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 a downward adjustment to the PUC of common shares issued in consideration for property whose FMV was subsequently determined by the CRA to be nominal results from the application of subsection 85(2.1) in respect of a disputed transaction that occurred in a statute-barred taxation year
Position: Yes
Reasons: Where the Agreed Amount exceeds the FMV of the transferred property, the PUC adjustment pursuant to subsection 85(2.1) shall be made automatically to the date of the disputed transaction
June 17, 2013 2013-047562
XXXXXXXXXX
XXXXXXXXXX TSO
Re: XXXXXXXXXX
Adjustment to the stated capital of a class of shares
This letter is in response to your request for a technical interpretation regarding CRA's ability to reduce the paid-up capital ("PUC") of common shares issued by XXXXXXXXXX to XXXXXXXXXX in consideration for the XXXXXXXXXX Forward Purchase Agreement ("XXXXXXXXXX FPA") and the XXXXXXXXXX Forward Purchase Agreement ("XXXXXXXXXX FPA") that XXXXXXXXXX transferred to XXXXXXXXXX pursuant to the rules found in section 85 of the Income Tax Act ("ITA") on XXXXXXXXXX.
FACTS
Corporate structure at the time of the Disputed Transaction
1. XXXXXXXXXX is a XXXXXXXXXX incorporated under the laws of the state of XXXXXXXXXX in the United States ("US").
2. XXXXXXXXXX owns all the issued and outstanding shares in XXXXXXXXXX, which is the amalgamated entity that resulted from the amalgamation of XXXXXXXXXX and XXXXXXXXXX.
3. XXXXXXXXXX owns all the issued and outstanding shares in XXXXXXXXXX, which is incorporated under the laws of XXXXXXXXXX.
4. XXXXXXXXXX owns all the issued and oustanding shares in XXXXXXXXXX, which is a company incorporated under the laws of XXXXXXXXXX.
5. XXXXXXXXXX is an operating corporation that manufactures XXXXXXXXXX in Canada.
6. XXXXXXXXXX and XXXXXXXXXX formed a partnership, XXXXXXXXXX, which carries on the manufacturing operations formerly carried on by XXXXXXXXXX.
7. XXXXXXXXXX and XXXXXXXXXX will respectively hold a XXXXXXXXXX% and XXXXXXXXXX% interest in XXXXXXXXXX.
8. XXXXXXXXXX will be treated as a corporation for US tax purposes.
The transactions that occurred prior to the Disputed Transaction
The XXXXXXXXXX Note and the XXXXXXXXXX FPA
9. On XXXXXXXXXX, XXXXXXXXXX loaned an amount of C$XXXXXXXXXX to XXXXXXXXXX, which had to be repaid on XXXXXXXXXX ("XXXXXXXXXX Note").
10. In accordance with a Security Agreement dated XXXXXXXXXX entered into by XXXXXXXXXX and XXXXXXXXXX, the XXXXXXXXXX Note was secured by XXXXXXXXXX's assignment of an interest in a promissory note in the amount of C$XXXXXXXXXX payable by XXXXXXXXXX to XXXXXXXXXX .
11. On XXXXXXXXXX, XXXXXXXXXX entered into a Forward Purchase Agreement with XXXXXXXXXX ("XXXXXXXXXX FPA") pursuant to which XXXXXXXXXX undertook to purchase XXXXXXXXXX common shares in XXXXXXXXXX for an aggregate subscription price of C$XXXXXXXXXX on XXXXXXXXXX.
The XXXXXXXXXX Note and the XXXXXXXXXX FPA
12. On XXXXXXXXXX, XXXXXXXXXX loaned an amount of C$XXXXXXXXXX to XXXXXXXXXX, which had to be repaid on XXXXXXXXXX ("XXXXXXXXXX Note").
13. In accordance with a Security Agreement dated XXXXXXXXXX entered into by XXXXXXXXXX and XXXXXXXXXX, the XXXXXXXXXX Note was secured by XXXXXXXXXX's assignment of an interest in a promissory note in the amount of C$XXXXXXXXXX payable by XXXXXXXXXX to XXXXXXXXXX.
14. On XXXXXXXXXX, XXXXXXXXXX entered into a Forward Purchase Agreement with XXXXXXXXXX ("XXXXXXXXXX FPA") pursuant to which XXXXXXXXXX undertook to purchase XXXXXXXXXX common shares in XXXXXXXXXX for an aggregate subscription price of C$XXXXXXXXXX on XXXXXXXXXX.
XXXXXXXXXX's transfer of the Notes and the FPAs to XXXXXXXXXX
15. Pursuant to a Contribution Agreement dated XXXXXXXXXX, XXXXXXXXXX transferred the XXXXXXXXXX FPA and the XXXXXXXXXX Note as well as the XXXXXXXXXX FPA and the XXXXXXXXXX Note to XXXXXXXXXX ("Acquired Property") in exchange for XXXXXXXXXX units in XXXXXXXXXX having a fair market value ("FMV") equal to the Acquired Property.
16. On XXXXXXXXXX, XXXXXXXXXX amalgamated with XXXXXXXXXX to form XXXXXXXXXX.
The Disputed Transaction
17. Pursuant to a Contribution Agreement dated XXXXXXXXXX, XXXXXXXXXX transferred the XXXXXXXXXX FPA and the XXXXXXXXXX FPA as well as the XXXXXXXXXX Note and the XXXXXXXXXX Note to XXXXXXXXXX in exchange for XXXXXXXXXX common shares in XXXXXXXXXX ("Disputed Transaction").
18. Both XXXXXXXXXX and XXXXXXXXXX agreed that XXXXXXXXXX's issuance of XXXXXXXXXX and XXXXXXXXXX common shares to XXXXXXXXXX in consideration for the XXXXXXXXXX Note and the XXXXXXXXXX Note would satisfy in full its obligations under such debt obligations
19. In accordance with the rules found in subsection 85(1) of the ITA, XXXXXXXXXX and XXXXXXXXXX jointly filed a T2057 form in respect of XXXXXXXXXX's transfer of the XXXXXXXXXX FPA and the XXXXXXXXXX FPA to XXXXXXXXXX.
20. XXXXXXXXXX and XXXXXXXXXX included a price adjustment clause ("PAC") at paragraph XXXXXXXXXX to the Contribution Agreement which provides that the consideration paid by XXXXXXXXXX was based on a bona fide determination of the FMV of the XXXXXXXXXX FPA and the XXXXXXXXXX FPA at the time of the Disputed Transaction. The PAC also provides that that the number of common shares to be issued by XXXXXXXXXX in consideration for the XXXXXXXXXX FPA and the XXXXXXXXXX FPA shall be adjusted in the event that any taxing authority determines that the FMV of such FPAs was other than as determined by the parties.
21. In consideration for the XXXXXXXXXX FPA and the XXXXXXXXXX FPA, XXXXXXXXXX issued XXXXXXXXXX common shares to XXXXXXXXXX having a paid-up capital ("PUC") and a purported FMV equal to C$XXXXXXXXXX.
22. The amount agreed to by XXXXXXXXXX and XXXXXXXXXX in their joint election was equal to C$XXXXXXXXXX, which was allegedly equal to the lesser of: (i) XXXXXXXXXX's cost of the XXXXXXXXXX FPA and the XXXXXXXXXX FPA and (ii) the FMV of the XXXXXXXXXX FPA and the XXXXXXXXXX FPA at the time of the Disputed Transaction.
23. As of XXXXXXXXXX, the PUC of XXXXXXXXXX's issued and outstanding common shares was reportedly equal to C$XXXXXXXXXX.
24. XXXXXXXXXX's XXXXXXXXXX taxation year is statute-barred.
The transactions that occurred after the Disputed Transaction
The amalgamation of XXXXXXXXXX and XXXXXXXXXX
25. Effective XXXXXXXXXX, XXXXXXXXXX and XXXXXXXXXX amalgamated to form XXXXXXXXXX.
26. As a result of the vertical amalgamation described above, XXXXXXXXXX surrendered the XXXXXXXXXX common shares that it held in XXXXXXXXXX and received XXXXXXXXXX common shares in XXXXXXXXXX.
27. As of XXXXXXXXXX, the opening PUC of XXXXXXXXXX's issued and outstanding common shares was equal to $XXXXXXXXXX.
The valuation of the XXXXXXXXXX FPA and the XXXXXXXXXX FPA
28. In a valuation report dated XXXXXXXXXX ("Valuation Report"), the CRA determined that the FMV of the XXXXXXXXXX FPA and the XXXXXXXXXX FPA was equal to XXXXXXXXXX.
CRA's reassessment proposal
29. On the basis of the conclusions found in the Valuation Report, the CRA determined that XXXXXXXXXX had increased the PUC in respect of its common shares by an amount in excess of the FMV of the XXXXXXXXXX FPA and the XXXXXXXXXX FPA.
30. In a letter dated XXXXXXXXXX, the CRA determined that XXXXXXXXXX was deemed to have paid, and XXXXXXXXXX was deemed to have received a taxable dividend in the amount of $XXXXXXXXXX pursuant to subsection 84(1) of the ITA as a consequence of the Disputed Transaction.
31. Given that XXXXXXXXXX is a resident of the US, the dividend deemed to have been paid by XXXXXXXXXX to XXXXXXXXXX should be subject to Part XIII tax at a reduced rate of 5% pursuant to paragraph (2)(a) of Article X of the Canada-US Tax Convention. According to the CRA, the Part XIII tax liability arising from the Disputed Transaction should amount to C$XXXXXXXXXX.
Taxpayer's rebuttal
32. In a letter dated XXXXXXXXXX, the tax representative for XXXXXXXXXX ("Representative") submitted that subsection 84(1) could not apply to the Disputed Transaction since the PUC of the common shares issued by XXXXXXXXXX to XXXXXXXXXX should automatically be reduced to XXXXXXXXXX pursuant to subsection 85(2.1) if he were to concede that the FMV of the XXXXXXXXXX FPA and the XXXXXXXXXX FPA was equal to XXXXXXXXXX.
Taxpayer's revised PUC calculation in respect of the common shares issued by XXXXXXXXXX
33. In a letter dated XXXXXXXXXX, the Representative enclosed revised PUC calculations for XXXXXXXXXX as of XXXXXXXXXX which reflected a XXXXXXXXXX value for the PUC of the common shares issued in consideration for the XXXXXXXXXX FPA and the XXXXXXXXXX FPA.
ISSUE
Whether and how a downward adjustment to the PUC of the common shares issued by XXXXXXXXXX to XXXXXXXXXX can be made under subsection 85(2.1) in respect of XXXXXXXXXX's taxation year that ended on XXXXXXXXXX?
ANALYSIS
The PUC reduction of the common shares issued by XXXXXXXXXX
Where subsection 85(1) applies to a disposition of property, subsection 85(2.1) provides that the PUC of the class of shares issued in consideration for the transferred property shall be reduced, at the time of the issuance of the shares and any time thereafter, by the amount, if any, by which the increase in the PUC of the shares so issued exceeds the cost to the issuing corporation of the acquired property.
In that regard, paragraph 85(1)(a) provides that the cost of the property to the issuing corporation shall be deemed to be the amount jointly elected by the parties to the transfer of property ("Agreed Amount").
In determining the Agreed Amount, paragraph 85(1)(c) provides that, where the Agreed Amount is greater than the FMV of the transferred property, the Agreed Amount shall be deemed to be an amount equal to the FMV of the transferred property irrespective of the amount actually reported in the joint election filed by the parties to the rollover transaction.
For the purposes of subsection 84(1), the PUC increase having to be taken into account is based on the statutory definition of that term found in subsection 89(1) as adjusted pursuant to the rule found in subsection 85(2.1).
Although we had initially believed that an amended T2057 form had to be filed by XXXXXXXXXX and XXXXXXXXXX in order to correct the amounts reported on their joint election, the wording of the aforementioned provisions rather suggests that the PUC adjustment pursuant to subsection 85(2.1) shall be made automatically where the Agreed Amount exceeds the FMV of the transferred property. Therefore, it would be incorrect to assess XXXXXXXXXX pursuant to subsection 84(1) on the basis that XXXXXXXXXX and XXXXXXXXXX have failed to file an amended election pursuant to paragraph 85(7.1)(b) since the PUC increase to the class of shares issued by XXXXXXXXXX is reduced to the FMV of the FPAs at the time of the Disputed Transaction.
Because of the automatic application of subsection 85(2.1) and paragraph 85(1)(c) to the date of the Disputed Transaction, the resulting PUC adjustments can be made irrespective of whether the taxation year in which the rollover transaction was completed is statute-barred. Even if the taxation year under review were statute-barred, it is our view that the CRA could rely on subsection 85(2.1) to reduce the outstanding balance of the PUC of the class of shares issued by XXXXXXXXXX by an amount of C$XXXXXXXXXX even though the Disputed Transaction occurred in a statute-barred taxation year. In support for the alternative position, we believe that the principles established in court cases such as New St-James Ltd. v. MNR 66 DTC 5241 (Ex.Ct.), Queen v. Bradley 98 DTC 6421 (FCA), and Papiers Cascades Cabano Inc. v. Queen 2008 DTC 6264 (FCA) support the proposition that the outstanding balance of a tax account such as the PUC of XXXXXXXXXX's common shares, which was improperly increased as a result of a transaction that took place in a taxation year, can be adjusted for the purposes of reassessing a non-statute-barred taxation year.
CONCLUSION
The PUC of the common shares issued by XXXXXXXXXX as a result of the Disputed Transaction is automatically reduced by an amount of $XXXXXXXXXX pursuant to subsection 85(2.1). However, we believe that the CRA is not in a position to demand that XXXXXXXXXX and XXXXXXXXXX file an amended T2057 form pursuant to subsection 85(7.1) to reflect the adjusted FMV of the FPAs at the time of the Disputed Transaction. In order to prevent any dispute that may arise upon XXXXXXXXXX's attempt to return PUC to XXXXXXXXXX tax-free, we nevertheless recommend that you send a letter to the Representative stating that the CRA acknowledges the PUC reduction of C$XXXXXXXXXX at the time of the Disputed Transaction, and that any transaction intended to use the PUC of the common shares of XXXXXXXXXX will be closely monitored in light of the possible application of subsection 84(3) or 84(4) to that transaction irrespective of whether XXXXXXXXXX's XXXXXXXXXX taxation year is statute-barred.
We trust that the aforementioned comments will be of assistance.
Yves Moreno
Manager
Reorganizations Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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