2005 Ruling 2005-0149751R3 - Reorganization of a business

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: Transfer of some operations which are highly integrated to the taxpayer's business and of the assets required for those operations to a third party. Whether the distribution of the sale proceeds gives rise to a deemed dividend under subsection 84(2) to the extent that the amount of that distribution exceeds the amount by which the paid-up capital is reduced on the distribution.

Position: Yes.

Reasons: Consistent with our position in previous rulings and with the Department of Finance policy.

XXXXXXXXXX 								2005-014975

XXXXXXXXXX, 2005

Dear XXXXXXXXXX:

Re: 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-referenced taxpayers. We also acknowledge receipt of your emails as well as our various telephone conversations. The documents submitted with your request are only part of this document to the extent described herein.

The above-referenced taxpayers file their corporate income tax returns at the XXXXXXXXXX Taxation Centre and their tax affairs are administered by the XXXXXXXXXX Tax Services Office.

To the best of your knowledge and that of the above-referenced taxpayers, none of the issues involved in this ruling request is:

(i) in an earlier return of the above-referenced 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 above-referenced taxpayers or a related person;

(iii) under objection by the above-referenced taxpayers or a related person;

(iv) before the courts; or

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

The above-referenced taxpayers have confirmed that the proposed transactions described herein will not affect their ability to pay any of their outstanding tax liabilities. All statutory references herein are to provisions of the Income Tax Act (Canada), R.S.C. 1985 (5th Supp.), c. 1, as amended to the date hereof and all references to monetary amounts are in Canadian dollars.

DEFINITIONS

In this letter, unless otherwise expressly stated, the following terms have the meanings specified:

"Account" means any account XXXXXXXXXX

"Alliance Agreement" means the proposed Program Agreement contemplated by Seller 1 and AlliedCo pursuant to the terms of the Purchase Agreement;

"AlliedCo" means XXXXXXXXXX;

"Business" means the XXXXXXXXXX;

"Buyer" means XXXXXXXXXX;

"Exchange 1" means the XXXXXXXXXX Stock Exchange;

"XXXXXXXXXX" means XXXXXXXXXX;

"Licensing Agreement" means an agreement pursuant to which AlliedCo will receive a license to use certain Seller 1 trademarks XXXXXXXXXX in connection with the activities governed by the Alliance Agreement;

"Management Committee" means a committee consisting of XXXXXXXXXX members, XXXXXXXXXX appointed by Seller 1 and XXXXXXXXXX AlliedCo;

"XXXXXXXXXX Agreement" means an agreement governing XXXXXXXXXX operating procedures in connection with the Alliance Agreement;

"Operations" means the following operations: XXXXXXXXXX

"Operating Assets" means all the property that can reasonably be regarded as being necessary to be capable of carrying on the Operations, XXXXXXXXXX

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

"Pre-1972 CSOH" means pre-1972 capital surplus on hand as that expression is defined in subsection 88(2.1);

"Program Agreement" means a XXXXXXXXXX agreement under the terms of which AlliedCo will become an important service supplier to Seller 1";

"Purchase Agreement" means the Purchase Agreement entered into by Seller 1 and the Buyer on XXXXXXXXXX in respect of the sale of the Operating Assets in consideration for the Purchase Price;

"Purchase Price" means the amount of cash paid by the Buyer as consideration for the Operating Assets, XXXXXXXXXX;

"Seller 1" means XXXXXXXXXX., a corporation XXXXXXXXXX under the Canada Business Corporations Act of XXXXXXXXXX

"Seller 2" means XXXXXXXXXX

"Seller 3" means XXXXXXXXXX;

"Services Agreement" means the XXXXXXXXXX Services Agreement entered into by Seller 1 and Seller 2 on XXXXXXXXXX;

"Shares" means the common shares of Seller 1 which are its only issued and outstanding class of shares; and

"Transition Agreement" means the XXXXXXXXXX Agreement to be entered into between Seller 1 and Seller 2 and to be assigned on the sale by Seller 2 to AlliedCo.

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

FACTS

1. Seller 1 is a taxable Canadian corporation and a public corporation, as defined in subsection 89(1). The Shares are publicly traded on Exchange 1. As at XXXXXXXXXX owned approximately XXXXXXXXXX% of the all the issued and outstanding Shares. The aggregate stated capital of the Shares for the purposes of the Canada Business Corporations Act was equal to $XXXXXXXXXX ($XXXXXXXXXX per Share) as at XXXXXXXXXX. Seller 1 never elected on a dividend as being paid out of its 1971 CSOH in accordance with the provisions of subsection 83(1) as it read with respect to dividends which became payable before 1979.

2. Seller 1 carries on the Business. XXXXXXXXXX

3. XXXXXXXXXX were merged in XXXXXXXXXX to create Seller 2 in order to pursue the Operations (XXXXXXXXXX). Seller 2 is a wholly owned subsidiary of Seller 1. Seller 1 transferred the XXXXXXXXXX to Seller 2 but retained certain assets and employees necessary to the Operations. Seller 2's primary assets consist of a significant portion of the Operating Assets.

4. Seller 3 is a wholly owned subsidiary of Seller 1. Seller 3 does not reside in Canada. It conducts the activity described in point (viii) of the definition of Operations above. All of its retained earnings are represented by income that has been included in computing the income of Seller 1 under section 91.

5. XXXXXXXXXX. The Operations represent approximately XXXXXXXXXX% of the consolidated earnings before interest and taxes of Seller 1, Seller 2 and Seller 3. The Operating Assets represent up to approximately XXXXXXXXXX% of Seller 1 and Seller 2 consolidated assets.

6. Seller 2 requires certain operations support services for which XXXXXXXXXX has the expertise and experience, qualified personnel and service philosophy and structure. Accordingly, Seller 1 and Seller 2 have entered into the Services Agreement that sets the terms under which Seller 1 provides services to Seller 2 in respect of the Operations. Those services are rendered on a cost recovery basis plus XXXXXXXXXX %. Seller 1 and Seller 2 have also entered into other agreements under which Seller 1 provides services in respect of the promotion of XXXXXXXXXX.

7. Seller 1 and Buyer have entered into the Purchase Agreement under which the parties agreed, subject to the satisfaction of the terms and conditions set out therein, to implement the following transactions or to fulfill the following obligations:

i. Seller 1, Seller 2 and Seller 3 will transfer all rights, title and interest in the Operating Assets;

ii The Buyer will pay the Purchase Price to Seller 1, Seller 2 and Seller 3 based on the allocation of the Purchase Price among the Operating Assets transferred by them;

iii XXXXXXXXXX;

iv The Buyer will assume substantially all of the liabilities of the Operations (other than intercompany indebtdness and tax liabilities);

v The Buyer will continue the Operations;

vi The Buyer will offer employment to all employees of Seller 1, Seller 2 or Seller 3 who are actively employed primarily in the Operations (this represents XXXXXXXXXX persons); and

vii The Buyer will continue to operate the Operations in a manner that supports Seller 1's business objective of enhancing its Business.

8. The Purchase Agreement stipulates that simultaneously with the closing, Seller 1 and the Buyer have agreed to enter into the following agreements:

i the Alliance Agreement;

ii the XXXXXXXXXX Agreement;

iii the Licensing Agreement; and

iv the Transition Agreement.

PROPOSED TRANSACTIONS

9. Seller 1 and AlliedCo, a wholly owned subsidiary of the Buyer, will negotiate the terms of their future alliance which will be governed by the terms of the various agreements described in Paragraph 8.

10. The purpose of the Alliance Agreement is to enter into an alliance for, XXXXXXXXXX. The Alliance Agreement will establish a XXXXXXXXXX-year alliance with successive automatic XXXXXXXXXX extensions, unless either party provides to the other a notice of termination of the Alliance Agreement.

11. The terms of the Alliance Agreement provide that the activities governed by it will be reviewed by the Management Committee with the objective of:

i Increasing the overall level of customer satisfaction XXXXXXXXXX;

ii Creating a successful and growing XXXXXXXXXX program;

iii XXXXXXXXXX;

iv Providing XXXXXXXXXX quality of service for XXXXXXXXXX, Seller 1 customers and users of the services described in point (viii) of the definition of Operations above;

v Supporting Seller 1's efforts to increase sales, XXXXXXXXXX and overall profitability;

vi XXXXXXXXXX;

vii Developing new and enhanced XXXXXXXXXX products and services that combine the services and capabilities of both Seller 1 and AlliedCo so as to increase profitability for each of the parties; and

viii Ensuring that the activities governed by the Alliance Agreement are at all times conducted in a safe and sound manner and in accordance with all applicable laws.

12. The primary responsibility of the Management Committee will be to:

i Review new XXXXXXXXXX;

ii Monitor actual marketing results as compared to XXXXXXXXXX expectations;

iii Review services, products and marketing activities which compete with the activities governed by the Alliance Agreement;

iv Identify XXXXXXXXXX market trends;

v Discuss major systems projects, including changes to Seller 1 XXXXXXXXXX systems;

vi Review and evaluate results of XXXXXXXXXX promotions;

vii Monitor AlliedCo's performance relative to confidentiality, service standards, XXXXXXXXXX;

viii Ensure that communication with XXXXXXXXXX customers through electronic interfaces (web site, electronic communication) meets certain standards;

ix Ensure systems reliability;

x XXXXXXXXXX;

xi Adopt periodic business plans describing strategies for growth of the activities governed by the Alliance Agreement and consider any potential impact on Seller 1's XXXXXXXXXX systems;

xii Develop periodic marketing plans containing the details of the marketing of the activities governed by the Alliance Agreement, including Seller 1 and Buyer's respective plans regarding the frequency, timing, size and methods of marketing to be conducted with respect to XXXXXXXXXX; and

xiii Explore and adopt additional products or enhancements to products governed by the Alliance Agreement.

13. The following activities will become the responsibility of AlliedCo according to the Alliance Agreement:

i XXXXXXXXXX;

ii Provide personnel in the areas of finance, marketing, XXXXXXXXXX and activities governed by the Alliance Agreement;

iii Maintain adequate computer and communications systems and other equipment and facilities necessary for servicing the XXXXXXXXXX;

iv XXXXXXXXXX;

v Incur regular costs to train its employees for purposes of the program;

vi Perform and provide to Seller 1 XXXXXXXXXX surveys; and

vii Other obligations listed in Schedule A.

14. The following costs will be incurred by AlliedCo under the terms of the Alliance Agreement:

i XXXXXXXXXX;

ii XXXXXXXXXX;

iii XXXXXXXXXX;

iv XXXXXXXXXX;

v processing;

vi servicing;

vii administration;

viii XXXXXXXXXX;

ix XXXXXXXXXX;

x XXXXXXXXXX; and

xi a significant portion of promotional and marketing costs incurred by Seller 1 in connection with the XXXXXXXXXX.

15. The obligations of Seller 1 under the Alliance Agreement are listed in Schedule B.

16. XXXXXXXXXX.

17. After receiving its share of the Purchase Price, Seller 2 will distribute that share to Seller 1 by way of a cash return of capital, a cash dividend and a cash repayment of debt.

18. After receiving its share of the Purchase Price, Seller 3 will distribute that amount to Seller 1 by way of a return of capital and a cash dividend.

19. A special meeting of shareholders of Seller 1 will be held XXXXXXXXXX for the purpose of considering and if appropriate, passing a special resolution to authorize the directors of Seller 1 to effect a reduction of the legal stated capital maintained in respect of the Shares to a relatively nominal amount (e.g., $XXXXXXXXXX or less) and to distribute an equivalent amount to the registered holders of Shares.

20. At the latest on XXXXXXXXXX, the Board of Directors of Seller 1 will consider and, if appropriate, adopt resolutions directing Seller 1 to (i) reduce the capital of the Shares as authorized by its shareholders as described in Paragraph 19; (ii) declare an extraordinary cash dividend for a portion of the excess of the proceeds described in Paragraphs 17 and 18 and the portion of Seller 1's share of the Purchase Price, over the amount of the capital reduction described in (i); and (iii) distribute an amount of cash equal to the total of the reduction of capital described in (i) and the extraordinary dividend described in (ii).

21. If the resolutions described in Paragraph 20 are adopted, Seller 1 will make the cash distribution attributable to the capital reduction described in Paragraph 20 (i) as soon as possible after the paid-up capital of the Shares is reduced as described in Paragraph 20 (i). That distribution will not be in lieu of Seller 1's regular XXXXXXXXXX dividend distribution. XXXXXXXXXX will not dispose of any of the Shares that it owns at the moment the capital is reduced as described in Paragraph 20(i) before it receives its total share of the cash distribution attributable to the capital reduction described in Paragraph 20 (i).

22. Seller 2 will be wound up.

PURPOSE OF THE TRANSACTIONS

Seller 1 entered into the Purchase Agreement to focus on the Business and to derive more revenue from the Business by growing the Operations through special arrangements with AlliedCo. A significant portion of the Purchase Price will not be required for Seller 1's Business operations. As such, Seller 1 wishes to distribute to its shareholders a significant portion of the balance of the Purchase Price as a return on investment to the extent of a portion of its stated capital and to distribute the excess as a cash dividend.

RULINGS GIVEN

Provided that the preceding statements constitute a complete and accurate disclosure of 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 follows:

A. The paid-up capital for income tax purposes of the Shares equals their legal stated capital, as adjusted in accordance with the definition of paid-up capital in subsection 89(1).

B. Subsection 84(2) will apply, and subsection 84(4.1) will not apply, to the return of capital, described in Paragraph 20, such that Seller 1 will be deemed to have paid to a particular holder of Shares, and such holder will be deemed to have received, a dividend only to the extent that the amount distributed by Seller 1 as a return of capital on such Shares exceeds the amount by which the paid-up capital as defined under section 89 in respect of such Shares is reduced on the distribution. The adjusted cost base of each Share will be reduced pursuant to subparagraph 53(2)(a)(ii) by the amount of the return of capital attributable to that share.

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 Canada Revenue Agency 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 which, if enacted, could have an effect on the rulings provided herein.

COMMENTS

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

(a) the determination of the fair market value or ACB of any particular asset or the PUC in respect of any share referred to herein;

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

(c) the nature of the legal relationship entered into or contemplated by the entities named above.

Yours truly,

For Director
Reorganizations and Resources Division
Income Tax Rulings Directorate

XXXXXXXXXX