2006 Ruling 2005-0161681R3 - 88(1)(c) and (d)

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: Where Acquisition Subco entered into an arrangement agreement ("Arrangement Agreement") to purchase all of the shares of Targetco, whether Targetco's subsidiary Lender Subco would be a specified shareholder of Targetco because of the Arrangement Agreement?

Position: No.

Reasons: Acquisition Subco would not be considered to have a significant direct or indirect interest in any of the Targetco shares because of the Arrangement Agreement under subparagraph 88(1)(c.2)(iii). Consequently, Lender Subco would not be a specified shareholder of Targetco.

XXXXXXXXXX

XXXXXXXXXX 							2005-016168

XXXXXXXXXX, 2006

Dear XXXXXXXXXX:

Re: XXXXXXXXXX
XXXXXXXXXX
Advance Income Tax Ruling Request

This is in reply to your letter of XXXXXXXXXX in which you requested an advance income tax ruling on behalf of the above-noted taxpayers. In your letters of XXXXXXXXXX, you provided additional information concerning the facts and proposed transactions described in your original letter. We also acknowledge the information provided during our various telephone conversations (XXXXXXXXXX).

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

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

(iii) under objection by one 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.

Definitions

In this letter, unless otherwise specified, all monetary amounts are expressed in Canadian dollars and the following terms have the meanings specified below:

(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) "adjusted cost base" has the meaning assigned by section 54;

(c) "agreed amount" in respect of an eligible property means the amount that the transferor and transferee of the property agree upon in their election under subsection 85(1) in respect of that property;

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

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

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

(g) "disposition" has the meaning assigned by subsection 248(1);

(h) "fair market value" ("FMV") means the highest price available in an open and unrestricted market between informed and prudent parties acting at arm's length and under no compulsion to act and contracting for a taxable purchase and sale;

(i) "ineligible property" has the meaning assigned by paragraph 88(1)(c);

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

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

(l) "predecessor corporation" has the meaning assigned by subsection 87(1);

(m) "principal amount" has the meaning assigned by subsection 248(1);

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

(o) "Proposed Transactions" has the meaning referred to in Paragraphs 26 to 40;

(p) "public corporation" has the meaning assigned by subsection 89(1);

(q) "related persons" has the meaning assigned by subsection 251(2);

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

(s) "specified shareholder" has the meaning assigned by subsection 248(1), as modified by subparagraph 88(1)(c.2)(iii);

(t) "subsidiary wholly-owned corporation" has the meaning assigned by subsection 248(1); and

(u) "taxable Canadian corporation" ("TCC") has the meaning assigned by subsection 89(1).

Our understanding of the relevant facts, Proposed Transactions and purposes of the Proposed Transactions are as follows:

Statement of Facts

Facts relating to the Partnership, AcqCo and Acquisition Subco

1. XXXXXXXXXX ("Partnership") is a XXXXXXXXXX limited partnership, the general partner of which is XXXXXXXXXX ("General Partner"). None of the units of the Partnership are publicly traded. They are sold through private placements under the applicable securities legislation.

2. XXXXXXXXXX.

XXXXXXXXXX.

XXXXXXXXXX.

3. General Partner is a XXXXXXXXXX limited liability company and is treated as a flow-through entity for U.S. tax purposes. It is controlled by an unrelated group consisting of XXXXXXXXXX.

4. The Partnership owns a number of subsidiary wholly-owned corporations which include XXXXXXXXXX.("Holdco1"). The Partnership also controls XXXXXXXXXX. ("Holdco2 ") through one of its subsidiary wholly-owned corporations.

5. Holdco1 is an entity formed as a XXXXXXXXXX under the laws of XXXXXXXXXX. It is a portfolio company investment of the Partnership. Holdco1 is treated as a flow-through entity for U.S. tax purposes.

6. Holdco2 is a company incorporated under the laws of the State of XXXXXXXXXX. It is also a portfolio company investment of the Partnership.

7. Holdco1 owns all of the issued and outstanding shares of XXXXXXXXXX. ("AcqCo").

8. AcqCo is an entity formed as a XXXXXXXXXX under the laws of XXXXXXXXXX. It is not a flow-through entity for U.S. tax purposes.

AcqCo owns all of the issued and outstanding shares of XXXXXXXXXX. ("Acquisition Subco").

9. Acquisition Subco is a TCC and is governed by the Canada Business Corporations Act ("CBCA"). Acquisition Subco's tax affairs are administered by the XXXXXXXXXX Tax Services Office and its corporate tax returns are filed at the XXXXXXXXXX Taxation Centre.

10. Holdco1, Holdco2, AcqCo and Acquisition Subco are related persons through the common control of the Partnership.

Facts relating to Targetco

11. XXXXXXXXXX ("Targetco") is a TCC and a public corporation. It is a resident of Canada for purposes of the Act and is governed by the CBCA. Targetco's tax affairs are administered by the XXXXXXXXXX Tax Services Office and its corporate tax returns are filed at the XXXXXXXXXX Taxation Centre.

12. The issued and outstanding common shares of Targetco are listed and posted for trading on the XXXXXXXXXX There are no other classes of issued and outstanding shares in the capital stock of Targetco. As at XXXXXXXXXX, there were XXXXXXXXXX issued and outstanding common shares in the capital stock of Targetco.

To the best of Targetco's knowledge, currently no person other than XXXXXXXXXX beneficially owns, directly or indirectly, 10% or more of the issued and outstanding common shares of Targetco.

13. Targetco is a XXXXXXXXXX company that provides products to XXXXXXXXXX. It segments its XXXXXXXXXX business ("Business") into XXXXXXXXXX ("Division 1") and XXXXXXXXXX ("Division 2").

XXXXXXXXXX .

14. Targetco carries on the Business through a number of Canadian and non-Canadian subsidiary wholly-owned corporations ("Targetco Canadian Subsidiaries" and "Targetco Non-Canadian Subsidiaries" and collectively referred to as the "Targetco Subsidiaries"). The assets of Targetco include

(a) shares of the Targetco Subsidiaries (individually referred to as a "Targetco Subsidiary Share"); and

(b) receivables owing by the Targetco Subsidiaries.

Targetco holds all of the shares of the Targetco Subsidiaries as capital property.

15. One of the Targetco Non-Canadian Subsidiaries is XXXXXXXXXX. ("TargetSubco") which is a corporation formed and existing under the laws of XXXXXXXXXX.

TargetSubco owns all of the issued and outstanding shares of XXXXXXXXXX. ("Lender Subco").

16. Lender Subco is a company incorporated under the laws of the State of XXXXXXXXXX.

17. Targetco currently has a shareholder rights plan ("Rights Plan") and a number of share compensation plans, namely, the employee share purchase plan ("Employee Share Purchase Plan"), several stock option plans ("Stock Option Plans"), the restricted share unit plan ("RSU Plan") and the director's deferred share unit plan ("DSU Plan").

18. The Rights Plan is what is sometimes called a "poison pill". It sets out rules to be followed by acquirors seeking to acquire control of Targetco. At the same time, the Rights Plan grants Targetco's existing shareholders rights to buy more shares at a discount. These rights are only triggered if an acquiror tries to acquire shares of Targetco without following the rules in the Rights Plan. The effect of the rights, if triggered, would be to frustrate the acquisition of control of Targetco by diluting the acquiror's interest in Targetco.

19. The Employee Share Purchase Plan is a voluntary plan which allows Targetco employees to purchase Targetco shares through payroll deductions. The purchase price is set at XXXXXXXXXX% of the FMV of the Targetco shares at the commencement of a particular offering period. At the end of the particular offering period, the deducted amounts are accumulated and applied to the purchase of Targetco shares for the benefit of participants. Targetco may, in its discretion, issue new shares for delivery to the participating employees, or arrange to purchase its shares on the open market.

20. Under the Stock Option Plans, Targetco can grant stock options to acquire its shares ("Options" and individually referred to as an "Option") to the directors, officers and employees of Targetco and its subsidiaries, as an incentive to stimulate greater performance.

21. The RSU Plan is a share-based compensation plan for Targetco's employees. It is not a "deferred profit sharing plan" as defined in subsection 147(1). Under the RSU Plan, Targetco could grant share units ("Share Units" and individually referred to as a "Share Unit") to employees as part of their compensation. The Share Units are not shares or options but are rights which entitle the recipient, subject to vesting, to receive one Targetco share for each Share Unit held or, in the discretion of Targetco, a cash payment equal to the FMV of a Targetco share at the time of payout.

The RSU Plan is administrated by a plan trustee ("Plan Trustee") pursuant to a trust agreement ("Trust Agreement").

There are XXXXXXXXXX Targetco shares now being held for this purpose by the Plan Trustee. These shares will be acquired by Acquisition Subco as part of the Proposed Transactions. Beneficiaries of the RSU Plan will (indirectly through the Plan Trustee) receive the proceeds. The Plan Trustee also holds a number of additional Targetco shares ("Excess RSU Shares").

Pursuant to the Trust Agreement, on termination of the RSU Plan, the Plan Trustee may be required, at the discretion of Targetco, to liquidate or return to Targetco any Targetco shares held by it. Accordingly, under the Plan of Arrangement described below, the Plan Trustee will sell to Acquisition Subco the XXXXXXXXXX Targetco shares held for employees and will pay the proceeds to participants. The Excess RSU Shares will be returned to Targetco for cancellation as provided in the Plan of Arrangement.

22. DSU Plan is not a "deferred profit sharing plan" as defined in subsection 147(1). Under the DSU Plan, only directors of Targetco are entitled to receive deferred share units ("DSUs" and individually referred to as a "DSU"). Each DSU is a unit credited to a director of Targetco as a bookkeeping entry in the books of Targetco. The FMV of a DSU at any date is equal to the FMV of a Targetco share on that date.

Each director is entitled to receive, following his or her retirement or otherwise ceasing to be a director of Targetco, a cash payment equal to the FMV of the DSUs that are held for him or her. In the discretion of Targetco's compensation committee, Targetco could also satisfy the obligation by purchasing Targetco shares in the open market and crediting them to the directors of Targetco.

Under the Plan of Arrangement described below, the DSUs are to be satisfied by a cash payment per DSU equal to the Purchase Price per Targetco share under the Plan of Arrangement.

23. On XXXXXXXXXX, AcqCo, Acquisition Subco and Targetco entered into an arrangement agreement ("Arrangement Agreement"), pursuant to which Acquisition Subco will acquire all of the Targetco common shares ("Share Acquisition") from the shareholders of Targetco on or before XXXXXXXXXX ("Effective Date") in an all-cash transaction valued at US$XXXXXXXXXX per share ("Purchase Price"), or in total approximately US$XXXXXXXXXX. The Share Acquisition is part of a plan of arrangement ("Plan of Arrangement") described in the Arrangement Agreement.

The Plan of Arrangement is pursuant to section 192 of the CBCA and is subject to customary shareholder, court and regulatory approvals.

24. On XXXXXXXXXX, Acquisition Subco and Targetco publicly announced that they had executed the Arrangement Agreement.

Proposed Transactions

25. Subject to the appropriate shareholder, court and regulatory approvals, the Proposed Transactions described in Paragraphs 26 to 40 (other than Paragraphs 33 and 36) will occur by virtue of the Plan of Arrangement and will be designated in the Plan of Arrangement to occur on the Effective Date and in the order and at the times set forth below.

You have advised that the Plan of Arrangement is legally effective under section 192 of the CBCA.

Reorganization of Internal Funding

26. AcqCo will obtain an aggregate amount of approximately US $XXXXXXXXXX through the issuance of shares to its related corporations and separate borrowings from its related corporations and third party lenders.

27. Acquisition Subco will borrow an amount of approximately US$XXXXXXXXXX ("Acquisition Debt #1") from AcqCo. As evidence for such indebtedness, Acquisition Subco will issue a note ("AcqCo Note") to AcqCo with a principal amount and FMV equal to the Acquisition Debt #1.

28. Lender Subco will borrow cash from certain Targetco Non-Canadian Subsidiaries.

Acquisition of Targetco common shares by Acquisition Subco

29. Effective at XXXXXXXXXX ("Effective Time") on the Effective Date, Acquisition Subco will borrow from Lender Subco an amount ("Acquisition Debt #2") approximately equal to

(a) US$XXXXXXXXXX, plus

(b) an amount, if any, of additional cash requested by Acquisition Subco and reasonably agreed to by Targetco, minus

(c) the aggregate amount to be paid by Targetco or its affiliates to satisfy the payout amounts in connection with the acquisition by Targetco of its outstanding Options described in Paragraph 32 and DSUs described in Paragraph 37.

As evidence for such indebtedness, Acquisition Subco will issue a note to Lender Subco ("Lender Subco Note") with a principal amount and FMV equal to the Acquisition Debt #2.

30. Effective at XXXXXXXXXX to the Effective Time, the Rights Plan will be terminated by Targetco for no consideration.

The purpose of terminating the Rights Plan is to ensure that it disappears as part of the Plan of Arrangement, as the Rights Plan has no utility once Targetco is no longer a public company.

31. Effective at XXXXXXXXXX to the Effective Time, Targetco shall issue its shares to its employees pursuant to the Employee Share Purchase Plan.

32. Effective at XXXXXXXXXX to the Effective Time, each outstanding Option shall be transferred to Targetco in exchange for a cash payment equal to the greater of

(a) $XXXXXXXXXX ; and

(b) the amount by which the Purchase Price exceeds the product of

(i) the exercise price of the Option (denominated in Canadian dollars); and

(ii) the applicable currency exchange factor.

All Options shall thereupon be cancelled pursuant to the Plan of Arrangement.

33. Effective XXXXXXXXXX the Effective Time, Targetco will transfer its shares of XXXXXXXXXX. ("Subco1") to XXXXXXXXXX. ("Subco2") under subsection 85.1(3). As consideration for the transfer, Subco2 will issue its shares to Targetco having an aggregate FMV equal to the aggregate FMV of the Subco1 Shares so transferred to Subco2.

Subco1 and Subco2 are two of the Targetco Non-Canadian Subsidiaries.

34. Effective at the Effective Time, Acquisition Subco will acquire all of the Targetco common shares (other than the Excess RSU Shares) from the shareholders of Targetco for the Purchase Price. As a consequence of the Share Acquisition, Acquisition Subco will acquire control of Targetco at the Effective Time.

Acquisition Subco will pay the Purchase Price in cash by using the loan proceeds that it borrowed from AcqCo of approximately US$XXXXXXXXXX described in Paragraph 26 and Lender Subco of approximately US$XXXXXXXXXX described in Paragraph 29.

Effective at XXXXXXXXXX, the Targetco common shares that the RSU Trust holds at that time in excess of XXXXXXXXXX Targetco common shares (such excess being approximately XXXXXXXXXX shares) shall be transferred to Targetco for no consideration, and such shares will thereupon be cancelled.

35. Effective at XXXXXXXXXX the Effective Time, the incumbent directors of Targetco will be replaced by new directors ("New Directors") of Targetco.

36. Effective at XXXXXXXXXX the Effective Time and immediately following the completion of the transaction described in Paragraph 35, appropriate officers of Targetco and the New Directors shall execute the documents referred to in subsection 4800(4) of the Regulations in order to give effect to the election by Targetco not to be a public corporation from and after that point in time, including without limitation

(a) prescribed form T2067;

(b) a written resolution of the New Directors authorizing such election to be made;

(c) a certified copy of such written resolution; and

(d) a statutory declaration made by a New Director stating that, after reasonable inquiry for the purpose of informing himself or herself in that regard, to the best of his or her knowledge, Targetco complies with all the prescribed conditions that must be complied with at the time the election is made.

37. Effective at XXXXXXXXXX the Effective Time, all of the DSUs will be satisfied in full by the payment by Targetco in cash of an amount equal to the Purchase Price for each such DSU. Upon completion of this transaction, no shares in the capital stock of Targetco, or rights to acquire shares in the capital stock of Targetco will be owned by any person other than Acquisition Subco. For greater certainty, in accordance with the Plan of Arrangement, the only shares of Targetco (or rights to acquire shares of Targetco) that will be outstanding at that time will be owned by Acquisition Subco.

Vertical Amalgamation of Acquisition Subco and Targetco

38. Effective at XXXXXXXXXX the Effective Time, Acquisition Subco and Targetco (collectively referred to as the "predecessor corporations" and individually referred to as a "predecessor corporation") will undertake a vertical amalgamation ("Amalgamation") under the provisions of the CBCA to form Amalco in such a manner that:

(a) all of the property (except any amounts receivable from any predecessor corporation or shares of the capital stock of any predecessor corporation) of the predecessor corporations held 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 the predecessor corporations immediately before the Amalgamation will become liabilities of Amalco by virtue of the Amalgamation; and

(c) all of the shares of Acquisition Subco that AcqCo held immediately before the Amalgamation will be converted into common shares of Amalco. All of the shares of Targetco that Acquisition Subco held immediately before the Amalgamation will be cancelled by virtue of the Amalgamation.

39. Targetco will elect not to have subsection 256(9) apply in its return of income for the taxation year that ended immediately prior to Acquisition Subco acquiring control of Targetco as described in Paragraph 34.

40. In connection with the Amalgamation, in the return of income for its first taxation year, Amalco will designate an amount under the provisions of subsection 87(11) and paragraph 88(1)(d) to increase the adjusted cost base of certain capital property (other than ineligible property) of Targetco, being shares of certain Targetco Subsidiaries (that Targetco owned without interruption at and since the time Acquisition Subco last acquired control of Targetco as described in Paragraph 34) that Amalco acquired on the Amalgamation, within the limits described in paragraph 88(1)(d).

Subsequent Transactions

41. After the Amalgamation, Amalco will transfer to AcqCo most of its shares of the Targetco Subsidiaries. As consideration for the transfer, AcqCo will assume the Lender Subco Note owing by Amalco and will set-off all or a portion of the AcqCo Note owing by Amalco.

42. AcqCo will thereafter transfer all of the shares of certain Targetco Subsidiaries that it received from Amalco described in Paragraph 41 (other than the shares of the Targetco Canadian Subsidiaries) to Holdco1 and Holdco2. In addition, AcqCo will transfer all of the shares of Amalco to Holdco2.

As consideration for each particular transfer, each of Holdco1 and Holdco2, as the case may be, will assume a portion of the Lender Subco Note that AcqCo assumed described in Paragraph 41 and will set-off all or a portion of its receivable owing by AcqCo.

Additional Information

43. Targetco has never paid a dividend on its common shares since XXXXXXXXXX and likely earlier nor does it intend to declare a dividend on its common shares prior to the Proposed Transactions. In fact, Targetco's policy has been not to pay any dividends on its shares. In addition, Targetco's senior secured credit facility provides for certain customary restrictions on its ability to pay dividends or make distributions with respect to Targetco's outstanding securities.

44. The Partnership has not issued, and will not issue, any units as part of the series of transactions or events that includes the Amalgamation as a means to raise capital to assist the financing of the acquisition by Acquisition Subco of the Targetco common shares.

45. None of the Third Party Lenders alone or in aggregate would constitute specified shareholders of Targetco at any time during the series of transactions or events that includes the Amalgamation.

Purposes of the Proposed Transactions

46. The Partnership has carefully selected Targetco to expand its business portfolio based on Targetco's growth potential and ability to deliver XXXXXXXXXX and deep market expertise to their customers. The Partnership views Targetco as a natural addition to its successful strategy.

47. The purpose of the Amalgamation is to allow Amalco to take advantage of the cost base "bump" provided for in paragraphs 88(1)(c) and (d) such that the Proposed Transactions can be completed in a tax-efficient manner.

48. The purpose of the subsequent transactions described in Paragraphs 41 and 42 is to consolidate Targetco's Business into the existing businesses of Holdco1 and Holdco2 such that the consolidation will provide an opportunity for Targetco's Business to grow significantly faster than would otherwise be the case.

Rulings

Provided that the preceding statements constitute complete and accurate disclosure of all of the relevant facts, proposed transactions and the purposes of the Proposed Transactions, and provided that the Proposed Transactions are completed in the manner described above, our rulings are as follows:

A. The provisions of subsections 87(11) and 88(1) will apply to the Amalgamation such that, for purposes of the Act, the cost to Amalco of each property of Targetco that becomes property of Amalco on the Amalgamation will be deemed to be the amount deemed by paragraph 88(1)(a) to be the proceeds of disposition of the property to Targetco, plus, subject to the provisions of subparagraphs 88(1)(d)(ii) and (iii), and provided that no such property acquired by Amalco on the Amalgamation, or "any property acquired by any person in substitution therefor" (within the meaning of that phrase for the purposes of clause 88(1)(c)(vi)(B)) is acquired by any person described in any of subclauses 88(1)(c)(vi)(B)(I), (II) or (III) (on the assumption that the "subsidiary" referred to in those subclauses is Targetco and the "parent" is Acquisition Subco) as part of the series of the transactions or events that includes the Proposed Transactions, and, on the assumption that such property is capital property, but not depreciable property, such portion of the amount, if any, by which:

(a) the aggregate of the adjusted cost base to Acquisition Subco of each Targetco common share immediately before the Amalgamation exceeds

(b) the aggregate of the amounts determined under subparagraphs 88(1)(d)(i) and (i.1),

as is designated by Amalco under paragraph 88(1)(d) in respect of the property in its return of income under Part I for the taxation year in which the Amalgamation occurred.

B. The lending of money by Lender Subco to Acquisition Subco described in Paragraph 29 will not, in and by itself, result in a liability for tax under Part II.1 to Targetco for its taxation year in which the lending of money occurred.

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

These rulings are given subject to the limitations and qualifications set out in Information Circular 70-6R5 issued by CRA on May 17, 2002 and are binding on the 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.

Comments

1. In our view, Targetco will have two taxation years as a result of the acquisition of control of Targetco by Acquisition Subco described in Paragraph 34 and the Amalgamation described in Paragraph 38. The first taxation year will end immediately before the acquisition of control of Targetco by Acquisition Subco under subsection 249(4) and the second taxation year will end immediately before the Amalgamation under paragraph 87(2)(a).

2. Nothing in this ruling should be construed as implying that CRA has agreed to or reviewed:

(a) the determination of the FMV or the cost amount of any particular asset or the paid-up capital of any shares referred to herein; and

(b) any tax consequences relating to the facts and Proposed Transactions described herein other than those specifically described in the rulings given above.

Yours truly,

XXXXXXXXXX
Section Manager
for Division Director
Reorganizations and Resources Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch