2006 Ruling 2005-0163191R3 - Paid-up capital reduction

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: Exchange by a public corporation of limited partnership units for units of a mutual fund trust that also holds an interest in the partnership. Subsequent distribution of the trust units to the shareholders on a reduction of capital. Whether the distribution of the trust units gives rise to a deemed dividend under subsection 84(4.1).

Position: No.

Reasons: The transaction is a transaction described in subsection 84(2). Therefore, the reduction of paid-up capital of the public corporation does not result in the application of subsection 84(4.1)

XXXXXXXXXX 								2005-016319

XXXXXXXXXX, 2006

Dear XXXXXXXXXX

Re: Advance Income Tax Ruling
XXXXXXXXX (XXXXXXXXX TSO; XXXXXXXXX Taxation Centre; Business No. XXXXXXXXX)

We are writing in response to your letter of XXXXXXXXXX and your amended letters dated XXXXXXXXXX wherein you requested an advance income tax ruling on behalf of the above-referenced taxpayer. We also acknowledge receipt of your emails as well as our telephone conversations. The documents submitted with your request are only part of this document to the extent described herein.

To the best of your knowledge and that of the above-referenced taxpayer, none of the issues involved in this ruling are:

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

(iii) under objection by the above-referenced taxpayer 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 taxpayer has confirmed that the proposed transactions described herein will not affect its ability to pay any of its 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:

"Business" means the XXXXXXXXXX;

"Capital" means the stated capital account of each Class of Shares under the XXXXXXXXXX;

"Capital Reduction" means the reduction of capital described in paragraph 10(c) below;

"Class of Shares" collectively referred to as the "Classes of Shares" means the XXXXXXXXXX of Pubco. The issued and outstanding shares of Pubco consist of XXXXXXXXXX;

"Exchangeable LP Units" at any time means the LP Units, but if that time is before the day that follows XXXXXXXXXX months after the closing of the offering of Fund Units pursuant to the final prospectus of the Fund, excludes XXXXXXXXXX% of the issued and outstanding LP Units held by Pubco;

"Exchange Right" means the right granted XXXXXXXXXX to Pubco to exchange, at any time and from time to time, its Exchangeable LP Units and GP Shares for Fund Units or cash XXXXXXXXXX. The exchange will be done by following these steps: (i) Pubco will issue a notice to GP indicating the number and value of the Exchangeable LP Units and GP Shares to be exchanged (ii) the Trust will issue Trust Units and notes having an aggregate value equal to XXXXXXXXXX (iii) the issuance by the Fund to the Trust of a number of Fund Units equal to the number of exchanged Exchangeable LP Units described in (i) (subject to adjustments for consolidations, subdivisions or for other reasons) (iv) the Trust will transfer the Fund Units described in (iii) to GP, as escrow agent (v) GP will effect the exchange (vi) GP will cause the Trust to be registered as holder of the exchanged Exchangeable LP Units and GP Shares and (vii) the Fund Units issuable on the exercise of the Exchange Right will be registered for the benefit of Pubco and the Trust will be deemed to have transferred to Pubco all its right, title and interest in and to the Fund Units described in (iii) and (iv), will cease to be the holder of such units and will not be entitled to exercise any of the rights in respect of such units. The Exchange Right can only be exercised if (a) its exercise does not cause the Fund to breach the restrictions respecting non-resident ownership contained in the Fund Declaration of Trust or otherwise cause the Fund to cease to be a mutual fund trust under subsection 104(6), (b) the Fund is legally entitled to issue the Fund Units in connection with the exercise of the Exchange Right, and (c) upon the exercise of the Exchange Right, the person receiving the Fund Units complies with all applicable security laws;

"Fund" means XXXXXXXXXX;

"Fund Units" means units of the Fund;

"GP" means XXXXXXXXXX., a corporation XXXXXXXXXX. GP has exclusive authority to manage the business and affairs of the Partnership, to make all decisions regarding the business of the Partnership and to bind the Partnership. The Fund, the Trust, Pubco, the Partnership and GP have entered into a unanimous securityholders' agreement governing their securityholdings in, and the business and affairs of, GP and the Partnership. The agreement provides that the board of directors of GP will be initially comprised of XXXXXXXXXX members. Pubco, in its sole discretion, will be entitled to appoint all of the directors of GP, except for XXXXXXXXXX directors who will be independent from Pubco and who will be appointed by the Fund, XXXXXXXXXX. The number of directors that can be named by Pubco will decrease as its holding of GP Shares drops XXXXXXXXXX, subject to Pubco's discretion to establish the number of directors of the board of GP so as to increase or decrease the number of directors which it is entitled to appoint to such board as long as it owns XXXXXXXXXX% or more of the GP Shares and LP Units;

"GP Shares" means the XXXXXXXXXX shares of GP;

"Investor Liquidity Agreement" means an agreement entered into on XXXXXXXXXX by the Fund, the Trust, the Partnership, GP and Pubco;

"LP Units" means the XXXXXXXXXX partnership units of the Partnership;

"Non-Resident Shareholder" means a Shareholder who resides in the United States, including any partnership or corporation organized or incorporated under the laws of the United States, an estate or trust of which any executor or administrator or trustee, respectively, is a U.S. Person as defined in Rule 902(k) of Regulation S promulgated under the U.S. Securities Act, or any other such U.S. Person;

"Old Partnership" means XXXXXXXXXX, a limited partnership established in XXXXXXXXXX under the laws of XXXXXXXXXX and wound up in XXXXXXXXXX;

"Paid-up Capital" means paid-up capital as defined in subsection 89(1);

"Partnership" means XXXXXXXXXX;

"Partnership Interests" means limited partnership interests in XXXXXXXXXX

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

"Proposed Transactions" means the transactions described in the "proposed transactions" section of this letter;

"Pubco" means XXXXXXXXXX., a corporation incorporated under the XXXXXXXXXX on XXXXXXXXXX. The address of Pubco is XXXXXXXXXX;

"Reduction Amount" means the fair market value of the Exchangeable LP Units exchanged by Pubco as described in the Proposed Transactions (which fair market value is estimated to be approximately equal to $XXXXXXXXXX);

"Reorganization" means the transactions XXXXXXXXXX;

"Shareholder" means a holder of a share of a Class of Shares;

"Subco" means XXXXXXXXXX, a corporation amalgamated and existing under the XXXXXXXXXX . Subco is XXXXXXXXXX; and

"Trust" means XXXXXXXXXX.

FACTS

1) Pubco is a public corporation and a taxable Canadian corporation as defined in section 89. None of the Paid-up Capital of the issued and outstanding shares of Pubco is derived from the capitalization of Pre-1972 CSOH in respect of which an election has been made in accordance with the provisions of subsection 83(1) as it read with respect to dividends which became payable before 1979. The aggregate Paid-up Capital of all the Classes of Shares exceeds the Reduction Amount.

2) The assets of the Business were transferred XXXXXXXXXX to Old Partnership on XXXXXXXXXX. As a result of that transfer, Subco was entitled to receive in respect of the eligible capital property, as defined in section 248, of the Business an amount of $XXXXXXXXXX described in "E" of the definition "cumulative eligible capital" in subsection 14(5). That amount resulted in an income inclusion under subsection 14(1). Old Partnership never claimed a deduction under paragraph 20(1)(b). The depreciable property, as defined in section 248, that was transferred to the Old Partnership was transferred for consideration equal to its fair market value (approximately $XXXXXXXXXX) and no election was filed pursuant to subsection 97(2) in respect of the transfer of the depreciable property.

3) Pubco owns all the issued and outstanding shares of GP.

4) As part of the Reorganization, Old Partnership and GP entered into a partnership agreement giving rise to the Partnership.

5) The assets of the Business were transferred to the Partnership in XXXXXXXXXX, on a partially tax-deferred basis under subsection 97(2). The eligible capital property, as defined under section 248, that was transferred to the Partnership will be transferred at an agreed amount, for the purposes of subsection 97(2), which is greater than its cost to the Old Partnership of $XXXXXXXXXX, but lower than its fair market value. Old Partnership will therefore recognize an income inclusion under subsection 14(1). The depreciable property, as defined in section 248, that was transferred to the Partnership will be transferred at an agreed amount, for the purposes of subsection 97(2), equal to its fair market value. As Old Partnership had never claimed a deduction under paragraph 20(1)(a), Old Partnership will not recognize recapture under subsection 13(1).

6) The Fund completed an initial public offering of Fund Units on XXXXXXXXXX. Following the initial public offering, the Fund acquired trust units and notes of the Trust. The Trust and the Fund are open-ended trusts. The Fund is a mutual fund trust within the meaning of subsection 132(6).

7) The Trust in turn acquired XXXXXXXXXX of the LP Units of the Partnership and the same proportion of GP Shares. The remaining issued and outstanding units of the Partnership are held by GP and Pubco.

8) Pubco has no prior history of selling securities in entities that it controls to unrelated parties, other than XXXXXXXXXX. From its inception, Pubco's activities can be summarized as follows:

a. Holding on account of capital of:

(a) the shares of Subco;

(b) the shares of GP;

(c) the Partnership Interests, including LP Units; and

(d) other strategic investments in businesses related to its core activities.

b. Managing and supervising the operation of the entities described in point a. above and carrying on extensive managerial, legal and treasury services for them on a cost-recovery basis.

9) On XXXXXXXXXX, Pubco's directors concluded that the adoption by the Shareholders of a resolution to give to Pubco's directors the authority to make one or more special distributions by way of a reduction of the Paid-up Capital maintained in respect of each Class of Shares was in the best interests of Pubco. The Shareholders adopted that resolution on XXXXXXXXXX. The directors may exercise that authority at such times, if any, as they shall deem appropriate and without further action on the part of the Shareholders. The resolution authorizes the directors to determine the exact amount of the reduction and the corresponding distribution(s). However, the aggregate reductions cannot exceed $XXXXXXXXXX.

PROPOSED TRANSACTIONS

10) The directors of Pubco will authorize Pubco to and Pubco will:

(a) enter into an agreement with a number of underwriters providing for the sale by the underwriters of Fund Units for cash and the remittance of that cash to the Non-Resident Shareholders, as the Fund Units may not be offered or sold in the United States;

(b) exercise its Exchange Right and exchange for Fund Units some Exchangeable LP Units and GP Shares having a fair market value equal to the Reduction Amount;

(c) reduce the Capital of each Class of Shares by an amount equal to the lesser of (i) the Capital of the Class of Shares, (ii) the Paid-up Capital of the Class of Shares and (iii) the proportionate share of the total Reduction Amount of the Class of Shares;

(d) remit Fund Units having a fair market value equal to the aggregate of the Non-Resident Shareholder's share of the Capital Reduction to a distribution agent for the sale of such Fund Units to the underwriters in consideration for cash proceeds which will be remitted to the Non-Resident Shareholders; and

(e) make one distribution to the other Shareholders of Fund Units having a fair market value equal to those shareholders' share of the Capital Reduction.

PURPOSE OF THE PROPOSED TRANSACTIONS

The overall purpose of the proposed transactions is to increase shareholder value by further unlocking the value of the Partnership and reduce, over time, the holding company discount which currently affects the market value of Pubco.

RULINGS

Provided that the preceding statements constitute a complete and accurate disclosure of all 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. Subsection 84(2) will apply, and subsection 84(4.1) will not apply, to the distribution on the Capital Reduction, described in paragraph 10 above, such that Pubco will not be deemed to have paid to a particular Shareholder, and such Shareholder will not be deemed to have received, a dividend provided that the amount of the distribution does not exceed the amount by which the Paid-up capital in respect of the shares of Pubco is reduced on the Capital Reduction. The adjusted cost base of each share will be reduced pursuant to subparagraph 53(2)(a)(ii) by the amount of the Capital Reduction attributable to that share.

B. The Shareholders who receive the Fund Units as described in paragraph 10(e) above will be considered to have acquired them at a cost equal to their fair market value at the time of the Capital Reduction.

COMMENTS

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

i the determination of the fair market value of any property or the Paid-up Capital in respect of any shares;

ii any tax consequences relating to the facts and Proposed Transactions described herein, other than those described in the rulings above, including, without restricting the generality of the foregoing:

(a) the tax consequences of any future Paid-up Capital reduction; and

(b) the tax consequences of the exchange of the Exchangeable LP Units and GP Shares.

Yours truly,

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