2091 Ruling 91268930 - QSBC SHARES PURIFICATION

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.

XXXXXXXXXX 							3-912689

Attention : XXXXXXXXXX

Dear Sirs:

Re: XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX

We are writing in response to your letter of XXXXXXXXXX in which you requested an advance income tax ruling on behalf of the above-noted taxpayers in respect of the proposed transactions described below. We also acknowledge your letters of XXXXXXXXXX and our telephone conversations in connection herewith.

Our understanding of the relevant facts, the proposed transactions and the purpose of the proposed transactions is as follows:

FACTS

1. XXXXXXXXXX was incorporated in XXXXXXXXXX under the laws of the Province of XXXXXXXXXX. It is a Canadian-controlled private corporation and a taxable Canadian corporation. The terms "Canadian-controlled private corporation" and "taxable Canadian corporation", as used here and subsequently, have the meanings assigned by paragraphs 125(7)(b) and 89(1)(i) of the Income Tax Act (the "Act").

2. The authorized share capital of XXXXXXXXXX is as follows:

XXXXXXXXXX Common shares with a par value of $XXXXXXXXXX each.

The issued and outstanding share capital of XXXXXXXXXX is as follows:

Number of
shares issued Paid-up capital

XXXXXXXXXX

The term "paid-up capital", as used here and subsequently, has the meaning assigned by paragraph 89(1)(c) of the Act.

XXXXXXXXXX each acquired their shares in XXXXXXXXXX at the time of the incorporation of XXXXXXXXXX with their own funds.

All the shareholders of XXXXXXXXXX hold their respective shares in the corporation as capital property. The term "capital property", as used here and subsequently, has the meaning assigned by paragraph 54(b) of the Act.

3. XXXXXXXXXX is a holding company whose assets consists of cash, deposit receipts and a non-interest-bearing note receivable, payable on demand, owing from XXXXXXXXXX. The cash and deposit receipts (the "non-business assets") have a fair market value of approximately $XXXXXXXXXX while the note receivable has a fair market value equal to its face amount of $XXXXXXXXXX. The liabilities of XXXXXXXXXX consist of current liabilities in the amount of approximately $XXXXXXXXXX. The amount due on the note receivable is $XXXXXXXXXX.

The note receivable arose as the result of the redemption in XXXXXXXXXX of the common shares of XXXXXXXXXX that were held by XXXXXXXXXX. These shares of XXXXXXXXXX, which had been originally acquired by XXXXXXXXXX, in part before XXXXXXXXXX and in part in XXXXXXXXXX, with their own funds, were transferred to XXXXXXXXXX in XXXXXXXXXX pursuant to the provisions of subsection 85(1) of the Act by XXXXXXXXXX.

4. XXXXXXXXXX was incorporated in XXXXXXXXXX under the laws of the Province of XXXXXXXXXX. It is a Canadian-controlled private corporation and a taxable Canadian corporation.

5. The authorized share capital of XXXXXXXXXX is as follows:

XXXXXXXXXX Common shares with a par value of $XXXXXXXXXX each.

The issued and outstanding share capital of XXXXXXXXXX is as follows:

Number of
shares issued Paid-up capital

XXXXXXXXXX

XXXXXXXXXX acquired his shares in XXXXXXXXXX from XXXXXXXXXX in XXXXXXXXXX as a result of transfers that were made pursuant to the provisions of subsection 73(5) of the Act. XXXXXXXXXX holds his shares in XXXXXXXXXX as capital property.

6. XXXXXXXXXX is carrying on a XXXXXXXXXX business in XXXXXXXXXX. You have advised us that:

(i) substantially all of the fair market value of the assets of XXXXXXXXXX throughout the XXXXXXXXXX months immediately preceding the time of the sale of shares described in paragraph 20 below (the "Relevant Time"), will have been attributable to assets that were used principally in an active business carried on primarily in Canada by XXXXXXXXXX;

(ii) substantially all of the fair market value of the assets of XXXXXXXXXX at the Relevant Time will be attributable to the note issued by XXXXXXXXXX described in paragraph 3 above. In addition, throughout the XXXXXXXXXX months immediately preceding the Relevant Time more than XXXXXXXXXX% of the fair market value of the assets of XXXXXXXXXX will have been attributable to such note; and

(iii) that there is no intention on the part of any of XXXXXXXXXX XXXXXXXXXX that any of the shares or property of XXXXXXXXXX or a corporation ("Newco") to be incorporated as described in paragraph 12 below, be disposed of to or issued to any person with whom either XXXXXXXXXX or Newco is dealing at arm's length for the purposes of the Act as part of a series of transactions or events that includes the transactions described in paragraphs 11 to 28 below.

The term "active business" has the meaning assigned by subsection 248(1) of the Act.

The term "series of transactions or events", as used here and subsequently, has the extended meaning assigned by subsection 248(10) of the Act.

7. XXXXXXXXXX are husband and wife, while XXXXXXXXXX is their son who is over the age of 18. They are all resident in Canada for the purposes of the Act.

8. None of the issued shares of XXXXXXXXXX or Newco, referred to herein, is or will be, subject to a guarantee agreement, within the meaning referred to in subsection 112(2.2) of the Act.

9. None of the issued shares of XXXXXXXXXX or Newco referred to herein has been or will be issued or acquired as part of a transaction or event or series of transactions or events of the type described in subsection 112(2.5) of the Act.

10. To the best of your knowledge and that of the officers and directors of XXXXXXXXXX, none of the issues involved in this advance income tax ruling request is under objection or appeal or is being considered by any of the District Taxation Offices or Taxation Centres of Revenue Canada, Taxation (the "Department") in connection with any tax return already filed.

PROPOSED TRANSACTIONS

11. XXXXXXXXXX will file Articles of Amendment pursuant to the XXXXXXXXXX to create the following new classes of shares:

XXXXXXXXXX Class A common, voting, participating shares with a par value of $XXXXXXXXXX each.

XXXXXXXXXX Class B common, voting, participating shares, of no par value, convertible into Class C preferred shares at the option of the holder, on the basis of a XXXXXXXXXX share exchange.

XXXXXXXXXX Class C preferred shares, non-voting, of no par value, having a non-cumulative dividend rate not exceeding XXXXXXXXXX%, redeemable and retractable at an amount equal to the fair market value of the consideration for which they are issued.

12. XXXXXXXXXX will cause Newco to be incorporated under the XXXXXXXXXX. Newco will be a Canadian-controlled private corporation and a taxable Canadian Corporation. XXXXXXXXXX will each subscribe for 50% of the common shares of Newco with consideration equal to the nominal fair market value of those shares.

13. The authorized share capital of Newco will consist of:

XXXXXXXXXX Class A common, voting, participating shares of no par value and convertible into Class B preference shares at the option of the holder, on the basis of a XXXXXXXXXX share exchange.

XXXXXXXXXX Class B preferred shares, non-voting, of no par value, having a non-cumulative dividend rate not exceeding XXXXXXXXXX %, redeemable and retractable at an amount equal to the fair market value of the consideration for which they are issued, and issuable as Series 1 and Series 2.

14. Each of XXXXXXXXXX will sell at fair market value an equal number of common shares of XXXXXXXXXX to Newco. The shares so transferred will have an aggregate fair market value at the time of the sale equal to the aggregate fair market value of the non-business assets of XXXXXXXXXX net of its liabilities described in paragraph 3 above at that time.

As sole consideration, Newco will issue to each of XXXXXXXXXX Class B Series 1 preferred shares having a redemption amount and fair market value equal to the fair market value of the XXXXXXXXXX shares transferred by XXXXXXXXXX, respectively.

15. XXXXXXXXXX and Newco, and XXXXXXXXXX and Newco, as the case may be, will jointly elect pursuant to subsection 85(1) of the Act, and within the time limit referred to in subsection 85(6) of the Act, in respect of a particular disposition of the common shares of XXXXXXXXXX. In respect of the elections the agreed amounts will be equal to the lesser of the cost amount to the respective transferor of such shares at the time of the disposition and the fair market value thereof at that time.

The term "cost amount" as used here and subsequently has the meaning assigned by subsection 248(1) of the Act.

16. XXXXXXXXXX will sell at fair market value to Newco the non-business assets described in paragraph 3 above. As consideration therefor, Newco will assume the current liabilities of XXXXXXXXXX described in that paragraph and will issue to XXXXXXXXXX Class B Series 2 preferred shares of Newco having an aggregate fair market value and redemption amount equal to the fair market value of the properties so transferred less the amount of current liabilities assumed by Newco. No election pursuant to subsection 85(1) of the Act will be made in respect of the non-business assets described herein. The fair market value of each of the non-business assets described herein will be equal to or exceed its respective cost amount.

