4 January 1991 Ruling 900651 F - Liquidation

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.

Dear Sirs:

Re:  Subsection 50(1) and 84(9)

This is in reply to your letter dated May 4, 1990 whereby you requested our views concerning the application of certain provisions of the Income Tax Act in respect of the following hypothetical situation as set forth in your letter:

"For example, assume that "A" is a corporation resident in Canada. A owns 100% of the issued and outstanding shares of "B", a corporation incorporated and resident outside Canada.  B's only activity has been to make a few substantial loans to a related operating company incorporated and resident outside Canada.  B has been funded entirely by equity subscriptions from A and has used all of its equity to fund the loans.  Assume further that the operating company has been unsuccessful and is insolvent.

A proposes to cause B to liquidate under the relevant laws of its jurisdiction of incorporation, or cause B to simply discontinue its activity as a prelude to a future liquidation.  Accordingly B will distribute its assets, the related party notes, to A as a reduction of capital.  Pursuant to subsection 69(5), A is deemed to acquire the notes at an amount equal to their fair market value which is assumed to be less than the face amount of the notes and less than the cost of A's investment in B.  B will continue the liquidation process under its domestic laws and in due course the corporation will be formally dissolved."

We must first note that we find the statement of hypothetical facts as set forth above in respect of which you request our views somewhat confusing as on the one hand you state that "B will distribute its assets ... to A as a reduction of capital" but then go on to state that subsection 69(5) applies.  Subsection 69(5) of course only applies where property of a corporation has been appropriated on the winding-up of the corporation. It would thus generally not apply to what is conventionally understood as a reduction of capital by a corporation.  For purposes hereof, we assume that the property of B is in fact distributed to A on the winding-up of B and that your reference to a reduction of capital was simply a collateral observation that the capital of the corporation is in effect reduced on the winding-up and dissolution thereof.

Questions and Responses

(a)     When is A considered to have disposed of the shares of B, when the assets are distributed, or when the corporation is actually dissolved under the relevant foreign law?

     In our opinion, the answer to this question depends upon whether the distribution of B's assets was part of the dissolution process. If B is dissolved and if the property of B is distributed to A as part of such dissolution and A became entitled to receive such property by virtue of the dissolution proceedings, we are of the opinion that such property constitutes proceeds of disposition and A will be considered to have disposed of the shares of B at the time A became entitled to such proceeds of disposition.  However, it is our administrative practice to permit the disposition to be considered to have occurred on the date of the final dissolution of B (or at the time specified in paragraph 5 of IT-126R) in cases where the formal final dissolution follows the distribution of the property of the corporation within a reasonably short period of time.

     If property of B is distributed to A otherwise than as part of the dissolution process, the distribution by B will likely be treated as a dividend or a benefit taxable to A pursuant to subsection 15(1).

(b)     Does subsection 84(9) apply on a dissolution of a corporation?

     We concur with your view that subsection 84(9) does not apply on dissolution of a corporation.  It is our position not to deny a shareholder's capital loss by virtue of paragraph 40(2)(e) or 85(4) on a winding-up on the grounds that the shares of the dissolved corporation were disposed of to the dissolved corporation.  We note, however, that subsection 93(2) may nevertheless apply to deny a capital loss on the disposition of the shares.

(c)     Can a company with no liabilities be considered insolvent for purposes of subsection 50(1)(b)(iii)?

     We are of the opinion that a corporation with no liabilities generally cannot be considered to be insolvent.  Accordingly, our comments in respect of Question (a) above as to the time at which the disposition of the shares occurs would apply.

(d)     Is the phrase "the corporation ceased to carry on all of its businesses" in 50(1)(b)(iii) interpreted to impose a positive requirement that the corporation previously carried on a business or is it interpreted to mean that if a business was previously carried on it has been discontinued and that all activities, if any, have ceased (i.e. can 50(1)(b)(iii) apply to a holding company or a company which otherwise does not have such a level of activity as to constitute the carrying on of a business)?

     In order for a corporation to have "ceased to carry on all of its businesses" as that phrase is used in paragraph 50(1)(b)(iii), the corporation must have previously carried on business.  It is essentially a question of fact whether a business is or has been carried on and as to whether and when a corporation has ceased to carry on all of its business.

(e)     Is the determination of whether an amount paid by a foreign affiliate to its Canadian shareholder a dividend made under foreign corporate law or Canadian domestic tax principles?

     Generally, in order to determine the proper tax treatment of any amount, it is necessary to first determine the proper characterization of the amount, e.g. proceeds of disposition, a dividend, a return of capital, etc.  Generally, the proper characterization of an amount is essentially a question of fact. After this fact has been determined, the Income Tax Act will provide for the manner in which amounts of that character are subjected to tax.

     In determining the question of fact as to the initial characterization of an amount received by a shareholder from a foreign affiliate, regard will be had to the foreign corporate law governing the foreign affiliate.  For example, subject to the possible application of subsection 15(1), the Department generally considers that any payment made by a non-resident corporation to its shareholders pro rata is a dividend unless the payment is made (i) on a formal reduction of capital in compliance with all applicable corporate law procedures respecting the reduction of capital, (ii) on a dissolution of the corporation, or (iii) on the redemption or repurchase of shares of the corporation.  Whether the payment is within one of these exceptions will generally be determined having regard to the corporate law governing the corporation that made the payment.

We note that the fact that there is no formal declaration of a dividend generally will not in and of itself result in the conclusion that the distribution is not a dividend for Canadian tax purposes.

Having regard to the foregoing we trust that you will appreciate why we cannot confirm that a distribution of contributed or paid-in surplus will not be treated as a dividend for Canadian tax purposes.

General

Our comments herein are made on the assumption that subsections 88(3) and 93(1.1) do not apply and that no election is made under subsection 93(1).

We note that the Draft Amendments to the Income Tax Act and Related Statutes issued by the Minister of Finance on July 13, 1990 propose many amendments to the Income Tax Act including amendments to subsections 69(5), 93(1), 93(2) and 93(4).  Our comments herein are based on the law as enacted at the date hereof ant do not take into account any proposed amendments.

The opinions expressed herein are not advance income tax rulings and, in accordance with paragraph 24 of Information Circular 70-6R, are not considered binding on the Department.

Yours truly,

for DirectorReorganizations and Non-Resident DivisionRulings DirectorateLegislative and Intergovernmental Affairs Branch