23 October 1995 External T.I. 9513425 - ARM'S LENGTH TEST

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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues:

At what point in time is the arm's length test in subparagraph 88(1)(d)(i.1) of the Act applied.

Position TAKEN:

The arm's length test is applied at the time inter-corporate dividends are paid.

Reasons FOR POSITION TAKEN:

The closing words of paragraph 88(1)(d) of the Act deem a new corporation to have been in existence from the time the parent was incorporated and to have been not dealing at arm's length with any corporation which was not dealing at arm's length with its parent. Subparagraph 88(1)(d)(i.1) of the Act is then applied whenever there have been inter-corporate dividends to determine if the "bump" under paragraph 88(1)(d) of the Act is reduced when wholly-owned subsidiaries are wound up.

		951342
XXXXXXXXXX	A. Seidel

Attention: XXXXXXXXXX

October 23, 1995

Dear Sirs:

This is in reply to your letter dated May 5, 1995 in which you requested a technical interpretation of the provisions of paragraph 88(1)(d) of the Income Tax Act (the "Act").

It appears that the interpretation you seek relates to specific taxpayers and, therefore, we bring to your attention Information Circular 70-6R2 dated September 28, 1990 and the Special Release thereto dated September 30, 1992, issued by Revenue Canada, Customs, Excise and Taxation. Confirmation with respect to proposed transactions involving specific taxpayers will only be provided in response to a request for an advance income tax ruling. If you wish to obtain an advance income tax ruling for particular taxpayers with respect to specific contemplated transactions, a written request for an advance income tax ruling should be submitted in accordance with the Information Circular. Nevertheless, we can offer the following general comments in response to your letter.

You have described a situation where a corporation ("Targetco") owns all of the shares of a second corporation ("Subco 1") and Subco 1 owns all of the shares of a third corporation ("Subco 2"). An arm's length corporation ("Acquisitionco") will acquire all of the shares of Targetco. Prior to the acquisition of the shares of Targetco by Acquisitionco, Subco 1 has paid taxable dividends to Targetco and Subco 2 has paid taxable dividends to Subco 1. Acquisitionco will then transfer the shares of Targetco to a newly incorporated subsidiary ("Newco"). Newco will then enter into a series of transactions whereby it will wind-up Targetco, Subco 1 and Subco 2. In filing its income tax return for the year in which Targetco, Subco 1 and Subco 2 are wound up, Newco will designate an amount in respect of each capital property received on the wind-ups pursuant to paragraph 88(1)(d) of the Act (herein referred to as the "88(1)(d) bump"). You have requested confirmation that the provisions of subparagraph 88(1)(d)(i.1) of the Act will not apply to reduce the 88(1)(d) bump available to Newco by the amount of the taxable dividends paid by Subco 2 to Subco 1 and by Subco 1 to Targetco prior to the acquisition of the shares of Targetco by Acquisitionco.

The closing words of paragraph 88(1)(d) ("the post-amble deeming provision") provide as follows:

"and for the purposes of this paragraph, where a parent corporation has been incorporated or otherwise formed after the time any other corporation (other than a corporation acquired by it from a person with whom it was dealing at arm's length) with which it did not deal at arm's length at any time prior to the winding-up was incorporated or otherwise formed, the parent corporation shall be deemed to have been in existence from the time of formation of the other corporation and to have been not dealing at arm's length with the other corporation from that time".

Therefore Newco is deemed to have been in existence from the time of the formation of Acquisitionco and to have been not dealing at arm's length with Acquisitionco and it is also deemed to have been in existence from the time that Targetco, Subco 1 and Subco 2 were incorporated and to have been not dealing at arm's length with Targetco, Subco 1 and Subco 2 since that time.

Pursuant to paragraph 88(1)(d.2) of the Act, Newco is deemed to have acquired control of Targetco at the time that Acquisitionco acquired the shares of Targetco and not at the time the shares were transferred to it by Acquisitionco. However, paragraph 88(1)(d.2) of the Act does not deem Newco to have acquired the shares of Targetco and therefore the post-amble deeming provision would apply to Newco.

It is our view that the arm's length test in subparagraph 88(1)(d)(i.1) is applied at the time that the dividends were received by Subco 1 and Targetco, respectively. Accordingly, in the situation you have described above, the dividends paid by Subco 1 to Targetco prior to the acquisition of the shares of Targetco by Acquisitionco and the subsequent transfer thereof to Newco would be dividends described in subparagraph 88(1)(d)(i.1) with respect to the winding-up of Subco 1 into Newco since Targetco and Newco are deemed by the post-amble deeming provision not to have been dealing at arm's length at the time that such dividends were received by Targetco. Similarly, dividends paid by Subco 2 to Subco 1 prior to the acquisition of the shares of Targetco by Acquisitionco and the subsequent transfer thereof to Newco would be dividends described in subparagraph 88(1)(d)(i.1) with respect to the winding-up of Subco 2 into Newco, since Subco 1 and Newco are deemed by the post-amble deeming provision not to have been dealing at arm's length at the time that such dividends were received by Subco 1. Accordingly, the amount of the 88(1)(d) bump that Newco may designate on the winding-up of Targetco, Subco 1 and Subco 2 will be reduced by the amount of the taxable dividends paid by Subco 2 to Subco 1 and by Subco 1 to Targetco.

These comments are provided in accordance with the guidelines set out in paragraph 21 of Information Circular 70-6R2.

Yours truly,

for Director
Reorganizations and Foreign Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch