2005 Ruling 2005-0129801R3 - labour sponsored venture capital corporations

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.

"The Department of Finance issued a comfort letter on Oct 17, 2005 stating that although a LSVCC will be temporarily offside 204.81(1)(c), in these circumstances Finance will recommend an amendment to the Act so that there will be no section 204.841 penalty tax."

Principal Issues: whether series of transactions is a "merger" for purposes of 204.85

Position: yes

Reasons: caselaw and corporate law

XXXXXXXXXX 							2005-012980

XXXXXXXXXX , 2005

Dear XXXXXXXXXX:

Re: XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
Advance Income Tax Ruling

We are writing in response to your letter of XXXXXXXXXX, wherein you requested an advance income tax ruling on behalf of the above taxpayers.

To the best of your knowledge and that of the taxpayers involved, none of the issues contained in this ruling request are:

(i) dealt with in an earlier return of the taxpayers 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) subject to a ruling previously issued by the Income Tax Rulings Directorate; or

(v) before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has not expired.

DEFINITIONS

In this letter, the following terms have the following meanings:

(a) "Act" means the Income Tax Act, R.S.C. 1985 (5th Suppl.) c.1, as amended to the date hereof. All statutory references in this letter are to the Act, unless stated otherwise;

(b) "Canco #1" means XXXXXXXXXX. Canco #1's head office is located at XXXXXXXXXX. The TSO and TC responsible for Canco #1 are the XXXXXXXXXX TSO and the XXXXXXXXXX TC. Canco #1's business number is XXXXXXXXXX;

(c) "Canco #2" means XXXXXXXXXX. Canco #2's head office is located at XXXXXXXXXX. The TSO and TC responsible for Canco #2 are the XXXXXXXXXX TSO and the XXXXXXXXXX TC. Canco #2's business number is XXXXXXXXXX;

(d) "Canco #3" means XXXXXXXXXX. Canco #3's head office is located at XXXXXXXXXX. The TSO and TC responsible for Canco #1 are the XXXXXXXXXX TSO and the XXXXXXXXXX TC. Canco #3's business number is XXXXXXXXXX;

(e) "Canco #4" means XXXXXXXXXX. Canco #4's head office is located at XXXXXXXXXX. The TSO and TC responsible for Canco #1 are the XXXXXXXXXX TSO and the XXXXXXXXXX TC. Canco #4's business number is XXXXXXXXXX;

(f) "Corporate Act" means the Canada Business Corporations Act, R.S.C. 1985, c. C-44, as amended;

(g) "CRA" means the Canada Revenue Agency;

(h) "Merger Share" and "Merger Shares" mean, respectively, a share and the shares referred to in Paragraph 21d;

(i) "Paragraph" means a numbered paragraph in this advance income tax ruling;

(j) "Proposed Transactions" means the transactions described in Paragraphs 21 to 23;

(k) "Redeemed Share" and "Redeemed Shares" mean, respectively, a share and the shares referred to in Paragraph 21a;

(l) "TC" means Taxation Centre; and

(m) "TSO" means Tax Services Office;

Our understanding of the facts and Proposed Transactions is as follows:

FACTS

1. Canco #1 is a corporation incorporated under the Corporate Act in XXXXXXXXXX.

2. Canco #2 is a corporation incorporated under the Corporate Act in XXXXXXXXXX.

3. Canco #3 is a corporation incorporated under the Corporate Act in XXXXXXXXXX.

4. Canco #4 is a corporation incorporated under the Corporate Act in XXXXXXXXXX.

5. Canco #1 is:

(a) a registered labour-sponsored venture capital corporation within the meaning assigned by subsection 248(1);

(b) XXXXXXXXXX; and

(c) XXXXXXXXXX.

6. Canco #2 is:

(a) a registered labour-sponsored venture capital corporation within the meaning assigned by subsection 248(1);

(b) XXXXXXXXXX; and

(c) XXXXXXXXXX.

7. Canco #3 is:

(a) a registered labour-sponsored venture capital corporation within the meaning assigned by subsection 248(1); and

(b) XXXXXXXXXX.

8. Canco #4 is:

(a) a registered labour-sponsored venture capital corporation within the meaning assigned by subsection 248(1); and

(b) XXXXXXXXXX.

9. Canco #1 currently has approximately $XXXXXXXXXX in net assets and over XXXXXXXXXX Canadian shareholders.

10. Canco #2 has approximately $XXXXXXXXXX in net assets and approximately XXXXXXXXXX Canadian shareholders.

11. Canco #3 has approximately $XXXXXXXXXX in net assets and approximately XXXXXXXXXX Canadian shareholders.

12. Canco #4 has approximately $XXXXXXXXXX in net assets and approximately XXXXXXXXXX Canadian shareholders.

13. The authorized capital of Canco #1 consists of an unlimited number of Class A shares, issuable in series, XXXXXXXXXX Class B shares and an unlimited number of Class C shares, issuable in series.

14. The authorized capital of Canco #2 consists of an unlimited number of Class A shares, XXXXXXXXXX Class B shares and an unlimited number of Class C shares, issuable in series.

15. The authorized capital of Canco #3 consists of an unlimited number of Class A shares, XXXXXXXXXX Class B shares and an unlimited number of Class C shares, issuable in series.

16. The authorized capital of Canco #4 consists of an unlimited number of Class A shares, issuable in series, XXXXXXXXXX Class B shares, an unlimited number of Class C shares, issuable in series.

17. The Class A shares of Canco #1 are offered by series to members of the public in XXXXXXXXXX. Investors are eligible to receive a labour sponsored funds tax credit under section 127.4 of the Act. Investors resident in XXXXXXXXXX are also eligible to receive a provincial tax credit. Investors must generally repay those tax credits if they redeem their shares within 8 years of purchasing them.

18. The Class A shares of Canco #2 are temporarily off-sale. Prior to going off-sale, Class A shares of Canco #2 were offered to members of the public XXXXXXXXXX. When offered, investors are eligible to receive a labour sponsored funds tax credit under section 127.4 of the Act. Investors resident in XXXXXXXXXX are also eligible to receive a provincial tax credit. Investors must generally repay those tax credits if they redeem their shares within 8 years of purchasing them.

19. The Class A shares of Canco #3 are temporarily off-sale. Prior to going off-sale, Class A shares of Canco #3 were offered to members of the public in XXXXXXXXXX. When offered, investors are eligible to receive a labour sponsored funds tax credit under section 127.4 of the Act. Investors resident in XXXXXXXXXX are also eligible to receive a provincial tax credit. Investors must generally repay those tax credits if they redeem their shares within 8 years of purchasing them.

20. The Class A shares of Canco #4 are currently off-sale. Prior to going off-sale, Class A shares of Canco #4 were offered to members of the public in XXXXXXXXXX. When offered, investors are eligible to receive a labour sponsored funds tax credit under section 127.4 of the Act. Investors resident in XXXXXXXXXX are also eligible to receive a provincial tax credit. Investors must generally repay those tax credits if they redeem their shares within 8 years of purchasing them.

PROPOSED TRANSACTIONS

21. Canco #1, Canco #2, Canco #3 and Canco #4 will be merged (the "Merger") by effecting the following series of steps:

(a) In connection with the Merger, the rights and restrictions attached to the outstanding Class A shares of Canco #2, Canco #3 and Canco #4 (the "Redeemed Shares") will be amended to incorporate a Merger redemption procedure whereby the Redeemed Shares would be automatically redeemed as at the effective date of the Merger immediately after the transfer of assets referred to below.

(b) In connection with the Merger, the rights and restrictions attached to the Class A shares of Canco #1 will be amended to allow them to be issued to each of Canco #2, Canco #3 and Canco #4 as consideration for the purchase of the assets of Canco #2, Canco #3 and Canco #4 and to be immediately thereafter transferred and distributed to the Class A shareholders of Canco #2, Canco #3 and Canco #4 under the Merger redemption procedure referred to above.

(These amendments would result in Canco #1's articles of incorporation containing Merger specific provisions that would not comply with clause 204.81(1)(c)(ii)(A) and subparagraph 204.81(1)(c)(vii). Canco #1 will request a comfort letter from the Minister confirming that the Minister will not exercise his powers under subsection 204.81(6) of the Act to revoke the fund's registration as a result of those Merger specific amendments.)

(c) After setting aside sufficient assets to satisfy its estimated liabilities, if any, each of Canco #2, Canco #3 and Canco #4 will transfer their remaining assets (the "Assets") to Canco #1 at a value equal to the net asset value of each of Canco #2, Canco #3 and Canco #4 as at the effective date of the Merger. Canco #1 will not assume the liabilities of Canco #2, Canco #3 or Canco #4. Each of Canco #2, Canco #3 and Canco #4 will use the retained assets to satisfy its remaining liabilities as soon as practicable after the effective date of the Merger.

(d) As consideration for the Assets, Canco #1 will issue Class A shares (the "Merger Shares") to each of Canco #2, Canco #3 and Canco #4. The issue price of the Merger Shares will be equal to their net asset value as at the effective date of the Merger.

(e) Pursuant to the Merger redemption procedure referred to in (a), the Merger Shares will be immediately transferred to the shareholders of each of Canco #2, Canco #3 and Canco #4 as payment of the redemption price for the Redeemed Shares. The number of Merger Shares transferred to a given holder of Redeemed Shares through the Merger redemption procedure will be determined by applying the ratio obtained by dividing the total Merger Shares by the total Redeemed Shares. The redemption price of the Redeemed Shares will be equal to the net asset value of the Merger Shares distributed under the Merger redemption procedure.

(f) As soon as practicable following the effective date of the Merger, Canco #2, Canco #3 and Canco #4 will be wound-up or dissolved in accordance with the provisions of the Corporate Act.

At the end of these Merger steps, Canco #1 will be the resulting single corporate entity with the consolidated assets and Class A shareholders of the pre-Merger entities.

22. The Merger will be subject to the prior approval by special resolution (XXXXXXXXXX% vote) of each of the shareholders of Canco #1, Canco #2, Canco #3 and Canco #4. An information circular with relevant information concerning the Merger and proxy materials will be mailed to each shareholder.

23. The Merger will also be subject to any necessary securities regulatory approvals.

PURPOSE OF PROPOSED TRANSACTIONS

24. The purpose of the Merger is to:

(a) achieve significant cost savings by combining Canco #1's, Canco #2's, Canco #3's, and Canco #4's management, administration, marketing and back office functions and realizing increased economies of scale;

(b) improve investment performance by creating a larger, more diversified venture investment portfolio;

(c) improve liquidity and resources to fund follow-on investments; and

(d) create a higher profile in the marketplace for the post-Merger Canco #1, thereby increasing awareness of the fund among both investors and entrepreneurs.

If achieved, this will create a larger, more efficient investment pool to improve the prospects for achieving positive returns for investors, providing a significant and stable source of venture capital for eligible businesses and fostering business development, economic growth and job creation in the regions in which Canco #1, Canco #2, Canco #3, and Canco #4 invest.

25. The Merger structure specifically seeks to:

(a) very substantially reduce transaction costs as compared to those associated with a statutory amalgamation. The materials that must be printed and mailed to the funds' shareholders are far less voluminous than those associated with a statutory amalgamation. Additionally, costs associated with a court process are eliminated;

(b) reduce "unfunded" risks associated with unknown, unanticipated claims that may arise after the Merger date and were not accounted for in the net asset values of each of Canco #2, Canco #3 and Canco #4 that determined the Merger share exchange ratio. As no indemnity will be available to compensate for such unknown or contingent liabilities, it would be unfair to the pre-Merger shareholders of Canco #1 to have to bear the burden of such costs attributable to Canco #2's, Canco #3's and Canco #4's pre-Merger history; and

(c) benefit from industry familiarity among investment advisors and back-office administration staff with the merger by purchase of assets structure.

26. More generally, LSVCC market consolidation and rationalization, whereby smaller, uneconomic funds merge to create larger, more efficient funds should be encouraged. Merger structures that permit these outcomes to be achieved on the most efficient basis are necessary to ensure that needed consolidation is not discouraged. The proposed transaction seeks to implement such an efficient structure.

RULINGS

Provided that the preceding statements constitute a complete and accurate disclosure of all of the relevant warranties on page 1 of this advance income tax ruling, as well as 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 set forth below:

A. The Merger described in Paragraph 21 will be a "merger" within the meaning of subsection 204.85(3) and subsection 211.7(2).

B. Upon the merger described in Paragraph 21, Canco #1 will be the "new corporation" formed by the merger within the meaning of subsection 204.85(3).

C. Pursuant to paragraph 204.85(3), Canco #1 will be the same corporation as, and a continuation of, each of Canco #2, Canco #3, and Canco #4 for the purposes of, inter alia, subsections 204.83(1) and (2).

D. A Redeemed Share will be "replaced on the amalgamation or merger" by a Merger Share and a Merger Share will be a "new share" of Canco #1 within the meaning of paragraph 204.85(3)(c).

CAVEAT

The above rulings are given subject to the general limitations and qualifications set out in Information Circular 70-6R5 (the "Circular") issued by the CRA on May 17, 2002, and are binding provided that the Merger as described in Paragraph 21 occurs on or before XXXXXXXXXX.

These rulings are based on the Act in its present form and do not take into account the effect of any proposed amendments to the Act.

Nothing in this letter should be construed as implying that the CRA has agreed to or accepted:

(i) the accuracy of any amounts referred to in this letter;

(ii) the GST implications of any of the proposed transactions;

(iii) any other tax consequences of the proposed transactions or of related transactions or events that are not described herein.

Yours truly,

XXXXXXXXXX
Manager
Corporate Financing Section
Financial Sector and Exempt Entities Division
Income Tax Rulings Directorate