29 November 2004 External T.I. 2004-0091771E5 - Substituted 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: Application of proposed subparagraph 88(1)(c.3)(vii) to particular fact situation.

2004-009177

XXXXXXXXXX Karen Cooper, LL.B.

(613) 957-2094
November 29 2004

Dear XXXXXXXXXX:

Re. Substituted Property - Proposed subparagraph 88(1)(c.3)(vii)

This is in reply to your letter dated August 19, 2004 in which you requested our comments with respect to the interpretation of proposed subparagraph 88(1)(c.3)(vii) of the Income Tax Act (the "Act"). Specifically, you have queried whether proposed subparagraph 88(1)(c.3)(vii) of the Act, as described in the Legislative Proposals and Draft Regulations relating to Income Tax issued by the Minister of Finance on February 27, 2004, will apply to deny the "bump" with respect to property of a subsidiary in a particular fact situation.

The situation outlined in your letter appears to be a factual one, involving specific taxpayers. As explained in Information Circular 70-6R5, it is not this Directorate's practice to comment on proposed transactions involving specific taxpayers other than in the form of an Advance Income Tax Ruling. Should your situation involve a specific taxpayer and a completed transaction, you should submit all relevant facts and documentation to the appropriate Tax Services Office for their views. However, we are prepared to offer the following general comments which may be of assistance.

Generally, property acquired on a winding-up pursuant to subsection 88(1) of the Act may be denied the benefit of a bump by virtue of subparagraph 88(1)(c)(vi) where, as part of the series of transactions that includes the winding-up, the parent acquires control of the subsidiary corporation and any property acquired by the parent on the winding-up or "any other property acquired by any other person in substitution therefor" ("substituted property") is acquired by "prohibited" persons (including specified shareholders of the subsidiary corporation). Pursuant to subparagraphs 88(1)(c.3)(i) and (ii) of the Act, substituted property is defined to include certain "attributable" and "determinable" properties. Subparagraphs 88(1)(c.3)(iii) to (v) and proposed subparagraphs 88(1)(c.3)(vi) and (vii) exclude certain properties which might otherwise be considered substituted property under subparagraphs 88(1)(c.3)(i) and (ii).

Specifically, proposed subparagraph 88(1)(c.3)(vii) excludes from substituted property a share of a corporation or a debt owing by a corporation if the fair market value of the share or debt was not, at any time after the beginning of the winding-up, wholly or partially attributable to property distributed to the parent on the winding-up. As you indicate in your letter, the Department of Finance explains the effect of proposed subparagraph 88(1)(c.3)(vii) in the Explanatory Notes with an example involving a safe income crystallization prior to a takeover:

This exemption would apply, for example, if an individual ("Mr. S"), who is a specified shareholder of Tco, incorporates Newco in contemplation of the takeover of Tco and transfers the Tco shares to Newco. Mr. S then transfers the Newco shares to Sco. Immediately after the increase in the adjusted cost base of the shares of Newco (i.e., following the safe income crystallization) Sco sells the Newco shares to Pco. In this scenario, the Sco shares owned by Mr. S after the sale would not be substituted property by reason of new subparagraph 88(1)(c.3)(vii).

The concern expressed in your letter is whether proposed subparagraph 88(1)(c.3)(vii) would still apply to deem the Sco shares in the example not to be substituted property if the Sco shares cease to exist after the acquisition of control referred to in clause 88(1)(c)(vi)(A) but prior to the windings-up of Newco and Tco. In our view, in those circumstances the Sco shares would still be excluded from being considered substituted property pursuant to proposed subparagraph 88(1)(c.3)(vii).

We trust that these comments are helpful.

Yours truly,

David Palamar
Manager
Corporate Reorganizations Section III
Income Tax Rulings Directorate
Policy and Planning Branch