22 May 2008 External T.I. 2008-0264561E5 - Subsection 89(7) Calculation

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: Calculation of the GRIP for the first taxation year of a CCPC that includes any part of January 1, 2006 where the CCPC paid and received taxable dividends as a consequence of a cross-redemption of shares between the CCPC and a corporation connected with the CCPC in a taxation year ending after 2000 and before 2006.

Position: Although the CCPC paid a taxable dividend on the cross-redemption that exceeded 63% of the full rate taxable income that the CCPC had accumulated in taxation years that ended prior to the cross-redemption, the cross-redemption will have no net effect on the amount determined under subsection 89(7) in respect of the CCPC in these particular circumstances.

Reasons: In the particular circumstances, and given the circular nature of a cross-redemption of shares, it is reasonable to consider that the dividend received by the connected corporation from the CCPC on the cross-redemption is attributable to (i) the after-tax portion of the full rate taxable income that the CCPC accumulated in taxation years prior to the cross-redemption and (ii) the amount that the connected corporation includes its subsection 89(7) computation in respect of the dividend that the CCPC paid to the connected corporation on the cross-redemption. This increases the amount that the connected corporation can add in its subsection 89(7) computation in respect of the dividend it was deemed to receive from the CCPC on the cross-redemption, which gives rise to a corresponding increase in the amount that the CCPC can include in its subsection 89(7) computation in respect of the dividend it was deemed to receive from the connected corporation on the cross-redemption.

									2008-026456
XXXXXXXXXX 								J. MacGillivray
(613) 957-2053
May 22, 2008

Dear Sir:

Re: Subsection 89(7) and Cross-Redemption of Shares

We are writing in response to your e-mail of January 8, 2008, in which you requested guidance with respect to the application of subsection 89(7) for the purposes of calculating the "general rate income pool" ("GRIP") of a "Canadian-controlled private corporation" ("CCPC"), as those terms are defined pursuant to subsections 89(1) and 125(7) of the Income Tax Act (Canada) (the "Act"), respectively.

You have asked us to consider the following situation:

Opco was a CCPC that held certain real property prior to the transactions described below. In a taxation year of Opco that commenced after 2000 and ended before 2006, the shareholders of Opco desired to transfer the real property to a taxable Canadian corporation related to Opco ("Holdco"). Holdco was also a CCPC. Opco and Holdco were connected with each other at all material times.

The fair market value of the real property was $2,000,000. To transfer the real property, the shareholders of Opco transferred a portion of their shares of Opco having a fair market value of $2,000,000 to Holdco in exchange for shares of Holdco. Opco then transferred the real property to Holdco in exchange for preferred shares of Holdco having a fair market value of $2,000,000.

The shares of Opco held by Holdco and the preferred shares of Holdco were then redeemed. Opco was deemed by subsection 84(3) to have paid a taxable dividend of $2,000,000 on the redemption of the shares held by Holdco and Holdco was deemed by subsection 84(3) to have paid a taxable dividend of $2,000,000 to Opco on the redemption of its preferred shares. It is assumed that paragraph 55(3)(a) was applicable to these taxable dividends such that the dividends were not recharacterized as capital gains pursuant to subsection 55(2). Accordingly, the taxable dividends were deductible in computing the respective taxable incomes of Opco and Holdco pursuant to subsection 112(1).

Opco had "full rate taxable income", as defined pursuant to section 123.4, for its taxation years that ended after 2000 and before 2006. Taking into account only the full rate taxable income of Opco for taxation years that ended prior to the share redemptions, the total amount determined under paragraphs (a) and (b) of the value for "A" in subsection 89(7) was $1,000,000. Holdco did not earn any full rate taxable income in its taxation years that ended prior to the redemptions. Opco and Holdco did not pay any taxable dividends during the period other than the taxable dividends that they were deemed to pay on the share redemptions.

You have asked us to consider the computation of the amount that may be added to the GRIP of both Opco and Holdco pursuant to subsection 89(7) in light of the cross-redemption of shares described above. You have asked us to assume that the redemption of the shares of Opco held by Holdco took place before the redemption of the preferred shares of Holdco. You then ask whether the computation would lead to a different result if the order of the redemptions is reversed.

Our Comments

Written confirmation of the tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R5, Advance Income Tax Rulings, dated May 17, 2002. Where the particular transactions are completed, the inquiry should be addressed to the relevant tax services office. The following comments are, therefore, of a general nature only and are not binding on the Canada Revenue Agency.

In computing the GRIP of a corporation that was a CCPC throughout its first taxation year that includes any part of January 1, 2006, the corporation's GRIP at the end of its immediately preceding taxation year is deemed to be the greater of nil and the amount determined by the formula 'A-B' in subsection 89(7). The value for 'A' in the formula is the total of the amounts described in paragraphs (a), (b) and (c). In general terms, the amounts described in paragraphs (a) and (b) of the value for "A" will reflect 63% of the total of the corporation's "full rate taxable income" for each taxation year of the corporation ending after 2000 and before 2006, with certain modifications depending on the taxation year in question, determined before taking into consideration the specified future income tax consequences for the year.

The amount determined under paragraph (c) is the total of all amounts each of which is deductible under subsection 112(1) in computing the corporation's taxable income in respect of taxable dividends received from another corporation connected with the corporation (the "payer corporation"), to the extent that it is reasonable to consider, having regard to all the circumstances, that the dividend was attributable to an amount that is, or would be if subsection 89(7) applied to the payer corporation, described in paragraphs (a), (b) or (c) of the value for "A" in respect of the payer corporation.

The value for "B" in the formula is equal to the total of all amounts each of which is a taxable dividend paid by the corporation in taxation years that end after 2000 and before 2006.

In the situation you described, it is assumed that 63% of Opco's full rate taxable income for taxation years ending before the share redemptions is equal to $1,000,000. If one then assumes that $1,000,000 of the $2,000,000 taxable dividend that Opco is deemed to pay Holdco is attributable to that portion (i.e., the after-tax portion) of Opco's accumulated full rate taxable income, and that $1,000,000 of the $2,000,000 taxable dividend that Holdco is deemed to pay to Opco is attributable to the after-tax portion of Opco's accumulated full rate taxable income, then the following amounts could be computed under subsection 89(7) in respect of Opco and Holdco:

Subsection 89(7) Computation:		Opco				Holdco

	A:   Paragraphs (a) and (b)	$1,000,000			nil

    	    Paragraph (c)			$1,000,000			$1,000,000

	B:					$(2,000,000)		$(2,000,000)

			Result:		nil				nil

If the cross-redemption of shares were to give rise to this result, it is clear that the full rate taxable income of Opco for taxation years ending prior to the redemptions could not be factored into the computation of the GRIP for Opco or Holdco. However, given the circular nature of a cross-redemption of shares and the assumption that neither corporation paid other taxable dividends in the relevant taxation years, it is our view that the taxable dividend paid by Opco to Holdco would be attributable to the after-tax portion of the full rate taxable income that Opco accumulated in taxation years ending before the share redemptions (i.e., Opco's pre-existing paragraph (a) and (b) amounts of $1,000,000) and to the $1,000,000 included in the computation of Opco's paragraph (c) amount. Consequently, in these circumstances, the amount that Holdco could include in its paragraph (c) computation would reflect the aggregate of Opco's pre-existing paragraph (a) and (b) amounts ($1,000,000) and the amount that Opco could include under paragraph (c) in respect of the dividend it was deemed to receive from Holdco ($1,000,000). This will result in an increase to the amount determined under Opco's paragraph (c) computation (i.e., from $1,000,000 to $2,000,000), which will give rise to an increase in the amount that Holdco may include in its paragraph (c) computation

(i.e., from $1,000,000 to $2,000,000), yielding the following result:

Subsection 89(7) Computation:		Opco				Holdco

	A:   Paragraphs (a) and (b)	$1,000,000			nil

    	    Paragraph (c)		  	2,000,000			2,000,000

	B:				 	(2,000,000)			(2,000,000)

			Result:		 $1,000,000			nil

In our view, the same result would arise in these circumstances if the ordering of the share redemptions was reversed.

Our comments are provided in accordance with the practice outlined in paragraph 22 of Information Circular IC 70-6R5, dated May 17, 2002.

David Palamar
Manager
Corporate Reorganizations Section II
Reorganizations and Resources Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch