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: Application of paragraph 131(11)(a) of S.C. 1998, c.19 of the coming into force provisions (referred to as the "First Grandfathering Rule") to the stop-loss rule in subsection 112(3) where terms of a written agreement that was entered into before April 27, 1995 are subsequently modified by a separate amending agreement.
Position: Protection under the First Grandfathering Rule will be lost. However, the shares owned by the shareholders on April 26, 1995 will meet all the conditions of paragraph 131(11)(b) of S.C. 1998, c.19 of the coming into force provisions (referred to as the "Second Grandfathering Rule") to the stop-loss rule in subsection 112(3).
Reasons: In our view, the Agreement has been sufficiently modified or altered to result in the loss of grandfathering under the First Grandfathering Rule.
XXXXXXXXXX 2005-016129
XXXXXXXXXX , 2007
Dear XXXXXXXXXX :
Re: XXXXXXXXXX ("Opco"),
XXXXXXXXXX ("Subco"),
XXXXXXXXXX ("Shareholder1")
XXXXXXXXXX ("Shareholder2")
XXXXXXXXXX ("Shareholder3")
Advance Income Tax Ruling Request
This is further to your letters of XXXXXXXXXX wherein you requested an advance income tax ruling on behalf of the above-captioned taxpayers. We also acknowledge the information provided during our numerous telephone conversations (XXXXXXXXXX ) and your numerous emails. You have advised that to the best of your knowledge, and that of the individual taxpayers and the responsible officers of Opco and Subco, none of the issues involved in this Ruling is:
(i) in an earlier return of any of the taxpayers or a related person;
(ii) being considered by a tax services office (TSO) or taxation centre (TC) in connection with a previously filed tax return of any of the taxpayers or a related person;
(iii) under objection by any of the taxpayers or a 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.
You have also advised that to the best of your knowledge and that of the individual taxpayers and the responsible officers of Opco and Subco, the Proposed Transactions will not result in any of 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, and clause or subclause is a reference to the relevant provision of the Act, and the Income Tax Regulations thereunder are referred to as the Regulations;
(b) "Canadian-controlled private corporation" has the meaning assigned by subsection 125(7);
(c) "CRA" means the Canada Revenue Agency;(d) "fair market value" means the highest price available in an open and unrestricted market between informed and prudent parties dealing at arm's length;
(e) "Paragraph" refers to a numbered paragraph in this advance income tax ruling;
(f) "Proposed Transactions" means the transactions described in Paragraphs 10 to 11;
(g) "Shareholder4" means XXXXXXXXXX ;
(h) "Shareholder5" means the late XXXXXXXXXX ; and
(i) "taxable Canadian corporation" has the meaning assigned by subsection 89(1).
The facts, proposed transactions and purposes of the Proposed Transactions are as set forth below.
FACTS
1. Opco is a Canadian-controlled private corporation and a taxable Canadian corporation. Opco carries on a XXXXXXXXXX business in XXXXXXXXXX and has done so for many years. Opco files its federal tax returns at the XXXXXXXXXX TC and the XXXXXXXXXX TSO administers its federal tax affairs.
2. The issued and outstanding share capital of Opco as of the date of this Ruling consists of XXXXXXXXXX voting Class A preferred shares ("Class A Shares"), XXXXXXXXXX non-voting Class B preferred shares ("Class B Shares") and XXXXXXXXXX common shares ("Common Shares"). The issued and outstanding Common Shares and Class B Shares of Opco are currently owned as follows:
Shareholder Class B Shares Common Shares
Shareholder1 XXXXXXXXXX XXXXXXXXXX
Shareholder2 XXXXXXXXXX XXXXXXXXXX
Shareholder3 XXXXXXXXXX XXXXXXXXXX
Shareholder1, Shareholder2 and Shareholder3 each beneficially own XXXXXXXXXX Class A Shares. Shareholder1, Shareholder2 and Shareholder3 are brothers, each of whom is resident in Canada for the purposes of the Act. Subco was a wholly-owned subsidiary of Opco. Subco was wound-up into Opco on XXXXXXXXXX and its only assets, namely XXXXXXXXXX Common Shares of Opco, were cancelled.
3. A written shareholders' agreement (the "Agreement") was entered into on XXXXXXXXXX , between Opco and its shareholders at that time. The shareholders of Opco and their respective shareholdings of Opco on XXXXXXXXXX were as follows:
Shareholder Class A Shares Class B Shares Common Shares
Shareholder1 XXXXXXXXXX XXXXXXXXXX XXXXXXXXXX
Shareholder2 XXXXXXXXXX XXXXXXXXXX XXXXXXXXXX
Shareholder3 XXXXXXXXXX XXXXXXXXXX XXXXXXXXXX
Shareholder4 XXXXXXXXXX XXXXXXXXXX XXXXXXXXXX
Shareholder5 XXXXXXXXXX XXXXXXXXXX XXXXXXXXXX
Shareholder5, who passed away in XXXXXXXXXX , was the father of Shareholder1, Shareholder2, Shareholder3 and Shareholder4.
4. The Agreement currently remains in place and has not been changed or modified in any way since the parties entered into it on XXXXXXXXXX . The Agreement will terminate, inter alia, on the occurrence of the death of the second to die of Shareholder1, Shareholder2 and Shareholder4.
The Agreement provides, inter alia, that on the death of any one of the four shareholders of Opco owning Common Shares, Opco will purchase for cancellation all of the Common Shares owned by such shareholder and redeem any Class B Shares owned by the deceased shareholder at that time for their fair market value at that time. The Agreement also requires Opco to make a capital dividend account election in respect of any deemed dividend that may arise from such a purchase/redemption to the extent that Opco has a balance in its capital dividend account at that time. For greater certainty, there is no requirement under the Agreement for Opco to purchase or redeem any of the Class A Shares that are currently beneficially owned by Shareholder1, Shareholder2 and Shareholder3.
In order to fund Opco's obligation to purchase/redeem its Common Shares or Class B Shares on death as described above, the Agreement also requires Opco to purchase sufficient life insurance on the lives of each such shareholder and name itself as the beneficiary under each such policy. In respect of Shareholder1, Shareholder2 and Shareholder4, the amount of life insurance that was purchased by Opco in XXXXXXXXXX for the purpose of funding its requirement to purchase/redeem the Common Shares and Class B Shares owned by Shareholder1, Shareholder2, and Shareholder4 was $XXXXXXXXXX each. In respect of Shareholder3, the amount of life insurance that was purchased by Opco in XXXXXXXXXX for the purpose of funding its requirement to purchase Shareholder3's XXXXXXXXXX Common Shares was $XXXXXXXXXX . With the exception of the insurance in respect of Shareholder4, which is discussed in Paragraph 8, all of this insurance currently remains in force and Opco is the beneficiary under each such insurance policy.
5. On April 26, 1995, the shareholders of Opco and number and type of shares of Opco held by each such shareholder were the same as on XXXXXXXXXX as described in Paragraph 3. You maintain that if, as a result of a disposition on April 27, 1995 of Common Shares or Class B Shares to Opco, which took place pursuant to the Agreement, a capital loss arose, such capital loss would not have been subject to the "stop-loss" rule in section 112(3) pursuant to paragraph 131(11)(a) of S.C. 1998, c.19 of the coming into force provisions (referred to as the "First Grandfathering Rule").
6. All of the life insurance that was purchased by Opco to fund a future share purchase or redemption pursuant to the Agreement as described in Paragraph 4 was in force on April 26, 1995. You also maintain that if, as a result of a disposition on April 27, 1995 of Common Shares or Class B Shares to Opco that were owned by a shareholder of Opco on April 26, 1995, a capital loss arose, such capital loss would not have been subject to the "stop-loss" rule in section 112(3) pursuant to paragraph 131(11)(b) of S.C. 1998, c.19 of the coming into force provisions (referred to as the "Second Grandfathering Rule").
7. In accordance with the terms of the Agreement, an unrelated individual was designated as a trustee to actually hold the share certificates and each life insurance policy on behalf of the parties to the Agreement. The original trustee was XXXXXXXXXX . However, in XXXXXXXXXX resigned and was replaced by two other unrelated individuals, you and XXXXXXXXXX .
8. In the XXXXXXXXXX , Shareholder4 brought a court action for oppressive conduct against Opco and its other shareholders. As a result of this court action, the court ultimately ordered the sale of Shareholder4's XXXXXXXXXX Class B Shares to Shareholder3 for their par value of $XXXXXXXXXX each and also ordered the sale of Shareholder4's XXXXXXXXXX Common Shares to Subco for $XXXXXXXXXX . These court-ordered sales actually took place in XXXXXXXXXX and neither sale occurred pursuant to the terms of the Agreement. The life insurance that Opco had maintained to fund the purchase/redemption of Shareholder4's Common Shares and Class B Shares was cancelled in XXXXXXXXXX as a result of these court-ordered share sales.
9. Following the court-ordered share sales described in Paragraph 8, Shareholder5 decided to retire from Opco. Shareholder1, Shareholder2 and Shareholder3, now beneficially own all of the Class A Shares formerly owned by Shareholder5 on an equal basis as described in Paragraph 2.
PROPOSED TRANSACTIONS
10. Shareholder1, Shareholder2 and Shareholder3, would like to own all of the issued and outstanding Common Shares of Opco equally. To achieve this objective, Shareholder1 and Shareholder2 have agreed to each sell XXXXXXXXXX Common Shares of Opco to Shareholder3 for their fair market value on a fully taxable basis such that, immediately thereafter, each of Shareholder1, Shareholder2 and Shareholder3 will own XXXXXXXXXX Common Shares of Opco.
11. Opco and Shareholder1, Shareholder2 and Shareholder3 would also like to update the Agreement, by entering into a new separate amending agreement (the "Amending Agreement") that will revise the terms of the Agreement in respect of the following:
- to amend Schedule A for the changes to the shareholdings that have occurred (or will occur) since the time the Agreement was entered into on XXXXXXXXXX .
- to amend Schedule C to recognize the fact that Opco will increase the amount of life insurance to $XXXXXXXXXX in respect of Shareholder3 to ensure that Opco can properly fund the redemption of Shareholder3's
- XXXXXXXXXX Class B Shares on death and decrease the amount of life insurance in respect of Shareholder1 and Shareholder2 to $XXXXXXXXXX each to reflect the decline in the fair market value of the Class B Shares;
- to amend the Agreement to recognize the change in Trustees that took place as a result of the resignation of XXXXXXXXXX and the corresponding change in the addresses for notice;
- to amend the Agreement to remove any references to the Schedule B Assets in the Agreement as no such assets were ever included in the Agreement;
- to amend the Agreement to remove any references to the Class C Shares of Opco in the Agreement as no such shares were ever issued by Opco; and
- to amend the Agreement to revise the termination clause in the Agreement as described in Paragraph 4 by replacing the reference to Shareholder4 with Shareholder3 since Shareholder4 no longer owns any shares of Opco.
12. Other than as described herein, there has been no disposition of any shares of Opco nor is there expected to be any disposition of shares of Opco in the foreseeable future.
PURPOSE OF THE PROPOSED TRANSACTIONS
13. Opco and the remaining shareholders of Opco would like to update the Agreement to reflect the changes brought on by time including the death of Shareholder5 in XXXXXXXXXX , the changes in share ownership described in Paragraphs 8 and 9, the changes to the trustee described in Paragraph 7, and to clean up some errors in the drafting of the Agreement without affecting the grandfathering.
RULING
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 ruling is set forth below.
Provided that:
(i) immediately following the completion of the Proposed Transactions, the following particular shares of Opco, namely: the remaining XXXXXXXXXX Common Shares and XXXXXXXXXX Class B Shares of Opco that were owned by Shareholder1 on April 26, 1995; the remaining XXXXXXXXXX Common Shares and XXXXXXXXXX Class B Shares of Opco that were owned by Shareholder2 on April 26, 1995; and the XXXXXXXXXX Common Shares that were owned by Shareholder3 on April 26, 1995, referred to as each such shareholder's "Historical Shares", continue to be owned by each such shareholder following the completion of the Proposed Transactions until his death;
(ii) Opco was a beneficiary under each of the life insurance policies described in Paragraph 4 that were in force on April 26, 1995; and
(iii) on April 26, 1995 a main purpose of each of the life insurance policies was to fund the purchase or redemption by Opco of its Class B Shares and Common Shares,
none of the Proposed Transactions will, in and by itself, affect the application of the Second Grandfathering Rule to preclude the application of subsection 112(3) to a future disposition of each such shareholder's Historical Shares to Opco following the completion of the Proposed Transactions and taking place as a consequence of the death of such shareholder.
The above ruling is subject to the limitations and qualifications set out in Information Circular 70-6R5 dated May 17, 2002 and is binding on CRA provided that the Proposed Transactions are completed by XXXXXXXXXX . The above ruling is based on the law as it presently reads and does not take into account any proposed amendments to the Act and the Regulations which, if enacted into law, could have an effect on the ruling provided herein.
It is our view that the proposed changes to the Agreement which form part of the Amending Agreement described in Paragraph 11 will result in the First Grandfathering Rule ceasing to apply to prevent subsection 112(3) from applying to a future disposition of Common Shares and/or Class B Shares to Opco by any of Shareholder1, Shareholder2 and Shareholder3.
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 paid-up capital of any share or the cost amount, adjusted cost base or fair market value of any property referred to herein;
(b) any other tax consequence relating to the facts, Proposed Transactions or any transaction or event 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 ruling given above.
Yours truly,
XXXXXXXXXX
for Director
Corporate Reorganizations Section II
Reorganizations and Resources Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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