2004 Ruling 2004-0101591R3 - Paid-up Capital Reduction - 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(2) applies to the proposed distribution of cash, to be effected as a reduction of the stated capital of the shares of a public corporation.

Position: Favourable rulings provided.

Reasons: In compliance with the law.

XXXXXXXXXX 2004-010159

XXXXXXXXXX, 2004

Dear Sirs:

Re: Advance Income Tax Ruling
XXXXXXXXXX

This is in reply 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 your letters of XXXXXXXXXX, and during our various telephone conversations in connection with your ruling request (XXXXXXXXXX).

We understand that to the best of your knowledge and that of the taxpayer involved, none of the issues involved in this ruling is:

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

(ii) being considered by a tax services office or taxation centre in connection with a previously filed tax return of the taxpayer or a related person,

(iii) under objection by the taxpayer or a related person,

(iv) before the courts,

(v) the subject of a ruling previously issued by the Income tax Rulings Directorate.

Unless otherwise indicated, all references to monetary amounts are in Canadian dollars.

LEGAL ENTITY DEFINITIONS

In this letter:

(a) "AcquisitionCo" means XXXXXXXXXX;

(b) "Opco" means XXXXXXXXXX;

(c) "Parentco" means XXXXXXXXXX;

(d) "Subco" means XXXXXXXXXX.

DEFINITIONS

In this letter, unless otherwise expressly stated, the following terms have the meanings specified.

(a) "ACB" has the meaning assigned to the expression "Adjusted Cost Base" in section 54 of the Act;

(b) "Parentco XXXXXXXXXX Shares" has the meaning assigned in Paragraph 15;

(c) "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 of the Act;

(d) "APA" has the meaning assigned in Paragraph 13;

(e) "Assumed Liabilities" has the meaning assigned in Paragraph 15;

(f) "Business" has the meaning assigned in Paragraph 8;

(g) "Cash on Hand" has the meaning assigned in Paragraph 9;

(h) "Cash Proceeds" has the meaning assigned in Paragraph 15;

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

(j) "CRA" means Canada Revenue Agency;

(k) "Distribution" means the proposed distribution of cash to the Opco Shareholders, to be effected as a reduction of the stated capital of the Opco Common Shares, as described in Paragraph 22;

(l) "IPO" has the meaning assigned in Paragraph 2;

(m) "Opco Common Shares" means common shares of Opco, as described in Paragraph 4;

(n) "Opco Shareholder" means a holder of Opco Common Shares;

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

(p) "Paragraph" refers to a numbered paragraph in this letter;

(q) "Program X" has the meaning assigned in Paragraph 8;

(r) "Program Y" has the meaning assigned in Paragraph 8;

(s) "Proposed Transactions" means the transactions described in Paragraphs 14 to 22;

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

(u) "Purchased Assets" has the meaning assigned in Paragraph 15;

(v) "Reduction of Capital" has the meaning assigned in Paragraphs 14 and 22;

(w) "Sale Transaction" has the meaning assigned in Paragraphs 12 and 15;

(x) "Tax Attributes" has the meaning assigned in Paragraph 11;

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

FACTS

1. Opco was incorporated under the CBCA on XXXXXXXXXX. Opco's articles of incorporation were, amongst other things, amended as follows:

(a) on XXXXXXXXXX to change its name from XXXXXXXXXX to XXXXXXXXXX;

(b) on XXXXXXXXXX to change its name to its present name; and

(c) on XXXXXXXXXX to remove the "closed company" restrictions.

2. On XXXXXXXXXX, Opco completed an initial public offering ("IPO") of XXXXXXXXXX common shares for gross proceeds of approximately $XXXXXXXXXX in cash. As stated in the prospectus issued on XXXXXXXXXX, the major portion of the net proceeds of the IPO by Opco was intended to be used to finance scientific research and experimental development carried on in XXXXXXXXXX. As to the balance of the net proceeds of the IPO, it was intended to be used as working capital and for general corporate purposes.

3. The Opco Common Shares are listed on the XXXXXXXXXX Stock Exchange. Opco is a public Canadian corporation and a taxable Canadian corporation.

4. The authorized capital stock of Opco provides for an unlimited number of voting common shares without par value and an unlimited number of preferred shares issuable in series. As at XXXXXXXXXX, Opco has issued XXXXXXXXXX common shares (the "Opco Common Shares") having a stated capital for accounting purposes of $XXXXXXXXXX. Opco does not have any issued and outstanding preferred shares. The following table summarizes the capitalization of Opco since XXXXXXXXXX:

XXXXXXXXXX

5. The paid-up capital of the Opco Common Shares is at least $XXXXXXXXXX.

6. Since Opco was incorporated only in XXXXXXXXXX, it has never increased its paid-up capital of any class of its shares and elected to treat such amount as a dividend paid out of its "pre-1972 capital surplus on hand" as that term is defined in subsection 88(2.1).

7. Opco business operations are carried on directly by Opco. Subco, which was formed in XXXXXXXXXX, is the sole wholly-owned subsidiary of Opco. Subco ceased its operations in XXXXXXXXXX, is currently inactive and has a working capital balance of $US XXXXXXXXXX.

8. The business of Opco is to XXXXXXXXXX (the "Business"). More specifically, the Business can be divided into the two following programs:

- the XXXXXXXXXX ("Program X"), which consists in XXXXXXXXXX; and

- the XXXXXXXXXX ("Program Y"), which consists in XXXXXXXXXX.

9. Opco has used the funds raised in the IPO to pursue its research and development activities. The research and development activities of Opco have not reached the commercial phase yet and, as such, its activities do not generate sufficient revenues. Therefore, Opco has used approximately $XXXXXXXXXX of the funds raised by the IPO in its Business and is now left with approximately $XXXXXXXXXX of cash on hand at XXXXXXXXXX (the "Cash on Hand").

10. As at XXXXXXXXXX , $XXXXXXXXXX of the Cash on Hand was invested in bankers' acceptance and commercial paper. These short-term investments mature between XXXXXXXXXX. The balance of the Cash on Hand is in cash.

11. Opco has an accumulated deficit for accounting purposes of $XXXXXXXXXX as at XXXXXXXXXX.

As at XXXXXXXXXX , Opco had the following tax attributes for federal tax purposes ("Tax Attributes"):

-  non-capital losses to carry forward			$XXXXXXXXXX
-  scientific research and experimental		$XXXXXXXXXX
    development expenses to carry forward
-  investment tax credits to carry forward 		 $XXXXXXXXXX 

Opco has never declared and paid any dividends since becoming a public corporation.

12. The Board of Directors of Opco has determined that it was in the best interest of Opco's Shareholders to proceed with the sale of the Business (the "Sale Transaction").

13. On XXXXXXXXXX, Opco and Parentco entered into a letter of intent setting out their understanding with respect to the proposed terms of a transaction. Since XXXXXXXXXX, Opco and Parentco are negotiating the Sale Transaction and the terms of the Asset Purchase Agreement ("APA").

PROPOSED TRANSACTIONS

14. Before the end of XXXXXXXXXX, Opco will issue a Management Information Circular inviting Opco Shareholders to attend the annual and special meeting of the shareholders. In this meeting, Opco Shareholders will be required to approve a special resolution in respect of the Sale Transaction. Should this resolution be approved, Opco Shareholders will be asked to approve a special resolution in respect of the change of Opco's name to XXXXXXXXXX and a special resolution to reduce the stated capital account of Opco Common Shares ("Reduction of Capital").

15. The APA will provide that AcquisitionCo, a wholly-owned subsidiary of Parentco, will acquire all of the assets of Opco related to the Business other than those related to the Program Y (the "Purchased Assets"). The initial objective of Opco's management was to include the Program Y in the Sale Transaction. However, Parentco was unwilling to acquire this program.

The purchase price for the Purchased Assets will be (i) an aggregate amount of US$XXXXXXXXXX, as may be adjusted, and (ii) the assumption of liabilities of Opco related to the Purchased Assets (the "Assumed Liabilities"). It is intended that the APA be entered into in XXXXXXXXXX. The Sale Transaction will be effective at the closing, which is expected to occur in XXXXXXXXXX.

The purchase price will be payable as follows:

(a) an amount of US$XXXXXXXXXX in cash ("Cash Proceeds");

(b) US$XXXXXXXXXX in shares of XXXXXXXXXX of Parentco ("Parentco XXXXXXXXXX Shares"); XXXXXXXXXX; and

(c) by the assumption of the Assumed Liabilities.

Opco will dispose of the Purchased Assets on a taxable basis. It is anticipated that most of the taxable gain realized on the Sale Transaction will be recapture and gain from the disposition of depreciable property and/or eligible capital property. Opco will apply a portion of its Tax Attributes against the taxable gain generated by the Sale Transaction. Therefore, no tax should be payable by Opco as a result of the Sale Transaction.

16. The APA will provide that Opco and Subco will be precluded, for a period of XXXXXXXXXX years after the Sale Transaction, to be engaged in any activities similar to the Business.

17. Following the Sale Transaction, Opco will have no material liabilities and will own the following assets:

(a) approximately $XXXXXXXXXX in cash and short-term investments;

(b) Parentco XXXXXXXXXX Shares;

(d) Shares of Subco; and

(e) rights pertaining to the Program Y.

18. In XXXXXXXXXX, Opco will dispose of all of its short-term investments related to the Cash on Hand, in order to convert these investments into cash.

19. Following the Sale Transaction, the current Management of Opco will cease to be employed by Opco as well as all the other employees involved in the Program Y. Therefore, Opco will not have any employees after the Sale Transaction.

20. Opco's Management is of the view that the carrying value of the intellectual property and assets related to the Program Y may not be recoverable and was written off for accounting purposes in the fiscal period ending in XXXXXXXXXX. Should the Sale Transaction be approved by Opco Shareholders, Opco will cease to carry on any research and development activities related to the Program Y, and the rights pertaining to this program will be liquidated as soon as practicable. Opco's Management anticipates that the liquidation of the Program Y should occur within XXXXXXXXXX months after the Sale Transaction.

21. XXXXXXXXXX.

22. Shortly following the Sale Transaction, the liquidation of its short-term investments and the ceasing of the research and development activities related to the Program Y, Opco will proceed with the Reduction of Capital and will distribute to the Opco Shareholders registered on the record date selected by the Board of Directors, in satisfaction of the payment of the Reduction of Capital, an amount of approximately $XXXXXXXXXX in cash ("Distribution"), being the aggregate of the Cash on Hand and the Cash Proceeds, less a cash reserve required to pay the expenses associated with maintaining the corporation in existence. The Reduction of Capital and the Distribution will be made on the record date.

ADDITIONAL INFORMATION

23. The objective of the Management and the Board of Directors of Opco is to dispose of, once appropriate, the Parentco XXXXXXXXXX Shares received on the Sale Transaction. XXXXXXXXXX.

24. For the moment, Opco's Management is of the view that the portion of the Tax Attributes not utilized to offset the taxable gain realized on the Sale Transaction should be used to offset any gain that may be realized by Opco on the eventual disposition of the Parentco XXXXXXXXXX Shares. Up to now, Opco's Management has not established any other strategy to utilize the remaining Tax Attributes.

25. The federal business number of Opco, the location of the tax services office and taxation centre where its returns are filed, and the address of its head office are as follows:

Opco
-  Business Number: 		XXXXXXXXXX
-  Tax Services Office:  	XXXXXXXXXX
-  Taxation Centre:  		XXXXXXXXXX
-  Address:			XXXXXXXXXX 

PURPOSE OF THE PROPOSED TRANSACTIONS

26. Opco wishes to terminate its operations in the most efficient manner for its shareholders. Accordingly, Opco has determined that the most efficient manner to proceed is by, namely:

(a) disposing of the Purchased Assets in favour of AcquisitionCo;

(b) distributing its available cash (i.e. Cash on Hand and Cash Proceeds) to its shareholders through a Reduction of Capital;

(c) ceasing its research and development activities in connection with the Program Y and liquidating, as soon as practicable, the rights pertaining to this program;

(e) terminating all employees, including management position; and

(f) disposing of the Parentco XXXXXXXXXX Shares as soon as practicable.

RULINGS GIVEN

Provided that the preceding statements constitute a complete and accurate disclosure of all relevant facts, proposed transactions and the purpose of the proposed transactions, and provided that the proposed transactions are completed in the manner described above, we confirm the following:

A. Subsection 84(2) will apply, and subsection 84(4.1) will not apply, to the Distribution referred to in Paragraph 22 above, such that Opco will be deemed to have paid, and the Opco Shareholders will be deemed to have received, a dividend only to the extent, if any, that the amount of the Distribution exceeds the amount by which the paid-up capital in respect of the Opco Common Shares is reduced.

B. Where an Opco Shareholder holds Opco Common Shares as capital property, the amount received by each such person upon the reduction of the paid-up capital of the Opco Common Shares, as described in Paragraph 22 above, will be deducted in computing the particular Opco Shareholder's ACB of such shares by virtue of subparagraph 53(2)(a)(ii).

C. Subsection 15(1) will not apply to require any amount distributed to an Opco Shareholder as a return of capital, as described in Paragraph 22 above, to be included in computing the income of such shareholder.

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

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

COMMENTS

The Ruling B above confirms that where an Opco Shareholder holds Opco Common Shares as capital property, the amount received by each such person upon the reduction of the paid-up capital of the Opco Common Shares, as described in Paragraph 22 above, will be deducted in computing the particular Opco Shareholder's ACB of such shares by virtue of subparagraph 53(2)(a)(ii).

Where the amount of such reduction of the paid-up capital of the Opco Common Shares exceeds the particular Opco Shareholder's ACB thereof, the excess will be deemed to be a gain of such holder for the year from the disposition of such share under subsection 40(3).

Furthermore, to the extent that an Opco Shareholder realizes a capital gain on their Opco Common Shares as a result of the application of subsection 40(3), in computing the ACB of such shareholder's Opco Common Shares, as the case may be, the amount of the gain will be added to the ACB of such shares under paragraph 53(1)(a).

Finally, nothing in this ruling should be construed as implying that the CRA has agreed to or reviewed:

(a) the determination of the fair market value, or ACB of any property referred to herein, the paid-up capital in respect of any share referred to herein, or the non-capital losses or any other tax attributes of any corporation; or

(b) any tax consequences relating to the facts and proposed transactions described herein other that those specifically confirmed in the rulings given above.

An invoice for our fees in connection with this ruling request will be forwarded to you under separate cover.

Yours truly,

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