2007 Ruling 2006-0205771R3 - 88(1)(d) Bump and Substituted Property

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: (1) The cost of property acquired in exchange for shares issued by the purchaser? (2) Whether shares of the acquirer corporation that are issued to the shareholders of the target corporation will be substituted property described in 88(1)(c.3)(ii)?

Position: (1) Subject to 143.3(3), where there is no agreement regarding the price the cost will be the amount added to the stated capital of the shares. (2) Not in the circumstances.

Reasons: (1) The position is consistent with previous rulings and jurisprudence. (2) The position is consistent with a previous ruling and Explanatory Notes of the Dept. of Finance.

XXXXXXXXXX 2006-020577

XXXXXXXXXX, 2007

Dear XXXXXXXXXX:

Re: XXXXXXXXXX (Business No. XXXXXXXXXX ) Advance Income Tax Ruling

This is in reply to your letter of XXXXXXXXXX in which you requested advance income tax rulings on behalf of the above-noted party. We also acknowledge the additional information provided thereafter in connection with your requests, both in further correspondence and in our various telephone conversations.

We understand that to the best of your knowledge, and that of XXXXXXXXXX, none of the issues contained herein:

(a) is in an earlier tax return of XXXXXXXXXX or any person related thereto;

(b) is being considered by a tax services office or taxation centre in connection with a previously filed tax return of XXXXXXXXXX or any person related thereto;

(c) is under objection by XXXXXXXXXX or any person related thereto;

(d) is before the Courts or, if a judgment has been issued, the time limit for appeal to a higher Court has expired;

(e) is the subject of an advance income tax ruling previously issued by the Income Tax Rulings Directorate to XXXXXXXXXX or any person related thereto;

(f) will result in XXXXXXXXXX or any person related thereto being unable to pay its outstanding tax liabilities; or

(g) will have any impact on the existing tax liabilities of the XXXXXXXXXX or any person related thereto.

DEFINITIONS

In this Rulings Request, unless otherwise expressly stated:

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

(b) "Amalco" means the corporation that was formed on the Amalgamation of Parent and Subsidiary, as described in paragraph 13 below;

(c) "Amalgamation" means the amalgamation of Parent and Subsidiary, as described in paragraph 13 below;

(d) "Arrangement" means the plan of arrangement carried out pursuant to the Arrangement Agreement;

(e) "Arrangement Agreement" means the amended and restated arrangement agreement between Parent and Subsidiary;

(f) "BCA1" means the XXXXXXXXXX;

(g) "BCA2" means the Canada Business Corporations Act, R.S., 1985, c. C-44, as amended from time to time;

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

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

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

(k) "depreciable property" has the meaning assigned by subsection 13(21);

(l) "Effective Date" means the date the Arrangement was effective under the BCA1;

(m) "foreign affiliate" has the meaning assigned by subsection 95(1);

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

(o) "Parent" means XXXXXXXXXX;

(p) "Proposed Transactions" means the transaction described in paragraph 14 below;

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

(r) "Subsidiary" means XXXXXXXXXX;

(s) "Subsidiary Affiliates" means the directly-held, wholly-owned foreign affiliates of Subsidiary described in paragraph 5 below; and

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

STATEMENT OF FACTS

Facts Relating to Parent

1. Parent was a public corporation and a taxable Canadian corporation that was resident in Canada. Parent's corporate head office was located at XXXXXXXXXX. Parent was incorporated under the BCA2, had a taxation year-end of XXXXXXXXXX and filed its annual federal tax return with the XXXXXXXXXX Taxation Centre. Parent's business number was XXXXXXXXXX.

2. Parent was a Canadian-based XXXXXXXXXX company engaged in the XXXXXXXXXX. Parent's issued shares comprised approximately XXXXXXXXXX common shares which were listed on the XXXXXXXXXX Stock Exchange and its depository receipts were issued on the XXXXXXXXXX. Parent's shares were widely held and actively traded. Prior to his death in XXXXXXXXXX, approximately XXXXXXXXXX of the Parent's shares (just under XXXXXXXXXX%) were held by XXXXXXXXXX and his affiliates. No other person owned shares carrying 10% or more of the voting rights.

Facts Relating to Subsidiary

3. Subsidiary was a public corporation and a taxable Canadian corporation that was resident in Canada. Subsidiary's corporate head office was located at XXXXXXXXXX. Subsidiary was incorporated under the BCA1, had a taxation year-end of XXXXXXXXXX and filed its annual federal tax return with the XXXXXXXXXX Taxation Centre. Subsidiary's business number was XXXXXXXXXX.

4. Subsidiary was a Canadian-based XXXXXXXXXX company engaged in the XXXXXXXXXX. Subsidiary's issued shares comprised approximately XXXXXXXXXX common shares which were listed on the XXXXXXXXXX Stock Exchange and the XXXXXXXXXX Stock Exchange. Subsidiary's shares were widely held and actively traded. No person owned shares carrying 10% or more of the voting rights. Approximately XXXXXXXXXX shares (just under 10%) were held by XXXXXXXXXX.

5. Subsidiary's primary assets were shares in its directly-held, wholly-owned, foreign affiliates ("Subsidiary Affiliates"). The Subsidiary Affiliates are holding companies which, in turn, own shares of wholly-owned XXXXXXXXXX subsidiaries involved in the XXXXXXXXXX. The principal material Subsidiary Affiliate is XXXXXXXXXX, which in turn owns XXXXXXXXXX % of the shares of XXXXXXXXXX.

6. Subsidiary's shares in the Subsidiary Affiliates were capital property of Subsidiary. Subsidiary's shares in the Subsidiary Affiliates were not acquired by Subsidiary in a series of transactions including the Arrangement or the Amalgamation or, in any event, from Parent or a person or partnership with whom Parent did not deal at arm's length and were not substituted for such property.

Facts Relating to Arrangement Agreement

7. Pursuant to the Arrangement Agreement, on XXXXXXXXXX Parent acquired all of Subsidiary's issued and outstanding common shares. The aggregate stated capital and the aggregate paid-up capital of the Subsidiary's common shares was approximately $XXXXXXXXXX.

8. For each of the Subsidiary's common shares, Parent issued XXXXXXXXXX of its common shares and paid $XXXXXXXXXX in cash. As a result, Parent issued approximately XXXXXXXXXX common shares having a fair market value of approximately $XXXXXXXXXX and paid total cash consideration of approximately $XXXXXXXXXX with each of the Subsidiary's registered shareholders being paid the relevant cash consideration amount with any fraction of a penny due being rounded up to the next whole cent.

9. Under subsection 26(2) of the BCA2, Parent added to the stated capital account maintained for its common shares, in respect of Parent common shares issued to Subsidiary shareholders in the Arrangement, an amount equal to the fair market value of the Subsidiary shares received in the Arrangement less the amount of cash consideration paid in the Arrangement.

10. Certain shareholders of the Subsidiary were entitled to file elections under section 85 to defer all or a portion of the gains that were otherwise realized in relation to the disposition of their shares to the Parent. Near the end of the initial filing deadline of XXXXXXXXXX (later extended to the end of XXXXXXXXXX) elections had been filed in respect of less than XXXXXXXXXX% of the common shares of the Subsidiary disposed of to the Parent.

11. Pursuant to subsection 85(2.1), the aggregate paid-up capital of the common shares of the Parent was reduced in respect of agreed amounts elected under subsection 85(1) in respect of particular Subsidiary shares transferred to the Parent where the agreed amount of the particular Subsidiary shares was less than the excess of the fair market value of those shares over the cash consideration paid for them.

12. As a result of the exchange, the former Subsidiary shareholders acquired approximately XXXXXXXXXX% of the Parent's issued and outstanding common shares with the continuing Parent shareholders owning the remaining approximately XXXXXXXXXX% of such shares.

Facts Relating to Amalgamation

13. Soon after XXXXXXXXXX the Subsidiary was continued as a BCA2 corporation and, on XXXXXXXXXX, Parent and Subsidiary amalgamated under section 184 of the BCA2 to form Amalco in such a manner that:

(a) all of the property (except amounts receivable from any predecessor corporation or shares of any predecessor corporation) and liabilities (except amounts payable to any predecessor corporation) of the predecessor corporations immediately before the Amalgamation became property and liabilities of Amalco by virtue of the Amalgamation;

(b) no shares of Amalco were issued on the Amalgamation but all of the shares of Parent immediately before the Amalgamation became shares of Amalco because of the Amalgamation; and

(c) all of the shares of Subsidiary were cancelled on the amalgamation without any payment to the holders thereof.

Immediately before the amalgamation, the aggregate amount determined under subparagraph 88(1)(b)(ii) in respect of the shares of the Subsidiary owned by the Parent exceeded the amounts determined under subparagraph 88(1)(b)(i).

PROPOSED TRANSACTIONS

14. In Amalco's tax return for the first taxation year immediately following the Amalgamation, Amalco will designate, in respect of each of the shares of the Subsidiary Affiliates acquired by it on the Amalgamation (and owned by Subsidiary at the time that Amalco acquired control of Subsidiary), an amount not exceeding the amount permitted by paragraph 88(1)(d).

OTHER INFORMATION

15. Any obligation to pay cash to Subsidiary shareholders under the Arrangement, which became the obligation of Amalco on the Amalgamation, was satisfied with cash other than cash acquired by Amalco from the Subsidiary as a consequence of the Amalgamation.

16. It is contemplated that the following transactions, or substantially similar transactions, will take place in XXXXXXXXXX:

(a) Amalco will transfer shares of the Subsidiary Affiliates to a new XXXXXXXXXX holding company in exchange for shares of the new XXXXXXXXXX holding company. It is intended that this exchange will be tax-deferred under subsection 85.1(3), subject to subsection 85.1(4).

(b) Amalco will then transfer its shares of the new XXXXXXXXXX holding company to XXXXXXXXXX, a wholly-owned subsidiary of Amalco (and formerly a wholly-owned subsidiary of Parent) in exchange for an interest-bearing promissory note (the "XXXXXXXXXX Note") with a principal amount equal to Amalco's tax cost of the shares of the new XXXXXXXXXX company (which would equal Amalco's former tax cost of the shares of the Subsidiary Affiliates). As long as the promissory note does not exceed the adjusted cost base of the transferred shares, it is expected that no gain would be realized for Canadian federal income tax purposes under subsection 85.1(3), subject to subsection 85.1(4).

(c) Amalco will then transfer the newly-issued XXXXXXXXXX note to its XXXXXXXXXX affiliate.

(d) It is expected that interest received by the XXXXXXXXXX affiliate on the XXXXXXXXXX Note would not be foreign accrual property income because of clause 95(2)(a)(ii)(D).

The purpose of the contemplated transactions is to integrate the foreign XXXXXXXXXX operations acquired from the Subsidiary into the Parent's existing operating structure (i.e. make these companies subsidiaries of the Parent's principal foreign holding company, XXXXXXXXXX). In addition, the subsequent transactions described in this paragraph 16 will be structured in a way that permits XXXXXXXXXX to obtain deductions in computing its income for XXXXXXXXXX income tax purposes in respect of interest on the XXXXXXXXXX Note.

PURPOSE OF ARRANGEMENT, AMALGAMATION AND PROPOSED TRANSACTION

17. The purpose of the Arrangement and the Amalgamation was to combine the Parent and the Subsidiary to create a single, new global XXXXXXXXXX company. The combined company is believed to have a market capitalization of approximately Cdn. $XXXXXXXXXX, creating a new, XXXXXXXXXX. In addition, the Amalgamation allows Amalco to obtain the benefit of the step-up in adjusted cost base afforded in connection with the designation referred to in paragraph 14 hereof, pursuant to paragraph 88(1)(d), in relation to the shares of the Subsidiary Affiliates acquired by Amalco on the Amalgamation. The Arrangement and the Amalgamation have the additional benefit of being tax-deferred for certain US shareholders.

RULINGS

Provided that the foregoing statements constitute a complete and accurate disclosure of all the relevant facts, proposed transactions and purposes of the proposed transactions, and provided that the proposed transactions are completed in the manner described above, we confirm the following:

A. Parent's cost of the Subsidiary shares acquired in the Arrangement:

(a) in respect of which valid elections under section 85 of the Act are filed on a timely basis will be equal to the amount determined under subsection 85(1); and

(b) in respect of which no elections under section 85 of the Act are filed will equal the amount added to the stated capital of the common shares of the Parent in respect of the issuance of such shares as consideration for the particular Subsidiary shares plus the amount of the cash consideration paid for the particular Subsidiary shares.

B. The provisions of subsections 87(11) and 88(1) will apply to the Amalgamation such that, for purposes of the Act:

(a) Subject to our comments in the section below headed "Comments" and subject to the provisions of subparagraphs 88(1)(d)(ii) and (iii) and provided that no property acquired by Amalco on the Amalgamation ("Subsidiary Distributed Property"), or "any property acquired by any person in substitution therefor" (within the meaning of the phrase as used in clause 88(1)(c)(vi)(B)) ("Subsidiary Substituted Property"), 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 sections is the Subsidiary and the "parent" is the Parent) as part of a series of transactions or events that includes the transactions described in paragraphs 7 through 13 above, the cost to Amalco of shares of the Subsidiary Affiliates that became 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 the Subsidiary plus such portion of the amount, if any, by which:

(i) the aggregate of the adjusted cost base to the Parent of its shares of the Subsidiary immediately before the Amalgamation

exceeded

(ii) 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 of the Act for its taxation year in which the Amalgamation occurred.

For these purposes, for greater certainty:

(b) the shares of Parent issued to the Subsidiary shareholders in the Arrangement and which became Amalco shares on the Amalgamation will not constitute Subsidiary Substituted Property or Subsidiary Distributed Property; and

(c) the cash paid to the former Subsidiary shareholders by Amalco under the Arrangement, as described in paragraphs 8 and 15 hereof, will not constitute Subsidiary Substituted Property or Subsidiary Distributed Property.

C. The provisions of subsection 245(2) will not be applied as a result of the transactions described in paragraphs 7 through 13 above, in and of themselves, to re-determine the tax consequences referenced above.

The above rulings are given subject to the general limitations and qualifications set forth in Information Circular 70-6R5 issued by the CRA on May 17, 2002 and are binding on the CRA provided that the income tax designation that is referred to in paragraph 14 hereof is made in the manner and within the time referred to in paragraph B(a) of the Rulings above.

The rulings are based on the Act in its present form and, except as expressly otherwise provided, do not take into account the effect of any proposed amendments thereto.

OPINIONS

Provided that proposed subsection 143.3(3) is enacted in substantially the same form as contained in Bill C-33, which received second reading in the House of Commons on May 14, 2007, for the purposes of Ruling A(b) above the Parent's cost of the Subsidiary shares acquired in the Arrangement will be reduced by the amount, if any, by which the fair market value of the Parent's common shares issued as consideration for the particular Subsidiary shares exceeded the aggregate of the amount of the cash consideration paid by the Parent for the particular Subsidiary shares and the fair market value of the particular Subsidiary shares at the time they were acquired by the Parent.

The foregoing opinion is not an advance income tax ruling and, as explained in paragraph 22 of Information Circular 70-6R5 referred to above, is not binding on the Canada Revenue Agency.

COMMENTS

1. Pursuant to paragraph 256(7)(c), an acquisition of control of the Parent will have taken place on the acquisition by the former Subsidiary shareholders of approximately XXXXXXXXXX% of the Parent's issued and outstanding common shares, as described in paragraph 12 above. As well, an acquisition of control of the Subsidiary will have taken place as a result of the acquisition by the Parent of all of the Subsidiary's issued and outstanding common shares, as described in paragraph 7 above.

2. The Minister of Finance released Part 2 of the "Legislative Proposals and Draft Regulations relating to Income Tax" (the "Draft Legislation") on February 27, 2004. The Draft Legislation proposes to add paragraph 88(1)(d.4) to the Act. Proposed paragraph 88(1)(d.4) of the Act applies, in certain circumstances where dividends have been received on the shares of foreign affiliates, to increase the cost amount of such shares for the purpose of subparagraph 88(1)(d)(ii) of the Act. It is proposed that paragraph 88(1)(d.4) will be applicable to amalgamations that occur, and windings-up that begin, after February 27, 2004. Provided that paragraph 88(1)(d.4) is enacted in substantially the same form as proposed in the Draft Legislation, it is our view that paragraph 88(1)(d.4) may apply, for the purpose of computing the cost amount of the shares of the Subsidiary Affiliates, at the time that Parent and Subsidiary amalgamated thereby limiting the amount of any increase in the cost base of the Subsidiary Affiliates' shares that might otherwise occur pursuant to the provisions of paragraph 88(1)(d) of the Act on the amalgamation described in paragraph 13 above.

The Draft Legislation proposes to add subsection 5905(5.1) to the Income Tax Regulations. It is proposed that subsections 5905(5.1) will apply, among other things, to an amalgamation that is described in paragraph 5905(5)(b) of the Regulations, to which subsection 87(11) of the Act applies and, in respect of that amalgamation, an amount has been designated under paragraph 88(1)(d) of the Act in respect of shares of a corporation that is, immediately before the amalgamation, a foreign affiliate of the corporation making such designation. Proposed subsection 5905(5.1) of the Regulations will apply for the purposes of paragraphs 5905(5)(d), (e), (f), (g) and (h) of the Regulations and will be applicable to amalgamations that occur after February 27, 2004. Provided that subsection 5905(5.1) of the Regulations is enacted in substantially the same form as proposed in the Draft Legislation, it is our view that subsection 5905(5.1) of the Regulations will apply in the determination of the surplus accounts of Subsidiary Affiliates in reference to Amalco.

3. Except as expressly stated, our rulings do not imply acceptance, approval or confirmation of any income tax implications of the facts or proposed transactions. In particular, nothing in this letter should be interpreted as confirming, either expressly or implicitly:

i) the reasonableness or deductibility of any expenditures referred to in this letter;

ii) the determination of fair market value or adjusted cost base of any property referred to in this letter;

iii) the determination of the amount to be added to the stated capital of a class of shares issued as consideration for any property;

iv) that a particular transaction or event will not be part of a series of transactions or events; or

v) any other tax consequences of the completed or proposed transactions set forth above or of related transactions or events, or of the transactions or events disclosed under the heading "Other Information".

Yours truly,

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