2006 Ruling 2005-0130401R3 - Patronage dividends

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 a distribution to be made by a cooperative corporation to its non-active members based on their member loan balances is an allocation in proportion to patronage for the purposes of section 135.

Position: No.

Reasons: In this case, the non-active members have not conducted any business with the cooperative corporation during the particular year. Accordingly, it is our view that the non-active members are not customers of the cooperative corporation for that particular year for the purposes of section 135.

XXXXXXXXXX 							2005-013040

XXXXXXXXXX, 2006

Dear XXXXXXXXXX:

Re: Advance Income Tax Ruling Request
XXXXXXXXXX

This is in reply to your letter dated XXXXXXXXXX in which you requested an advance income tax ruling on behalf of the above-noted taxpayer. We also acknowledge the additional information provided in subsequent correspondence and during our various telephone conversations in connection with your request (XXXXXXXXXX).

You advise that to the best of your knowledge and that of the taxpayer referred to above, none of the issues involved in the ruling request:

i. is in an earlier return of the taxpayer or a related person;

ii. is being considered by a tax services office or tax centre in connection with a previously filed tax return of the taxpayer or a related person;

iii. is under objection by the taxpayer or a related person;

iv. is before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has not expired; and

v. is the subject of a ruling previously issued by the Directorate.

Unless otherwise stated, all references to a statute are to the provisions of the Income Tax Act, R.S.C. 1985, 5th Supplement, c.1, as amended, (the "Act") and all terms and conditions used herein that are defined in the Act have the meaning given in such definition unless otherwise indicated.

Our understanding of the relevant definitions, facts, proposed transactions and their purposes is set out below.

DEFINITIONS

a) "ACO" means the XXXXXXXXXX,

b) "Board" means the board of directors of Parentco,

c) "Canadian-controlled private corporation" has the meaning assigned by subsection 125(7),

d) "BCO" means XXXXXXXXXX,

e) "Cooperative Association Act" means the XXXXXXXXXX,

f) "CRA" means Canada Revenue Agency,

g) "Paid-up capital" has the meaning assigned by subsection 89(1),

h) "Parentco" means XXXXXXXXXX,

i) "Rules" means the Rules of Parentco as at XXXXXXXXXX,

j) "Subco 1" means XXXXXXXXXX.,

k) "Subco 2" means XXXXXXXXXX.,

l) "Taxable Canadian corporation" has the meaning assigned by subsection 89(1), and

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

FACTS

1) Parentco is governed by the provisions of the Cooperative Association Act. It is a taxable Canadian corporation. Its head office is located in XXXXXXXXXX Parentco files its tax returns at the XXXXXXXXXX Taxation Centre and its tax services office is the XXXXXXXXXX TSO. Parentco's fiscal and taxation year-end is XXXXXXXXXX.

2) The principal business activities of Parentco were XXXXXXXXXX.

3) The authorized share capital of Parentco consists of one class of shares. The shares have a par value of $XXXXXXXXXX per share. Each member must at all times be the holder of XXXXXXXXXX such shares. Each member is entitled to one vote.

4) Pursuant to the Rules, a person is eligible to be a member of Parentco if the person is resident in XXXXXXXXXX and is a XXXXXXXXXX.

5) Parentco is authorized to act as an agent for its members in connection with the XXXXXXXXXX. To carry out these activities, Parentco acquired real property, equipment and hired employees. These acquisitions were made on its own behalf and not as agent for its members.

6) Parentco has both active and non-active members. XXXXXXXXXX

7) Parentco presently has approximately XXXXXXXXXX active members and XXXXXXXXXX non-active members all of whom are resident in Canada. Most of the members are companies resident in Canada but some of the members are individuals.

8) A non-active member is entitled to all rights and privileges of a member until all member loans to the non-active member are paid, at which time the non-active member's shares in Parentco will be redeemed by Parentco for $XXXXXXXXXX

9) Parentco, with the approval of the Board, may withhold from the gross income due to each member, an amount referred to as member loans. The amounts were withheld in order to provide funding to Parentco for operations and business expansion. The amount withheld from members was based upon a percentage of the gross income earned by the member and the percentage is the same for all members. Therefore, the amount of new member loans for a year was directly proportional to the XXXXXXXXXX by a particular member in the year. You advise that since XXXXXXXXXX the percentage held back has always been XXXXXXXXXX% and has never varied. Member loans did not increase in a particular year for any member that was a non-active member throughout the year.

10) The member loans are evidenced by a promissory note or a revolving loan certificate.

11) Parentco determined, each year, the repayments to be paid on member loans and the interest, if any, to be credited in respect of member loans. The Rules provide that the oldest loans be repaid first and the repayments are pro-rata based upon the amount of the members' loan for that particular year. You advise that since XXXXXXXXXX interest was paid every year on the member loans at a rate of XXXXXXXXXX% and such amount was paid out annually.

12) The Rules provide for the payment to members pursuant to allocations in proportion to patronage. However, no patronage payments have been made by Parentco to date because Parentco did not have sufficient income.

13) The Rules contain a provision for distributing any surplus to the members on the dissolution of Parentco. The surplus is to be paid pro-rata to members to retire member loans. If the surplus exceeds member loans, the balance is to be paid to members pro-rata based upon the amount of member loans outstanding at the dissolution date.

14) Parentco has two wholly-owned subsidiaries, Subco 1 and Subco 2. Both subsidiaries are Canadian-controlled private corporations. Subco 1 is inactive and has no assets. Subco 2 operated a XXXXXXXXXX.

15) XXXXXXXXXX

16) On XXXXXXXXXX, Parentco and Subco 2 sold all of their assets to BCO for total proceeds of approximately $XXXXXXXXXX, of which, approximately $XXXXXXXXXX was allocated to Parentco and $XXXXXXXXXX to Subco 2. In consideration for the assets, BCO assumed liabilities and paid cash. All of the proceeds were for assets of Parentco or Subco 2 and not assets of Parentco's members. The assets sold by Parentco consisted of plant equipment, real property used entirely in the operations, working capital, contracts and goodwill. The proceeds of sale exceeded the cost of real property, the undepreciated capital cost of depreciable property and the cumulative eligible capital of the intangible property sold.

17) On XXXXXXXXXX, Parentco utilized $XXXXXXXXXX of the cash received on the sale of its assets to advance funds to all the members. The amount of funds advanced to each member equalled the amount of the member's loan outstanding as at that date. You advise that the member loans have not been repaid at this time. Parentco currently has assets of $XXXXXXXXXX represented by cash.

PROPOSED TRANSACTIONS

18) The Rules will be amended to formally recognize the two classes of members (i.e., active and non-active) and to add a right to permit Parentco to redeem the shares of either the non-active or active members to the exclusion of the other members. The sole purpose of the amendments is to allow Parentco to redeem the shares of each non-active member without having to redeem the shares of the active members, as described in 21 below. All members will continue to hold their existing shares and no new shares will be issued. Only on redemption or dissolution of Parentco will a member relinquish the member's shares. Since Parentco is required to update its Rules to comply with the new Cooperative Association Act if it seeks to amend its Rules in any way, the revisions to the Rules will incorporate the requirements of the new Cooperative Association Act.

19) The redemption amount for the members' shares will equal the amount equivalent to what they would be entitled to receive under the Rules on the dissolution of Parentco as described in 13 above.

20) Subco 2 will distribute the net proceeds from the sale of its assets to Parentco in the form of dividends. The distribution to Parentco will form part of the surplus distributable to members of Parentco. As soon as practicable, Parentco will cause Subco 2 to be wound-up pursuant to subsection 88(1).

21) Prior to the payment of patronage dividends to the active members as described in 22 below, Parentco will, over a period of time, exercise its new right under the Rules to redeem each non-active member's shares. Concurrent with the redemption of each non-active member's shares, the member loan to the non-active member will be repaid. Repayment will occur by netting the advance paid to the non-active member against the non-member's loan payable.

22) Parentco will pay a patronage dividend in the form of cash to the active members. The amount of the patronage dividend will equal that portion of Parentco's income calculated pro-rata based upon the XXXXXXXXXX. It is anticipated that the amount of the patronage dividend will be approximately $XXXXXXXXXX. Parentco will not be making any patronage dividends to its non-member customer, ACO.

23) After the patronage is paid, Parentco will determine if it holds cash in excess of current and estimated future liabilities. If so, Parentco will use the excess cash to redeem some of the shares held by the active members over a period of time.

24) Parentco will be wound-up as soon as reasonably possible. The member loans to the active members will be repaid upon dissolution. Repayment will occur by netting the advances paid to the active members against their loans payable.

PURPOSE OF THE PROPOSED TRANSACTIONS

25) The purpose of the proposed transactions is to distribute to the members of Parentco in a tax effective manner, the net proceeds from the sale of the assets of Parentco and Subco 2.

RULINGS GIVEN

Provided that the preceding statements constitute a complete and accurate disclosure of all the relevant facts, proposed transactions, and purpose of the proposed transactions, and provided further that the proposed transactions are carried out as described above, and provided that the proposed amendments to the Rules as described in 18 above are legally effective, we confirm the following:

A. Subsection 84(3) will apply on each redemption by Parentco of its shares owned by the non-active or active members, as described in 21 and 23 above respectively, to deem Parentco to have paid, and the non-active or active members, as the case may be, to have received, a dividend on a separate class of shares equal to the amount, if any, by which the amount paid upon each such redemption exceeds the paid-up capital in respect of such shares immediately before such redemption, and any such dividend will be included, pursuant to subsection 82(1) and paragraph 12(1)(j), in computing the income of the member deemed to have received such dividend.

B. Provided that for its XXXXXXXXXX taxation year Parentco held out the prospect that amounts would be credited to its members in accordance with subsection 135(5), Parentco will be entitled to deduct pursuant to paragraph 20(1)(u) and subsection 135(1), subject to the limitation in subsection 135(2), in computing its income for the year patronage dividends paid by Parentco prior to XXXXXXXXXX to its active members as described in 22 above and such patronage dividends will be included in computing the income of the active members for the taxation year of the member in which such amounts are received pursuant to subsection 135(7).

C. For the purposes of section 135, members who were non-active members throughout Parentco's XXXXXXXXXX taxation year will not be Parentco's "customers", within the meaning assigned by subsection 135(4), for that year.

D. The addition of a right to the Rules to permit Parentco to redeem the members' shares as described in 18 above will not, in and of itself, result in a "disposition" (within the meaning of that term in subsection 248(1)) by the members of their shares in Parentco.

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

Yours truly,

XXXXXXXXXX
Manager
Charitable and Financial Institution Sectors
Financial Sector and Exempt Entities Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch