of creation of a NASP affecting their own lands, and in that process, the Third Party Owners included approximately XXXXXXXXXX % of the Land in the NASP. The NASP has been approved by the municipality with the said portion of the Land included in the approved NASP. The balance of the Land remains without inclusion in any NASP. All activities relating to the creation and approval of the NASP were conducted by the Third Party Owners with the knowledge of, but without consent, opposition or participation from Farmco1, Farmco2 or each such corporation's shareholders.

15. Prior to the commencement of the Proposed Transactions, a corporation which has some of the same shareholders and directors as DeveloperCo, XXXXXXXXXX , and which also owns lands in the vicinity of the Land has undertaken due diligence and feasibility studies respecting the Land and its development at its own cost and expense. In addition, at its own cost and expense, XXXXXXXXXX has pursued normal preliminary planning activities, including physical inspections of the Land, testing and preliminary surveying on the Land. XXXXXXXXXX has also initiated procedures and applications for changes to the zoning affecting a portion of the Land included in the NASP (from Agricultural to Residential use). These procedures and applications have been undertaken with the knowledge, but without the consent, opposition or participation of Farmco1, Farmco2 or each such corporation's shareholders. A formal application for rezoning was made by DeveloperCo to the City of XXXXXXXXXX on XXXXXXXXXX and the rezoning of the Land was approved.

PRELIMINARY TRANSACTIONS

16. Immediately prior to the Proposed Transactions contemplated herein, each of Farmco1 and Farmco2 will own assets other than the Land ("surplus assets") which have an aggregate approximate fair market value of about $XXXXXXXXXX to each such corporation. These surplus assets will be removed prior to the sale of the shares of each such corporation to PurchaseCo as described below.

17. A number of XXXXXXXXXX Preferred Shares of Farmco1 currently owned by Parent and having an aggregate fair market value of $XXXXXXXXXX will be transferred to XXXXXXXXXX . ("Transferee1"), which is wholly-owned by Sibling1, in exchange for fair market value consideration being newly issued shares of Transferee1.

Similarly, a number of XXXXXXXXXX Preferred Shares of Farmco2 currently owned by Parent and having an aggregate fair market value of $XXXXXXXXXX will be transferred to XXXXXXXXXX . ("Transferee2"), which is wholly-owned by Sibling2, in exchange for fair market value consideration being newly issued shares of Transferee2.

18. Farmco1 and Farmco2 will then each redeem its XXXXXXXXXX Preferred Shares held by Transferee1 and Transferee2, as the case may be, at their fair market value. As consideration for such redemption, Farmco1 will transfer its surplus assets to Transferee1 and Farmco2 will transfer its surplus assets to Transferee2. For greater certainty, the surplus assets of each Farmco1 and Farmco2 represent less than 10% of the gross asset value of such corporation immediately before the particular transfer and the Class C Preferred Shares of each such corporation owned by Transferee1 and Transferee2, as the case may be, will have safe income on hand at least equal to the amount of the deemed dividend arising from such redemption.

PROPOSED TRANSACTIONS

19. PurchaseCo will purchase all of the issued and outstanding shares of each of Farmco1 and Farmco2 (referred to collectively as the "Shares") from each such corporation's shareholders (referred to as a "Vendor" or collectively as "Vendors", as the case may be) for their aggregate fair market value of $XXXXXXXXXX . As sole consideration for the purchase price of the Shares owned by each Vendor, PurchaseCo will pay cash on closing equal to the fair market value of such Vendor's shares of the particular corporation. You confirm that PurchaseCo is acting as principal and not as agent for any other person with respect to its acquisition of the Shares and ultimately the Land.

Specifically, each Vendor will receive the following:

Farmco2

Shareholder

Cash on Closing

Sibling1 Spouse
XXXXXXXXXX
Sibling1 Family Trust
XXXXXXXXXX
Sibling1
XXXXXXXXXX
Parent
XXXXXXXXXX
Total
XXXXXXXXXX

Farmco2

Shareholder

Cash on Closing

Sibling2 Spouse
XXXXXXXXXX
Sibling2 Family Trust
XXXXXXXXXX
Sibling2
XXXXXXXXXX
Parent
XXXXXXXXXX
Total
XXXXXXXXXX

20. PurchaseCo will then transfer all of the Shares of Farmco1 and Farmco2 to Newco in exchange for a non-interest bearing demand promissory note payable by Newco (the "Newco Note") to PurchaseCo having a principal amount and fair market value of $XXXXXXXXXX and one newly issued XXXXXXXXXX common share in Newco. Each of PurchaseCo and Newco will make a joint election under subsection 85(1) on a protective basis, electing at the cost amount of such Shares, in the event that the fair market value of the Shares have somehow increased after such shares are acquired by PurchaseCo and before they are transferred to Newco. For greater certainty, the only property owned by Farmco1 and Farmco2 at the time of the Shares are transferred from PurchaseCo to Newco will be its respective 50% undivided interest in the Land.

21. Farmco1 and Farmco2 will each commence winding-up under the applicable provisions of the BCA into Newco such that the 50% undivided interest in the Land owned by each of Farmco1 and Farmco2 will be distributed to Newco on these windings-up.

22. In filing its income tax return for its taxation year in which Farmco1 and Farmco2 are wound-up, Newco will designate an amount (the "Designated Amount") in respect of Farmco1 and Farmco2's respective 50% undivided interest in the Land as follows:

(a) The Designated Amount with respect to the 50% undivided interest in the Land distributed to Newco from Farmco1 will not exceed the amount by which the aggregate ACB to Newco of all its shares of Farmco1 immediately before the winding-up of Farmco1 exceeds the total of the amounts described in subparagraphs 88(1)(d)(i) and (i.1). Further, the Designated Amount with respect to the 50% undivided interest in the Land distributed from Farmco1 will not exceed the amount by which the fair market value of Farmco1's 50% undivided interest in the Land at the time Newco last acquired control of Farmco1 exceeds the cost amount to Farmco1 of its 50% undivided interest in the Land immediately before the winding-up. Farmco1 will not own any other property at the time of its winding-up into Newco.

(b) The Designated Amount with respect to the 50% undivided interest in the Land distributed to Newco from Farmco2 will not exceed the amount by which the aggregate ACB to Newco of all its shares of Farmco2 immediately before the winding-up of Farmco2 exceeds the total of the amounts described in subparagraphs 88(1)(d)(i) and (i.1). Further, the Designated Amount with respect to the 50% undivided interest in the Land distributed from Farmco2 will not exceed the amount by which the fair market value of Farmco2's 50% undivided interest in the Land at the time Newco last acquired control of Farmco2 exceeds the cost amount to Farmco2 of its 50% undivided interest in the Land immediately before the winding-up. Farmco2 will not own any other property at the time of its winding-up into Newco.

No interest in the Land (or property in substitution therefore within the meaning of clause 88(1)(c)(vi)(B)) will be distributed to any person described in any of subclauses 88(1)(c)(vi)(B)(I), (II) or (III) as part of the series of transactions or events that includes the winding-up of either Farmco1 or Farmco2 into Newco.

23. Newco will then transfer the Land to PurchaseCo at its fair market value. It is anticipated that the fair market value of the Land at the time of this transfer will be $XXXXXXXXXX . As consideration for the transfer of the Land from Newco to PurchaseCo, the principal amount of $XXXXXXXXXX owing by Newco to PurchaseCo under the Newco Note will be offset against the purchase price owing by PurchaseCo to Newco in respect of the Land in its entirety and the Newco Note will be cancelled. It is anticipated that the XXXXXXXXXX common shares of Newco owned by PurchaseCo will remain outstanding indefinitely.

24. PurchaseCo will then transfer the Land to DeveloperCo as bare trustee for the JVPs for $XXXXXXXXXX , plus interest. As consideration for the transfer of the Land to DeveloperCo, PurchaseCo will receive the $XXXXXXXXXX as follows: cash on closing of $XXXXXXXXXX and a vendor take-back mortgage in the amount of $XXXXXXXXXX , plus interest at a rate of prime plus XXXXXXXXXX %.

ADDITIONAL INFORMATION

25. It is the intention that DeveloperCo will develop the Land for resale. Due to the relationship between DeveloperCo and XXXXXXXXXX , (as an owner of some adjacent land), DeveloperCo has the immediate ability to service the Land for development, whereas other parties may not have that immediate ability. Accordingly, DeveloperCo will continue with its planning activities relating to the Land. These activities will include the preparation of subdivision, engineering and servicing plans for the Lands, but it will not proceed with subdivision of the Land until it becomes the owner thereof and the Proposed Transactions have been consummated.

26. Neither Farmco1 nor Farmco2 has acquired its 50% undivided interest in the Land in the course of a reorganization in which a dividend was received to which subsection 55(2) would, but for paragraph 55(3)(b), apply.

27. It is your view that the characterization of the Land as capital property to each of Farmco1 and Farmco2 will not change as a result of the pre-development activities on the Land described in Paragraphs 13, 14, 15 and 25 above, and zoning changes on the Land that have taken place before the Proposed Transactions. Consequently, you maintain that the 50% undivided interest in the Land will be capital property to each of Farmco1 and Farmco2 at the time Newco last acquired control of each such corporation for the purposes of paragraphs 88(1)(c) and (d).

28. Neither Newco nor any corporation with which it does not deal at arm's length has or will have received any amount as a taxable dividend, a capital dividend or a life insurance capital dividend in respect of any of the shares of Farmco1 or Farmco2.

29. For greater certainty, you advise that none of the Proposed Transactions have been undertaken, commenced, entered into, or otherwise completed prior to the issuance of this letter.

PURPOSE OF THE PROPOSED TRANSACTIONS

30. The Proposed Transactions will permit PurchaseCo to acquire the Land owned by Farmco1 and Farmco2 for its fair market value and will allow each of the Vendors to claim their capital gains deduction for qualified farm property, pursuant to subsection 110.6(2) of the Act. Newco is required by PurchaseCo to protect it from an outstanding litigation claim against Farmco2. After PurchaseCo acquires the Land from Newco, DeveloperCo will then be able to acquire the Land directly from PurchaseCo at fair market value.

RULINGS

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. On the winding-up of each of Farmco1 and Farmco2 into Newco as described in Paragraph 21, Newco will be deemed to have disposed of its shares of each such corporation on the respective winding-up for proceeds equal to the greater of the amounts determined pursuant to subparagraphs 88(1)(b)(i) and (ii).

B. On the winding-up of each of Farmco1 and Farmco2 into Newco, as described in Paragraph 21 above, provided that no property acquired by Newco on such winding-up or "any other property acquired by any person in substitution therefor" (within the meaning of that phrase for the purposes of clause 88(1)(c)(vi)(B)) is acquired by any person described in any of subclauses 88(1)(c)(vi)(B)(I), (II) or (III) (on the assumption that the "subsidiary" referred to in those subclauses is Farmco1 and Farmco2, as the case may be, and the "parent" is Newco) as part of the series of transactions or events that includes the Proposed Transactions described herein, the cost to Newco of the 50% undivided interest in the Land owned by each of Farmco1 and Farmco2 at the time Newco last acquired control of each such corporation and that became property of Newco pursuant to the winding-up will be deemed by paragraph 88(1)(c) to be the cost amount of such property plus, on the assumption that such property is capital property, but not depreciable property, the amount designated by Newco under paragraph 88(1)(d) in respect of the property as described in Paragraph 22 above.

The above Rulings are subject to the limitations and qualifications set out in Information Circular 70-6R5 dated May 17, 2002 and are binding on CRA 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 and the Regulations which, if enacted into law, could have an effect on the rulings provided herein.

OTHER COMMENTS

You have requested a ruling that the 50% undivided interest in the Land owned by each of Farmco1 and Farmco2 will be capital property at the time Newco last acquired control of each of Farmco1 and Farmco2 for the purposes of paragraphs 88(1)(c) and (d). As we discussed, we are not able to grant any ruling or opinion on this matter because it involves an issue that is solely dependent on the facts. Consequently, the determination of this matter is subject to future verification by the CRA's audit branch and should it be subsequently be determined by CRA or a court that the 50% undivided interest in the Land is not capital property to such corporation at the relevant time, the ruling given above would not be binding.

In addition, nothing in this letter should be construed as implying that the CRA 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, including for greater certainty, the fair market value of the shares of Farmco1 and Farmco2 and the fair market value of the Land;

(b) whether the shares of Farmco1 and Farmco2 are "qualified farm property" within the meaning of that term in subsection 110.6(1);

(c) the amount of any "safe income" or "safe income on hand" that may be attributable to any share; or

(d) 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 Planning Branch