2012 Ruling 2011-0425211R3 - Reduction of capital

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 subsection 84(2) applies to a reduction of capital

Position: Yes

Reasons: Complies with the law and CRA administrative positions.

XXXXXXXXXX
													2011-042521
													XXXXXXXXXX
	

XXXXXXXXXX, 2012

Dear XXXXXXXXXX:

Re: XXXXXXXXXX
Advance Income Tax Ruling Request

This is in reply to your letter dated XXXXXXXXXX in which you requested an advance income tax ruling on behalf of the taxpayer referred to above. We also acknowledge the information provided during our telephone conversations (XXXXXXXXXX) and correspondence concerning your request. The information or documents submitted with your request are part of this letter only to the extent described herein.

To the best of your knowledge, and that of the taxpayer involved, none of the issues involved in this ruling request is:

(i) dealt with in a return of the above-referenced taxpayer or a related person;

(ii) being considered by a tax services office or taxation centre in connection with a previously filed tax return of the above-referenced taxpayer or a related person;

(iii) under objection by the above-referenced taxpayer or a related person;

(iv) before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has expired; or

(v) the subject of a ruling previously issued by the Income Tax Rulings Directorate of the CRA.

Further, the above-referenced taxpayer has advised that the transactions described herein will not result in the taxpayer or any related person described herein being unable to pay its existing outstanding tax liabilities.

DEFINITIONS

In this letter, the following terms have the meanings specified and, where the circumstances so require, words importing the singular include the plural and vice versa and words importing any gender or the neuter include all genders and the neuter.

Unless otherwise noted, all references herein to a currency are a reference to Canadian dollars.

“Act” means the Income Tax Act, R.S.C. 1985, c.1, (5th Suppl.), as amended to the date hereof, and unless otherwise stated, a reference herein to a part, section, subsection, paragraph or subparagraph is a reference to the relevant provision of the Act;

“adjusted cost base” or “ACB” has the meaning assigned by section 54;

“Assessment” means the preliminary economic assessment described in Paragraph 11;

XXXXXXXXXX;

“CRA” means the Canada Revenue Agency;

“Canco 1” means XXXXXXXXXX, a corporation incorporated under the XXXXXXXXXX on XXXXXXXXXX;

“Canco 2” means XXXXXXXXXX, a corporation incorporated under the XXXXXXXXXX on XXXXXXXXXX;

“Canco 3” means XXXXXXXXXX, a corporation incorporated under the XXXXXXXXXX on XXXXXXXXXX;

"capital" has, in relation to a corporation that exists under the XXXXXXXXXX, the meaning assigned by the XXXXXXXXXX;

“capital property” has the meaning assigned by section 54;

“Core Assets” means the assets owned by FA, as described in Paragraphs 9 to 11;

“cost amount” has the meaning assigned by subsection 248(1);

“Distribution” means the distribution by Pubco of the Spinco Distributed Shares, as described in Paragraph 33;

“FA” means XXXXXXXXXX, a corporation incorporated under the laws of XXXXXXXXXX;

“FA 1” means XXXXXXXXXX, a corporation incorporated under the laws of XXXXXXXXXX;

"FA 1 Note 1" means the promissory note issued by FA 1 to FA, as described in Paragraph 15;

"FA 1 Note 2" means the promissory note issued by FA 1 to Pubco, as described in Paragraph 17;

“FA 2” means XXXXXXXXXX, a corporation incorporated under the laws of XXXXXXXXXX;

"FA 2 Note 1" means the promissory note issued by FA 2 to FA, as described in Paragraph 16;

"FA 2 Note 2" means the promissory note issued by FA 2 to Pubco, as described in Paragraph 17;

“FA 3” means XXXXXXXXXX, a XXXXXXXXXX Cooperative resident in XXXXXXXXXX;

“FA 4” means XXXXXXXXXX, a XXXXXXXXXX company resident in XXXXXXXXXX;

“FA JV” means XXXXXXXXXX, a corporation incorporated under the laws of XXXXXXXXXX;

“fair market value” or “FMV” means the highest price available in an open and unrestricted market, between informed, prudent parties, acting at arm's length and under no compulsion to act and contracting for a taxable purchase and sale expressed in terms of cash;

“Non-Core Assets” means collectively, the Non-Core Asset 1 and the Other Non-Core Assets;

“Non-Core Asset 1” means the XXXXXXXXXX property owned by FA 1, as described in Paragraphs 12 and 13;

“Other Non-Core Assets” means the Non-Core Assets excluding the Non-Core Asset 1 that are owned by FA 2, as described in Paragraphs 12 and 13;

“paid-up capital” or “PUC” has the meaning assigned by subsection 89(1);

“Paragraph” means a numbered paragraph in this letter;

“pre-1972 capital surplus on hand” has the meaning assigned by subsection 88(2.1);

“Pre-Distribution Transactions” means the transactions described in Paragraphs 15 and 16;

“principal amount” has the meaning assigned by subsection 248(1);

"Proposed Transactions" means the proposed transactions described in Paragraphs 19 to 33;

“Pubco” means XXXXXXXXXX;

“public corporation” has the meaning assigned by subsection 89(1);

"recognized stock exchange" has the meaning assigned by subsection 248(1);

“Regulations” means the Income Tax Regulations, as amended;

“Spinco” means XXXXXXXXXX, a corporation incorporated under the XXXXXXXXXX, as described in Paragraph 18;

“Spinco Distributed Shares” means all of the common shares of Spinco distributed by Pubco to its shareholders on the Distribution, as described in Paragraph 32; and

“taxable Canadian corporation” or “TCC” has the meaning assigned by subsection 89(1).

FACTS

Our understanding of the Facts, Proposed Transactions and purposes of the Proposed Transactions are as follows:

General facts regarding Pubco

1. Pubco is a TCC and a public corporation. Pubco was incorporated on XXXXXXXXXX and is governed by the XXXXXXXXXX. Pubco files its tax returns at the XXXXXXXXXX Taxation Centre and its income tax affairs are administered by the XXXXXXXXXX Tax Services Office.

2. Pubco’s authorized share capital consists of an unlimited number of common shares without par value. Pubco’s common shares are widely held by the public and are listed on XXXXXXXXXX under the symbol “XXXXXXXXXX” and on XXXXXXXXXX under the symbol “XXXXXXXXXX.” XXXXXXXXXX Pubco common shares are currently issued and outstanding.

Pubco deals at arm’s length with each of its shareholders.

3. The aggregate capital of Pubco’s common shares is currently estimated to be approximately $XXXXXXXXXX. The aggregate PUC of Pubco’s common shares is estimated to be not less than $XXXXXXXXXX.

Pubco has reviewed and calculated its PUC verifying only an amount that is conservatively sufficient to cover the return of capital being contemplated in the Distribution, as described in Paragraph 33.

Pubco’s actual PUC is significantly higher than $XXXXXXXXXX as this amount was derived from a review of the corporate, financial and legal records pertaining only to certain private placements and public offerings of common shares of Pubco and does not include any amount that was derived from shares issued by Pubco as consideration for any asset or share acquisitions, business combinations or the exercise of any options or warrants of Pubco.

Pubco Corporate Group Structure

4. Pubco owns:

(a) XXXXXXXXXX% of XXXXXXXXXX (“FA”);

(b) all of the issued and outstanding shares of XXXXXXXXXX (“Canco 1”), and

(c) all of the issued and outstanding shares of XXXXXXXXXX (“Canco 2”).

FA is a corporation resident in XXXXXXXXXX and is governed by XXXXXXXXXX. The remaining XXXXXXXXXX% of FA is held by XXXXXXXXXX (“Mr. X”) in trust for Pubco. Mr. X is XXXXXXXXXX of Pubco.

Each of Canco 1 and Canco 2 is a TCC and is governed by the XXXXXXXXXX.

5. Canco 1 owns:

(a) all of the issued and outstanding shares of XXXXXXXXXX (“Canco 3”), and

(b) XXXXXXXXXX% of XXXXXXXXXX (“FA 3”).

Canco 3 is a TCC and is governed by the XXXXXXXXXX. Canco 3 owns the remaining XXXXXXXXXX% of FA 3.

FA 3 is a XXXXXXXXXX Cooperative resident in XXXXXXXXXX.

6. FA 3 owns all of the issued and outstanding shares of XXXXXXXXXX (“FA 4”).

FA 4 is a XXXXXXXXXX company resident in XXXXXXXXXX.

7. FA 4 owns XXXXXXXXXX% of XXXXXXXXXX (“FA 1”). The remaining XXXXXXXXXX% of FA 1 is held by Mr. X in trust for Pubco.

FA 1 is a corporation resident in XXXXXXXXXX and is governed by XXXXXXXXXX.

8. Canco 2 owns XXXXXXXXXX% of XXXXXXXXXX (“FA 2”). The remaining XXXXXXXXXX% of FA 2 is held by Mr. X in trust for Pubco.

FA 2 is a corporation resident in XXXXXXXXXX and is governed by XXXXXXXXXX

Pubco’s Business

9. Pubco’s business operations involve XXXXXXXXXX, which are carried on through its various indirect subsidiaries. Pubco’s assets consist of core assets (“Core Assets”) and non-core assets (“Non-Core Assets”), which are located in XXXXXXXXXX and are owned by its various indirect subsidiaries.

Core Assets

10. FA owns the Core Assets, which consist of:

(a) a XXXXXXXXXX% interest in XXXXXXXXXX. (“FA JV”); and

(b) a XXXXXXXXXX% ownership in other XXXXXXXXXX assets known as XXXXXXXXXX properties.

FA JV is a XXXXXXXXXX joint venture company. The remaining XXXXXXXXXX% of FA JV is owned by XXXXXXXXXX, a shareholder of Pubco, which owns approximately XXXXXXXXXX% of all of the issued and outstanding common shares of Pubco.

FA JV owns a XXXXXXXXXX known as the XXXXXXXXXX property, which is located in XXXXXXXXXX.

XXXXXXXXXX.

11. The Core Assets are the dominant properties of Pubco. They are more advanced than the Non-Core Assets and have been the most valuable assets of Pubco. An independent preliminary economic assessment (“Assessment”) was done for the XXXXXXXXXX property in XXXXXXXXXX, which indicated that the property could be developed into a profitable operating XXXXXXXXXX. FA JV has currently engaged an independent third party to provide an updated Assessment for the XXXXXXXXXX property.

Non-Core Assets

12. The Non-Core Assets consist of the XXXXXXXXXX property (“Non-Core Asset 1”) and the other non-core assets (“Other Non-Core Assets”). FA 1 owns the Non-Core Asset 1 and FA 2 owns the Other Non-Core Assets.

13. The Non-Core Assets are predominantly XXXXXXXXXX projects with no projections relating to the existence of a XXXXXXXXXX. They are not sufficiently advanced enough to have a preliminary economic assessment completed on them.

However, the Non-Core Asset 1 is more advanced than the Other Non-Core Assets. The Non-Core Asset 1 project has an initial resource estimate on a XXXXXXXXXX. XXXXXXXXXX. Subject to a successful XXXXXXXXXX testing, Pubco will engage a XXXXXXXXXX assessment study on the Non-Core Asset 1.

Pre-Distribution Transactions

14. Prior to XXXXXXXXXX, FA owned both the Core Assets and the Non-Core Assets.

15. On XXXXXXXXXX, FA transferred the Non-Core Asset 1 to FA 1 in consideration for an interest bearing promissory note in the amount of XXXXXXXXXX (“FA 1 Note 1”), which was equal to the FMV of the Non-Core Asset 1 at the time of the transfer.

16. On XXXXXXXXXX, FA transferred the Other Non-Core Assets to FA 2 in consideration for an interest-bearing promissory note in the amount of XXXXXXXXXX (“FA 2 Note 1”), which was equal to the FMV of the Other Non-Core Assets at the time of the transfer.

Other Transactions

17. Since XXXXXXXXXX, Pubco has made advances of:

(a) $XXXXXXXXXX to FA 1 in consideration for a promissory note issued by FA 1 to Pubco in the principal amount of $XXXXXXXXXX (“FA 1 Note 2”), and

(b) $XXXXXXXXXX to FA 2 in consideration for a promissory note issued by FA 2 to Pubco in the principal amount of $XXXXXXXXXX (“FA 2 Note 2”).

The advances described in (a) and (b) above were used by FA 1 and FA 2 to finance their XXXXXXXXXX activities.

18. On XXXXXXXXXX, Pubco incorporated XXXXXXXXXX (“Spinco”) under the XXXXXXXXXX. Spinco is a TCC and is governed by the XXXXXXXXXX.

Spinco’s authorized share capital consists of an unlimited number of common shares without par value. Pubco subscribed for one Spinco common share for $ XXXXXXXXXX.

PROPOSED TRANSACTIONS

Internal Funding - Pubco, Canco 1, FA 3, FA 4 and FA 1

19. Pubco will subscribe for Canco 1 common shares for $XXXXXXXXXX. In addition, Pubco will contribute the FA 1 Note 2 to Canco 1 in exchange for additional common shares of Canco 1 having an aggregate FMV equal to the FMV and principal amount of the FA 1 Note 2 at the time of the exchange.

As a result of the share subscription described herein, the aggregate PUC of the Canco 1 common shares will be approximately $XXXXXXXXXX.

20. Canco1 will loan the subscription proceeds of $XXXXXXXXXX, as described in Paragraph 19, to FA 3 in consideration for a promissory note issued by FA 3 to Canco 1 in the principal amount of $XXXXXXXXXX.

21. FA 3 will advance the loan proceeds of $XXXXXXXXXX received from Canco1, as described in Paragraph 20, to FA 4 in consideration for a promissory note issued by FA 4 to FA 3 in the principal amount of $XXXXXXXXXX.

22. FA 4 will advance the loan proceeds of $XXXXXXXXXX received from FA 3, as described in Paragraph 21, to FA 1 in consideration for a promissory note issued by FA 1 to FA 4 in the principal amount of $XXXXXXXXXX.

23. FA 1 will use the loan proceeds of $XXXXXXXXXX received from FA 4, as described in Paragraph 22, to repay the outstanding principal amount of the FA 1 Note 1 that FA holds. The FA 1 Note 1 will be cancelled.

24. FA will use the proceeds received from FA 1, as described in Paragraph 23, to finance its XXXXXXXXXX operations.

Internal Funding - Pubco, Canco 2 and FA 2

25. Pubco will subscribe for Canco 2 common shares for $XXXXXXXXXX. In addition, Pubco will contribute the FA 2 Note 2 to Canco 2 in exchange for additional common shares of Canco 2 having an aggregate FMV equal to the FMV and principal amount of the FA 2 Note 2 at the time of the exchange.

As a result of the share subscription described herein, the aggregate PUC of the Canco 2 common shares will be approximately $XXXXXXXXXX.

26. Canco 2 will loan the subscription proceeds of $XXXXXXXXXX, as described in Paragraph 25, to FA 2 in consideration for a promissory note issued by FA 2 to Canco 2 in the principal amount of $XXXXXXXXXX.

27. FA 2 will use the loan proceeds of $XXXXXXXXXX received from Canco 2, as described in Paragraph 26, to repay the outstanding principal amount of the FA 2 Note 1 that FA holds. The FA 2 Note 1 will be cancelled.

28. FA will use the proceeds received from FA 2, as described in Paragraph 27, to finance its XXXXXXXXXX operations.

Transfer Shares of Canco 1 and Canco 2 to Spinco

29. Pubco will transfer all of its shares of Canco 1 and Canco 2 to Spinco. As sole consideration therefor, Spinco will issue common shares to Pubco having an aggregate FMV, at the time of the transfer, equal to the aggregate FMV of the common shares of Canco 1 and Canco 2 transferred by Pubco to Spinco.

30. Pubco and Spinco will jointly elect in prescribed form and within the time period referred to in subsection 85(6) to have the provisions of subsection 85(1) apply to the transfer described in Paragraph 29. The agreed amount for the purposes of the election will not be less than the lesser of the two amounts specified in paragraph 85(1)(c.1), nor will such amount exceed the aggregate FMV of the common shares of Canco 1 and Canco 2 transferred to Spinco.

Spinco will add to its capital account maintained for the Spinco common shares the agreed amount pursuant to subsection 85(1), as referred to above. For greater certainty, the increase to the PUC of Spinco common shares will not exceed the maximum amount that could be added to the PUC of such shares, having regard to subsection 85(2.1).

Capital Reduction and Distribution

31. Pubco will comply with the statutory requirements under the XXXXXXXXXX and the relevant securities law with respect to the Capital Reduction, as described in Paragraph 32, and the Distribution, as described in Paragraph 33, including:

(a) obtaining the approval of the XXXXXXXXXX regarding the Capital Reduction and the Distribution; and

(b) obtaining: (i) a receipt from one or more securities regulatory authorities in certain provinces of Canada that qualifies the Spinco Distributed Shares to be eligible for distribution to the Pubco shareholders under the relevant securities law, and (ii) the final listing approval of the relevant recognized stock exchange on which the Spinco Distributed Shares will be listed.

32. Pubco will reduce the capital of its issued and outstanding common shares (“Capital Reduction”) in accordance with the provisions of the XXXXXXXXXX by an amount that will be equal to the aggregate FMV of all of the Spinco common shares that Pubco owns (“Spinco Distributed Shares”) at such time.

For greater certainty, the Capital Reduction will not exceed the aggregate PUC of the Pubco common shares issued and outstanding at such time.

Concurrently with the Capital Reduction, Pubco will make a pro-rata distribution (“Distribution”) of the Spinco Distributed Shares to the Pubco shareholders.

ADDITIONAL INFORMATION

33. The amount of the Distribution will not exceed the aggregate PUC of the Pubco common shares that is in respect of the share issuances for cash only.

34. The proposed reduction in the capital of Pubco’s issued and outstanding common shares, as described in Paragraph 32, has not been preceded by an increase in the PUC of that class of shares that has resulted in a dividend in respect of which Pubco elected to treat as having been paid out of Pubco’s pre-1972 capital surplus on hand.

35. The Capital Reduction and the Distribution are one-time transactions, and are not being made in lieu of ordinary course dividends. Pubco has never paid dividends to its shareholders.

36. The transfer by Pubco of all of its common shares of Canco 1 and Canco 2 to Spinco in exchange for the Spinco common shares, as described in Paragraph 29, is a transaction that will occur outside the ordinary course of the business of Pubco.

37. Pubco will realize a capital gain on the disposition of the Spinco Distributed Shares to its shareholders.

38. Spinco intends to enter into arm’s length negotiations with one or more third parties for a private placement of approximately XXXXXXXXXX% of the common shares of Spinco to be issued out of treasury. If Spinco proceeds with the private placement, it will occur before the Capital Reduction and the Distribution, and Pubco’s share ownership in Spinco will be diluted from XXXXXXXXXX% to approximately XXXXXXXXXX%. The purpose of Spinco’s private placement is to raise funds for FA 1 and FA 2’s XXXXXXXXXX activities and administrative costs.

Pubco does not know whether any of its shareholders will participate in Spinco’s private placement as described in Paragraph 39.

PURPOSES OF THE PROPOSED TRANSACTIONS

39. Pubco has determined that it is in the best interests of its shareholders to distribute the Spinco Distributed Shares to its shareholders for a number of reasons, including the following:

(a)The Canadian equity market continues to offer access to funding for XXXXXXXXXX ventures.
The Distribution will facilitate access by Spinco to additional financing for ongoing and 
future projects with respect to the Non-Core Assets.

(b) The Distribution will allow Pubco to develop the Core Assets into an XXXXXXXXXX, without diluting the existing ownership of the Core Assets through equity financings to fund XXXXXXXXXX of the Non-Core Assets.

(c) The Distribution will enable Pubco’s shareholders to make independent investment decisions regarding their interests in the Core Assets and the Non-Core Assets.

(d) It is anticipated that the Non-Core Assets will achieve higher valuations operating independently of the Core Assets.

40. Spinco was incorporated for the purpose of acquiring Pubco’s Non-Core Assets owned indirectly by Canco 1 and Canco 2, with the intention of Spinco being spun out to the Pubco shareholders as a separately traded public corporation.

41. The purpose of FA transferring the Non-Core Asset 1 to FA 1 and the Other Non-Core Assets to FA 2, as described in Paragraphs 15 and 16, respectively, was to facilitate the proposed indirect distribution of the Non-Core Assets by Pubco to its shareholders through the proposed indirect ownership of the Non-Core Assets by Spinco and the proposed spin-off of Spinco to the Pubco shareholders.

42. The purpose of Pubco channelling the amount of $XXXXXXXXXX through Canco 1, FA 3 and FA 4 to FA 1, as described in Paragraphs 19 through 22, and the amount of $XXXXXXXXXX through Canco 2 to FA 2, as described in Paragraphs 25 and 26, as opposed to channelling such amounts directly to FA 1 and FA 2, is to capitalize such amounts in the ACB of Pubco’s shares in Canco 1 and Canco 2 and, consequently, in the ACB of Pubco’s shares in Spinco when Pubco exchanges all of its shares of Canco 1 and Canco 2 for the Spinco shares, as described in Paragraph 29.

43. The reason for Mr. X holding XXXXXXXXXX% interest in each of FA, FA 1 and FA 2 in trust for Pubco, as described in Paragraphs 4, 7 and 8, respectively, was because XXXXXXXXXX corporate law requires that a XXXXXXXXXX corporation have a minimum of two shareholders.

44. The reason for Canco 3 owning XXXXXXXXXX% interest in FA3, as described in Paragraph 5, was because XXXXXXXXXX law requires that a XXXXXXXXXX Cooperative have a minimum of two shareholders.

RULINGS

Provided that the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, proposed transactions and the purposes of the Proposed Transactions, and provided that the Proposed Transactions are undertaken in the manner described above, our rulings are set forth below:

A. Subject to the application of subsection 40(3), the Capital Reduction described in Paragraph 32 will not, in and by itself, result in a disposition by the Pubco shareholders of their Pubco common shares.

B. Subsection 84(2) will apply, and subsection 84(4.1) will not apply, to the Distribution as described in Paragraph 33, such that Pubco will be deemed to have paid, and the holders of the Pubco common shares will be deemed to have received, a dividend on their Pubco common shares only to the extent, if any, that the amount of the Distribution (equal to the aggregate FMV of the Spinco Distributed Shares at the time of the Distribution) exceeds the amount by which the PUC of the Pubco common shares is reduced on the Distribution.

C. Where a Pubco shareholder holds his or her Pubco common shares as capital property, by virtue of subparagraph 53(2)(a)(ii), the amount of the Distribution received on such shares will be deducted in computing the Pubco shareholder’s ACB of such shares. To the extent such amount exceeds the ACB to such shareholder of the shares, the shareholder will be deemed to have a capital gain pursuant to subsection 40(3).

D. Subject to the application of section 47, the cost amount to a Pubco shareholder of a Spinco Distributed Share received on the Distribution will be equal to the FMV of the Spinco Distributed Share at the time of the Distribution.

E. The provisions of subsection 15(1) will not apply to the Distribution as described in Paragraph 33.

The above rulings are given subject to the limitations and qualifications set out in Information Circular 70-6R5 dated May 17, 2002 and are binding on the CRA provided that the Proposed Transactions are completed before XXXXXXXXXX.

The above rulings are based on the law as it presently reads and do not take into account any proposed amendments to the Act and the Regulations which, if enacted into law, could have an effect on the rulings provided herein.

COMMENTS

Nothing in this letter should be construed as implying that the CRA has confirmed, reviewed, made any determination, or accepted any method for the determination in respect of:

(a) the PUC of any share or the ACB or FMV of any property referred to herein; or

(b) any other tax consequence relating to the facts, Proposed Transactions or any transaction or event taking place either prior to the Proposed Transactions or subsequent to the Proposed Transactions, whether described in this letter or not, other than those specifically described in the rulings given above, including whether any of the Proposed Transactions would also be included in a series of transactions or events that includes other transactions or events that are not described in this letter.

Yours truly,

XXXXXXXXXX
Section Manager
for Division Director
Reorganizations Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch