19 July 1985 Income Tax Severed Letter 5-7200 - Transfer of property—foreign affiliates

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.

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This is in reply to your letters of December 4, 1985 and January 15, 1985 in which you request Revenue Canada, Taxation's position on certain issues as follows:

I. Does the nature of property change as the result of a transfer pursuant to the provisions of subsection 85(2) of the Income Tax Act (the Act) followed by another transfer pursuant to the provisions of 85.1(3) of the Act?

II. Is a foreign corporation whose shares are held by Canadian corporate partnership considered a foreign affiliate of the corporate partners?

III. Assuming that the foreign corporation is a foreign affiliate of the corporate partners can be exempt surplus of the foreign corporation flow-through as the result of a transfer of the shares of the foreign corporation pursuant to subsection 85(2) of the Act?

The following hypothetical situation illustrates these issues:

• 1. Partnership XYZ consists of five arm's length corporate partners each of which is a taxable corporation resident in Canada. None of the five partners has a controlling interest in the partnership but each has a greater than 10% interest.
• 2. Partnership XYZ holds all the issued and outstanding shares of Co. A which was incorporated in, and is resident of, the U.S.
• 3. Partnership XYZ incorporates and holds all the issued shares in Co. B., a corporation which is incorporated in, and is a resident of, Canada.
• 4. Partnership XYZ transfers its shares in Co. A to Co. B, electing the proceeds to be their aggregate adjusted cost base, pursuant to subsection 85(2) of the Act.
• 5. At the time of the transactions, the fair market value of the shares in Co. A is significantly in excess of cost.

Case A

• 6. Subsequent to the transaction described in item 4 above Co. B sells the shares in Co. A at fair market value to an arm's length third-party.

Case B

• 7. Co. B incorporates a new wholly-owned subsidiary, Co. C, which is incorporated in, and is resident of, the U.S.
• 8. Subsequent to the transaction described in item 4 above, Co. B sells the shares in Co. A to Co. C, pursuant to the share for share exchange provisions of subsection 85.1(3) of the Act in circumstances where the provisions of subsection 85.1(4) of the Act do not apply.

Revenue Canada, Taxation's Position

I. In either Case A or B, it is the Department's position that the nature of the property will not change solely as a result of the transfer or transfers. Therefore provided the shares of Co. A are capital property to partnership XYZ they will be capital property to Co. B or Co. C, as the case may be. Whether or not the anti-avoidance provisions in the Act would be applicable to any such transfers as described above can only be determined with the respect to the facts of the particular case.

II. As Subdivision 1 of Division B of Part 1 of the Act is for the purposes of computing income, pursuant to the provisions of paragraph 96(1)(c) of the Act, partnership XYZ is considered to own the shares of Co. A for the purposes of computing the income of its corporate partners and therefore, Co. A can not be considered to be a foreign affiliate of the corporate partners for purpose of computing their income. Therefore, it follows that Co. A does not have any exempt surplus or taxable surplus in relation to any of the corporate partners of partnership XYZ.

III. Even if Co. A was considered to be a foreign affiliate of the corporate partners none of them would be considered to be dealing at non-arm's length with Co. B as is required by paragraph 5905(5)(a) of the Income Tax Act Regulations. Therefore, the surplus pots could not flow-through as a result of the transfer.

We trust that this information will be of assistance to you.