18 October 1989 Ministerial Letter 58428 F - Corporate Reorganization

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.

October 18, 1989

Dear Sirs:

Re:  Subsection 55(2) and Subparagraph 55(3)(a)(ii) of the Income Tax Act (Canada) (the "Act")

This is in response to your letter of July 21, 1989 in which you requested our opinion as to the application of subsection 55(2) and subparagraph 55(3)(a)(ii) of the Act to the hypothetical facts and transactions described below.

1.     Opco is a Canadian-controlled private corporation within the meaning assigned by paragraph 125(6)(b) of the Act.

2.     The common shares of Opco are owned 62.75% by A, 25% by 8 and 12.25% by C.  A, 8 and C are individuals resident in Canada and none is related, within the meaning of subsection 251(2) of the Act, to either of the others.

3.     Opco has total assets with a fair market value of $5,000,000 substantially all of which are used in an active business carried on in Canada.  Included in such assets is real estate with a fair market value of $2,000,000.

4.     The fair market value of the common shares of Opco held by each of. A, 8 and C is substantially in excess of the aggregate of his adjusted cost base, within the meaning of paragraph 54(a) of the Act, of such shares and the "safe income" attributable thereto.

5.     The share capital of Opco would be reorganized pursuant to section 86 of the Act such that A, B and C would exchange their common shares of Opco for redeemable, retractable preferred shares with an aggregate redemption amount and fair market value of $2,000,000 (the "Opco Preferred Shares") and new common shares of Opco.  A, B and C would respectively receive 62.75%, 25% and 12.5% of the Opco Preferred Shares and the new common shares.

6.     Newco would be incorporated and each of' A, B and C would transfer his Opco Preferred Shares to Newco in exchange for common shares of Newco with an equivalent fair market value.  An election under subsection 85(1) of the Act would be filed in respect of each such transfer so that the transfers would occur on a fully tax-deferred basis to A, 8 and C.

7.     Opco would transfer all of its real estate with a fair market value of $2,000,000 to Newco in exchange for preferred shares of Newco having a redemption amount and fair market value of $2,000,000 (the "Newco Preferred Shares").  An election under subsection 85(1) of the Act would be filed in respect of such transfer so that it would occur on a fully tax-deferred basis to Opco.

8.     Newco would redeem the Newco Preferred Shares in consideration for the redemption by Opco of the Opco Preferred Shares (the "cross-cancellation").

Opinions

On the cross-cancellation, Newco would be deemed by paragraph 84(3)(b) of the Act to have received a dividend equal to the amount by which the redemption amount of the Opco Preferred Shares exceeds their paid-up capital, within the meaning of paragraph 89(1)(c) of the Act.  Similarly, Opco would be deemed to receive a dividend equal to the amount by which the redemption amount of the Newco Preferred Shares exceeds their paid-up capital.  Paragraph 55(2)(b) of the Act would apply to deem such dividends to be proceeds of disposition for the Newco Preferred Shares to Opco or proceeds of disposition of the Opco Preferred Shares to Newco, as the case may be, unless the exemptions from the application of that provision contained in paragraphs 55(3)(a) or (b) of the Act applied.  We have assumed that the provisions of paragraph 55(3)(b) are not applicable.

Paragraph 55(3)(a) of the Act, in general terms, provides that subsection 55(2) of the Act will not apply to a dividend received by a corporation (the "dividend recipient") if the dividend was received as part of a series of transactions or events that did not result in

(i)     a disposition of any property to a person with whom the dividend recipient was dealing at arm's length, or

(ii)     a significant increase in the interest in any corporation of any person with whom the dividend recipient was dealing at arm's length.

Assuming that the proposed transactions described herein comprise the complete series of transactions or events, read with reference to subsection 248(10) of the Act, such series would not result in a disposition of property to any person with whom either dividend recipient, Newco or Opco, dealt at arm's length. As Newco and Opco would both be controlled by A, they would be related by virtue of subparagraph 251(2)(c)(i) of the Act and thus be deemed not to deal at arm's length with each other by virtue of paragraph 251(1)(a) of the Act.  If the transactions described were undertaken in contemplation of any disposition of shares or property to a person with whom either of Opco or Newco deal at arm's length, the series would be described in subparagraph 55(3)(a)(i) of the Act.

With respect to subparagraph 55(3)(a)(ii) of the Act, in our view the proposed transactions would result in a significant increase in interest in Newco by each of A, B and C This view is consistent with the following comment contained on page 94 of the paper presented by John Robertson of Revenue Canada, Taxation at the 1981 Canadian Tax Foundation Conference:

     "Where a person or persons incorporate new companies and the incorporation of these companies is involved in the series of transactions that include the payment of dividends, their interest in the new corporation will be considered as an interest in any corporation."

Therefore, in this case if either B or C in fact deal at arm's length with either of Newco or Opco, the series of transactions or events which includes the deemed receipt of dividends by Newco and Opco would result in an increase in the interest in a corporation of a person with whom a dividend recipient dealt at arm's length. Consequently, paragraph 55(3)(a) of the Act would not apply to exempt the dividends deemed to be received by Opco or Newco from the application of subsection 55(2) of the Act.

The above comments represent our opinion and are given in accordance with the practice described in paragraph 24 of Information Circular 70-6R.

Yours truly,

for Director Reorganizations and Non-Resident DivisionSpecialty Rulings DirectorateLegislative and IntergovernmentalAffairs Branch