2004 Ruling 2004-0075471R3 - Stated capital reduction by a public corporation

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 subsection 84(4.1) will apply to deem a dividend to arise on the proposed payment on the reduction of stated capital (and PUC) of a public corporation?

Position: No.

Reasons: Facts and law. The proposed payment on the reduction of stated capital (and PUC) will take place on the reorganization of the particular public corporation's business such that subsection 84(2) will apply.

XXXXXXXXXX 2004-007547

XXXXXXXXXX, 2004

Dear XXXXXXXXXX:

Re: XXXXXXXXXX . Advance Income Tax Ruling Request

This is in reply to your letter of 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 taxpayer has also represented that the proposed transactions described herein will not result in the taxpayer or any related person 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;

(b) "BCA" means the Canada Business Corporations Act, R.S.C. 1985, c. C-44, as amended from time to time;

(c) "Buyco1" means XXXXXXXXXX, a company organized under the laws of a U.S. jurisdiction;

(d) "Buyco2" means XXXXXXXXXX, a company organized under the laws of a U.S. jurisdiction;

(e) "Core Operations" means XXXXXXXXXX;

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

(g) XXXXXXXXXX;

(h) XXXXXXXXXX;

(i) XXXXXXXXXX;

(j) "Forco1" means XXXXXXXXXX, a company organized under the laws of the State of XXXXXXXXXX;

(k) "Forco2" means XXXXXXXXXX a company organized under the laws of the State of XXXXXXXXXX;

(l) "Forco3" means XXXXXXXXXX, a company described in Paragraph 4;

(m) "Forco4" means XXXXXXXXXX, a company organized under the laws of the State of XXXXXXXXXX;

(n) "Forco5" means XXXXXXXXXX, a company organized under the laws of a U.S. jurisdiction;

(o) "Holdco" means XXXXXXXXXX, a company described in Paragraph 5;

(p) "Non-Core Operations" means Opco1's preferred provider organization operations and care management operations carried on through Forco2 and Forco5 as described in Paragraph 7, the XXXXXXXXXX operations and all the activities in connection with the Opco2 Contract;

(q) "Opco1" means XXXXXXXXXX, a company described in Paragraph 1;

(r) "Opco2" means XXXXXXXXXX, a company described in Paragraph 6;

(s) "Opco2 Contract" means an agreement concluded between Opco1 and Opco2 for the XXXXXXXXXX;

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

(u) "Proposed Transactions" means the transactions described in Paragraphs 13 and 14;

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

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

(x) "stated capital" has the meaning assigned by the BCA;

(y) "Stock Exchange" means the XXXXXXXXXX Stock Exchange;

(z) "Sub1" means XXXXXXXXXX, a TCC governed by the BCA;

(aa) "Sub2" means XXXXXXXXXX, a TCC governed by the BCA;

(bb) "Subscription Receipt Agreement" means the agreement relating to an offering by Holdco of XXXXXXXXXX subscription receipts, each of which entitles the holder thereof to receive one common share of Opco1, owned directly or indirectly by Holdco, upon satisfaction of certain conditions and without payment of additional consideration to be qualified by prospectus; and

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

FACTS

1. Opco1 was incorporated on XXXXXXXXXX, under the BCA and is a public corporation and a TCC. Opco1 files its corporate income tax returns at the XXXXXXXXXX TC and its tax affairs are administered by the XXXXXXXXXX TSO.

XXXXXXXXXX.

Opco1's consolidated revenue in fiscal XXXXXXXXXX from its Core Operations and Non-Core Operations was $XXXXXXXXXX. In XXXXXXXXXX, Opco1 undertook a strategic review of its business operations with a view to enhancing shareholder value. This resulted in management's decision to focus on Opco1's Core Operations that offer long-term growth opportunities.

2. The authorized share capital of Opco1 consists of an unlimited number of common shares without par value and an unlimited number of preferred shares issuable in series. As at XXXXXXXXXX, there were XXXXXXXXXX common shares and no preferred shares of Opco1 issued and outstanding. The aggregate stated capital of the common shares of Opco1 is approximately $XXXXXXXXXX, and the PUC of such shares will be, at the time of the commencement of the Proposed Transactions, in excess of $XXXXXXXXXX per share.

3. Each holder of a common share of Opco1 is entitled to receive notice and attend all general and special meetings of the shareholders of Opco1 and to one vote per share at such meetings, and to receive dividends if, as and when declared by the directors of Opco1. Holders of the common shares of Opco1 will participate, pro rata, in any distribution of assets made by Opco1 upon its liquidation, dissolution or winding-up.

4. Forco3 is governed by the laws of XXXXXXXXXX and is a non-resident of Canada for the purposes of the Act. The sole shareholder of Forco3 is Sub2. The shares of Sub2 are XXXXXXXXXX % owned by Opco1 and XXXXXXXXXX% owned by Sub1, which is a wholly-owned subsidiary of Opco1. Forco3 currently owns short-term investments valued at more than US$XXXXXXXXXX which were derived substantially from the repayment of a US$XXXXXXXXXX loan from Forco3 to Forco2 as described in Paragraph 7 below. Recently, Sub2, as sole shareholder of Forco3, has approved a US$XXXXXXXXXX reduction in the capital of Forco3. Registration of this reduction in the capital of Forco3 by the XXXXXXXXXX is still pending.

5. Holdco is the corporation resulting from the amalgamation of XXXXXXXXXX . (which was originally incorporated under the BCA in XXXXXXXXXX), XXXXXXXXXX, which was effective on XXXXXXXXXX. Holdco is governed by the BCA and is a public corporation and a TCC. Holdco currently owns directly and indirectly XXXXXXXXXX common shares of Opco1 representing approximately XXXXXXXXXX% of the outstanding common shares of Opco1.

6. Opco2 is a public corporation, a TCC and a subsidiary controlled corporation of Holdco which holds XXXXXXXXXX% of Opco2's issued and outstanding common shares. Opco2 is governed by the BCA. Opco2 also has outstanding preference shares, all of which are non-voting, fixed value, non-participating and non convertible into common shares. All preference shares are held by persons who are not related to Holdco.

XXXXXXXXXX.

7. XXXXXXXXXX.

The sale of the preferred provider organization operations was effected on XXXXXXXXXX, by having Forco1 sell all its shares of Forco2 to Buyco1 for cash consideration of US$XXXXXXXXXX . At the time of the sale, Forco2 was a wholly-owned subsidiary of Forco1, Forco1 was a wholly-owned subsidiary of Forco4 and Forco4 was a wholly-owned subsidiary of Opco1. The sale of the Forco2 shares by Forco1 was also conditional upon the repayment by Forco2 of an interest-bearing loan of US$XXXXXXXXXX owing to Forco3 (the "Forco3 Loan"). In order to repay the Forco3 Loan, Opco1 borrowed US$XXXXXXXXXX from a Canadian bank (the "Bank Loan") and contributed such loan proceeds to Forco4 as a contribution to the common shares surplus of Forco4. Forco4 then contributed the proceeds to the common shares surplus of Forco1 and Forco1 then contributed the proceeds to the common shares surplus of Forco2. Forco2 then used these proceeds to repay the principal amount of the Forco3 Loan in full. Immediately thereafter, the proceeds from the sale of the Forco2 shares were distributed to Opco1 by having Forco4 wind-up into Opco1 which was followed by the wind-up of Forco1 into Opco1. Opco1 used a portion of these sale proceeds to repay the principal amount owing on the Bank Loan in full.

Forco3 has held, and continues to hold, a substantial portion of the proceeds it received from Forco2 as a result of the early repayment of the Forco3 Loan in the form of short-term investments.

8. On XXXXXXXXXX, Forco4 completed the sale of the care management operations by disposing of its shares of Forco5 to Buyco2 for total cash consideration of US$XXXXXXXXXX. As mentioned in Paragraph 7 above, Forco4 was wound-up into Opco1 shortly after the sale.

9. Recently, Holdco entered into the Subscription Receipt Agreement with a syndicate of underwriters led by XXXXXXXXXX (the "Underwriter"), on a bought deal basis, which represents a right to receive one common share of Opco1 from Holdco. The proceeds from the public offering of Opco1 common shares under the Subscription Receipt Agreement will be held in escrow until the delivery by Holdco and Underwriter of a joint notice confirming that the conditions of the release of the escrow have been satisfied. If the special cash distribution, as described in Paragraph 14 below, is unconditionally declared by Opco1 on or prior to XXXXXXXXXX, the subscription receipts will be automatically exchanged for common shares. If the special cash distribution is not unconditionally declared on or prior to XXXXXXXXXX, the escrowed subscription proceeds will be returned to investors with any accrued interest. If the special cash distribution resolution is passed, it is anticipated that the ex-distribution date for the special cash distribution will be XXXXXXXXXX, that the record date will be XXXXXXXXXX and that the special cash distribution will be paid on XXXXXXXXXX (i.e. Holdco will not receive any portion of the special cash distribution to be paid by Opco1).

Holdco expects to receive total gross proceeds of approximately $XXXXXXXXXX, net of an underwriters' fee of approximately $XXXXXXXXXX. Opco1 will become an independent, widely-held corporation as a result of Holdco's decision to sell its common shares of Opco1 through this public offering.

10. As part of the public offering of Opco1 common shares under the Subscription Receipt Agreement, Opco1 and Holdco have undertaken an extensive review of their existing bilateral commercial agreements and have signed a memorandum of understanding establishing the essential terms of their commercial relationship upon the closing of the public offering. The memorandum of understanding is conditional upon the unconditional declaration by the board of directors of Opco1 of the special cash distribution and the delivery by Holdco and Underwriter of a joint notice confirming that the conditions of the release of the escrow have been satisfied. In accordance with the terms of the memorandum of understanding, the following agreements have been or will be entered into:

(i) Opco1 will sell its XXXXXXXXXX operations to Opco2 on or before XXXXXXXXXX, or such later date as the parties may agree.

(ii) Opco2 and Opco1 have agreed to terminate the Opco2 Contract on XXXXXXXXXX, and Opco1 will transfer to Opco2 any residual intellectual property in connection with these legacy products; and

(iii) Opco2 has agreed to pay approximately C$XXXXXXXXXX in consideration of the above as well as for other minor assets transferred in relation to certain other services.

Opco2 and its subsidiaries are and will continue to be important customers of Opco1. To better define their on-going relationship, Opco1 and Opco2 have entered into a XXXXXXXXXX -year reciprocal commercial agreement whereby Opco1 will be the XXXXXXXXXX to Opco2 and its subsidiaries. The XXXXXXXXXX operations and the Opco2 Contract are Non-Core Operations of Opco1 and the execution of the above agreement is in accordance with Opco1's business strategy.

A transition plan for the continued use of the XXXXXXXXXX name and logo by Opco1 in its trade name and branding will be established. Opco1 anticipates that a new corporate name will be presented for approval by its shareholders in the near future.

11. Contemporaneously with the announcement of the Subscription Receipt Agreement, Opco1 announced its intention to pay on XXXXXXXXXX a special cash distribution by way of a return of its stated capital in the amount of $XXXXXXXXXX per common share to its shareholders (for a total of approximately $XXXXXXXXXX). Opco1 will convene a special meeting of shareholders on XXXXXXXXXX to seek approval of the special cash distribution, by way of a return of stated capital. The favourable vote of at least XXXXXXXXXX % of the votes cast by those in attendance or by proxy is required. Holdco has the right to vote its approximate XXXXXXXXXX% interest in Opco1 and has agreed irrevocably to vote in favour of the special cash distribution.

12. The transactions relating to the disposition of Opco1's Non-Core Operations described in Paragraphs 7, 8, 10(i) and 10(ii) above, have taken place, or will take place, as the case may be, outside the ordinary course of the business of Opco1 and its subsidiaries. Consolidated revenue generated from the above mentioned Non-Core Operations was more than $XXXXXXXXXX in XXXXXXXXXX, which represented more than XXXXXXXXXX% of Opco1's total consolidated revenue.

PROPOSED TRANSACTIONS

13. Subject to approval by the XXXXXXXXXX, Forco3 will distribute to Sub2, as a reduction of capital, an amount of US$XXXXXXXXXX, as described in Paragraph 4 above. Immediately after such distribution on the reduction of capital, Sub2 and Sub1, will each also effect a distribution on a return of stated capital, such that Opco1 will ultimately receive the US$XXXXXXXXXX distributed by Forco3. Opco1 will use a portion of these proceeds to finance its special cash distribution on the stated capital reduction described in Paragraph 14 below and intends to use the balance of such funds to make investments and/or acquisitions in its Core Operations.

14. Subject to the appropriate shareholders approval, Opco1 will effect to the benefit of the holders of Opco1 common shares, a return of stated capital of $XXXXXXXXXX per common share issued and outstanding as at XXXXXXXXXX, as described in Paragraph 11 above. Opco1 will use the proceeds of the stated capital reduction made by each of Sub1 and Sub2, as described in Paragraph 13 above, to fund the payment of its special cash distribution as a return of its stated capital provided the reduction of capital by Forco3 has been registered by the XXXXXXXXXX. If Forco3's reduction of capital is not registered by the XXXXXXXXXX at that time, Opco1 will borrow the amount required to make the special cash distribution as a return of its stated capital to its shareholders and will subsequently use a portion of the proceeds it will receive from Sub1 and Sub2 to repay any amount so borrowed.

For greater certainty, the proposed reduction in the stated capital of Opco1's common shares has not been preceded by an increase in the PUC of those shares that resulted in a dividend which Opco1 (or a predecessor corporation of Opco1, if any) elected to treat as having been paid out of its 1971 capital surplus on hand.

ADDITIONAL INFORMATION

15. On XXXXXXXXXX, the board of directors of Opco1 concluded unanimously that a second reduction of stated capital in an aggregate amount of $XXXXXXXXXX without any payment or distribution is in the best interests of Opco1 and recommended that the shareholders of Opco1 vote for the approval of such reduction at a special meeting to be held on XXXXXXXXXX. This stated capital reduction, if approved by the shareholders, will facilitate Opco1 to satisfy the solvency test provided by the BCA, if as, and when, the board of directors of Opco1 decides to pay dividends on such shares or repurchase such shares for cancellation. In the event that this second reduction of stated capital is approved by the shareholders, its effective time will be after the approval of the special cash distribution by way of a return of capital in the amount of $XXXXXXXXXX per common shares issued and outstanding as at XXXXXXXXXX as described in Paragraph 14 above.

PURPOSES OF THE PROPOSED TRANSACTIONS

16. In the execution of its business strategy, Opco1 is reorganizing its operations to focus on its Core Operations by selling or terminating its Non-Core Operations with a view to enhancing shareholder value. In light of this objective, Opco1 wishes to return a portion of its stated capital to its shareholders by using a portion of the amount that may reasonably be considered to have been derived from the proceeds of the sale of its Non-Core Operations.

RULING 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. Subsection 84(2) will apply, and subsection 84(4.1) will not apply, to the special cash distribution made by Opco1 in respect of the reduction to its stated capital account maintained in respect of its common shares, described in Paragraph 14 above, such that Opco1 will be deemed to have paid, and each holder of Opco1 common shares will be deemed to have received, a dividend only to the extent that the amount so distributed by Opco1 to each such holder on the stated capital reduction exceeds the amount by which the PUC in respect of such shares is reduced.

The above ruling is given subject to the limitations and qualifications set out in IC 70-6R5 and are binding on the CRA 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 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; 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, including for greater certainty, any income tax consequences relating to the distribution on reduction of capital of Forco3 described in Paragraph 13.

Yours truly,

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