29 April 2009 External T.I. 2009-0311331E5 - Substituted Property - Paragraph 88(1)(c.3)

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 proposed subparagraph 88(1)(c.3)(vii) would apply in a particular fact situation.

Position: Yes. Proposed subparagraph 88(1)(c.3)(vii) would apply on the assumption that the amendments to paragraph 88(1)(c.3), particularly the introduction of proposed subparagraph 88(1)(c.3)(vii), are reintroduced and enacted into law in substantially the same form as proposed in Bill C-10.

Reasons: Wording of the proposed amendment and previous position.

								2009-031133
XXXXXXXXXX 							G. Gladu
(613) 946-5344
April 29, 2009

Dear XXXXXXXXXX :

Re: Technical Interpretation Request - Substituted Property
Paragraph 88(1)(c.3) of the Income Tax Act (the "Act")

We are writing in response to your letter dated February 19, 2009 in which you request our views regarding the potential application of paragraph 88(1)(c.3) of the Act in respect of the "Balance Due" that would result from the transaction described below in 1)f).

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 as set out in Information Circular 70-6R5 dated May 17, 2002. Where the particular transactions are completed, the inquiry should be addressed to the relevant tax services office. Notwithstanding the above, we are prepared to provide the following general comments, which may be of assistance.

Unless otherwise stated, every reference herein to a part, section, subsection, paragraph or subparagraph is a reference to the relevant provision of the Act.

1) The Situation

a) A partnership (hereinafter the "Partnership") would hold land as capital property in the Province of Quebec. More specifically, the land would be held for rental to another partnership (hereinafter the "Operating Partnership") that would hold a land lease and would operate a shopping centre on the land.

b) The Operating Partnership would not deal at arm's length with the Partnership.

c) Various corporations (hereinafter the "Partnercos"), which would be Canadian-controlled private corporations ("CCPC"), would hold interests in the Partnership. The partners of the Partnership would be the Partnercos.

d) The Partnercos and the shareholders of the Partnercos (hereinafter the "Vendors") would deal at arm's length with Holdco prior to and following the implementation of the transactions described below. We understand that the Vendors would be persons described in clause 88(1)(c)(vi)(B).

e) The Partnercos would each pay a dividend (hereinafter the "Dividend") to the Vendors by the issuance by the Partnercos to the Vendors of a non-interest bearing note due on demand (hereinafter the "Partnerco Notes").

f) On the following day, a corporation (hereinafter "Holdco"), which would be a CCPC, would purchase from the Vendors all of the issued and outstanding shares of the capital stock of the Partnercos and the Partnerco Notes.

The consideration paid by Holdco to the Vendors would be cash and a balance of sale (hereinafter the "Balance Due").

The aggregate amount due on the Balance Due to each Vendor of a particular Partnerco would be equal to the dividend refund in each particular Partnerco that would result from the payment of the Dividend, less any income tax due that would result from the income of the Partnership for a specified time period.

g) Upon later determination of the amounts due to each Vendor under the Balance Due, Holdco would pay cash to the Vendors to satisfy the full amount of the Balance Due. Consequently, the Balance Due would be extinguished.

h) The Partnercos would then be wound-up into Holdco under subsection 88(1).

Other information:

i) The interests in the Partnership would be capital property of the Partnercos at the time that Holdco last acquired control of the Partnercos. Furthermore, the interests in the Partnership would have been owned by the Partnercos without interruptions since the last time that Holdco acquired control until the time it would be distributed to Holdco on the winding-up of the Partnercos.

j) The interests in the Partnership would not be property described in subparagraph 88(1)(c)(v).

2) Your question

You request our comments on whether the Balance Due would be excluded from being "substituted property", as defined in subparagraphs 88(1)(c.3)(i) and (ii), by virtue of the application of proposed subparagraph 88(1)(c.3)(vii).

3) Your position

In your view and without considering the application of proposed subparagraph 88(1)(c.3)(vii), the Balance Due would constitute "substituted property" described in subparagraph 88(1)(c.3)(i) since the value of the Balance Due owned by the Vendors after the acquisition of control of the Partnercos would be wholly or partly attributable to the fair market value of the properties that would be transferred to Holdco on the winding-up of the Partnercos. In your opinion, paragraph 88(1)(c.4) would not preclude the Balance Due from being "substituted property" since the Balance Due would not be issued by Holdco solely as consideration for the acquisition of shares of the capital stock of the Partnercos by Holdco.

Furthermore, in your opinion, none of the existing subparagraphs 88(1)(c.3)(iii) to (v) would apply to preclude the Balance Due from being "substituted property".

However, you are of the view that proposed subparagraph 88(1)(c.3)(vii) would exclude the Balance Due from the definition of "substituted property" under paragraph 88(1)(c.3) since, the fair market value of the Balance Due would not, at any time after the beginning of the winding-up of the Partnercos, be wholly or partly attributable to property distributed to Holdco on the winding-up. This is because the Balance Due would not be in existence at any time after the beginning of the winding-up of the Partnercos since it would have already been extinguished at that time. You refer to Technical Interpretation 2004-0091771E5 in support of your position.

4) Our comments

As you know, Bill C-33, which was issued on October 29, 2007 and contained amendments to paragraph 88(1)(c.3) (including new subparagraph 88(1)(c.3)(vii)), was incorporated in Bill C-10 which received second reading in the House of Commons on December 4, 2007. However, Bill C-10 died on the Order Paper when Parliament was dissolved on September 7, 2008.

That being said, we agree with your analysis that, in the situation described above, the Balance Due would be excluded from the definition of "substituted property" in subparagraph 88(1)(c.3)(i), on the assumption that the amendments to paragraph 88(1)(c.3), particularly the introduction of proposed subparagraph 88(1)(c.3)(vii), are reintroduced and enacted into law in substantially the same form as proposed in Bill C-10. More precisely and considering that the Balance Due would be extinguished prior to the beginning of the winding-up of the Partnercos, the Balance Due would not constitute "substituted property" pursuant to proposed subparagraph 88(1)(c.3)(vii).

We trust that our comments will be of assistance. The opinion expressed in this letter is limited to the potential application of paragraph 88(1)(c.3) in respect of the Balance Due and consequently, should not be viewed as expressing any views on whether the interests in the Partnership would not otherwise constitute "ineligible property" for the purposes of paragraph 88(1)(c).

Yours truly,

Stéphane Prud'homme, LL.B, M. Fisc.

Manager
Mergers and Acquisitions Section
Reorganizations and Resources Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch