2006 Ruling 2005-0133571R3 - Avoidance of subsection 212.1(1)

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 GAAR should apply to a non-arm's length sale of shares by a non-resident shareholder to a trust where subsection 212.1(1) of the Income Tax Act was avoided.

Position: No.

Reasons: The sale would not appear to abuse the object and spirit of subsection 212.1(1).

XXXXXXXXXX 								2005-013357

XXXXXXXXXX, 2006

Dear XXXXXXXXXX:

Subject: XXXXXXXXXX - Advance Income Tax Ruling Request

This is in reply to your letter of XXXXXXXXXX, and your other correspondence, wherein you requested an advance income tax ruling on behalf of the taxpayers described in this ruling request. You have advised us that to the best of your knowledge and that of the taxpayers involved none of the issues involved in this ruling request are:

(i) in an earlier return of the taxpayers or any related person;

(ii) being considered by a tax services office ("TSO") or taxation centre ("TC") in connection with a previously filed tax return by the taxpayers or any related person;

(iii) under objection by the taxpayers or any related person;

(iv) before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has expired; or

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

The taxpayers have also represented that the proposed transactions described herein will not result in the taxpayers or any related person described herein being unable to pay its existing outstanding tax liabilities.

DEFINITIONS

In this letter, all monetary amounts are expressed in Canadian dollars unless otherwise indicated, and the following terms or expressions have the meaning specified:

(a) "Act" means the Income Tax Act, R.S.C. 1985 (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, clause or subclause is a reference to the relevant provision of the Act, and the Income Tax Act Regulations thereunder are referred to as the "Regulations";

(b) "adjusted cost base" ("ACB") has the meaning assigned by subsection 248(1);

(c) "agreed amount" means the amount agreed on by the transferor and transferee in respect of an eligible property in an election filed pursuant to subsection 85(1);

(d) "Amalco" means the corporation that continues upon the amalgamation of Bco, Holdco and Cco as described in Paragraph 14;

(e) "BCA" means the XXXXXXXXXX Business Corporations Act;

(f) "Bco" means XXXXXXXXXX;

(g) "capital property" has the meaning assigned by section 54;

(h) "Cco" means XXXXXXXXXX;

(i) "cost amount" has the meaning assigned by subsection 248(1);

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

(k) "eligible property" has the meaning assigned by subsection 85(1.1);

(l) "fair market value" ("FMV") means the highest price available in an open and unrestricted market, between informed prudent parties, acting at arm's length and with no compulsion to act, expressed in terms of cash;

(m) "Holdco" means XXXXXXXXXX;

(n) "Individual A" means XXXXXXXXXX, an individual who is a non-resident of Canada for the purposes of the Act;

(o) "Individual B" means XXXXXXXXXX, an individual who is resident in Canada for the purposes of the Act;

(p) "Individual C" means XXXXXXXXXX, an individual who is resident in Canada for the purposes of the Act;

(q) "Individual D" means XXXXXXXXXX, an individual who is resident in Canada for the purposes of the Act;

(r) "Individual E" means XXXXXXXXXX, an individual who is resident in Canada for the purposes of the Act;

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

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

(u) "Paragraph" refers to a numbered paragraph in this advance income tax ruling;

(v) "Proposed Transactions" means the proposed transactions described in Paragraphs 13 to 17;

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

(x) "safe income on hand" in respect of a particular share of a corporation at a particular time means the portion of the unrealized gain inherent in such share of the corporation at that time that cannot reasonably be considered to be attributable to anything other than income earned or realized (as determined pursuant to subsection 55(5)), to the extent that it is on hand, by any corporation after 1971 and before the safe-income determination time for the transaction, event or series of transactions or events that includes the Proposed Transactions;

(y) "series of transactions or events" includes the transactions or events referred to in subsection 248(10);

(z) "stated capital" means stated capital as that expression is used in the BCA;

(aa) "Subco" means XXXXXXXXXX;

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

(cc) "taxable dividend" has the meaning assigned by subsection 89(1); and

(dd) "Trust1" means the XXXXXXXXXX.

Our understanding of the Facts, Proposed Transactions and the purpose of the Proposed Transactions is as follows:

FACTS

1. Individual A, Individual B, Individual C and Individual D are adult siblings. Individual A has been a resident of the United Kingdom ("U.K.") since XXXXXXXXXX. Individual E is the spouse of Individual B.

2. Trust1 was established in XXXXXXXXXX for the benefit of Individual B, Individual E and their children. Individual B and Individual E are the only two trustees of Trust1. The TSO for Trust1 is the XXXXXXXXXX TSO and it files its T3 trust income tax return at the XXXXXXXXXX.

3. The assets of Trust1 include:

(a) approximately XXXXXXXXXX of all the issued and outstanding shares of Holdco as described in Paragraph 6;

(b) all of the issued and outstanding shares of Cco, which in turn, owns approximately XXXXXXXXXX of all of the issued and outstanding shares of Holdco. Trust1 acquired those Cco shares from Individual C and her family trust ("Trust2") in XXXXXXXXXX; and

(c) all of the common shares of Bco, which in turn, owns approximately XXXXXXXXXX of all of the issued and outstanding shares of Holdco.

4. Bco is a TCC that was incorporated under the BCA. Bco is a holding company that is resident in Canada. The issued and outstanding shares of Bco are held as follows:

• XXXXXXXXXX common shares are owned by Trust1;
• XXXXXXXXXX class A special shares are owned by Individual B; and
• XXXXXXXXXX class A special shares are owned by Individual E.

The class A special shares of Bco are non-voting, redeemable and retractable for $XXXXXXXXXX per share and carry a non-cumulative monthly dividend of XXXXXXXXXX%. The shares of Bco are held by each holder as capital property.

5. Cco is a TCC that was incorporated under the BCA. Cco is a holding company that is resident in Canada. The issued and outstanding shares of Cco are held as follows:

• XXXXXXXXXX common shares are owned by Trust1; and
• XXXXXXXXXX class A special shares are owned by Trust1.

The class A special shares of Cco are non-voting, redeemable and retractable for $XXXXXXXXXX per share and carry a non-cumulative monthly dividend of XXXXXXXXXX%. The shares of Cco are held by Trust1 as capital property.

6. Holdco is a TCC that was incorporated under the BCA. Holdco is a holding company that is resident in Canada. Holdco's assets consist mainly of shares of Subco, which represent XXXXXXXXXX% of all of the issued and outstanding shares of Subco. Holdco acquired those Subco shares from Individual B and his siblings by issuing its shares to each of them as consideration. Bco owns the remaining XXXXXXXXXX% of the issued and outstanding shares of Subco. The shares of Subco are held by each holder as capital property.

The issued and outstanding shares of Holdco are held as follows:

• XXXXXXXXXX common shares are owned by Trust1;
• XXXXXXXXXX common shares are owned by Bco;
• XXXXXXXXXX common shares are owned by Cco;
• XXXXXXXXXX class A special shares are owned by Trust1;
• XXXXXXXXXX class A special shares are owned by Bco; and
• XXXXXXXXXX class A special shares are owned by Cco.

The class A special shares of Holdco are non-voting, redeemable and retractable for $XXXXXXXXXX per share and carry a non-cumulative dividend of XXXXXXXXXX% per annum. The shares of Holdco are held by each holder as capital property.

7. Subco is a TCC that was incorporated in XXXXXXXXXX under predecessor legislation of the BCA. Individual B's father XXXXXXXXXX ("Parent") purchased his brother's common shares of Subco in XXXXXXXXXX. In so doing, Parent became the owner of all but XXXXXXXXXX of the common shares of Subco at time. Subco operates a XXXXXXXXXX business ("Business") in XXXXXXXXXX. Through a number of estate-freeze transactions, Parent transferred all of his Subco shares to his children. Parent died in XXXXXXXXXX. Individual B is the only child who is actively involved in the operation of the Business.

The issued and outstanding shares of Subco are held as follows:

• XXXXXXXXXX common shares are owned by Holdco; and
• XXXXXXXXXX common shares are owned by Bco.

The shares of Subco are held by each holder as capital property.

8. As trustees in Trust1, Individual B and Individual E control each of Bco, Cco, Holdco and Subco.

9. Between XXXXXXXXXX and XXXXXXXXXX, Individual B had numerous discussions with each of his siblings regarding the purchase of their Holdco shares. In XXXXXXXXXX, Holdco redeemed all of its shares that Individual D's holding company owned at that time. In XXXXXXXXXX, Trust1 purchased all of the issued and outstanding shares of Cco from Individual C and Trust2. In the same month, Trust1 entered into a purchase and sale agreement ("Purchase and Sale Agreement") with Individual A to purchase the XXXXXXXXXX common shares and XXXXXXXXXX class A special shares of Holdco (the "Subject Shares") that were owned by Individual A at that time for their aggregate FMV of $XXXXXXXXXX. One of the terms of the Purchase and Sale Agreement was that Individual A acknowledged and consented to: Trust1 obtaining guarantees of Holdco and Subco, the pledging of Holdco's and Subco's assets, and the removal of surplus cash from Subco, in order to assist Trust1 in securing the financing necessary to complete the purchase of the Subject Shares. The other XXXXXXXXXX class A special shares of Holdco were acquired by Trust1 in a non-arm's length transaction giving rise to a capital gain in the hands of the particular transferor.

10. Prior to Individual A entering into the Purchase and Sale Agreement in XXXXXXXXXX, Individual A was advised that, because the capital gains tax rate was lower than the dividend tax rate in the UK, Individual A should sell the Subject Shares as opposed to having those shares redeemed by Holdco, which redemption would have resulted in a deemed dividend to Individual A under subsection 84(3). In addition, Individual A was also advised that if he were to sell the Subject Shares to a corporation that Individual B controlled directly or indirectly, the proceeds that Individual A would receive on the sale of the Subject Shares would be deemed by subsection 212.1(1) to be a dividend. Any deemed dividend arising under subsection 84(3) or subsection 212.1 would be subject to non-resident withholding tax under Part XIII and which would also receive unfavourable U.K. tax treatment for Individual A. As a result, Individual A insisted that he would only sell his Subject Shares to Individual B or Trust1 but not to Holdco or any corporation that Individual B controlled directly or indirectly.

11. In XXXXXXXXXX, Trust1 purchased all of the Subject Shares from Individual A for cash consideration of $XXXXXXXXXX. Trust1 financed the full purchase of the Subject Shares with funds it borrowed ("Trust1 Debt") from XXXXXXXXXX (the "Bank"). The aggregate PUC of the Subject Shares that were sold by Individual A to Trust1 was substantially less than the aggregate FMV of such shares at the time of such sale.

12. Individual A obtained a section 116 certificate from the CRA in respect of the sale of the Subject Shares and Individual A claimed a treaty exemption with respect to the capital gain that he realized on the sale of the Subject Shares under the Canada-United Kingdom Income Tax Convention.

PROPOSED TRANSACTIONS

13. Trust1 will transfer XXXXXXXXXX Holdco common shares and XXXXXXXXXX Holdco class A special shares (the "Particular Shares") to Bco for their aggregate FMV. As consideration for the transfer, Bco will issue a demand promissory note to Trust1 ("Trust1 Note") having a principal amount of $XXXXXXXXXX and Bco will also issue a number of its redeemable and retractable class B shares. The aggregate FMV of the consideration paid by Bco for the Particular Shares will equal the aggregate FMV of the Particular Shares transferred to Bco. The Particular Shares will be held by Bco as capital property.

Each of Trust1 and Bco will jointly elect, in prescribed form and within the time referred to in subsection 85(6), to have the provisions of subsection 85(1) apply to the transfer of the Particular Shares to Bco. The aggregate of the agreed amounts in respect of the transfer of the Particular Shares by Trust1 will be equal to Trust1's aggregate ACB of such shares immediately before the transfer and for greater certainty no agreed amount will be less than the lesser of the two amounts described in subparagraphs 85(1)(c.1)(i) and (ii) nor will any such agreed amount be less than the amount described in paragraph 85(1)(b).

For the purposes of the BCA, the increase to the stated capital of the Bco class B shares that Bco issued to Trust1 as consideration for the Particular Shares will not exceed the amount determined as B for the purposes of paragraph 84.1(1)(a).

14. Bco, Cco and Holdco will amalgamate to form Amalco under the BCA. On the amalgamation:

(a) all of the property (except amounts receivable from any predecessor corporation or shares of the capital stock of any predecessor corporation) of Bco, Cco and Holdco immediately before the amalgamation will become property of Amalco by virtue of the amalgamation;

(b) all of the liabilities (except amounts payable to any predecessor corporation) of Bco, Cco and Holdco will become liabilities of Amalco by virtue of the amalgamation; and

(c) all of the shareholders (except any predecessor corporation), who owned shares of the capital stock of any predecessor corporation immediately before the merger, will receive shares of the capital stock of Amalco because of the merger.

For greater certainty, the Trust1 Note owed by Bco to Trust1 will become a liability of Amalco. Subco will become a subsidiary wholly-owned corporation of Amalco.

15. Since XXXXXXXXXX, Trust1 has been making periodic payments in respect of the principal amount owing by it under the Trust1 Debt. Accordingly, the principal amount of the Trust1 Debt has been decreasing (the "Trust1 Residual Debt"). Subco will declare a taxable dividend in an amount that is equal to the Trust1 Residual Debt on its common shares held by Amalco. The amount of the taxable dividend declared and paid by Subco will not exceed the amount of safe income on hand that is attributable to its common shares held by Amalco at the safe-income determination time. At the time this taxable dividend is declared and paid by Subco, the unconsolidated retained earnings of Subco, with investments accounted for on the cost basis will be in excess of the amount of the dividend. The retained earnings of Subco reflect income/losses from Subco's business operations and income/losses from Subco's investments, including gains and losses from the sale of investments and assets. There are no amounts included in Subco's retained earnings that relate to an appraisal surplus or that arose as a consequence of any transaction undertaken to transform an appraisal surplus into retained earnings. There are no amounts included in Subco's retained earnings that resulted from profits or gains from transactions between Subco and non-arm's length parties. Subco will compute the portion of its retained earnings that reflect its accumulated profits as described in paragraph 23 of Interpretation Bulletin IT-533, entitled 'Interest Deductibility and Related Issues' (hereinafter referred to as "Accumulated Profits Amount"). Subco will enter into a loan agreement with the Bank. Pursuant to the loan agreement, the Bank will make an interest-bearing loan having a principal amount equal to the Trust1 Residual Debt (the "Subco Debt") to Subco. For greater certainty, the principal amount of the Subco Debt will not exceed the Accumulated Profits Amount and the proceeds from the Subco Debt will be used to fund the payment of the taxable dividend declared by Subco.

16. Amalco will use all the proceeds it will receive on the taxable dividend paid by Subco to pay a portion of the outstanding principal amount owing by it to Trust1 under the Trust1 Note.

17. Trust1 will use all the proceeds it will receive from Amalco on the partial payment of the Trust1 Note to pay the outstanding principal amount owing by it to the Bank under the Trust1 Debt.

PURPOSES OF THE PROPOSED TRANSACTION

18. To simplify the existing holding company structure (i.e. Holdco, Bco and Cco will amalgamate to form Amalco) to reduce the number of holding companies from three to one, which will decrease the ongoing financial and time requirements.

19. To effectively transfer Trust1's indebtedness owing to the Bank under the Trust1 Debt to Subco (under the Subco Debt), which in turn, will have the following benefits:

(a) lower interest charges than are currently being paid under the Trust1 Debt and greater flexibility in reacting to on-going funding requirements; and

(b) facilitate better global budgeting by management with a view to enhancing overall return for shareholders. Consolidating this debt in Subco will also facilitate more accurate costing out of products as this process contains an overhead component.

RULINGS

Provided that the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, proposed transactions and the 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. Provided the appropriate joint elections are filed in the prescribed form and manner within the time limits specified in subsection 85(6), the provisions of subsection 85(1) will apply to the transfer of the Particular Shares by Trust1 to Bco as described in Paragraph 13. The agreed amount in respect of each such transfer shall be deemed to be Trust1's proceeds of disposition and Bco's cost amount thereof pursuant to paragraph 85(1)(a) and paragraph 85(1)(e.2) will not apply to the share transfers referred to in Paragraph 13.

B. Section 212.1 will not be applicable to the Proposed Transactions.

C. Provided that at the time of the transfer of the Particular Shares described in Ruling A, the FMV of the Trust1 Note that is issued as consideration for the Particular Shares, does not exceed the greater of (i) the PUC of such shares and (ii) the aggregate ACB of such shares, as determined for the purposes of section 84.1, Trust1 will not be deemed to have received any dividend from Bco pursuant to paragraph 84.1(1)(b) as a consequence of the transfer of the Particular Shares to Bco as described in Paragraph 13.

D. The provisions of subsection 87(1) will apply to the amalgamation of Bco, Cco and Holdco to form Amalco as described in Paragraph 14.

E. Provided that Subco has a legal obligation to pay interest on the Subco Debt and that Subco uses the proceeds from the Subco Debt to pay the taxable dividend to Amalco as described in Paragraph 15, Subco will be entitled, pursuant to paragraph 20(1)(c), to deduct the lesser of (i) interest paid or payable (depending on the method regularly followed by Subco in computing its income for the purposes of the Act) in respect of the year on the Subco Debt or (ii) a reasonable amount in respect thereof.

F. The provisions of subsection 245(2) will not be applied, as a result of the Proposed Transactions, in and by themselves, to re-determine the tax consequences confirmed in the rulings given above.

The above rulings are subject to the limitations and qualifications set out in Information Circular 70-6R5 dated May 17, 2002 and are binding on CRA provided that the Proposed Transactions are completed by XXXXXXXXXX. The above rulings are based on the law as it presently reads and do not take into account any proposed amendments to the Act and the Regulations which, if enacted into law, could have an effect on the rulings provided herein.

Unless otherwise confirmed in the above rulings, nothing in this letter should be construed as implying that the CRA has confirmed, reviewed or has made any determination in respect of:

(a) the PUC of any share or the ACB or FMV of any property referred to herein;

(b) the amount of safe income on hand in respect of any share; or

(c) any other tax consequence relating to the facts, Proposed Transactions or any transactions or events taking place either prior to the Proposed Transactions or subsequent to the Proposed Transactions, whether described in this letter or not, other than those specifically described in the rulings given above, including whether any of the Proposed Transactions would also be included in a series of transactions or events that include other transactions or events that are not described in this letter.

Yours truly,

XXXXXXXXXX
Corporate Reorganizations Section II
Reorganizations and Resources Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch