2008 Ruling 2008-0290361R3 - Foreign divisive reorganization

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) What are the proceeds of disposition to the distributing corporation of the property disposed of in the course of the reorganization? 2) What is the cost of the property acquired by the transferee corporations? 3) What is the cost to the shareholders of the distributing corporation of the shares of the transferee corporations acquired in the course of the reorganization? 4) Does the proposed reorganization result in benefits under subsection 15(1), 56(2) or 246(1)?

Position: 1) For the purposes of section 5907 of the Regulations, the proceeds of disposition of a property that is described in subsection 5907(5.1) of the Regulations will be equal to the aggregate of its adjusted cost base to the distributing corporation and any outlays incurred to make the disposition; 2) For the purposes of section 5907 of the Regulations, the cost to the transferee corporations of a property described in subsection 5907(5.1) of the Regulations will be an amount equal to the distributing corporation's proceeds of disposition; 3) Fair market value of the shares acquired; 4) No

Reasons: 1) Paragraph 5907(5.1)(a) of the Regulations; 2) Paragraph 5907(5.1)(b) of the Regulations; 3) General principles of cost determination; 4) Conditions precedent to the application of subsections 15(1), 56(2) and 246(1) are not met

XXXXXXXXXX 								2008-029036

XXXXXXXXXX , 2008

Dear XXXXXXXXXX :

Re: XXXXXXXXXX
Business Number: XXXXXXXXXX
Advance Income Tax Ruling Request

We are writing in response to your request dated XXXXXXXXXX for an advance income tax ruling on behalf of the above-noted taxpayer.

To the best of your knowledge and that of the taxpayer, none of the issues involved in this request for an advance income tax ruling is:

(i) dealt with in an earlier return of the taxpayer or a related person;
(ii) being considered by any tax services office or taxation centre in connection with a tax return previously filed by the taxpayer or a related person;
(iii) under objection by the taxpayer or by a related person;
(iv) the subject of a previously issued ruling by the Income Tax Rulings Directorate; or
(v) before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has expired.

The rulings and opinions provided herein are 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.

The following terms have the meanings specified below:

(a) "Act" means the Income Tax Act, R.S.C. 1985 (5th supp.), c. 1, as amended, and unless otherwise stated, all statutory references herein are to the Act;

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

(c) "capital property" has the meaning assigned by section 54 of the Act;

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

(e) "corporation" has the meaning assigned by subsection 248(1) of the Act;

(f) "Division" means the divisive reorganization described in paragraphs 7 and 8;

(g) "earnings" has the meaning assigned by subsection 5907(1) of the Regulations;

(h) "excluded property" has the meaning assigned by subsection 95(1) of the Act;

(i) "FA1" means XXXXXXXXXX .;

(j) "FA2" means XXXXXXXXXX .;

(k) "First Transferee Corporation" means the corporation incorporated under the laws of the Foreign Country to acquire the Low Return Real Estate Assets;

(l) "foreign accrual property income" (referred to herein as "FAPI") has the meaning assigned by subsection 95(1) of the Act;

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

(n) "Foreign Country" means XXXXXXXXXX ;

(o) XXXXXXXXXX

(p) "High Return Real Estate Assets" has the meaning given in paragraph 5;

(q) "Low Return Real Estate Assets" has the meaning given in paragraph 5;

(r) "Parentco" means XXXXXXXXXX ;

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

(t) "Regulations" means the Income Tax Regulations, C.R.C. 1977, c. 945, as amended;

(u) "Second Transferee Corporation" means the corporation incorporated under the laws of the Foreign Country to acquire the High Return Real Estate Assets;

(v) "Specified Real Estate Assets" has the meaning given in paragraph 5; and

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

Our understanding of the facts, proposed transactions and the purposes of the proposed transactions is as follows.

Facts

1. Parentco is a taxable Canadian corporation and a public corporation. Parentco carries on the business of XXXXXXXXXX Parentco carries on its business in Canada and outside Canada directly and through affiliated corporations. The shares of Parentco trade on the XXXXXXXXXX Stock Exchange.

2. Parentco is headquartered in XXXXXXXXXX . It has a XXXXXXXXXX taxation year end.

3. FA1 is a limited liability company incorporated under the laws of the Foreign Country. FA1 is a resident of the Foreign Country under common law and under the residency principles of the Foreign Country's tax laws. Parentco directly owns XXXXXXXXXX % of the outstanding shares of FA1 while the remaining XXXXXXXXXX % is owned indirectly by Parentco through a wholly-owned Canadian subsidiary.

4. FA2 is a corporation (XXXXXXXXXX ), incorporated under the laws of the Foreign Country. FA2 is a resident of the Foreign Country under common law and under the residency principles of the Foreign Country's tax laws. FA1 owns XXXXXXXXXX % of the outstanding shares of the capital stock of FA2, while the remaining XXXXXXXXXX % is owned by Parentco. FA2 is a controlled foreign affiliate of Parentco and is engaged in an active business that includes the XXXXXXXXXX The shares of FA2 are capital property to FA1 and Parentco.

5. FA2 owns real estate located in the Foreign Country (the "Specified Real Estate Assets"). The Specified Real Estate Assets are capital property to FA2 and all or substantially all of the Specified Real Estate Assets are being used or held principally for the purpose of gaining or producing income from the active business carried on by FA2. The Specified Real Estate Assets are categorized into two groups: the "Low Return Real Estate Assets" (where the return on Foreign Country tax book value is less than XXXXXXXXXX %) and the "High Return Real Estate Assets" (where the return on Foreign Country tax book value exceeds XXXXXXXXXX %).

6. All or substantially all of the property (by fair market value) of FA2 (including the Specified Real Estate Assets) is excluded property.

Proposed Transactions

7. FA2 will undergo a divisive reorganization (referred to hereafter as the "Division") under the laws of the Foreign Country.

8. In accordance with the provisions of FA2's governing corporate and commercial laws, its shareholders (FA1 and Parentco) will adopt, publish and file such resolutions and other legal acts or instruments as may be necessary or appropriate to effect the Division, with the result that:

(a) Two new corporations will be created under, and governed by, the laws of the Foreign Country as limited liability corporations (referred to hereafter as the "First Transferee Corporation" and the "Second Transferee Corporation").

(b) The Low Return Real Estate Assets of FA2 will be transferred by operation of law to the First Transferee Corporation and certain specified liabilities of FA2 will be assumed by the First Transferee Corporation. The amount of the liabilities assumed by the First Transferee Corporation will be less than the fair market value of the Low Return Real Estate Assets.

(c) The High Return Real Estate Assets of FA2 will be transferred by operation of law to the Second Transferee Corporation and certain specified liabilities of FA2 will be assumed by the Second Transferee Corporation. The amount of the liabilities assumed by the Second Transferee Corporation will be less than the fair market value of the High Return Real Estate Assets.

(d) Shares of the First and Second Transferee Corporations will be issued to FA1 (XXXXXXXXXX %) and Parentco (XXXXXXXXXX %) in proportion to their shareholdings of FA2.

(e) The capital attributable to the FA2 shares will be reduced. The amount of the reduction will be determined by multiplying the capital of FA2 (immediately before the Division) by an amount determined by dividing the net tax book value of the assets (as determined in the Foreign Country) transferred to the First and Second Transferee Corporations by the total net tax book value of all FA2's assets (as determined in the Foreign Country). An amount equal to the reduction in the capital attributable to the FA2 shares will be added to the capital of the shares of the First and Second Transferee Corporations in proportion to the net tax value of the assets transferred to each of these corporations.

9. The shares of the First and Second Transferee Corporations issued to FA1 and Parentco will have a fair market value equal to the amount by which the fair market value of the property transferred to each of the First and Second Transferee Corporations exceeds the liabilities assumed by each corporation. The total fair market value of the shares of the First and Second Transferee Corporations at the time the shares are issued will be approximately equal to the amount by which the fair market value of the shares of FA2 is diminished by the Division. No shares of FA2 will be redeemed, acquired or cancelled on the Division and neither Parentco nor FA1 will receive any property from FA2 on the Division.

10. The retained taxable earnings and non-taxable earnings of FA2 (as determined under the law of the Foreign Country immediately before the Division) will be reduced and attributed to the First and Second Transferee Corporations in the same proportion as the capital of FA2.

11. For Foreign Country income tax purposes, as well as Foreign Country VAT purposes:

(a) the Division will not trigger any income, gains or losses;

(b) the tax basis of the property acquired by the First and Second Transferee Corporations will be equal to the tax basis of the property to FA2 immediately before the Division; and

(c) the tax basis of the property retained by FA2 will not be affected.

12. The First and Second Transferee Corporations will be residents of the Foreign Country under common law and under the residency principles of the Foreign Country's tax laws.

13. Parentco will not make any election under subsection 93(1) of the Act in respect of any gain it may be deemed to have realized as a result of the proposed transactions.

Purposes of the Proposed Transactions

14. The purposes of the proposed transactions are to create a corporate structure in the Foreign Country

(a) which benefits from tax savings in the Foreign country through the lower effective tax rate available for real estate income earned by a dedicated real estate company (in the case of the Low Return Real Estate Assets to be transferred to the First Transferee Corporation); and

(b) which separates the Specified Real Estate Assets from the other operating assets of FA2.

Rulings Given

Provided that the preceding 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, and there are no other transactions which may be relevant to the rulings requested, our rulings are as follows:

A. For the purposes of section 5907 of the Regulations:

(a) The proceeds of disposition to FA2 of the Specified Real Estate Assets described in subsection 5907(5.1) of the Regulations will, in respect of each such asset, be deemed by paragraph (a) of that subsection to be an amount equal to the aggregate of the adjusted cost base to FA2 of the asset immediately before the Division and any outlays and expenses made or incurred by FA2 for the purpose of disposing of the asset;

(b) the cost to the First Transferee Corporation of the Low Return Real Estate Assets described in subsection 5907(5.1) of the Regulations will, in respect of each such asset, be deemed by paragraph (b) of that subsection to be an amount equal to the proceeds of disposition of the asset to FA2, as determined under paragraph (a) of that subsection;

(c) the cost to the Second Transferee Corporation of the High Return Real Estate Assets described in subsection 5907(5.1) of the Regulations will, in respect of each such asset, be deemed by paragraph (b) of that subsection to be an amount equal to the proceeds of disposition of the asset to FA2, as determined under paragraph (a) of that subsection; and

(d) the First and Second Transferee Corporations will be deemed to have acquired each asset described in paragraphs (b) and (c) on the date that it was acquired by FA2.

B. Except as provided in Ruling A:

(a) The proceeds of disposition to FA2 of each of the Specified Real Estate Assets transferred to the First or Second Transferee Corporations will be equal to its fair market value at the time of the Division;

(b) the cost to the First Transferee Corporation of each of the Low Return Real Estate Assets will be equal to its fair market value at the time of the Division; and

(c) the cost to the Second Transferee Corporation of each of the High Return Real Estate Assets will be equal to its fair market value at the time of the Division.

C. The proposed transactions will not give rise to FAPI to FA2 except to the extent that FA2 realizes a taxable capital gain from the disposition of a property that is not an excluded property of FA2.

D. Subparagraph 53(2)(b)(ii) of the Act will apply, at the time the shares of the First and Second Transferee Corporations are received by FA1 and Parentco, to reduce the adjusted cost base of the FA2 shares to FA1 and Parentco, by an amount equal to the fair market value, at that time, of the shares of the First and Second Transferee Corporations received by them on the Division.

E. If the reduction in the adjusted cost base to FA1 of the FA2 shares owned by FA1 (referred to in Ruling D) causes there to be an excess, as described in subsection 40(3) of the Act, and the shares of FA2 are excluded property of FA1 at the time the excess arises,

(a) subsections 40(3), 93(1) and 93(1.1) of the Act and the relevant Regulations will cause the amount, as is prescribed under Regulation 5902(6), to be treated as a dividend received by FA1 from FA2 immediately before that time; and

(b) the amount of the excess that is not treated as a dividend will be deemed to be a gain of FA1 from the disposition of the FA2 shares owned by FA1 at that time and no portion of the gain will be included in the FAPI of FA2.

F. If the reduction in the adjusted cost base of the FA2 shares owned by Parentco, (referred to in Ruling D) causes there to be an excess, as described in subsection 40(3) of the Act, the amount of the excess will be deemed to be a gain of Parentco from the disposition of the FA2 shares at the time the excess arises.

G. The cost to FA1 and Parentco of the shares of the First and Second Transferee Corporations issued to each corporation will be equal to the fair market value of those shares at the time such shares are issued.

H. Subsections 15(1), 56(2) and 246(1) of the Act will not apply to the proposed transactions.

I. Subsection 245(2) of the Act will not apply, as a result of the proposed transactions, in and by themselves, to redetermine the tax consequences described in the Rulings given above.

Opinions

Provided that the draft amendments to the Act and the Regulations that were released by the Minister of Finance on February 27, 2004 ("Draft Legislation") are, in respect of the proposed amendment to paragraph 95(2)(e.1), the proposed addition of paragraphs 95(2)(e.2) to (e.5) and 95(2)(f.3) to (f.9), and the proposed repeal of subsection 5907(5.1) of the Regulations, enacted in substantially the same form as proposed in the Draft Legislation, or in the case of subsection 5907(5.1) of the Regulations, repealed in respect of dispositions to which paragraphs 95(2)(f.3) to (f.9) of the Act apply, our opinions are as follows:

1. Where paragraph 95(2)(f.4) applies to FA2 in respect of a particular disposition of an asset that is a Specified Real Estate Asset, FA2 will, provided that Parentco does not elect under clause 95(2)(f.4)(i)(B), be deemed by clause 95(2)(f.4)(i)(A), to have disposed of the asset for proceeds of disposition equal to its adjusted cost base to FA2 at the time of the disposition.

2. Pursuant to subparagraph 95(2)(f.4))(ii):

(a) the cost to the First Transferee Corporation of each of the Low Return Real Estate Assets that is a specified property referred to in paragraph 95(2)(f.3) will be deemed to be equal to its fair market value at the time the asset is disposed of by FA2 to the First Transferee Corporation; and

(b) the cost to the Second Transferee Corporation of each of the High Return Real Estate Assets that is a specified property referred to in paragraph 95(2)(f.3) will be deemed to be equal to its fair market value at the time the asset is disposed of by FA2 to the Second Transferee Corporation.

3. Where paragraph 95(2)(f.4) applies to FA2 in respect of a particular disposition of an asset that is a Specified Real Estate Asset:

(a) FA2 will be deemed to have an unadjusted suspended gain in respect of the asset, at the time of the disposition, equal to the amount determined in subparagraph 95(2)(f.4)(iv); and

(b) FA2 will be deemed to have a capital gain (equal to the amount prescribed to be its adjusted suspended gain) from the disposition of the asset at the earlier of the times specified by paragraph 95(2)(f.5).

4. Where paragraph 95(2)(f.4) of the Act applies to FA2 in respect of a particular disposition of an asset that is a Specified Real Estate Asset, such disposition will not, provided that Parentco does not elect under clause 95(2)(f.4)(i)(B), give rise to FAPI to FA2.

5. Where paragraph 95(2)(f.4) of the Act does not apply to FA2 in respect of a particular disposition of an asset that is a Specified Real Estate Asset, any taxable capital gain realized by FA2 on the disposition of the asset will give rise to FAPI to FA2.

6. The Draft Legislation, as it applies to the proposed amendment to paragraph 95(2)(e.1) and the proposed addition of paragraphs 95(2)(e.2) to (e.5) and 95(2)(f.3) to (f.9), will not affect the Rulings given in D, E and F above.

These rulings are given subject to the limitations and qualifications set forth in Information Circular 70-6R5 issued on May 17, 2002, and are binding on the Canada Revenue Agency provided that the proposed transactions are completed before XXXXXXXXXX .

The above rulings are based on the Act in its present form and do not take into account any proposed amendments to the Act, which, if enacted, could affect the rulings provided herein.

Caveat

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

(a) whether any particular corporation described in this ruling is a foreign affiliate of Parentco;

(b) whether any property described in the facts or the proposed transactions is excluded property of any person; or

(c) any tax consequences relating to the facts and the proposed transactions described herein other than those specifically described in the Rulings and Opinions given above.

Yours truly,

for Director
International and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch