2 April 2007 Internal T.I. 2007-0225221I7 - Foreign Spin-off & Foreign Merger

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. Whether the spin-off of Parent's XXXXXXXXXX business qualifies as an "eligible distribution" within the meaning thereof in subsection 86.1(2) of the Act.

2. Whether the subsequent merger of Subco with and into Amalco's XXXXXXXXXX business qualifies as a "foreign merger" within the meaning thereof in subsection 87(8.1) of the Act.

Position: 1. Yes 2. Yes

Reasons: 1. Satisfies all of the requirements of subsection 86.1(2) of the Act.

2. Satisfies all of the requirements of subsection 87(8.1) of the Act.

									April 2, 2007

Sylvie Chenette							HEADQUARTERS
Auditor								A. Seidel, CMA
International Tax							(613) 957-2058
Québec Taxation Services Office
									2007-022522

XXXXXXXXXX

We are writing in response to your February 19, 2007 e-mail in which you requested our comments as to whether the shares of XXXXXXXXXX ("Subco"), that were distributed to the shareholders (the "Shareholders") of XXXXXXXXXX ("Parent") as part of the series of transactions that resulted in the re-structuring of Parent, were an "eligible distribution" within the meaning thereof in subsection 86.1(2) of the Income Tax Act (the "Act") and whether the subsequent amalgamation of Subco with XXXXXXXXXX. ("Newco") to form XXXXXXXXXX ("Amalco") qualifies as a "foreign merger" within the meaning thereof in subsection 87(8.1) of the Act.

Background

1. Parent is a corporation that is, and has always been, a resident of the United States. Prior to the split-off of its XXXXXXXXXX business, Parent provided XXXXXXXXXX services in the United States. Some of Parent's XXXXXXXXXX business was carried on by various wholly-owned subsidiaries. Parent's shares were widely held and actively traded on the XXXXXXXXXX Stock Exchange (the "Exchange") immediately before the split-up of the XXXXXXXXXX businesses of Parent.

2. Newco was a corporation that was a resident of the United States prior to its merger with Subco. Newco's shares were widely held and actively traded on the Exchange prior to its merger with Subco. XXXXXXXXXX.

3. Subco was incorporated as a XXXXXXXXXX corporation on XXXXXXXXXX for the purpose of holding Parent's XXXXXXXXXX business. Subco was a corporation that was a resident of the United States from the time of its incorporation to the time of its merger with and into Newco. Parent transferred all of its assets, including the shares of its subsidiaries, relating to its XXXXXXXXXX business to Subco. Subco issued notes payable and additional shares to Parent as consideration for the assets transferred to it by Parent.

4. On XXXXXXXXXX, Parent distributed all of the common shares of Subco to a third-party exchange agent, to be held for the benefit of Parent's current stockholders, in a ratio of one share of Subco for each share of Parent held by a shareholder of record on XXXXXXXXXX. As a result of this distribution, the shareholders of Parent also became the beneficial shareholders of Subco.

5. Subsequent to the distribution of its common shares by Parent, but also on XXXXXXXXXX, Subco merged with and into Newco. As a result of the merger of Subco with and into Newco, all or substantially all of the property (except amounts receivable from Subco and Newco or shares of the capital stock of Subco or Newco) of Subco and Newco immediately before the merger became property of Newco as a consequence of the merger and all or substantially all the liabilities (except amounts payable to Subco and Newco) of Subco and Newco immediately before the merger became liabilities of Newco as a consequence of the merger. All of the shareholders of Newco immediately before the merger continued to be shareholders of Newco after the merger. All of the shares of Subco held by the exchange agent immediately before the merger were converted into that number of shares of Newco common stock that the Subco stockholders were entitled to receive pursuant to the merger agreement. The exchange agent issued shares of Newco to the former shareholders of Subco in accordance with the terms of the merger agreement such that all of the shareholders of Subco before the merger became shareholders of Amalco as a result of the merger. Newco changed its name to Amalco. The shares of Amalco commenced trading on the Exchange immediately after the merger of Subco and Newco.

6. The spin-off of Subco to the shareholders of Parent qualified as a tax-free transaction to the shareholders of Parent under Section 355 of the Internal Revenue Code (the "Code") and the merger of Subco and Newco constituted a tax-free reorganization to the shareholders of Subco and Newco under Section 368(a) of the Code.

Issue

Subsection 86.1(1) of the Act

Does Parent's transfer of the shares of Subco to the third party exchange agent qualify as an eligible distribution within the meaning thereof in subsection 86.1(2) of the Act?

Subsections 87(8) and (8.1) of the Act

Does the merger of Subco with and into Newco qualify as a foreign merger within the meaning thereof in subsection 87(8.1) of the Act?

Legislation

Subsection 86.1(1) of the Act currently excludes from a taxpayer's income any amount received as an "eligible distribution". Paragraph 86.1(2)(c) of the Act provides, among other things, that a distribution by a particular corporation is an eligible distribution where the following conditions are satisfied:

(i) at the time of the distribution, both corporations are resident in the United States and were never resident in Canada,

(ii) at the time of the distribution, the shares of the particular corporation, of the class that includes the original shares, are widely held and actively traded on a prescribed stock exchange in the United States, and

(iii) under the United States Internal Revenue Code applicable to the distribution, the shareholders of the particular corporation who are resident in the United States are not taxable in respect of the distribution.

The Department of Finance has proposed amendments to subparagraphs 86.1(2)(c)(ii) and (iii), applicable to distributions made after 1999, as follows:

"(ii) at the time of the distribution, the shares of the class that includes the original shares are widely held and

(A) are actively traded on a prescribed stock exchange in the United States, or

(B) are required, under the Securities Exchange Act of 1934 of the United States, as amended from time to time, to be registered with the Securities and Exchange Commission of the United States and are so registered, and

(iii) under the provisions of the Internal Revenue Code of 1986 of the United States, as amended from time to time, that apply to the distribution, the shareholders of the particular corporation who are resident in the United States are not taxable in respect of the distribution."

Subsection 87(8) of the Act provides that "subject to subsection 95(2), where there has been a foreign merger in which a taxpayer's shares or options to acquire shares of the capital stock of a corporation that was a predecessor foreign corporation immediately before the merger were exchanged for or became shares or options to acquire shares of the capital stock of the new foreign corporation or the foreign parent corporation, unless the taxpayer elects in the taxpayer's return of income for the taxation year in which the foreign merger took place not to have this subsection apply, subsections (4) and (5) apply to the taxpayer ..."

"Foreign merger" is defined in subsection 87(8.1) of the Act as "a merger or combination of two or more corporations each of which was, immediately before the merger or combination, resident in a country other than Canada (each of which is in this section referred to as a "predecessor foreign corporation") to form one corporate entity resident in a country other than Canada (in this section referred to as the "new foreign corporation") in such a manner that, and otherwise than as a result of the distribution of property to one corporation on the winding-up of another corporation,

(a) all or substantially all the property (except amounts receivable from any predecessor foreign corporation or shares of the capital stock of any predecessor foreign corporation) of the predecessor foreign corporations immediately before the merger or combination becomes property of the new foreign corporation as a consequence of the merger or combination;

(b) all or substantially all the liabilities (except amounts payable to any predecessor foreign corporation) of the predecessor foreign corporations immediately before the merger or combination become liabilities of the new foreign corporation as a consequence of the merger or combination; and

(c) all or substantially all of the shares of the capital stock of the predecessor foreign corporations (except any shares or options owned by any predecessor foreign corporation) are exchanged for or become, because of the merger or combination,

(i) shares of the capital stock of the new foreign corporation, or

(ii) if, immediately after the merger, the new foreign corporation was controlled by another corporation (in this section referred to as the "foreign parent corporation") that was resident in a country other than Canada, shares of the capital stock of the foreign parent corporation".

Our Comments

Subsection 86.1(1) of the Act

To qualify as an "eligible distribution", a distribution must, amongst other things, satisfy the requirements of paragraph 86.1(2)(c) of the Act. Parent's distribution of its shares of Subco to the third-party exchange agent would therefore qualify as an eligible distribution where, at the time of the distribution, Parent and Subco are both resident in the United States and were never resident in Canada, the shares of the class that includes the original shares of Parent are widely held and actively traded on a prescribed stock exchange in the United States and, under the Code, the shareholders of Parent who are resident in the United States are not taxable in respect of the distribution.

It is our view that each of these conditions in paragraph 86.1(2)(c) of the Act is satisfied at the time that Parent distributes its shares of Subco. Firstly, although Parent transferred legal title of the shares of Subco to the third-party exchange agent, Parent transferred beneficial ownership of the shares of Subco to its shareholders at the time of the distribution. Secondly, Parent and Subco were both resident in the United States at the time of the distribution of Parent's shares of Subco to the third-party exchange agent. Thirdly, Parent and Subco were never resident in Canada prior to the distribution of Parent's shares of Subco to the third-party exchange agent. Fourthly, Parent's shares were widely held and actively traded on the Exchange immediately prior to the distribution of its shares of Subco to the third-party exchange agent. Finally, the shareholders of Parent who are resident in the United States were not taxable in respect of Parent's distribution of its Subco shares to them by virtue of Section 355 of the Code.

The requirements of the proposed amendments to subparagraphs 86.1(2)(c)(ii) and (iii) of the Act, which would be applicable to Parent's distribution of the Subco shares to the third-party exchange agent, would also be satisfied. Parent's shares were widely held and actively traded on the Exchange immediately prior to the distribution of its shares of Subco to the third-party exchange agent, as required by proposed clause 86.1(2)(c)(ii)(A), and the shareholders of Parent who are resident in the United States were not taxable in respect of Parent's distribution, of the Subco shares, to them by virtue of Section 355 of the Code, as required by proposed subparagraph 86.1(2)(c)(iii).

Subsections 87(8) and (8.1) of the Act

Subsection 87(4) of the Act applies where there has been an amalgamation of two or more corporations and where each shareholder of the predecessor corporations, who owned shares of a predecessor corporation as capital property, received only share consideration from the new corporation upon the amalgamation. Subsection 87(8) of the Act provides that subsection 87(4) of the Act applies to a foreign merger, as defined in subsection 87(8.1) of the Act, unless the taxpayer elects not to have subsection 87(8) of the Act apply to the share(s) received upon the amalgamation.

The merger of Subco with and into Newco is a merger of two or more corporations, each of which was immediately before the merger resident in the United States, which results in the formation of one corporate entity resident in the United States, Amalco. Furthermore, all or substantially all the property (except amounts receivable from Subco and Newco or shares of the capital stock of Subco or Newco) of Subco and Newco immediately before the merger became property of Amalco as a consequence of the merger, all or substantially all of the liabilities (except amounts payable to Subco or Newco) of Subco and Newco immediately before the merger became liabilities of Amalco as a consequence of the merger and all or substantially all of the shares of the capital stock of Subco were exchanged, because of the merger, for shares of the capital stock of Amalco.

Conclusion

It is our view that Parent's distribution of the beneficial ownership of the Subco shares to its shareholders qualifies as an "eligible distribution" within the meaning thereof in subsection 86.1(2) of the Act. Our conclusion is equally applicable to Parent's distribution of the Subco shares to the shareholders of Parent if subparagraphs 86.1(2)(c)(ii) and (iii) of the Act are amended as proposed in the July 18, 2005 draft legislation. It is also our view that the merger of Subco with and into Newco qualifies as a "foreign merger" within the meaning thereof in subsection 87(8.1) of the Act.

We hope that our comments are of assistance. If you wish to discuss any of the above, please contact the writer.

For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Customs and Revenue Agency's electronic library. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, they can be provided with the electronic library version, or they may request a copy severed using the Privacy Act criteria which does not remove client identity. Requests for this latter version should be made by you to Mrs. Jackie Page at (819) 994-2898. A copy will be sent to you for delivery to the client.

Olli Laurikainen, CA
for Director
International & Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch