2007 Ruling 2006-0187681R3 - Distribution of capital

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: Whether an Icelandic "Sameignarfélag" (SF) is a partnership such that the distribution that will be made by it to its members will constitute a distribution of capital of the SF?

Position: Yes, it is a partnership.

Reasons: The attributes of an SF resemble more closely those of a partnership than a corporation.

XXXXXXXXXX 2006-018768

XXXXXXXXXX , 2007

Dear Sir:

Re: XXXXXXXXXX. ("Pubco")
Business Number XXXXXXXXXX
Advance Income Tax Ruling

We are writing in reply to your letter of XXXXXXXXXX in which you requested an advance income tax ruling on behalf of the above-referenced taxpayer.

Pubco's tax affairs are administered by the XXXXXXXXXX Tax Services Office and it files its tax returns at the XXXXXXXXXX Taxation Centre.

To the best of your knowledge and that of the taxpayer involved, none of the issues involved with this request:

(i) is involved in an earlier return of the taxpayer or a related person;

(ii) is being considered by a tax services office or a taxation centre in connection with a tax return already filed by the taxpayer or a related person;

(iii) is under objection; or

(iv) is before the courts or, if a judgement has been issued, the time limit for appeal has not expired.

This document is based solely on the facts and proposed transactions described below. The documentation submitted with your request does not form part of the facts and proposed transactions and any references thereto are provided solely for the convenience of the reader.

Definitions

In this letter the following terms have the meanings specified:

(a) "Act" means the Income Tax Act R.S.C. 1985 c.1 (5th Supp.), as amended to the date hereof, and unless otherwise stated, every reference herein to a Part, section, subsection, paragraph or subparagraph is a reference to the relevant provision of the Act;

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

(c) "controlled foreign affiliate" has the meaning assigned by subsection 95(1) of the Act;

(d) "Distribution" means the distribution that will be paid by FinSF to each of FA Holdco 1 and FA Holdco 2 of a specified amount as described in paragraph 11 below;

(e) "FA Holdco 1" means XXXXXXXXXX;

(f) "FA Holdco 2" means XXXXXXXXXX;

(g) "FinSF" means XXXXXXXXXX;

(h) "foreign affiliate" has the meaning assigned by subsection 95(1) of the Act;

(i) "Proposed Transactions" means the transactions described in paragraphs 11 and 12 below which appear under the heading "Proposed Transactions";

(j) "Pubco" means XXXXXXXXXX;

(k) "public corporation" has the meaning assigned by subsection 89(1) of the Act; and

(l) "taxable Canadian corporation" has the meaning assigned by subsection 89(1) of the Act.

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

Facts

1. Pubco is a taxable Canadian corporation and a public corporation that operates a XXXXXXXXXX enterprise both directly and indirectly through affiliated corporations, including foreign affiliates, throughout the world.

2. FinSF was established in Iceland and is registered under the laws of Iceland as a "Sameignarfélag" (an "SF"). All of the equity interests in FinSF are held by FA Holdco 1 and FA Holdco 2, as to approximately XXXXXXXXXX% and XXXXXXXXXX%, respectively.

3. Each of FA Holdco 1 and FA Holdco 2 is a corporation governed by the laws of XXXXXXXXXX, and is a non-resident of Canada and a resident of XXXXXXXXXX for the purposes of the Act and the Canada-XXXXXXXXXX Income Tax Convention. Moreover, each is an indirect wholly-owned subsidiary (held through a chain of XXXXXXXXXX affiliates) and a foreign affiliate and controlled foreign affiliate of Pubco.

4. Over time, FA Holdco 1 and FA Holdco 2 have contributed substantial amounts of capital to FinSF. A relatively modest amount was initially contributed as "initial contributed capital of initial members" (in order to minimize certain local transaction taxes - namely, stamp duties) and a much more substantial contribution was made subsequently as "additional contributed capital of members", which has been credited to each member's "current account", together with such member's share of the "undistributed profits" of FinSF.

5. FinSF carries on a group treasury and financing function.

6. In Iceland, there is no formal legislation regulating the formation of an SF. However, this type of entity has been used in Iceland for centuries, and the applicable rules have been established by practice developed over that period. In most cases, SFs are established for business purposes and, in such cases, they are required to be registered with the Register of Firms, maintained by the Magistrate's Office in Iceland. Such registration must include specified information, including information as to the name of the entity, its purpose, the name and address of all the members, the amount of any initial capital contributed by them, and who will be entitled to represent and commit the entity with respect to third parties. Upon registration, a Certificate of Registration is issued by the Magistrate's Office.

7. Certain prominent characteristics of an SF may be described as follows:

(a) Existence: An SF will exist from its formation until its dissolution. An SF that ceases to carry on business must notify the Magistrate's Office. The death of a member will not, in and of itself, cause the SF to dissolve, even if its governing Sameignarfélagssamningur ("Members' Agreement") says nothing. The remaining members/heirs are entitled to continue the SF. Normally, the practice is that the dissolution of an SF is provided for in its governing Members' Agreement.

(b) Transferability of Interests: Subject to any provision to the contrary in the governing Members' Agreement, the general rule is that a new member may not be invited to take part in the SF except with the acceptance of all the existing members.

(c) Liability: The members of an SF have direct, unlimited liability for its obligations, and they are jointly and severally liable for the SF's debts ("liable in solidum"). The members guarantee the SF's liabilities by means of their entire assets, and the creditors of the SF are not required to seek fulfillment of their claims against the SF first, but may claim directly from any member of the SF. An SF is not declared bankrupt unless all the members are declared bankrupt at the same time.

(d) Ownership Separated from Governance, and Agency: Members of an SF must unanimously agree to all decisions concerning what kind of contracts or agreements the SF may conclude, unless the Members' Agreement provides otherwise. Exceptions apply to decisions concerning the daily business of the entity and other routine decisions, as specified in the Members' Agreement. A member (or other person) may be granted a power of procuration (i.e., a power of attorney) to manage the SF's business and sign on behalf of the SF. The Members' Agreement generally governs whether any particular member may act to bind the SF. An agreement concluded by one of the members with a third party without seeking the approval of the others may commit the SF if the third party did not know that the member lacked authority or if the entity registration does not specify limitations as to the authority of the member to commit the SF.

(e) Ownership of Property: The members of an SF own the "capital" of the SF, but do not have any proprietary interest (undivided or not) in the property of the SF unless such property is distributed to them at the dissolution of the SF.

(f) Division of Profits and Other Distributions: The division of profits among members is based on initial capital contributions and current contributions. Salary may be paid to a member based on performance, but a member's salary is separate from any share of the profits of the SF to which that member may be entitled. Distributions by a SF normally result in adjustments to the underlying accounts maintained in respect of the SF and its members. It is the practice to indicate, in the resolutions associated with the distribution, that the distribution in question will result in an adjustment (i.e., a reduction) to a particular account - and, in particular, whether the distribution would be regarded as a division of profits, or a return of additional contributed capital or initial capital), but Icelandic law does not otherwise distinguish between (or for any particular purpose characterize) SF distributions (whether as "dividends" or otherwise as such). Moreover, there exists a process by which what could be regarded as "registered capital" may come into being, and this capital may be distinguished from any other capital of an SF on the basis that its contribution has been registered with the Magistrate's Office, and any reduction thereof resulting from a distribution must likewise be registered with the Magistrate's Office, but this capital does not result in any "solvency" or other such restriction preventing a distribution that would cause the net assets of an SF to be less than its "registered capital". The Distribution described in the Proposed Transactions below is not a division of profits or distribution of such "registered capital".

(g) Fiduciary Obligations: Members of an SF have no special duties of care or any special fiduciary duties to each other.

8. For Icelandic tax purposes, a registered SF is taxed as a separate taxable entity at a flat rate of 26% (compared with 18% on a limited company). Any distribution of profits from a registered SF will not be taxed in the hands of the SF or its members whereas the distribution of profits from a limited company will be taxed in the hands of the shareholders.

9. Various elements of the respective rights and obligations of the parties interested in FinSF are set forth in its governing Members' Agreement. As noted in Section XXXXXXXXXX of the Members' Agreement:

"On registration as a body corporate in the Company Register of the Magistrate's Office, the Company [FinSF] is an independent legal entity, and a taxable entity pursuant to Article XXXXXXXXXX on Income Tax and Net Worth Tax." [Translation]

10. The following additional points are noted with regard to the legal characteristics of FinSF under the laws of Iceland:

(a) Membership interests in an SF such as FinSF are proportionate - in the sense that they determine annual profit distribution entitlements as a function of relative contributions and the like. More specifically, pursuant to Section XXXXXXXXXX of the Members' Agreement,

"Any profit of the Company operations to be distributed to each Member shall be distributed in proportion to the total of the initial capital contributed by the Member as set out in Section XXXXXXXXXX , contributions pursuant to Section XXXXXXXXXX , and the current account of the Member, as the case may be, at the time of distribution. For purposes of this Agreement, the "current account" of a Member consists of:

(i) any capital contributed by the Member pursuant to Section XXXXXXXXXX; and

(ii) any profits of the Company that have not been distributed to the Member."

Similar provision is made in respect of any distributions to be made on liquidation, in accordance with Article XXXXXXXXXX of the Members' Agreement. Thus, what could be regarded as the "legal accounts" of FinSF must be divided among the following items - namely: the following three main accounts - being the "initial contributed capital of initial members" (as set out in Section XXXXXXXXXX of the Members' Agreement), the "initial contributed capital of secondary members" (i.e., contributions pursuant to Section XXXXXXXXXX), the "current account" - and the following two supporting accounts, being the "additional contributed capital of members" (i.e., any capital contributed by the Member pursuant to Section XXXXXXXXXX), and the "undistributed profits" of FinSF, with the latter two items constituting the "current account".

(b) Decisions made by or on behalf of FinSF, through meetings of and voting by the members of FinSF, and of its board of directors, are governed by Articles XXXXXXXXXX of the Members' Agreement. Pursuant to Section XXXXXXXXXX, "[v]oting rights of each Member are allocated in accordance with the share held by each Member as set out in Section XXXXXXXXXX". There must be an annual "general Members' meeting", and at each such meeting the members are required to "appoint a board of directors, review and accept financial statements according to Article XXXXXXXXXX and appoint auditors according to Article XXXXXXXXXX" (section XXXXXXXXXX). The composition and functions of the board of directors of FinSF are provided for in Article XXXXXXXXXX of the Members' Agreement. Section XXXXXXXXXX of the Members' Agreement provides as follows:

"The Company's Board of Directors shall consist of XXXXXXXXXX persons. The Annual General Meeting of the Members appoints the Board for one year at a time. A General Meeting of the Members may decide to increase or decrease the number of directors. Each Member shall nominate a proportion of directors equal to its share as set out in Section XXXXXXXXXX, provided however that each Member shall nominate at least one director. The Chairman of the Board shall be appointed by the Members from among the nominated directors."

As provided for in Section XXXXXXXXXX of the Members' Agreement, FinSF's board of directors, which "operates by formal meetings", "directs the Company between meetings of the Members". Moreover, pursuant to Section XXXXXXXXXX of the Members' Agreement, the board of directors "can hire a Managing Director and decide his terms of employment"; and, pursuant to Section XXXXXXXXXX of the Members' Agreement, the board of directors "may also appoint one or more managers of any branch of the Company and grant powers of procuration to one or more such branch managers". Pursuant to Section XXXXXXXXXX of the Members' Agreement, "[a]ny two Members of the Board may sign jointly on behalf of the Company and represent the seal of the Company, provided always that at least one director designated by each Member is a signatory".

(c) Pursuant to Section XXXXXXXXXX of the Members' Agreement, "[t]here are no limits regarding the lifetime of the Company"; however, "[t]he Company may be dissolved at any time by a decision of a Members' meeting".

(d) Pursuant to Section XXXXXXXXXX of the Members' Agreement, the members of FinSF shall, toward its creditors, "be liable in solidum for the debts of the Company".

Proposed Transactions

11. Finco's board of directors will adopt a resolution (which will be complemented by any other necessary formalities) that will approve the Distribution, to be paid to each member out of and in proportion to its respective "current account", and to be debited from "additional contributed capital of members". In that resolution, a notation to the following effect will be made:

"Whereas the amount of the distribution does not exceed the amount that can reasonably be considered to have been received previously by the Company as additional capital contributed by members (minus any prior distribution treated by the Company as a return of such additional capital), it is hereby provided that the entire amount of the distribution shall be treated by the Company as a return of such additional capital."

12. FinSF will then pay the appropriate amounts in respect of the Distribution to FA Holdco 1 and FA Holdco 2, in accordance with that resolution.

Purpose of the Proposed Transactions

13. The purpose of the Proposed Transactions is to permit FinSF to distribute among its members funds no longer required by it for the purposes of its business operations. It is expected that those funds would ultimately be distributed to Pubco, which would use them for its various corporate purposes.

Additional Information

14. The adjusted cost base ("ACB") to each of FA Holdco 1 and FA Holdco 2 of its interest in FinSF (resulting from its contributions of "initial capital" and "additional capital") immediately before the Distribution exceeds the amount of its share of the Distribution. More specifically, as of the end of its fiscal year on XXXXXXXXXX, FinSF's Members' Equity accounts, as prepared for financial accounting purposes, reflected total Members' initial capital contributions in the aggregate amount (in XXXXXXXXXX) of XXXXXXXXXX, and total additional capital contributions in the aggregate amount (in XXXXXXXXXX) of XXXXXXXXXX, for an aggregate total capital (in XXXXXXXXXX) of XXXXXXXXXX, and an accumulated deficit (in XXXXXXXXXX) of XXXXXXXXXX. There is thus no accounting profit to distribute.

15. The interests in FinSF held by each of FA Holdco 1 and FA Holdco 2 will be excluded property as defined in subsection 95(1) of the Act at the time of the Distribution and accordingly, the calculating currency for the purposes of subparagraph 95(2)(f)(ii) of the Act of each of FA Holdco 1 and FA Holdco 2 in respect of its interest in FinSF is XXXXXXXXXX.

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. FinSF is considered to be a partnership for the purposes of the Act.

B. The amount paid by FinSF and received by each of FA Holdco 1 and FA Holdco 2 in respect of the Distribution will be considered to have been paid and received as a distribution of capital to the members of FinSF for the purposes of the Act.

C. Pursuant to subparagraph 5907(12)(b)(iv) of the Income Tax Regulations and paragraph 95(2)(j) of the Act, the ACB of the partnership interest in FinSF held by FA Holdco 1 and FA Holdco 2, as the case may be, will be reduced by the amount of the capital distributed to FA Holdco 1 and FA Holdco 2, respectively.

The above rulings are given subject to the general limitations and qualifications set out in Information Circular 70-6R5 dated May 17, 2002, and are binding on the Canada Revenue Agency ("CRA") provided that the proposed transactions are completed by XXXXXXXXXX.

These rulings are based on the Act in the present form and do not take into account amendments to the Act which, if enacted into law, could have an effect on the rulings provided herein.

Other Comment

Nothing in this ruling should be construed as implying that the CRA has agreed to or reviewed 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
International and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch