2004 Ruling 2004-0079541R3 - Transfer of shares of FA a related non-resident

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: (i) Whether subsection 85.1(3) would apply in a situation where a taxpayer transfers both cash and shares of a foreign affiliate ("FA1") to another foreign affiliate ("FA2") in exchange for "shares" (i.e., an additional "capital contribution" having a face value equal to the amount of cash transferred) of FA2? (ii) Whether a benefit is considered to have been conferred on a minority interest owner, who is a wholly-owned subsidiary of the taxpayer, of FA2 as a result of the transfer described in (i) above? (iii) Whether a non-resident transferor who has no nexus to Canada would be considered to be a taxpayer for the purposes of subsection 85(1) with respect to the transfer of eligible property that is not taxable Canadian property?

Position: (i) Yes. (ii) No. (iii) Probably not.

Reasons: (i) For the particular situation at issue, the additional "capital contribution" of FA2 would be considered "share" in accordance with IT-392 and it appears a "share" or a portion thereof is received as consideration for the disposition of FA1 shares for the purposes of subsection 85.1(3) in this case. There is also no particular policy reason to deny the application of subsection 85.1(3) in this case. (ii) Since the potential beneficiary (if there were a benefit conferred) is a wholly-owned subsidiary of the taxpayer and since such subsidiary will be wound up immediately after the transfer, no benefit is considered to have been conferred. (iii) In view of the Oceanspan case and the Lea-Don case, it may be difficult to say that such a non-resident person is a taxpayer for the purposes of the Income Tax Act. We do not have to make the determination in this regard because the taxpayer decided to carry out the proposed transactions without making a subsection 85(1) election.

XXXXXXXXXX 2004-007954

XXXXXXXXXX, 2004

Dear XXXXXXXXXX:

Re: XXXXXXXXXX ("Canco")
Advance Income Tax Ruling

We are writing in reply to your letter of XXXXXXXXXX in which you requested an advance income tax ruling on behalf of the above-referenced taxpayer. We also acknowledge the additional information you provided during our several telephone conversations and e-mail correspondences and the receipt of the revised ruling request, dated XXXXXXXXXX.

Canco's tax affairs are administered by the XXXXXXXXXX Tax Services Office and it files its tax returns at the XXXXXXXXXX Taxation Centre under Account Number XXXXXXXXXX.

To the best of your knowledge and that of the taxpayer involved, none of the issues involved with this request:

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

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

(iii) is under objection; or

(iv) is before the courts or, if a judgement has been issued, the time limit for appeal has not expired.

Definitions

In this letter the following terms have the meanings specified:

(a) "Act" means the Income Tax Act R.S.C. 1985 c.1 (5th Supp.), as amended to the date hereof, and unless otherwise stated, every reference herein to a Part, section, subsection, paragraph or subparagraph is a reference to the relevant provisions of the Act;

(b) "adjusted cost base" has the meaning assigned to that term by section 54.

(c) "arm's length" has the meaning assigned to that term by subsection 251(1).

(d) "capital property" has the meaning assigned to that term by section 54.

(e) "Canco" means XXXXXXXXXX, a corporation incorporated under the XXXXXXXXXX. The business number for Canco is XXXXXXXXXX.

(f) "CanHoldco" means XXXXXXXXXX, a corporation incorporated under the XXXXXXXXXX during XXXXXXXXXX.

(g) "CanSubco" means XXXXXXXXXX, a corporation incorporated under the XXXXXXXXXX. The business number for CanSubco is XXXXXXXXXX.

(h) "foreign affiliate" and "controlled foreign affiliate" each has the meaning assigned to that term by subsection 248(1).

(i) "Hungarian LLC" means XXXXXXXXXX.

(j) "Hungary Treaty" means the Canada-Hungary Income Tax Convention, as modified.

(k) "Koreanco" means XXXXXXXXXX, an entity formed in Korea.

(l) "Korean Opco" means XXXXXXXXXX which was incorporated as a joosik-hwesa (a.k.a. Chusik Hoesa) under the Korean statute entitled the Commercial Act, which governs the existence of enterprises that have the purpose of profit-making.

(m) "Korea Treaty" means the Canada-Korea Income Tax Convention.

(n) "non-resident" has the meaning assigned to that term by subsection 248(1).

(o) "NSULC" means XXXXXXXXXX.

(p) XXXXXXXXXX.

(q) "subsidiary wholly-owned corporation" has the meaning assigned to that term by subsection 248(1).

(r) "taxable Canadian corporation" has the meaning assigned to that term by subsection 89(1).

(s) "taxable Canadian property" has the meaning assigned to that term by subsection 248(1).

(t) "U.K. Holdco" means XXXXXXXXXX incorporated under the laws of the U.K.

(u) "U.K. Treaty" means the Canada-United Kingdom Income Tax Convention, as amended.

(v) "U.S. Holdco" means XXXXXXXXXX, a corporation incorporated in the U.S. under the laws of the State of XXXXXXXXXX.

(w) "U.S. Parent" means XXXXXXXXXX, a corporation incorporated in the U.S under the laws of the State of XXXXXXXXXX. It has its registered office at XXXXXXXXXX. U.S. Parent is a publicly held corporation listed on the XXXXXXXXXX Stock Exchange.

(x) "U.S. Subco" means XXXXXXXXXX, a corporation incorporated in the U.S. under the laws of the State of XXXXXXXXXX.

(y) "U.S. Treaty" means the Canada-United States Income Tax Convention, as amended.

Facts

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

1. XXXXXXXXXX.

2. U.S. Holdco's common stock is owned XXXXXXXXXX% by U.S. Parent. XXXXXXXXXX, a subsidiary wholly-owned corporation of U.S. Parent, owns XXXXXXXXXX shares of Series A Preferred Stock (XXXXXXXXXX% preferred dividend, non-participating, non-voting and no liquidation preference) of U.S. Holdco. U.S. Holdco manufactures XXXXXXXXXX products at XXXXXXXXXX located in the U.S., and is also the owner of patents and trademarks. In addition, U.S. Holdco is the primary direct/indirect holding company for its subsidiary companies located in various jurisdictions around the world.

3. U.S. Subco is a subsidiary wholly-owned corporation of U.S. Holdco. It is the parent company of a group of companies located in various jurisdictions around the world.

4. Each of U.S. Parent, U.S. Holdco and U.S. Subco is a non-resident of Canada and does not carry on business in Canada for purposes of the Act, and does not have a permanent establishment in Canada as defined under Article V of the U.S. Treaty. None of U.S. Parent, U.S. Holdco or U.S. Subco is a "limited liability company" ("LLC"), governed by LLC legislation of a particular State of the U.S.

5. CanHoldco is a subsidiary wholly-owned corporation of U.S. Subco.

6. CanSubco is a subsidiary wholly-owned corporation of CanHoldco.

7. Canco is a subsidiary wholly-owned corporation of CanSubco. Canco's issued share capital consists of XXXXXXXXXX voting Class A common shares. XXXXXXXXXX. The fair market value of the shares of Canco is not derived principally from real property situated in Canada.

8. Each of CanHoldco, CanSubco and Canco is a taxable Canadian corporation and has its registered office at XXXXXXXXXX. Each of CanHoldco, CanSubco and Canco files its respective T2 income tax return at the XXXXXXXXXX Taxation Centre, and is serviced by the XXXXXXXXXX Tax Services Office.

9. XXXXXXXXXX.

10. The shares of Korean Opco are held as follows:

(a) XXXXXXXXXX% by Canco;

(b) XXXXXXXXXX% by Koreanco; and,

(c) XXXXXXXXXX% by U.S. Parent.

Canco acquired its XXXXXXXXXX% interest (XXXXXXXXXX common shares) in Korean Opco in XXXXXXXXXX from U.S. Parent. Such common shares constitute capital property of Canco.

Korean Opco is a non-resident of Canada and does not carry on business in Canada for purposes of the Act, and does not have a permanent establishment in Canada as defined under Article 5 of the Korea Treaty.

Korean Opco is principally engaged in the business of XXXXXXXXXX in Korea.

11. Koreanco is unrelated to the U.S. Parent group of companies, and it deals at arm's length with all the other entities described herein.

12. U.K. Holdco is a subsidiary wholly-owned corporation of U.S. Holdco. U.K. Holdco is a non-resident of Canada, does not carry on business in Canada for the purposes of the Act, and does not have a permanent establishment in Canada as defined under Article 5 of the U.K. Treaty. U.K. Holdco is a holding company.

13. Hungarian LLC is incorporated as a Korlatolt Feleossegu Tarsaag ("KFT") under the Hungarian legislation governing business associations entitled Act CXLIV of 1997 on Business Associations (the "HBA Act").

U.S. Holdco has all of the beneficial interest (represented by a business share) in Hungarian LLC.

In respect of its business share in Hungarian LLC, U.S. Holdco has made a capital contribution of XXXXXXXXXX Hungarian Forint ("HUF").

Hungarian LLC is a not resident in Canada, does not carry on business in Canada for the purposes of the Act, and does not have a permanent establishment in Canada as defined under Article 5 of the Hungarian Treaty.

Hungarian LLC is a distributor of XXXXXXXXXX.

Hungarian LLC is valued at approximately US$XXXXXXXXXX (approx. CDN$XXXXXXXXXX).

14. NSULC is a subsidiary wholly-owned corporation of Canco. It is a taxable Canadian corporation. XXXXXXXXXX.

Proposed Transactions

15. U.S. Holdco will contribute additional cash in the amount of XXXXXXXXXX HUF or approximately US$XXXXXXXXXX (approx. CDN$XXXXXXXXXX) to Hungarian LLC. After the transaction outlined in paragraph 17 below, U.S. Holdco will have a business share with a capital contribution of XXXXXXXXXX HUF, or XXXXXXXXXX% of Hungarian LLC.

16. Canco will contribute US$XXXXXXXXXX to NSULC in exchange for shares of NSULC.

17. NSULC will contribute cash in the amount of US$XXXXXXXXXX (approx. CDN$XXXXXXXXXX) to Hungarian LLC in exchange for a business share of Hungarian LLC with a capital contribution of XXXXXXXXXX HUF. The amount of US$XXXXXXXXXX represents XXXXXXXXXX% of the value of Hungarian LLC, thereby providing NSULC with a XXXXXXXXXX% interest in Hungarian LLC.

The articles of association of Hungarian LLC will provide that each business share will have voting rights proportionate to their capital contribution. The articles of association will not provide for an alternative method of determining dividend and liquidation rights. That is, such rights will also be proportionate with each business share's capital contribution (see paragraph 29 for further discussion of characteristics of business shares).

18. U.S. Holdco will transfer its XXXXXXXXXX% interest in Hungarian LLC to Canco and will receive, as consideration, shares of Canco with an aggregate fair market value equal to the fair market value of U.S. Holdco's XXXXXXXXXX% interest in Hungarian LLC. U.S. Holdco will direct Canco to issue the shares of Canco to CanSubco. U.S. Holdco will not receive any consideration from CanSubco for this disposition. U.S. Holdco will apply to the Canada Revenue Agency ("CRA") for a certificate under section 116 in respect of the disposition of the Canco shares to CanSubco.

19. U.S. Parent will cause a new company ("Hungary Newco") to be formed in Hungary with a capital of XXXXXXXXXX HUF or approximately CDN$XXXXXXXXXX. Hungary Newco will be a KFT incorporated under the laws of Hungary.

20. U.S. Parent will make a capital contribution consisting of its XXXXXXXXXX% ownership in Korean Opco to Hungary Newco.

21. Canco will amend its articles to authorize a class of preferred shares once the taxpayers obtain this ruling letter.

22. CanHoldco will subscribe for one preferred share of Canco.

23. Canco will transfer cash of XXXXXXXXXX HUF (approx. CDN$XXXXXXXXXX) and its XXXXXXXXXX% interest in Korean Opco to Hungarian LLC in exchange for XXXXXXXXXX HUF in additional capital contribution of Hungarian LLC. This transaction will occur under subsection 85.1(3). Hungarian LLC will not dispose of the shares of Korean Opco to a person with whom Canco does not deal at arm's length as part of the series of transactions or events that includes the proposed transactions described herein.

24. NSULC will be wound up into Canco under subsection 88(1).

As Canco has more than one owner (i.e., CanSubco and CanHoldco), the requirements of Hungarian corporate law noted in paragraph 29 are satisfied.

25. Canco will transfer its business share representing all its interest in Hungarian LLC to U.K. Holdco in exchange for preferred shares of U.K. Holdco having an aggregate fair market value equal to the fair market value of the interest in Hungarian LLC so transferred.

This transaction will occur under subsection 85.1(3) such that the shares of U.K Holdco received by Canco will have an adjusted cost base equal to the adjusted cost base of the share (as such term is described below in Ruling C) held by Canco in Hungarian LLC. U.K. Holdco will not dispose of the shares of Hungarian LLC to a person with whom Canco does not deal at arm's length as part of the series of transactions or events that includes the proposed transactions described herein.

26. U.S. Parent will contribute its entire interest in Hungary Newco to U.K. Holdco. In exchange, U.S. Parent will direct U.K. Holdco to issue shares of U.K. Holdco directly to U.S. Holdco.

27. Hungary Newco will merge into Hungarian LLC.

Additional Information

28. Based on a XXXXXXXXXX forecast of Korean Opco, a stock dividend is scheduled for XXXXXXXXXX. It is anticipated that all steps prior to the merger noted in paragraph 27 above will take place prior to XXXXXXXXXX. However the timing is dependent upon the Hungarian court approval process. Previous cash dividends received by Canco from Korean Opco were fully deductible in computing Canco's taxable income pursuant to section 113.

29. The following is the nature and characteristics of a KFT (limited liability company) formed in Hungary:

? Under the HBA which regulates the foundation, organization and operation of business associations with a registered office in Hungary, a Hungarian limited liability company is included as a business association with legal personality (subsection 2(2) of the HBA).

? A business association with legal capacity may acquire rights and undertake obligations and, in particular, may acquire property, conclude contracts, and may sue and be sued (subsection 2(3)).

? Business associations may be founded by foreign and domestic natural persons, legal persons or business associations without legal personality for the purpose of pursuing business-like economic activity (subsection 3(1)).

? With the exception of limited liability companies and companies limited by shares, at least two members are required for the foundation of a business association (subsection 3(2)).

? Unless otherwise provided by law, a single-member business association may not be the sole member or shareholder of a business association (subsection 4(4)).

? The provision of the Civil Code of Hungary shall be applied in respect of the property and personal relations of business associations and their members (shareholders) not regulated by the HBA (subsection 9(2)).

? If the articles of association (deed of foundation, statutes) do not provide for the duration of the business association, such business association shall be considered to have been established for an unlimited duration. (subsection 10(4)).

? A contribution of each member (shareholder) shall be required for the foundation of a business association and the contribution shall consist of contributions in cash and contributions in kind (subsections 12(1) and 124(2)).

? The supreme body for limited liability companies is the members' meeting and all members (shareholders) of a business association are entitled to take part in the activity of the business association's supreme body (subsections 18(1) and 18(2)).

? Unless otherwise provided by law or the articles of association (deed of foundation, statutes), the supreme body of business associations shall pass resolutions by a simple majority of votes (subsection 19(1)).

? Members (shareholders) of business associations shall be liable for the obligations of business associations terminated without legal successor, but if the liability of a member for the obligations of the business association was limited during the existence of the business association, the liability of the member (shareholder) for the obligation of the terminated business association shall be limited to that share of the assets distributed upon the termination of the business association which is due to such member (shareholder) (subsections 55(2) and 56(2)).

? Limited liability companies are business associations founded with an initial capital (subscribed capital) consisting of capital contributions of a pre-determined amount. The obligation of members to the company extends only to the provision of their capital contributions, and to other possible contributions as set forth in the articles of association, and members shall not be liable for the obligations of the company except as otherwise provided in the HBA (subsection 121(1)).

? The designation "limited liability company" (korlatolt felelossegu tarsasag), or its abbreviation "KFT", shall be indicated in the limited liability company's name (subsection 121(2)).

? The capital contribution of members may be of varying value, but the value of each member's cumulative capital contribution may not be less than 100,000 HUF. Capital contributions shall be expressed in HUF and shall be exactly divisible by 10,000. (subsection 125(1)).

? All contributions in cash shall be paid up within a period of one year following registration of the company (subsection 127(1)).

? Members may be entitled to separate remuneration for ancillary services (subsection 131(2)).

? Following registration of the limited liability company, the rights of members and the share due to them from the assets of the company are embodied by the business shares. Identical membership rights shall be attached to equivalent business shares. The articles of association may, however, invest certain business shares with membership rights which are different from those of others business shares (subsection 133(1)).

? Each member shall have only one business share. If a member acquires another independent business share, his business share shall increase by the business share acquired (subsection 133(2)), and one business share may have several owners (subsection 133(3)).

? With the exception of the business shares owned by the limited liability company itself, business shares of that company may be freely transferred to members and non-members if the member-seller has paid his capital contribution in full (subsections 134(1) and (2))

? During the limited liability company's existence, members may not reclaim from the company contributions that they have provided. Members are only entitled to dividends in proportion to the contributions that they have already provided (subsection 141(1)).

? Unless otherwise provided by the articles of association, after-tax profits shall be distributed to members in proportion to their capital contributions (subsection 141(2)).

? No dividends may be paid to members, if, as a result of such, the equity of the company does not reach the initial capital of the company as set forth in the legal regulations on accounting (subsection 141(3)).

? With the exception of the reduction of initial capital and remuneration for ancillary services, no payments to the debit of initial capital may be made to members on the basis of their membership (subsection 142(1)).

? In the event of termination of a limited liability company without legal successor, from the assets remaining after the satisfaction of creditors, first additional payments shall be repaid, then unless otherwise provided by the articles of association, the remaining assets shall be distributed among the members of the company in proportion to their capital contributions (subsection 169(4)).

30. The following is the nature and characteristics of a joosik-hwesa formed in Korea:

? The Commercial Act of South Korea, which regulates the existence and the relationships of the enterprises that have the purposes of profit-making, groups companies into four categories: hapmyong-hwesa (partnership companies), Hapja-hwesa (limited partnership companies), joosik-hwesa (stock companies) and yuhan-hwesa (Limited liability companies).

? Under the Commercial Act, a joosik-hwesa shall be incorporated jointly by at least one person, and the total number of shares authorized to be issued, the par value per share, and the total number of shares to be issued at the time of incorporation shall be determined.

? The number of shares to be issued at the time of incorporation shall not be less than one-fourth of the total number of shares authorized to be issued by the company, and the capital shall be no less than fifty million won.

? The par value per share shall be at least one hundred won.

? The shares of a joosik-hwesa may be transferred.

? A joosik-hwesa shall have a general shareholders' meeting, directors and the board of directors, auditors and an audit committee. Directors and the board of directors shall manage the affairs of the company.

? Article 169 of the Commercial Act defines a company to mean an association incorporated for the purpose of engaging in commercial activities and/or other profit-making activities.

? Article 170 states that a company shall come into existence upon the registration of its incorporation at the place of its principal office.

? Article 171 states that a company shall be a juristic person.

? Article 173 forbids a company to become a member with unlimited liability of another company.

? Article 331 states that the liability of a shareholder shall be limited to the subscription price which he has paid for his shares.

? Article 335 provides the availability of the transfer of shares to other persons.

Purpose of the Proposed Transactions

The purpose of the proposed transactions is three-fold:

(a) The ownership of Korean Opco by U.K. Holdco will preserve interest deductions for the companies in the U.K. by improving their thin capitalization position;

(b) The repatriation of Korean Opco's cash will become more tax efficient as withholding tax on dividends paid by Korean Opco will be 5%, instead of the higher current withholding tax that is paid on dividends to U.S. Parent and Canco; and

(c) Such a structure will provide increased flexibility for future opportunities to redeem or modify the third party ownership interest in Korean Opco.

Rulings Given

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. Korean Opco is considered to be a corporation for the purposes of the Act.

B. Hungarian LLC is considered to be a corporation for the purposes of the Act.

C. Since Hungarian LLC is considered to be a corporation for the purposes of the Act, the comments contained in Interpretation Bulletin IT-392 regarding the meaning of the term "share" for the purposes of the Foreign Accrual Property Income provisions of the Act would apply for the purposes of subsection 85.1(3). Therefore, that subsection will apply to the transfer of Korean Opco shares described in paragraph 23 above such that, for the purposes of paragraph 85.1(3)(b), Canco will be entitled to reflect as the cost of the share consideration receivable from the Hungarian LLC an amount equal to the total of the adjusted cost bases to Canco of the Korean Opco shares immediately before the transfer. For the purposes of paragraphs 85.1(3)(c) and 85.1(3)(d), the proceeds of disposition of Korean Opco shares to Canco and the cost of Korean Opco shares to Hungarian LLC will also be equal to the total of the adjusted cost bases to Canco of the Korean Opco shares immediately before the transfer.

D. Subsection 95(6) will not apply to the transfers described in paragraphs 23 and 25 above.

E. Subsections 15(1), 56(2) and 246(1) will not apply to the transactions described in paragraphs 18 and 23 above.

F. Subsection 245(2) will not be applied, as a result of the proposed transactions described in paragraphs 15 to 27 above, to redetermine the tax consequences described in the rulings given.

The above rulings are given subject to the general limitations and qualifications set out in Information Circular 70-6R5 dated May 17, 2002, and are binding on the CRA provided that the proposed transactions are completed by XXXXXXXXXX.

These rulings are based on the Act in the present form and do not take into account amendments to the Act which, if enacted into law, could have an effect on the rulings provided herein.

Other Comments

(i) Paragraph 53(1)(c) will not apply to provide an addition to the adjusted cost base to Canco of the interest (shares - see comments in Ruling C above) in Hungarian LLC as a result of the transactions described in paragraph 23 above.

(ii) Nothing in this ruling should be construed as implying that the CRA has agreed to or reviewed any tax consequences relating to the facts and proposed transactions described herein other than those specifically described in the rulings given above. In particular, nothing in this ruling should be construed as implying that the CRA agreed to or reviewed

(a) the fair market value or the adjusted cost base of the shares or interests in any entity described in this ruling; and

(b) the nature of any entity described in this ruling as to whether it is a corporation, a partnership or any other type of entity for the purposes of the Act, except for those entities specifically stated in this ruling.

Yours truly,

XXXXXXXXXX
Section Manager
for Division Director
International and Trusts Division
Income Tax Rulings
Policy and Planning Branch

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