2005 Ruling 2005-0130141R3 - safe income extraction

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 the taxpayer is entitled to a bump under paragraph 88(1)(c)

Position: Yes

Reasons: Meets the requirements of the law

XXXXXXXXXX 2005-013014

XXXXXXXXXX, 2005

Dear XXXXXXXXXX:

Re: XXXXXXXXXX (hereinafter referred to as "Holdco")
XXXXXXXXXX ("Newco1")
XXXXXXXXXX ("Newco2")
XXXXXXXXXX (hereinafter referred to as "Shco")

XXXXXXXXXX.

XXXXXXXXXX (hereinafter referred to as "Lco")

This is in reply to your letter of XXXXXXXXXX, wherein you requested an advance income tax ruling on behalf of the above-noted taxpayers.

To the best of the knowledge of the above-mentioned taxpayers, none of the issues involved in the ruling request:

(i) is in an earlier return of the taxpayers or a related person,

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

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

(iv) is before the courts.

STATUTORY DEFINITIONS

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

"Act" means the Income Tax Act, R.S.C. 1985, c.1 (5th Supp.), as amended to the date hereof (the "Act"), and unless otherwise indicated, all references herein to a statute are references to the Act;

"adjusted cost base" has the meaning assigned in section 54;

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

"capital property" has the meaning assigned in section 54;

"CBCA" means the Canada Business Corporations Act;

"CCPC" or "Canadian-controlled private corporation" has the meaning assigned by subsection 248(1);

"ineligible property" has the meaning assigned by paragraph 88(1)(c);

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

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

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

"related persons" has the meaning assigned by subsection 251(2);

"Safe Income On Hand" in respect of particular shares at a particular time means the portion of the unrealized gain inherent in the shares at that time that cannot reasonably be considered to be attributable to anything other than income earned or realized (as defined in paragraph 55(5)(b), (c) or (d) depending on the circumstances) by Pubco and its subsidiaries after 1971 and before the safe-income determination time for the series of transactions that includes the dividends;

"safe income determination time" has the meaning assigned by subsection 55(1);

"specified financial institution" has the meaning assigned by subsection 248(1);

"subsidiary wholly-owned corporation" has the meaning assigned by subsection 248(1);

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

"taxable dividend" has the meaning assigned by subsection 89(1).

Our understanding of the facts, proposed transactions and purposes of the proposed transactions is as follows:

FACTS

1. XXXXXXXXXX ("Pubco") is a public corporation, the outstanding common shares of which are listed for trading on the XXXXXXXXXX Stock Exchange.

2. There are currently outstanding approximately XXXXXXXXXX common shares of Pubco.

3. Holdco was incorporated under the CBCA on XXXXXXXXXX. Holdco is a CCPC and a taxable Canadian corporation.

4. The authorized share capital of each of Newco1 and Newco2, (which corporations were incorporated on XXXXXXXXXX , respectively) consists of:

(a) an unlimited number of class A common shares;

(b) an unlimited number of class B common shares;

(c) an unlimited number of class A preferred shares;

(d) an unlimited number of class B preferred shares;

(e) an unlimited number of class C preferred shares; and

(f) an unlimited number of class D preferred shares.

Newco1 and Newco2 are CCPCs and taxable Canadian corporations incorporated under the CBCA.

Newco1 and Newco2 are hereinafter sometimes referred collectively as the "Newcos".

5. Holdco owns the one (1) outstanding class A common share of each Newco.

6. The principal asset of Holdco is Pubco common shares which it holds as capital property.

7. The shareholders of Holdco and the number of shares held are as follows:

	SHAREHOLDER			NUMBER AND SHARES HELD

	Shco					XXXXXXXXXX  common shares
	XXXXXXXXXX .			XXXXXXXXXX  common shares
	XXXXXXXXXX 			XXXXXXXXXX  class A preferred shares
	XXXXXXXXXX 			XXXXXXXXXX  class A preferred shares
	XXXXXXXXXX 			XXXXXXXXXX  class A preferred shares
	XXXXXXXXXX 			XXXXXXXXXX  class A preferred shares
	XXXXXXXXXX 			XXXXXXXXXX  class A preferred shares

XXXXXXXXXX

8. Lco is a TCC and is not a financial institution. Lco is controlled by XXXXXXXXXX . Lco is not related to Holdco and deals at arm's length with Holdco. XXXXXXXXXX deals at arm's length with each of XXXXXXXXXX. Lco does not act as an agent for any person.

PROPOSED TRANSACTIONS

9. Holdco will sell some common shares of Pubco in one or more transactions to Newcol and Newco2 for an equal number of Class A Common Shares of Newcol and Newco2, respectively.

10. In respect of the transfers described in paragraph 9 above, Holdco will jointly elect with each of Newcol and Newco2, pursuant to subsection 85(1), in prescribed form and within the time referred to in subsection 85(6), to transfer the common shares of Pubco at an amount equal to the adjusted cost base thereof to Holdco (approximately [$XXXXXXXXXX] per share), which will be substantially less than the fair market value thereof at the time of the transfer.

The amount to be added to the stated capital of the Newcol Class A Common Shares so issued will be an amount equal to the aggregate adjusted cost base of the common shares of Pubco so transferred (the "Transferred Shares "1"" ). The amount to be added to the stated capital of the Newco2 Class A Common Shares so issued will be an amount equal to the aggregate adjusted cost base of the common shares of Pubco so transferred (the "Transferred Shares "2"").

11. Each of Newcol and Newco2 will declare and pay a series of sequential stock dividends on the Newco1 Class A Common Shares and the Newco2 Class A Common Shares respectively, to be satisfied by the issuance of Newcol Class A Preferred Shares and Newco2 Class A Preferred Shares respectively. The stated capital and the value of the Newco1 Class A Preferred Shares and the Newco2 Class A Preferred Shares will not exceed the Safe Income on Hand of Pubco in respect of the Transferred Shares "1" and the Transferred Shares "2", respectively. For this purpose, it is your view that all of the Safe Income on Hand of Pubco that is attributable to the common shares of Pubco transferred by Holdco to each of Newco1 and Newco2 will, immediately after such transaction, be attributed to the Newco1 Class A Common Shares and the Newco2 Class A Common Shares, respectively.

12. Holdco will then sell for cash, at a price to be negotiated on an arm's length basis, all of the outstanding shares of each of Newco1 and Newco2 to Lco.

13. Newco1 and Newco2 will then be wound up into Lco under the relevant corporate law and, accordingly, all the shares of Pubco owned by each of Newco1 and Newco2 will be transferred and assigned to Lco.

14. Lco will designate, in respect of the Transferred Shares "1" and the Transferred Shares "2" in its income tax return of income for the taxation year in which each of Newco1 and Newco2 is wound up, an amount pursuant to paragraph 88(l)(d), equal to the difference between:

(a) the purchase price paid by Lco for the shares of Newco1 and Newco2, as the case may be, as described in paragraph 12 above; and

(b) the adjusted cost base to Newco1 and Newco2, as the case may be, of the Transferred Shares "1" and the Transferred Shares "2", (hereinafter collectively referred to as the "Transferred Shares"), as the case may be, as a result of the transaction described in paragraph 12 above.

15. Lco will, immediately or soon after the distribution of the Transferred Shares "1" and the Transferred Shares "2", to it by each of Newcol and Newco2, sell some or all of the Pubco shares so acquired for an aggregate sale price that will probably be slightly in excess of the purchase price paid by it for the shares of Newcol and Newco2, as described in paragraph 12 above. None of the Pubco shares will be sold to a person described in subclause 88(l)(c)(vi)(B)(I), (II) or (III) in relation to Newcol and Newco2.

16. The purchase and sale agreement between Holdco and Lco pursuant to which Holdco will sell the shares of Newcol and Newco2 to Lco will include usual representations and warranties, including a representation by Holdco that the facts disclosed in this ruling relating to Holdco and Pubco are true and complete and that no person described in subclause 88(l)(c)(vi)(B)(I), (II) or (III) in relation to Newcol and Newco2 will purchase any Pubco shares from Lco as part of the series of transactions that includes the winding-up of the Newcos. The purchase agreement will also include indemnities for any losses incurred by a party as a result of a breach of representation or warranty by the other party and for any taxes, interest or penalties incurred by Lco as a result of the cost of the Transferred Shares acquired by Lco on the winding-up of the Newcos being less than the amount described in ruling (I) below. However, Lco will not be indemnified against commercial risks and will be subject to market considerations subsequent to its acquisition of the shares of the Newcos and the proposed resale of the Pubco shares.

SUBSEQUENT TRANSACTION

Holdco proposes to use the net after-tax proceeds of the sale of the Newcos shares to purchase for cancellation a portion of its shares owned by Shco.

ADDITIONAL INFORMATION

None of the shares of the Newcos is, or will be at any time during the implementation of the Proposed Transactions:

(i) the subject of any undertaking that is referred to in subsection 112(2.2) as a "guarantee agreement";

(ii) the subject of a dividend rental arrangement referred to in subsection 112(2.3), as that term is defined in subsection 248(1);

(iii) the subject of any secured undertaking of the type described in paragraph 112(2.4)(a); or

(iv) issued for consideration that is or includes:

A. an obligation of the type described in subparagraph 112(2.4)(b)(i); or

B. any right of the type described in subparagraph 112(2.4)(b)(ii).

None of the corporations referred to herein (including the corporations to be incorporated as described in the proposed transactions) is or will be, at any time during the series of transactions herein described, a "specified financial institution" or a "restricted financial institution" as those terms are defined in subsection 248(1).

PURPOSE OF THE PROPOSED TRANSACTIONS

The purpose of the proposed transactions is to allow Holdco to recover, on a tax-deferred basis, the Safe Income on Hand of Pubco in respect of the Transferred Shares held by Holdco. Since Pubco is a public corporation, Holdco is unable to cause Pubco to declare a dividend. Accordingly, it must transfer its shares in Pubco which are to be sold to a corporate third party in order to be able to realize on a tax-deferred basis the Safe Income on Hand of Pubco attributable to its Pubco common shares.

RULINGS

Provided that the above statements constitute a complete and accurate disclosure of all the relevant facts, purposes of the proposed transactions and proposed transactions, we rule as follows:

(A) The provisions of subsections 15(1), 56(2) and 246(1) will not apply to the proposed transactions described above, in and of themselves.

(B) Immediately after the transfers described in paragraph 9 above, the Safe Income on Hand of Pubco in respect of the Class A Common Shares of Newcol will include the Safe Income on Hand of Pubco in respect of the Transferred Shares "1".

(C) Immediately after the transfers described in paragraph 9 above, the Safe Income on Hand of Pubco in respect of the Class A Common Shares of Newco2 will include the Safe Income on Hand of Pubco in respect of the Transferred Shares "2".

(D) The Newcos will be considered to have paid dividends on the Class A Common Shares in an amount equal to the paid-up capital of the Class A Preferred Shares issued in respect of the stock dividends paid as described in paragraph 11 above and each such dividend received by the recipient will:

(i) be deductible by the recipient, to the extent that it is a taxable dividend, in computing its taxable income for the taxation year in which such dividend is deemed to be received, pursuant to subsection 112(1), and none of subsections 112(2.1), (2.2), (2.3) or (2.4) will apply to deny the deductibility under subsection 112(2.1);

(ii) not be subject to tax under Part IV of the Act except as provided in paragraph 186(1)(b); and

(iii) be an "excluded dividend" within the meaning of subsection 191(1) and an "excepted dividend" within the meaning of section 187.1.

(E) The provisions of subsection 55(2) will not apply to a dividend described in ruling (D) above that is paid by Newco1, provided that the full amount of the dividend does not exceed the Safe Income on Hand of Pubco in respect of the Class A Common Shares of Newcol immediately before the time of the dividend.

(F) The provisions of subsection 55(2) will not apply to a dividend described in ruling (D) above that is paid by Newco2, provided that the full amount of the dividend does not exceed the Safe Income on Hand of Pubco in respect of the Class A Common Shares of Newco2 immediately before the time of the dividend.

(G) The provisions of paragraph 52(3)(a) will apply in determining the adjusted cost base to Holdco of the Class A Preferred Shares of the Newcos received in respect of the dividends paid as described in ruling (D) above.

(H) The provisions of subsection 88(1) will apply in respect of the winding-up of Newcol and Newco2 into Lco as described in paragraph 13 above with the result that:

(i) each of Newcol and Newco2 will, pursuant to subparagraph 88(l)(a)(iii), be deemed to have disposed of the Transferred Shares for proceeds of disposition equal to their cost amount to the respective Newco immediately before the winding-up, and

(ii) Lco will, pursuant to paragraph 88(l)(b), be deemed to have disposed of its shares of Newcol and Newco2 for proceeds equal to the greater of the amounts described in subparagraphs 88(l)(b)(i) and (ii).

(I) Pursuant to paragraphs 88(l)(c) and 88(l)(d), provided that no property acquired by Lco on the winding-up described in paragraph 13 above, or "any other property acquired by any person in substitution therefor" (within the meaning of the phrase for the purposes of clause 88(l)(c)(vi)(B)) is acquired by any person described in any of subclauses 88(l)(c)(vi)(B)(I), (II) or (III), the cost to Lco of the Transferred Shares "1" and the Transferred Shares "2", acquired by it on the windings-up described in paragraph 13 above will be deemed to be the amount deemed by paragraph 88(l)(a) to be the proceeds of disposition of the Transferred Shares to the particular Newco plus, subject to the provisions of subparagraphs 88(l)(d)(ii) and (iii), such portion of the amount, if any, by which:

(1) the aggregate of the adjusted cost base to Lco of its shares of the particular Newco immediately before the winding-up of the Newco
exceeds

(2) the aggregate of the amounts determined under subparagraphs 88(l)(d)(i) and (i.1) (which will not include any dividends deemed to be received by Holdco by reason of the sequential dividends as described in paragraph 11 above) in respect of the particular Newco

as is designated by Lco in respect of the Transferred Shares in its return of income under Part I of the Act for its taxation year in which the particular Newco is wound up, as described in paragraph 14 above.

(J) Subsection 245(2) will not be applied as a result of the proposed transactions, in and by themselves, to redetermine the tax consequences confirmed in the rulings given.

These rulings are given subject to the limitations and qualifications set forth in Information Circular 70-6R5 issued on May 29, 2002, and are binding on the Canada Revenue Agency 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 which, if enacted, could have an effect on the rulings given.

Comments

Nothing in this ruling should be construed as implying that the Canada Revenue Agency has reviewed, accepted or otherwise agreed to:

(a) the determination of the adjusted cost base, the fair market value or the paid-up capital of any shares referred to herein; or

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

We confirm that the time for completing the proposed transactions described in the advance income tax ruling issued on XXXXXXXXXX, 2005 (our file number 2004-010158) will be extended until XXXXXXXXXX.

Yours truly,

XXXXXXXXXX
Manager
Corporate Reorganizations Section 1
Income Tax Rulings Directorate
Policy and Planning Branch