4 March 2013 Internal T.I. 2012-0449371I7 - Downstream absorptive 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: Would proposed subsection 87(8.2) to the Act apply to the 2006 foreign downstream absorptive merger described.

Position: Yes

Reasons: The conditions in the preamble to proposed subsection 87(8.2) to the Act are met and if enacted in its current form subsection 87(8.2) will apply in respect of mergers or combinations that occur after 1994 unless the taxpayer elects to have the subsection apply only in respect of mergers or combinations that occur after August 19, 2011.

March 4, 2013

XXXXXXXXXX HEADQUARTERS
International Tax Auditor Income Tax Rulings
XXXXXXXXXX Tax Services Office Directorate
L. Carruthers, CA
(613) 957-2113

2012-044937

Absorptive Mergers

We are writing in response to your May 28, 2012 e-mail concerning foreign absorptive mergers and your January 21, 2013 email concerning proposed subsection 87(8.2) to the Income Tax Act (the "Act").

Legislative proposals dealing specifically with absorptive mergers of non-resident corporations were originally introduced by the Department of Finance on August 19, 2011, as an amendment to section 95 of the Act, with the introduction of draft subsection 95(4.2). However, the draft legislation released by the Department of Finance on October 24, 2012, which received first reading in the House of Commons on November 21, 2012 as Bill C-48, proposes instead to enact subsection 87(8.2) to the Act to address absorptive mergers of non-resident corporations.

Background

It is our understanding that you are reviewing a situation where, prior to 2006, a taxable Canadian corporation ("Canco") owned all of the issued shares of a corporation resident in a country other than Canada ("FA1") which owned all of the issued shares of another corporation resident in a country other than Canada ("FA2"). In 2006, Canco arranged for the merger of FA1 into FA2 with FA2 as the surviving corporation under the corporate law of the foreign jurisdiction (i.e., a downstream merger). In accordance with the corporate law of that foreign jurisdiction, the shares of FA2 held by FA1 were distributed to Canco and the shares of FA1 were cancelled; all the property held by FA1 immediately before the merger was transferred to FA2 at the time of the merger; and FA1 ceased to exist after the merger.

Issue

You requested our view as to whether proposed subsection 87(8.2) to the Act, if enacted in the form contained in Bill C-48, would apply to the merger of FA1 into FA2? In particular, you queried:

1. What is the tax treatment of the properties transferred by FA1 to FA2? Does proposed paragraph 95(2)(d.1) to the Act, in the form contained in Bill C-48, apply?

2. What is the tax treatment of the FA1 shares that are cancelled as a result of the merger? Does proposed paragraph (n) to the definition of "disposition" in subsection 248(1) of the Act, in the form contained in Bill C-48, apply?

3. What is the tax treatment of the shares of FA2 transferred by FA1 to Canco? Does proposed paragraph (n) to the definition of "disposition" in subsection 248(1) of the Act, in the form contained in Bill C-48, apply?

Our Comments

The explanatory notes released by the Department of Finance on October 24, 2012, state that: "New subsection 87(8.2) of the Act clarifies the circumstances in which certain foreign "absorptive mergers" will qualify as "foreign mergers" under subsection 87(8.1) of the Act. This rule is mainly designed to ensure that certain common forms of U.S. mergers qualify for the rollover provisions that are provided for in the foreign affiliate rules, as well as in other areas of the Act.

This new subsection applies in respect of mergers or combinations that occur after 1994. However, taxpayers may elect to have it apply only in respect of mergers or combinations that occur after August 19, 2011."

Proposed subsection 87(8.2) to the Act, in the form contained in Bill C-48, reads as follows:

"For the purposes of the definition "foreign merger" in subsection (8.1), if there is a merger or combination, otherwise than as a result of the distribution of property to one corporation on the winding-up of another corporation, of two or more non-resident corporations (each of which is referred to in this subsection as a "predecessor foreign corporation"), as a result of which one or more predecessor foreign corporations ceases to exist and, immediately after the merger or combination, another predecessor foreign corporation (referred to in this subsection as the "survivor corporation") owns properties (except amounts receivable from, or shares of the capital stock of, any predecessor foreign corporation) representing all or substantially all of the fair market value of all such properties owned by each predecessor foreign corporation immediately before the merger or combination, then

(a) the merger or combination is deemed to be a merger or combination of the predecessor foreign corporations to form one non-resident corporation;

(b) the survivor corporation is deemed to be the non-resident corporation so formed;

(c) all of the properties of the survivor corporation immediately before the merger or combination that are properties of the survivor corporation immediately after the merger or combination are deemed to become properties of the survivor corporation as a consequence of the merger or combination;

(d) all of the liabilities of the survivor corporation immediately before the merger or combination that are liabilities of the survivor corporation immediately after the merger or combination are deemed to become liabilities of the survivor corporation as a consequence of the merger or combination;

(e) all of the shares of the capital stock of the survivor corporation that were outstanding immediately before the merger or combination that are shares of the capital stock of the survivor corporation immediately after the merger or combination are deemed to become shares of the capital stock of the survivor corporation as a consequence of the merger or combination; and

(f) all of the shares of the capital stock of each predecessor foreign corporation (other than the survivor corporation) that were outstanding immediately before the merger or combination and that cease to exist as a consequence of the merger or combination are deemed to be exchanged by the shareholders of each such predecessor corporation for shares of the survivor corporation as a consequence of the merger or combination."

Proposed subsection 87(8.2) to the Act will, in our view, apply to both upstream and downstream absorptive mergers. For example, in the downstream absorptive merger of FA1 into FA2 as described above, all of the requirements set out in the preamble of proposed subsection 87(8.2) to the Act appear to be satisfied with the result that as a consequence of the application of proposed paragraphs 87(8.2)(a) to (f) to the Act, the 2006 merger of FA1 into FA2 will, unless the taxpayer elects to have the subsection apply only in respect of mergers or combinations that occur after August 19, 2011, qualify as a "foreign merger" as defined in subsection 87(8.1) of the Act.

In this respect, the phrase "except any shares or options owned by any predecessor foreign corporation" as it appears in brackets in paragraph 87(8.1)(c) of the Act, in our view, serves as an exception to the requirement of that paragraph and not as an added requirement. For example, in a different scenario, if the shares or options owned by a predecessor foreign corporation were cancelled because of a merger or combination not described in proposed subsection 87(8.2) to the Act (i.e. a merger other than an absorptive merger) and, therefore, were neither exchanged for nor became shares described in subparagraphs 87(8.1)(c)(i) and (ii) of the Act, that fact would not, in and of itself, result in the merger not meeting the requirements of paragraph 87(8.1)(c). This would be so because of the placement of the phrase "except any shares or options owned by any predecessor foreign corporation" in paragraph 87(8.1)(c) of the Act. In the merger of FA1 into FA2 described above, as a consequence of the application of proposed paragraphs 87(8.2)(b) and (e) to the Act, the shares of FA2 owned by FA1, a predecessor corporation immediately before the merger, become shares described in subparagraph 87(8.1)(c)(i) of the Act. However, as discussed above, because we do not view the phrase in brackets in paragraph 87(8.1)(c) of the Act as being an added requirement, the merger nevertheless satisfies the test in that paragraph.

In response to your specific queries, if Bill C-48 is enacted in the form which received first reading in the House of Commons on November 21, 2012 and the taxpayer does not elect to have proposed subsection 87(8.2) of the Act apply only in respect of mergers or combinations that occur after August 19, 2011:

1. all of the property of FA1 will be transferred to FA2 subject to the rules in proposed paragraph 95(2)(d.1) to the Act;

2. unless Canco elects not to have subsection 87(8) of the Act apply, paragraph 87(4)(a) of the Act, as modified by subsection 87(8), will apply to the cancelled shares of FA1 to deem them to have been disposed of by Canco at their adjusted cost base to Canco immediately before the merger of FA1 into FA2. In this respect, proposed paragraph (n) of the definition of "disposition" in subsection 248(1) of the Act would not apply to the disposition by Canco of its FA1 shares by virtue of clause (iii)(A) thereof. That is because Canco did receive consideration for its disposition of the shares of FA1 in the form of the FA2 shares it received; and

3. unless Canco elects not to have subsection 87(8) of the Act apply, paragraph 87(4)(b) of the Act, as modified by subsection 87(8), will apply to the shares of FA2 distributed to Canco to deem them to have been acquired by Canco at a cost equal to the proceeds for which the FA1 shares were deemed disposed of pursuant to paragraph 87(4)(a) of the Act. Furthermore, proposed paragraph (n) of the definition of "disposition" in subsection 248(1) of the Act will apply to the shares of FA2 disposed of by FA1 and as a result FA1 would not realize a gain or a loss on those shares as a result of its merger into FA2.

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