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: 1. Opinion - Whether TCo has acquired residence in Canada?
2. Ruling - Whether 84(4.1) will apply to reduction of PUC?
Reasons: Central management and control resides in Canada.
The PUC reduction is "on the winding-up, discontinuance or reorganization" of a business.
collectively, the "Taxpayers"
Advance Income Tax Ruling
This is in reply to your letter of XXXXXXXXXX and subsequent correspondence in which you ask for an advance income tax ruling and opinions on behalf of the above Taxpayers.
In this letter, the following terms have the meanings specified:
(a) "ACo" means a corporation to be created under the laws of XXXXXXXXXX that will be a non-resident of Canada for purposes of the Act. ACo will be a wholly-owned subsidiary of S1Co.
(b) "Act" means the Income Tax Act, R.S.C. 1985 (5th Supp.) c.1 as amended to the date hereof. All statute references in this letter are to the Act unless otherwise indicated.
(c) "active business" has the meaning assigned by subsection 95(1) of the Act.
(d) "CallCo" means XXXXXXXXXX ., a corporation existing under the laws of Canada and a wholly-owned subsidiary of SCo.
(e) "CBCA" means the Canada Business Corporations Act.
(f) "controlled foreign affiliate" has the meaning assigned by subsection 95(1).
(g) "CRA" means the Canada Revenue Agency.
(h) "designated treaty country" has the meaning assigned by subsection 5907(11) of the Regulations.
(i) "dividend rental arrangement" has the meaning assigned by subsection 248(1).
(j) "ECo" means XXXXXXXXXX, a corporation existing under the laws of Canada.
(k) "excluded property" has the meaning assigned by subsection 95(1).
(l) "exempt earnings" and "exempt loss" have the meanings assigned by subsection 5907(1) of the Regulations.
(m) "Note A" is described in 24 below.
(n) "Note B" is described in 28 below.
(o) "public corporation" has the meaning assigned by subsection 89(1).
(p) "PUC" means paid-up capital, as defined in subsection 89(1).
(q) "Regulations" means Income Tax Regulations, Consolidated Regulations of Canada, Chapter 945 as amended to the date hereof.
(r) "SCo" means XXXXXXXXXX. It is a non-resident of Canada for purposes of the Act.
(s) "S Group" means SCo and each predecessor corporation of SCo and each corporation that is controlled directly or indirectly by SCo. The S Group was founded in XXXXXXXXXX and began fully trading in XXXXXXXXXX.
(t) "specified financial institution" has the meaning assigned by subsection 248(1).
(u) "stated capital" means stated capital as that expression is used in the CBCA.
(v) "S1Co" means XXXXXXXXXX, S1Co is a wholly-owned subsidiary of SCo, and is a non-resident of Canada for purposes of the Act.
(w) "S2Co" means XXXXXXXXXX, a corporation existing under the laws of Canada.
(x) "S3Co" means XXXXXXXXXX, and a wholly-owned subsidiary of SCo.
(y) "taxable Canadian corporation" has the meaning assigned by subsection 89(1).
(z) "taxable Canadian property" has the meaning assigned by subsection 248(1).
(aa) "taxable dividend" has the meaning assigned by subsection 89(1).
(bb) "taxable surplus" has the meaning assigned by subsection 5907(1) of the Regulations.
(cc) "TCo" means XXXXXXXXXX, a corporation existing under the laws of XXXXXXXXXX.
(dd) "TCo Business" means all of the assets owned by TCo and used in the activities described in 6 a) and b) below, net of any associated liabilities, less certain assets and liabilities that are described in 22 below.
(ee) "term preferred shares" has the meaning assigned by subsection 248(1).
(ff) "TIP" means the intellectual property license which is currently owned by TCo and sublicensed to third parties.
1. The S Group operates a XXXXXXXXXX.
2. ECo is a public corporation and a taxable Canadian corporation incorporated under the CBCA. Its address is XXXXXXXXXX. ECo files its income tax returns with the XXXXXXXXXX Tax Centre and is served by the XXXXXXXXXX Tax Services Office. The issued capital of Eco consists of XXXXXXXXXX common shares and XXXXXXXXXX exchangeable shares (XXXXXXXXXX of the exchangeable shares are in public hands as at XXXXXXXXXX). All of the common shares are owned by S1Co. The common shares have a PUC balance of approximately Cdn $XXXXXXXXXX, which arose on the capitalization of ECo on XXXXXXXXXX. None of the PUC of ECo arose as the result of a conversion of the exchangeable shares (see 3 below).
3. On XXXXXXXXXX, ECo acquired S2Co, at which time it was called "XXXXXXXXXX". As part of the acquisition, ECo issued exchangeable shares (referred to in 2 above) to certain Canadian resident shareholders of XXXXXXXXXX.
4. S2Co is a taxable Canadian corporation incorporated under the CBCA. Its address is XXXXXXXXXX. The issued capital of S2Co consists of XXXXXXXXXX common shares, all of which are owned by ECo. S2Co files its income tax returns at the XXXXXXXXXX Tax Centre and is served by the XXXXXXXXXX Tax Services Office.
5. TCo is a wholly-owned subsidiary and a controlled foreign affiliate of S2Co. TCo is a resident of XXXXXXXXXX and is a non-resident of Canada for purposes of the Act. Its current address is XXXXXXXXXX. The adjusted cost base (as that term is defined in section 54) of the shares of TCo is XXXXXXXXXX.
6. The activities of the TCo Business consists entirely of:
a) XXXXXXXXXX, and
The fair market value of the TCo Business is approximately US $XXXXXXXXXX.
7. There are more than five full-time employees dedicated to the activities of the TCo Business. XXXXXXXXXX are designated treaty countries and TCo has no permanent establishment (within the meaning of that term in section 5906 of the Regulations) in any other country. Therefore, TCo is a resident of, and carries on an active business only in, a designated treaty country.
8. All of the assets of the TCo Business are used or held by TCo principally for the purpose of gaining or producing income from an active business, and therefore, constitute excluded property. TCo does not own shares in any other corporation or an interest in a partnership. Any gains or losses on the disposition of assets owned by TCo would give rise to exempt earnings or an exempt loss. TCo does not currently have a taxable surplus balance.
9. TCo does not own any property that is a taxable Canadian property or an excluded right or interest (as contemplated by subparagraph 128.1(1)(b)(iv)).
10. Although TCo and S2Co are both involved in the XXXXXXXXXX business, the TCo Business is distinct from the business of S2Co. XXXXXXXXXX.
11. There are XXXXXXXXXX wholly-owned non-resident XXXXXXXXXX corporations within the S Group, and therefore, TCo, S2Co, ECo, and SCo are all considered specified financial institutions as a result of being related to these XXXXXXXXXX corporations. As a result, the issued and outstanding shares of TCo, S2Co and ECo constitute term preferred shares.
12. No person or partnership is obligated, either absolutely or contingently, to effect an undertaking, including any guarantee, covenant or agreement to purchase or repurchase the shares of TCo or S2Co. The shareholders of TCo and S2Co have not entered into any arrangement with respect to the shares of TCo or S2Co respectively which would be considered a dividend rental arrangement.
13. Following ECo's acquisition of S2Co (which occurred in XXXXXXXXXX), the XXXXXXXXXX income being earned by TCo became subject to the XXXXXXXXXX controlled foreign company legislation. The S Group has reviewed various restructuring alternatives that would allow it to mitigate the punitive effects of this legislation. The S Group has concluded that the most effective solution (from both a business and overall tax perspective) would be to have the TCo Business repatriated to XXXXXXXXXX by or shortly after XXXXXXXXXX.
14. Step 1 of the Proposed Transactions is expected to be undertaken on or before XXXXXXXXXX. All subsequent steps are expected to be undertaken on XXXXXXXXXX or thereafter.
Subject to and conditional upon the receipt of this advance income tax ruling, as well as any appropriate shareholder and court approvals, the following transactions will be undertaken.
STEP 1 - Migration of TCo from XXXXXXXXXX to Canada
15. TCo will pass a resolution, effective XXXXXXXXXX, to remove the existing board of directors and replace it with a new board of directors, a majority of which will reside in Canada. These new directors will conduct a meeting in Canada on XXXXXXXXXX. Included in the agenda for the XXXXXXXXXX meeting will be:
? a discussion of the accounts for the period ended XXXXXXXXXX including if appropriate the appointment of auditors for the following year;
? a discussion of, and ratification of the moving of the books and records of TCo from XXXXXXXXXX to Canada;
? a discussion of, and ratification of moving the bank account of TCo to Canada; and
? to consider and approve if appropriate the declaration of a dividend "in specie" on XXXXXXXXXX of certain intellectual property rights, cash and fixed assets and the transfer of various employment contracts with certain employees of the company and the transfer of certain other assets. The discussion will focus on the merits of a transfer, the issues surrounding a transfer and provide the Board with a full explanation of each.
16. A subsequent meeting of the new board will be held in Canada on XXXXXXXXXX to authorize, if they deem it appropriate, the subsequent steps described below.
17. All books and records of TCo which are currently maintained in XXXXXXXXXX will be moved to Canada. All bank accounts maintained by TCo in XXXXXXXXXX will be closed. TCo will obtain new bank accounts in Canada. Its address in Canada will be XXXXXXXXXX. It will files its tax returns at the XXXXXXXXXX Tax Centre, and will be served by the XXXXXXXXXX Tax Services Office.
18. TCo will be deemed by paragraph 128.1(1)(b) to have disposed of the property of the TCo Business at the time that is immediately before the time that is immediately before the time that TCo becomes resident in Canada for proceeds equal to the fair market value of the property at the time of disposition. The deemed disposition will give rise only to exempt earnings in TCo.
19. While TCo is resident in Canada, deductions under the Act claimed by TCo in respect of the TCo Business will be immaterial.
20. TCo will not elect to add any amount to the PUC of its shares under subparagraph 128.1(2)(b)(i) upon establishing residence in Canada.
STEP 2 - Distribution of TCo Business by TCo to S2Co.
21. The new board of directors of TCo will declare a dividend payable in kind to its shareholder, S2Co, which will be satisfied through the distribution to S2Co of the TCo Business.
22. At least US $XXXXXXXXXX in trade receivables and/or cash will remain in TCo. An additional US $XXXXXXXXXX will remain and be used to settle certain trade and tax liabilities as they become due. The new board of directors will manage the collection of these receivables and will determine the preferred method to redeploy the cash, depending on market conditions, projected return on investment, and other criteria as established by the new board of directors as well as supervise the payment of these liabilities.
23. The distribution of the TCo Business to S2Co will give rise to a taxable dividend to S2Co.
STEP 3 - Sale of TCo Business by S2Co to ACo
24. S2Co will sell the TCo Business to ACo. The sale of the TCo Business will be at fair market value. In payment for the TCo Business, ACo will issue Note A to S2Co in an amount equal to the fair market value of the TCo Business.
STEP 4 - Distribution of Note A by S2Co to ECo
25. The board of directors of S2Co will declare a dividend payable in kind to its shareholder, ECo, which will be satisfied through the distribution of Note A to ECo.
26. The distribution of Note A to ECo will give rise to a taxable dividend to ECo.
STEP 5 - Return of PUC by ECo to S1Co
27. The board of directors of ECo will pass a resolution in order to effect a return of PUC to its non-resident shareholder, S1Co, which will be satisfied through the distribution of Note A to S1Co. Pursuant to this resolution, the legal stated capital of the ECo common shares will be reduced by an amount equal to the fair market value of Note A. The fair market value of Note A is less than the PUC of the ECo common shares.
STEP 6 - ACo Licenses TIP to S3Co
28. ACo will enter into an arrangement under which it will license the TIP it owns to S3Co. The licensing arrangement will be for a period of XXXXXXXXXX years, and S3Co will pay to ACo as consideration, a lump-sum amount. Payment for the lump-sum amount will be financed by S3Co through the issuance of Note B.
29. The ownership of the residual interest in the TIP (after the XXXXXXXXXX-year licensing arrangement has expired) will remain with ACo. ACo will also continue to operate the research and development activities in XXXXXXXXXX.
STEP 7 - Transfer and Capitalization of Note B
30. S1Co will assume S3Co's obligation to ACo pursuant to Note B, in exchange for S3Co becoming indebted to S1Co for an equivalent amount.
31. S1Co will partially extinguish the amount it is owed by ACo (i.e. the Note A amount) by legal extinguishment against the amount it owes to ACo (i.e. the Note B amount).
32. The remaining portion of the amount owing to S1Co by ACo (as a result of the principal amount of Note A exceeding the principal amount of Note B) will be contributed to ACo's share capital account in exchange for the issuance of additional fully paid-in shares by ACo to S1Co.
Purpose of the Proposed Transactions
The purpose of the proposed transactions is to simplify the organizational structure of the S Group. As a result of the acquisition in XXXXXXXXXX of S2Co, S2Co and TCo are subject to the XXXXXXXXXX controlled foreign company legislation. More specifically, the royalty income earned by TCo from the licensing of the TIP is subject to current taxation in XXXXXXXXXX under this legislation with effect from XXXXXXXXXX . As a result of this, it is the S Group's desire to have the TCo Business repatriated to XXXXXXXXXX, so as to eliminate this result. By undertaking the proposed transactions, the activities associated with the TCo business can be carried on in a more comprehensive and cost effective manner directly by SCo and its subsidiaries.
The proposed transactions are aimed at achieving efficiencies as they relate to the TCo Business, by aligning the ownership and exploitation of the TIP with the governing jurisdiction in which the S Group is predominately based (being XXXXXXXXXX).
The proposed transactions in and by themselves give rise to no material income taxes in any jurisdiction. As a result of the proposed transactions set out in Step 6 above, the XXXXXXXXXX taxes otherwise payable as a result of the application of the XXXXXXXXXX controlled foreign company legislation are effectively eliminated for a further XXXXXXXXXX years. Had TCo carried out the transaction in 28 above, a gain in an amount equal to the net present value of the expected income from the TCo Business over the next XXXXXXXXXX years would be taxable in XXXXXXXXXX and/or XXXXXXXXXX.
To the best of your knowledge, and that of the Taxpayers, none of the issues involved in this advance income tax ruling is:
a. in an earlier return of the Taxpayers or a person related to them;
b. being considered or under assessment by a tax services office or taxation centre in connection with a previously filed tax return of the Taxpayers or a person related to them;
c. under objection by the Taxpayers or a person related to them; or
d. before the courts, and no judgement has been issued which may be under appeal.
Provided the preceding statements constitute a complete and accurate disclosure of all the relevant definitions, facts, proposed transactions, purpose of the proposed transactions and other information, and provided the proposed transactions are completed in the manner described above, our ruling is as follows:
Subsection 84(4.1) will not apply to deem the distribution of Note A to S1Co and the reduction of the PUC of the common shares of ECo as described in 25 above to be a dividend paid by ECo and received by S1Co.
The above ruling is given subject to the general limitations and qualifications set out in Information Circular 70-6R5, dated May 17, 2002, and is binding on the CRA provided that the proposed transactions are completed by XXXXXXXXXX.
A) We are of the opinion that TCo will become a corporation resident in Canada for purposes of the Act on XXXXXXXXXX.
Our opinion regarding the residency of TCo is based on the understanding that all information relevant to that determination has been provided and is included in the facts and proposed transactions set out above, and is not found during a subsequent audit by the CRA to be materially incomplete or inaccurate. For example, as set out in paragraph 15 of IT-391R, Status of Corporations, if the management and control of TCo is actually exercised by some other party who is resident in another country, TCo will be resident in the other country.
This opinion is given taking into account the provisions of the XXXXXXXXXX in force as of the date of this advance income tax ruling. XXXXXXXXXX.
B) Provided that draft subsection 84(4.1) is enacted in substantially the same form as proposed in the draft legislation released by the Department of Finance on February 27, 2004, we are of the opinion that draft subsection 84(4.1) will not apply to deem the distribution of Note A to S1Co and the reduction of the PUC of the common shares of ECo as described in 25 above to be a dividend paid by ECo and received by S1Co.
The foregoing opinions are not advance income tax rulings and, as explained in paragraph 22 of Information Circular 70-6R5 referred to above, are not binding on the CRA.
Nothing in this advance income tax ruling should be construed as implying that the CRA has agreed to or reviewed any of the tax consequences set out in the facts or relating to the facts and proposed transactions other than those described in the ruling and opinions above.
In addition, we have not examined the possible effects of the changes to the foreign affiliate rules as set out in draft legislation released on February 27, 2004.
International & Trusts Division
Income Tax Rulings Directorate
All rights reserved. Permission is granted to electronically copy and to print in hard copy for internal use only. No part of this information may be reproduced, modified, transmitted or redistributed in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, or stored in a retrieval system for any purpose other than noted above (including sales), without prior written permission of Canada Revenue Agency, Ottawa, Ontario K1A 0L5
© Her Majesty the Queen in Right of Canada, 2004
Tous droits réservés. Il est permis de copier sous forme électronique ou d'imprimer pour un usage interne seulement. Toutefois, il est interdit de reproduire, de modifier, de transmettre ou de redistributer de l'information, sous quelque forme ou par quelque moyen que ce soit, de facon électronique, méchanique, photocopies ou autre, ou par stockage dans des systèmes d'extraction ou pour tout usage autre que ceux susmentionnés (incluant pour fin commerciale), sans l'autorisation écrite préalable de l'Agence du revenu du Canada, Ottawa, Ontario K1A 0L5.
© Sa Majesté la Reine du Chef du Canada, 2004