17. Newco will redeem all of its Class B Series 2 preferred shares held by XXXXXXXXXX by issuing a non-interest-bearing promissory note, payable on demand, having a principal amount equal to the aggregate redemption amount of those shares.

The term "principal amount" as used here and subsequently has the meaning assigned by subsection 248(1) of the Act.

18. XXXXXXXXXX will purchase for cancellation all of its common shares held by Newco by issuing to Newco a non-interest-bearing promissory note, payable on demand, having a principal amount equal to the aggregate fair market value of those shares.

19. The promissory notes issued by Newco to XXXXXXXXXX and by XXXXXXXXXX to Newco, as described in paragraphs 17 and 18 respectively, will be set off against each other as payment in full of the obligations under those notes, and each such note will be cancelled.

20. Immediately after the completion of the transactions described in paragraphs 11 through 19 above, each of XXXXXXXXXX will sell at fair market value all of the remaining common shares of XXXXXXXXXX held by them to XXXXXXXXXX. These shares will be cancelled after they have been acquired by XXXXXXXXXX.

As sole consideration, XXXXXXXXXX will issue to each of XXXXXXXXXX Class B common shares and XXXXXXXXXX Class C preferred shares. The XXXXXXXXXX Class C preferred shares issued to each of XXXXXXXXXX will have an aggregate redemption amount equal to the fair market value of the XXXXXXXXXX shares transferred by them, respectively, less the aggregate amount added to the capital of the Class B common shares and Class C preferred shares of XXXXXXXXXX in respect of such shares issued as consideration for their XXXXXXXXXX shares.

21. XXXXXXXXXX and Newco, and XXXXXXXXXX and Newco, as the case may be, will jointly elect pursuant to subsection 85(1) of the Act, in prescribed form and within the time limit referred to in subsection 85(6) of the Act, in respect of a particular disposition of the common shares of XXXXXXXXXX. In respect of the elections, the agreed amounts will neither be in excess of the fair market value nor less than the cost amount to XXXXXXXXXX of such shares at the time of their disposition (the cost amount of a particular share will not exceed its fair market value at that time). The agreed amounts will also be determined in light of the amount of any deduction available to XXXXXXXXXX pursuant to subsection 110.6(2.1) of the Act in respect to these transfers.

The transfer will be subject to a price adjustment clause.

22. The note receivable from XXXXXXXXXX in the amount of $XXXXXXXXXX which is held by XXXXXXXXXX will be exchanged for two separate notes, one in the amount of $XXXXXXXXXX and one in the amount of $XXXXXXXXXX. These notes will carry the same terms as the original note and will have a fair market value to XXXXXXXXXX equal to their face amount.

23. XXXXXXXXXX will transfer to Newco the note receivable in the amount of $XXXXXXXXXX. In consideration Newco will issue to XXXXXXXXXX in full settlement a note in the amount of $XXXXXXXXXX with the same terms as the note issued by XXXXXXXXXX.

24. XXXXXXXXXX will each sell at fair market value an equal number of Class C preferred shares of XXXXXXXXXX to Newco. The shares so transferred will have an aggregate fair market value equal to that of the note receivable held by Newco and which was issued by XXXXXXXXXX in the principal amount of $XXXXXXXXXX.

As sole consideration, Newco will issue to each of XXXXXXXXXX Class B Series 1 preferred shares having a redemption amount equal to the fair market value of the XXXXXXXXXX shares transferred by them, respectively.

25. XXXXXXXXXX and Newco, and XXXXXXXXXX and Newco, as the case may be, will jointly elect pursuant to subsection 85(1) of the Act, and within the time limit referred to in subsection 85(6) of the Act, in respect of a particular disposition of the Class C preferred shares of XXXXXXXXXX. In respect of the elections the agreed amounts will be equal to the lesser of the cost amount to the respective transferor of such shares at the time of the disposition and the fair market value thereof at that time.

Newco will add to the stated capital account, that it maintains with respect to the Class B Series 1 preferred shares issued to XXXXXXXXXX, an amount not to exceed the aggregate paid-up capital, immediately before the dispositions, of the Class C preferred shares of XXXXXXXXXX transferred by them to Newco.

The transfers will be subject to a price adjustment clause.

26. XXXXXXXXXX will purchase for cancellation the Class C preferred shares held by Newco and acquired in the transaction described in paragraph 24 above by issuing to Newco a non-interest-bearing promissory note, payable on demand, having a principal amount equal to the aggregate fair market value of these shares.

27. The promissory notes issued by Newco to XXXXXXXXXX and by XXXXXXXXXX to Newco, as described in paragraphs 23 and 26 respectively, will be set off against each other as payment in full of the obligations under those notes, and each such note will be cancelled.

28. After the transfers described in paragraph 24 above, XXXXXXXXXX will transfer by way of a gift to XXXXXXXXXX all of their remaining Class C preferred shares and Class B common shares in XXXXXXXXXX.

PURPOSES OF THE PROPOSED TRANSACTIONS

29. XXXXXXXXXX wish to "purify" XXXXXXXXXX so that its shares will qualify as shares of a small business corporation within the meaning assigned under subsection 110.6(1) of the Act.

After qualifying these shares as shares of a small business corporation, XXXXXXXXXX also wish to "crystallize" the capital gain inherent in these shares.

Finally, XXXXXXXXXX wish to gift part of their shares in XXXXXXXXXX to their adult son XXXXXXXXXX.

RULINGS

Provided that the above statements of facts and proposed transactions are accurate and constitute complete disclosure of all the relevant facts and proposed transactions and that the proposed transactions are carried out as set forth herein, the following rulings are given:

A. Provided joint elections are filed pursuant to subsection 85(1) of the Act, within the time set forth in subsection 85(6) of the Act, the provisions of subsection 85(1) of the Act, other than paragraph (e.2) thereof, will apply to the dispositions by each of XXXXXXXXXX of:

(i) common shares of XXXXXXXXXX to Newco, as described in paragraph 14 above,

(ii) common shares of XXXXXXXXXX to XXXXXXXXXX, as described in paragraph 20 above, and

(iii) Class C preferred shares of XXXXXXXXXX to Newco, as described in paragraph 24 above

with the result that the agreed amounts in the transfers described in (i), (ii) and (iii) for the purposes of paragraph 85(1)(a) of the Act will be deemed to be the proceeds of disposition.

B. On the redemption of the Newco Class B Series 2 preferred shares held by XXXXXXXXXX described in paragraph 17 above, the purchase for cancellation of the XXXXXXXXXX common shares held by Newco described in paragraph 18 above, and the purchase for cancellation of the XXXXXXXXXX Class C preferred shares held by Newco described in paragraph 26 above:

(i) the holder of the shares will be deemed, pursuant to subsection 84(3) of the Act, to have received at that time a dividend equal to the amount, if any, by which the amount paid to redeem or purchase the particular shares exceeds the paid-up capital of the particular shares immediately before the redemption or purchase, as the case may be;

(ii) to the extent that the dividend described in (i) above is a taxable dividend, such dividend will, pursuant to subsection 112(1) of the Act, be deductible in computing the taxable income of the recipient for the year in which the dividend is deemed to have been received and such deduction will not be denied by any of subsections 112(2.1), 112(2.2), 112(2.3) or 112(2.4) of the Act; and

(iii) by virtue of the application of subparagraph 54(h)(x) of the Act, the amount of the deemed dividend will be excluded from the proceeds of disposition of the shares, and any loss in respect to the disposition of these shares will be reduced by those dividends pursuant to subsection 112(3) of the Act.

C. The recipients of the taxable dividends described in Ruling B above, will not be subject to tax under Part IV of the Act, except as provided in paragraph 186(1)(b) of the Act.

D. Part IV.1 of the Act will not apply to the deemed dividends described in Ruling B above because the dividends will be excepted dividends pursuant to paragraph 187.1(c) of the Act.

Part VI.I of the Act will not apply to the deemed dividends described in Ruling B above because the dividends will be excluded dividends pursuant to paragraph (a) of the definition of that term contained in subsection 191(1) of the Act.

E. The application of paragraph 84.1(1)(a) of the Act will result in a deduction in computing the paid-up capital of the Class B Series 1 preferred shares of Newco received by XXXXXXXXXX, respectively, as a result of the transactions described in paragraph 14 above.

F. The application of paragraph 84.1(1)(a) of the Act will result in a deduction in computing the paid-up capital of the Class B Series 1 preferred shares of Newco received by XXXXXXXXXX, respectively, as a result of the transactions described in paragraph 24 above.

G. The application of paragraph 85(2.1)(a) of the Act will result in a deduction in computing the paid-up capital of the Class B common shares and the Class C preferred shares of Newco received by XXXXXXXXXX, respectively, as a result of the transactions described in paragraph 20 above.

H. The provisions of subsections 74.1(1), 74.2(1) and 74.4(2) of the Act will not apply to the transfers of

(a) the common shares of XXXXXXXXXX to Newco described in paragraph 14 above,

(b) the common shares of XXXXXXXXXX to XXXXXXXXXX described in paragraph 20 above, and

(c) the Class C preferred shares of XXXXXXXXXX to Newco described in paragraph 24 above.

I. By virtue of paragraph 55(3)(a) of the Act, the provisions of subsection 55(2) of the Act will not apply to the deemed dividends described in Ruling B above, provided that there is not:

(a) a disposition of any property to a person with whom XXXXXXXXXX or Newco deals at arm's length for the purposes of the Act,

or

(b) a significant increase in the interest in any corporation of a person with whom XXXXXXXXXX or Newco deals at arm's length for the purposes of the Act,

which is subsequent to the proposed transactions described herein, and which is part of a series of transactions or events, determined with reference to subsection 248(10) of the Act, that includes such proposed transactions.

J. A common share of XXXXXXXXXX acquired by either XXXXXXXXXX as described in paragraph 2 above will constitute a qualified small business corporation share, within the meaning assigned that term under subsection 110.6(1) of the Act, of that individual at the Relevant Time.

K. The provisions of subsection 110.6(7) of the Act will not apply, as a result of the proposed transactions in and by themselves, to deny a deduction otherwise available under subsection 110.6(2.1) of the Act with respect to any capital gain arising on a disposition of the common shares of XXXXXXXXXX by either of XXXXXXXXXX or XXXXXXXXXX to XXXXXXXXXX as described in paragraph 20 above.

L. The provisions of subsection 80(1) of the Act will not apply, to the settlements by way of set-off, described in paragraphs 19 and 27 above, of the obligations evidenced by the promissory notes referred to in those paragraphs.

M. The provisions of subsection 80(1) of the Act will not apply as a result of the exchange of the single note receivable from XXXXXXXXXX held by XXXXXXXXXX for two separate notes receivable in the manner described in paragraph 22 above.

N. The provisions of paragraph 69(1)(b) of the Act will apply to the dispositions by XXXXXXXXXX of their remaining Class B common shares and Class C preferred shares of XXXXXXXXXX to XXXXXXXXXX as described in paragraph 28 above, such that they will be deemed to have received proceeds of disposition therefor equal to the fair market value of those shares at the time of their disposition.

O. The provisions of paragraph 69(1)(c) of the Act will apply to deem XXXXXXXXXX to have acquired the shares of XXXXXXXXXX described in Ruling M at a cost equal to their fair market value at the time of his acquisition thereof.

P. The provisions of subsections 15(1) and 56(2) of the Act will not apply to the proposed transactions, in and by themselves.

Q. The provisions of subsection 245(2) of the Act will not be applied as a result of the proposed transactions, in and by themselves, to redetermine the tax consequences confirmed in the rulings given.

These rulings are given subject to the limitations and qualifications set out in Information Circular 70-6R2 dated September 28, 1990 issued by Revenue Canada, Taxation and are binding provided that the proposed transactions are completed before XXXXXXXXXX.

These rulings are based on the Act and the Income Tax Regulations (the "Regulations") as they currently read and do not take into account any future amendments, whether currently proposed or not, to the Act or to the Regulations.

OTHER COMMENTS

1. Our favourable advance rulings as stated herein should not be considered as an indirect approval of any kind with respect to the possible operation of the price adjustment clauses referred to in paragraphs 21 and 25 above. The position of the Department with regard to price adjustment clauses is as stated in Interpretation Bulletin IT-169.

2. Nothing in the above rulings should be construed as implying that the Department has agreed to the amount, if any, of a deduction which may be available under subsection 110.6(2.1) of the Act, in respect of a capital gain realized on the disposition of the common shares of XXXXXXXXXX by either of XXXXXXXXXX as described in paragraph 14 above. Furthermore, the availability of such deduction is subject to the application of the provisions of subsection 110.6(8) of the Act.

Yours truly,

for Director
Reorganizations and Foreign Division
Specialty Rulings Directorate
Legislative and Intergovernmental
Affairs Branch