8 September 1995 External T.I. 9318215 F - Transfers Between Related Corporations

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:

Would 55(2) apply in a situation where transactions are undertaken among 2 brothers' holding companies and an operating company owned equally by the brothers?

POSITION TAKEN:

55(2) would apply since series includes transfers between unrelated persons.

REASONS FOR POSITION TAKEN:

The application of 55(5)(e)(i) results in the brothers not being a related group so relation could not be established between the holding companies and the operating company.

XXXXXXXXXX

Attention:  XXXXXXXXXX

Dear Sirs:

Re:  Subsection 55(2) of the of the Income Tax Act 1

We are writing in response to your letter of June 15, 1995 wherein you requested our comments on whether subsection 55(2) will apply in the hypothetical situation described below.  We apologize for the delay in our reply.

Situation

•      Brothers A and B respectively own all of the shares of Aco and Bco.  Each of Aco and Bco is a Canadian- controlled private corporation ("CCPC") and a taxable Canadian corporation ("TCC").  The terms "CCPC" and "TCC", as used here and subsequently, have the meanings assigned by subsections 125(7) and 89(1), respectively.

•      The assets of Aco and Bco each consist of cash which represents between 10 and 50 percent of the fair market value ("FMV") of the assets of the company and a 50 percent interest in Opco.  Opco is a CCPC and a TCC which carries on an active business in Canada and uses more than 50 but less than 90 percent of the FMV of its assets in the active business.  The term "active business", as used here and subsequently, has the meaning assigned by subsection 248(1).

•      Each of the shares of Aco and Bco is not a qualified small business corporation share ("QSBC share") which, as used here and subsequently, has the meaning assigned by subsection 110.6(1).

•      In order for the shares of Aco and Bco to become QSBC shares, subject to the twenty four month holding period requirement, Opco will transfer, pursuant to section 85, equal undivided interests in certain assets to Aco and Bco with the result that more than 90 percent of Opco's assets will be used in an active business.  As consideration, Opco will receive an equal number of preferred shares of Aco and Bco which will be redeemable and retractable at an amount equal to the FMV of the assets so transferred and which will have a nominal paid-up capital.  The term "paid-up capital" has the meaning assigned by subsection 89(1).  The preferred shares of Aco and Bco will be redeemed at their redemption amount which will be paid by the issuance of demand promissory notes.  Opco will purchase for cancellation from each of Aco and Bco an equal number of its common shares having a FMV equal to the redemption amount of the preferred shares of Aco and Bco redeemed by Opco.  The purchases for cancellation will be paid by the issuance of demand promissory notes.  The notes owing by Opco to Aco and Bco and the notes owing by Aco and Bco to Opco will then be offset.

•      In a similar manner to that described above, each of Aco and Bco will respectively transfer the undivided interests that each received from Opco, as described in paragraph  above, and all or a portion of its cash to Cco and Dco, newly formed companies all the shares of which are owned respectively by A and B, with the result that each of Aco and Bco will have more than 90 percent of the FMV of their assets used in an active business.  Each of Cco and Dco is a CCPC and a TCC.

•      No sale of any of the shares of Opco, Aco, Bco, Cco and Dco is presently contemplated.

Your question

Since subparagraph 55(5)(e)(i) deems A not to be related to B for the purposes of section 55, would subsection 55(2) apply to the dividends deemed to be received by Opco, Aco, Bco, Cco and Dco pursuant to subsection 84(3) as a result of the redemptions and purchases for cancellation?

Comments

•      Subparagraph 55(5)(e)(i) deems A and B not to be related to each other and to be dealing with each other at arm's length.  Subparagraph 55(5)(e)(i) prevents A and B from being a related group which controls Opco. The term "related group", as used here and subsequently, has the meaning assigned by subsection 251(4).

•      A is related to Aco and Cco and B is related to Bco and Dco by virtue of subparagraph 251(2)(b)(i).  Aco and Cco are related to each other and Bco and Dco are related to each other by virtue of subparagraph 251(2)(c)(i).  None of Aco, Bco, Cco and Dco are related to Opco under the provisions of paragraph 251(2)(c) since A and B are not members of a related group that controls Opco.

It is our view that a dividend deemed to be paid: by Opco to Aco or Bco; between Aco and Cco; or between Bco and Dco; will not be exempted from the application of subsection 55(2) by virtue of subparagraph 55(3)(a)(i) since the payment of the dividend is part of a series of transactions or events that resulted in a disposition of property (the purchase for cancellation of the shares of Opco held by Aco and Bco) to a person (Opco) to whom the dividend recipient was not related. A dividend deemed to be paid by Aco or Bco to Opco will not be exempted from the application of subsection 55(2) by virtue of subparagraph 55(3)(a)(i) since the payment of the dividend is part of a series of transactions or events that resulted in a disposition of property (Opco's assets) to a person (Aco or Bco) to whom the dividend recipient is not related.

It is also our view that the transfer of certain property by Opco to Aco and Bco will not meet the definition of "distribution" found in subsection 55(1) since the distributing corporation (Opco) will not transfer the appropriate proportion of each type of property to the transferee corporations (Aco and Bco).

The foregoing comments are given in accordance with the practice referred to in paragraph 21 of Information Circular 70-6R2 dated September 28, 1990 and are not binding on Revenue Canada.

Yours truly

for DirectorReorganizations and Foreign DivisionIncome Tax Rulings and Interpretations DirectoratePolicy and Legislation Branch

ENDNOTES

1     All statutory references in this letter are to the Income Tax Act (Canada), R.S.C. 1985 (5th Supp.) c. 1, as amended.