2006 Ruling 2005-0135751R3 - Advance Tax Ruling

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: 1) Determine whether the sale of XXXXXXXXXX will be a disposition of capital property.

2) Determine whether the sale will result in an income inclusion under subsection 13(1) in respect of recaptured depreciation in relation to any of the salaries and wages deducted as SR&ED.

3) Determine whether the sale will result in the recapture of investment tax credits earned in relation to any of the salaries and wages deducted as SR&ED pursuant to subsection 127(29).

Position: 1) Yes.

2) No.

3) No.

Reasons: 1)The sale of the XXXXXXXXXX will be a disposition of a capital property as defined in section 54 of the Act, with a nil adjusted cost base, and will result in a taxable capital gain as calculated under subdivision c, division B of the Act.

2)The sale of the XXXXXXXXXX will not, as a result of subsection 37(6) of the Act, result in an income inclusion under subsection 13(1) in respect of recaptured depreciation as the salaries and wages were deducted pursuant to 37(1)(a) of the Act.

3)The sale of the XXXXXXXXXX will not, as a result of subsection 127(29) of the Act, result in the recapture of investment tax credits earned in relation to any of the salaries and wages deducted as SR&ED in respect of the XXXXXXXXXX. This position is confirmed in the SR&ED policy statement number 2000-04R2.

XXXXXXXXXX 								2005-013575

XXXXXXXXXX, 2006

Dear XXXXXXXXXX:

Re: Advance Tax Ruling - XXXXXXXXXX

This is in reply to your letter of XXXXXXXXXX, wherein you requested an advance income tax ruling on behalf of the above named company, on the tax treatment of the proceeds from the sale of XXXXXXXXXX by the company. We apologize for the delay in our response.

We understand that, to the best of your knowledge and that of the taxpayers involved, none of the issues involved in the ruling request:

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

iii. is under objection by a 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 Canada Revenue Agency (hereafter, the "CRA").

Unless otherwise stated, all references to a statute are to the Income Tax Act R.S.C. 1985 (5th Supp.), 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 facts, proposed transactions and the purpose of the proposed transactions is as follows:

Definitions

"A Co." means XXXXXXXXXX, formerly C Co.

"Application Program" means XXXXXXXXXX

"B Co." means XXXXXXXXXX.

"C Co." means XXXXXXXXXX.

"Component 1" means XXXXXXXXXX

"Component 2" means XXXXXXXXXX

"Component 3" means XXXXXXXXXX

"Component 4" means XXXXXXXXXX

"D Co." means XXXXXXXXXX.

XXXXXXXXXX

"XXXXXXXXXX Application Program" means XXXXXXXXXX.

Facts

1. The location of A Co.'s head office is XXXXXXXXXX. A Co.'s income tax account number is #XXXXXXXXXX and A Co.'s tax service office is in XXXXXXXXXX.

2. A Co., a taxable Canadian corporation, incorporated in the Province of XXXXXXXXXX (formerly C Co., a corporation that was federally incorporated) carries on business in XXXXXXXXXX and is engaged in the business of XXXXXXXXXX

3. XXXXXXXXXX. The salaries and wages expenses incurred to XXXXXXXXXX qualified as scientific research and experimental development ("SR&ED") costs and were deducted by C Co. pursuant to paragraph 37(1)(a) of the Act.

4. The shares of C Co. were acquired by D Co., an arm's length corporation, on XXXXXXXXXX. D Co. was a taxable Canadian corporation existing under the laws of XXXXXXXXXX and a wholly owned subsidiary of B Co. at the time of this acquisition.

5. C Co. was continued into XXXXXXXXXX on XXXXXXXXXX and changed its name to A Co.

6. On XXXXXXXXXX, A Co. amalgamated with D Co. A Co. is now a wholly owned subsidiary of B Co. The amalgamated corporation has not yet selected its first year-end.

7. B Co. is a company incorporated in XXXXXXXXXX and carries on the business of developing, licensing and supporting XXXXXXXXXX.

8. A Co. licenses Component 2 from B Co. by way of a XXXXXXXXXX Distribution Agreement. At all times the proprietary interest in Component 2 remains with B Co. The license was effective from XXXXXXXXXX and expired on XXXXXXXXXX. The license fee is paid by way of a royalty. The licence automatically renewed at the end of the expiry period for an additional year.

9. B Co. licenses Components 1, 3 and 4 from A Co. by way of a XXXXXXXXXX Distribution Agreement. At all times the proprietary interest in Components 1, 3, and 4 remains with A Co. The license is effective from XXXXXXXXXX and expired on XXXXXXXXXX. The licence fee is paid by way of a royalty. The license automatically renewed at the end of the expiry period for an additional year.

10. A Co. licences Application Program to unrelated third parties by way of XXXXXXXXXX Licence Agreements.

11. The XXXXXXXXXX Licence Agreements allow customers to use Application Program and any updates for a fixed fee and for a fixed term. The XXXXXXXXXX Licence Agreements specifically provide that Application Program remains the exclusive property of A Co.

12. In addition to the XXXXXXXXXX Licence Agreements, A Co. enters into Service Provider Agreements. The Service Provider Agreements are contracts entered into with a service provider who is in the business of XXXXXXXXXX

13. The Service Provider Agreements provide for a licence to be granted to the service provider to use Application Program for a fixed period of time and for a fixed fee. The Service Provider Agreement incorporates the XXXXXXXXXX Licence Agreement, which specifically provides that Application Program remains the exclusive property of A Co.

14. The primary source of revenue realized by A Co. is from the licensing of the XXXXXXXXXX. The only other source of revenue that A Co. has is from the licensing of the XXXXXXXXXX Application Program and from providing customer support services in respect of the XXXXXXXXXX Application Program. Profit from the licensing of XXXXXXXXXX and XXXXXXXXXX Application Program is included in A Co.'s income pursuant to a combination of both subsection 9(1) and paragraph 12(1)(a) of the Act.

15. A Co. has undertaken an initial fair market valuation of the XXXXXXXXXX and the approximate value is $XXXXXXXXXX Canadian.

16. A Co. made one prior sale of XXXXXXXXXX in XXXXXXXXXX to a non-arm's length party for $XXXXXXXXXX Canadian. Management of A Co. considers this sale to be outside the ordinary course of A Co.'s business because this XXXXXXXXXX neither fit with the strategic direction of the company nor was it in any way related to Application Program or XXXXXXXXXX Application Program.

17. On a global basis, the strategic focus of B Co. is XXXXXXXXXX: dealing with XXXXXXXXXX.

18. B Co. purchased all of the shares of C Co. to control the strategic business plan for the Application Program and have it complement B Co.'s existing XXXXXXXXXX. The transaction was undertaken by way of a share purchase rather than an asset purchase as a share sale was more beneficial to the vendor. If B Co. were to have purchased only the assets of C Co. they may not have purchased the XXXXXXXXXX Application Program unit.

19. The XXXXXXXXXX Application Program unit of A Co. is no longer a strategic unit in A Co. and B Co.'s continued focus on XXXXXXXXXX. In addition, more recently, it has been the case that conflicts of interest would arise as between the XXXXXXXXXX Application Program unit and the rest of A Co., which could prohibit the XXXXXXXXXX Application Program unit from entering into sizable engagements.

20. A letter of intent was recently signed to sell the XXXXXXXXXX Application Program unit - as a going concern - to an arm's length Canadian corporation (the "Purchaser") for US$ XXXXXXXXXX, plus or minus a working capital adjustment. It is expected that all employees devoted to the XXXXXXXXXX Application Program unit (being approximately XXXXXXXXXX of the total XXXXXXXXXX employees employed by A Co.) will be transferred to the Purchaser, although the agreement at this time provides the Purchaser the option to decline employment to a maximum of XXXXXXXXXX employees. If any of the employees are declined employment with the Purchaser, it is most likely that their employment will be terminated unless there are open positions in A Co. to which they can be assigned. All of the assets and obligations associated with the XXXXXXXXXX Application Program unit - as a going concern - will be sold to the Purchaser, including: the accounts receivable; office computers; XXXXXXXXXX and all intellectual property; customer contracts, XXXXXXXXXX and unfilled orders; trade payable; and deferred revenue. The sale and purchase agreement between A Co. and the Purchaser is currently being negotiated and is expected to close about XXXXXXXXXX.

21. Neither A Co. nor B Co. on a global basis is expected to re-enter the XXXXXXXXXX Application Program market space in the near future. Both A Co. and B Co. have decided to fully exit the XXXXXXXXXX Application Program business market. Selling the XXXXXXXXXX Application Program unit achieves this strategic objective, plus the sale raises capital needed for reinvestment in the XXXXXXXXXX market space. A Co. and B Co. will offer the Purchaser of the XXXXXXXXXX Application Program unit certain non-compete undertakings.

22. A Co. is in the business of XXXXXXXXXX as it relates to the Application Program, for the purposes of earning licensing income therefrom. Subsequent to the sale of the Application Program and the XXXXXXXXXX Application Program, A Co. will continue to employ the same employees (with the exception of those employees referred to in paragraph 20). The business operations of A Co. will only include the continuation of the licensing of the Application Program to its client base; the provision of ongoing maintenance of the Application Program for its clients in the form of XXXXXXXXXX; and the provision of upgrades/updates to the Application Program for B Co.

23. After the sale of the Application Program to B Co., all proprietary interest (rights of ownership) in any XXXXXXXXXX created by A Co. or the employees of A Co., will accrue to B Co. A Co. will earn a fee from B Co., commensurate with the fair market value of the services rendered, for continuing to XXXXXXXXXX owned by B Co. or an affiliate of B Co. Neither A Co. nor A Co.'s employees will continue to develop XXXXXXXXXX for the benefit of A Co.

Proposed Transaction

24. A Co. will sell all of its proprietary rights in the XXXXXXXXXX to B Co. for a lump sum cash payment equivalent to fair market value, which is estimated to be $XXXXXXXXXX Canadian. The sale of the XXXXXXXXXX will include:

a) all documentation and XXXXXXXXXX related to the XXXXXXXXXX;

b) all derivative works of the XXXXXXXXXX;

c) all documents and materials related to the certification and development of the XXXXXXXXXX;

d) all governmental permits related to the XXXXXXXXXX;

e) all material sales support and promotional materials, advertising materials etc.;

f) all copyright, trademarks, intellectual property and similar rights owned, used or held in relation to the XXXXXXXXXX; and

g) any other components or items that allow the XXXXXXXXXX to operate.

25. A Co. will not retain any residual rights to the XXXXXXXXXX for its own purpose.

26. A Co. will enter into XXXXXXXXXX Distribution Agreements with B Co. similar to other subsidiaries of B Co. for the right to licence Application Program to its clients.

27. A Co. will select the end of its first taxation year since its amalgamation to end either immediately before or contemporaneously with the sale of XXXXXXXXXX to B Co.

Purpose of the Transaction

28. B Co. desires to purchase XXXXXXXXXX. Centralizing the ownership of XXXXXXXXXX in B Co. aligns the development and licensing business model of XXXXXXXXXX with that of other B Co. products. This is seen as important from the standpoint of streamlining the management of the group of companies.

Rulings Given

Provided that:

(a) The preceding statements constitute a complete and accurate disclosure of all of the relevant facts, proposed transactions and the purpose of the proposed transactions;

(b) The proposed transactions are completed in the manner described above; and

(c) There are no other transactions, which may be relevant to the rulings requested,

our rulings are as follows:

A. The sale of the XXXXXXXXXX from A Co. to B Co. will be a disposition of a capital property as defined in section 54 of the Act, with a nil adjusted cost base, and will result in a taxable capital gain as calculated under Subdivision c, Division B of the Act.

B. The sale of the XXXXXXXXXX will not, as a result of subsection 37(6) of the Act, result in an income inclusion under subsection 13(1) in respect of recaptured depreciation in relation to any of the salaries and wages deducted by A Co. as SR&ED in respect of the XXXXXXXXXX.

C. The sale of XXXXXXXXXX will not, as a result of subsection 127(29) of the Act, result in the recapture of investment tax credits earned in relation to any of the salaries and wages deducted by A Co. as SR&ED in respect of the XXXXXXXXXX.

Caveats

These rulings are given subject to the limitations and qualifications set out in Information Circular 70-6R5 issued by the CRA on May 17, 2002, and are binding on the CRA provided the proposed transactions are carried out no later than immediately after the end of A Co.'s first fiscal period following A Co.'s amalgamation with D Co.

These 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.

Except as expressly stated, these rulings do not imply acceptance, approval or confirmation of any income tax implications of the facts or proposed transactions.

Nothing in these rulings should be construed as implying that the CRA has agreed to or reviewed the fair market value of any particular asset referred to herein.

Yours truly,

XXXXXXXXXX
For Director
Business and Partnerships Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch