2004 Ruling 2004-0091531R3 - Franchise rights - eligible property

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 goodwill and rights under a franchise agreement are eligible property within the meaning of subsection 85(1.1).

Position: Factual determination

Reasons: See Statement of principal issues.

XXXXXXXXXX 2004-009153

XXXXXXXXXX, 2004

Dear XXXXXXXXXX:

Re: XXXXXXXXXX ("Opco")
Advance Income Tax Ruling Request

We are writing in response to your letter of XXXXXXXXXX in which you requested an advance income tax ruling on behalf of the above-noted taxpayer. We also acknowledge the information provided in subsequent correspondence and various telephone conversations. You have advised us that to the best of your knowledge and that of the taxpayer involved none of the issues involved in this ruling request are:

(i) in an earlier return of the taxpayer 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 taxpayer or related persons;

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

(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.

DEFINITIONS

In this letter the following terms have the meanings specified:

(a) "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, and the Income Tax Regulations thereunder are referred to as the "Regulations";

(b) "adjusted cost base" ("ACB") has the meaning assigned by section 54 and subsection 248(1);

(c) "agreed amount" in respect of a property means the amount that the transferor and the transferee of the property have agreed upon in an election under subsection 85(1);

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

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

(f) "CBCA" means the Canada Business Corporations Act;

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

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

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

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

(k) "eligible capital expenditure" has the meaning assigned by subsection 14(5);

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

(m) "FMV" ("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;

(n) XXXXXXXXXX;

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

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

(q) "Subco" means XXXXXXXXXX , a separate wholly-owned subsidiary of Opco;

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

(s) "Xco" means the XXXXXXXXXX.

FACTS

1. Opco was incorporated under the XXXXXXXXXX and is a taxable Canadian corporation and a CCPC.

2. Opco is a franchisor that has franchisees located in XXXXXXXXXX. The majority of the franchisees operate under XXXXXXXXXX. Opco has franchise agreements with several stores located in XXXXXXXXXX. For stores XXXXXXXXXX. Xco has a number of franchisees in XXXXXXXXXX. The franchisees operate XXXXXXXXXX.

3. We have been provided with a copy of the standard franchise agreement between Opco and its franchisees (the "Franchise Agreement"). Pursuant to section XXXXXXXXXX of the Franchise Agreement, the franchisees pay a royalty fee to Opco XXXXXXXXXX.

4. Opco has structured its operations into XXXXXXXXXX distinct divisions which operate together to provide services to the franchisees. These divisions may be described as follows:

XXXXXXXXXX.

5. XXXXXXXXXX.

PROPOSED TRANSACTIONS

6. Newco will be incorporated under the CBCA and will be a taxable Canadian corporation and a private corporation. The articles of Newco will authorize share capital which will include common shares (the "Newco Common Shares"), each of which will be a fully participating voting common share entitling the holder thereof to one vote at meetings of shareholders of Newco. Upon incorporation, Opco will subscribe for 1 Newco Common Share for a total subscription price of $XXXXXXXXXX.

7. Opco will transfer the XXXXXXXXXX to Newco in exchange for XXXXXXXXXX Newco Common Shares. Newco and Opco will jointly elect in prescribed form within the time prescribed by subsection 85(6), to have the provisions of subsection 85(1) apply to each eligible property transferred. The agreed amount 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);

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

(c) in the case of eligible capital property, an amount equal to the least of the amount 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 non-share consideration received by Newco as consideration for the transfer of such property.

8. For further clarity, the transfer of the XXXXXXXXXX will comprise the following steps:

(a) The lease for the current office space of the XXXXXXXXXX will be assigned to Newco as permitted under the lease agreement.

(b) All XXXXXXXXXX employees currently employed by the XXXXXXXXXX will become employees of Newco.

(c) Opco and Newco will enter into an agreement providing for the purchase and sale of the business comprising the XXXXXXXXXX (the "Memorandum of Agreement"). The Memorandum of Agreement will provide for the transfer of all assets of the XXXXXXXXXX including:

(i) the furniture, fixtures and equipment more particularly described in Schedule A to the Memorandum of Agreement;

(ii) all saleable stock in trade;

(iii) all leasehold improvements and other leasehold interests in any real property leases held by Opco in the XXXXXXXXXX;

(iv) any other leases relating to the XXXXXXXXXX;

(v) all employment contracts relating to the XXXXXXXXXX;

(vi) all rights under the franchise agreements that relate to the XXXXXXXXXX which have been entered into from time to time between Opco and third parties with respect to the franchises that are operated as XXXXXXXXXX with a uniform business format and identified to the public under the trade marks XXXXXXXXXX These rights include the right to receive the portion of royalty fees related to services currently provided by the XXXXXXXXXX which are currently payable to Opco by the franchisees for services with respect to XXXXXXXXXX, and the exclusive right to provide such services; and

(vii) the goodwill of the XXXXXXXXXX together with the exclusive right to Newco to represent itself as carrying on business in succession to Opco.

9. Newco and Opco will enter into a Joint Venture agreement pursuant to which Newco will provide the services of the XXXXXXXXXX, as described above in paragraph 8(c)(vi), and Opco will provide the services of the XXXXXXXXXX other divisions, as described above in paragraph 4, to the franchisees.

ADDITIONAL INFORMATION

10. 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.

PURPOSE OF PROPOSED TRANSACTIONS

The purpose of the transactions is to isolate the XXXXXXXXXX into a separate company for ease of administration, performance management, and profitability analysis. Furthermore, having a separate company housing the XXXXXXXXXX operations will provide better access to all the incentives provided by the XXXXXXXXXX government for businesses operating in XXXXXXXXXX since the revenue related to the operation of the XXXXXXXXXX in XXXXXXXXXX will now be taxed there.

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. With respect to the transfer of the XXXXXXXXXX by Opco to Newco as described in paragraphs 7 and 8(c) above, subsection 85(1) will apply to the transfer of each property that is eligible property 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 Opco'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 and the property described in paragraphs 8(c)(vi) and (vii) will constitute eligible property within the meaning of subsection 85(1.1).

B. Subsection 56(4) will not apply to include in Opco's income, income earned by Newco as a result of the transfer of the right to receive a portion of the royalty fees described in paragraph 8(vi).

The Rulings given are subject to the limitations and qualifications set out in Information Circular 70-6R5 dated May 17, 2002 and are binding on the Canada 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 ACB or FMV of any shares or other property referred to herein, including the goodwill, if any, relating to the XXXXXXXXXX;

(b) the amount of, or FMV of, Opco's goodwill, if any, that relates to the XXXXXXXXXX; or

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

Yours truly,

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