20 January 1998 External T.I. 9729235 - INTERNAL 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.

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: whether proposed 55(3)(a) applies to a particular series of transactions

Position:

no

Reasons: In order for the exemption in proposed subparagraph 55(3)(a) to apply, 5 tests have to be met. In this particular situation, the provisions of subparagraph (ii) are offended. Similar to response given in file 950022

xxxxxxxxxx 972923
F. Francis

Attention: xxxxxxxxxx

January 20, 1998

Dear Sirs:

Re: Interpretation of proposed paragraph 55(3)(a) in Bill C-28 which received first reading on December 10, 1997 ("proposed paragraph 55(3)(a)")

This is in reply to your letter of October 30, 1997, wherein you requested a technical interpretation in respect of the following situation:

1. VCO is a Canadian-controlled private corporation which owns land and a building out of which it operates an active business.

2. The shareholders of VCo are as follows:

Mr. S. 70 common shares (35%)
Mr. D. 70 common shares (35%)
Mr. SJ. 60 common shares (30%)

3. Mr. S. is the father of Mr. SJ.

4. Mr. D. is unrelated to both Mr. S. and Mr. SJ, for purposes of the Income Tax Act (the "Act").

5. The particulars of the land and building are as follows:

		Original cost		UCC			FMV

Land		$ 29,000		N/A			$ 40,000
Building	 281,000		$103,000		$360,000
		$310,000					$400,000

6. VCo is contemplating a reorganization in order to separate the land and building from the risk of the ongoing business operations.

7. Holdco will be incorporated, the shareholders of which will be as follows:

Mr. S. 70 common shares (35%)

Mr. D. 70 common shares (35%)

Mr. SJ. 60 common shares (30%)

8. The shareholders of VCO will transfer their shares of VCo to Holdco electing under the provisions of subsection 85(1) of the Act at adjusted cost base. VCO will then be a wholly owned subsidiary of Holdco.

9. Newco will be incorporated as a wholly owned subsidiary of Holdco.

10. The land and building owned by VCo will be transferred to Newco electing under subsection 85(1) of the Act at ACB and uCC respectively. In exchange, Newco will issue 400,000 preference shares to VCO. These 400,000 preference shares will have a redemption value of $400,000 in total and a paid up capital of $132,000 in total.

11. Newco will then redeem the 400,000 preference shares and issue a promissory note to VCo in the amount of $400,000.

12. VCO will then declare and pay a dividend of $400,000 to Holdco, payment of which will be made by assigning the $400,000 promissory note issued previously by Newco to Holdco.

You pose the following questions:

a) Will the deemed dividend arising on the redemption of 400,000 preference shares by Newco be allowed as a deduction by VCo under subsection 112(1) of the Act and not be deemed proceeds or capital gain as contemplated by proposed section 55.

b) Will a contemplation of a sale of shares of Holdco by Mr. D. to either Mr. SJ. or an arm's length party affect the answer to question a) above.

c) Will a subsequent amalgamation of Holdco and Newco affect the answers to questions a) and b) above.

Our Comments

The situation described in your letter would appear to involve an actual proposed transaction. Assurance as to the tax consequences of actual proposed transactions will only be given in the context of an advance income tax ruling. The procedures for requesting an advance income tax ruling are outlined in Information Circular 706R3 dated December 30, 1996 issued by Revenue Canada. However, we can offer the general comments which we hope will be of assistance to you.

Paragraph 55(3)(a) of the Act provides an exemption from the application of subsection 55(2) of the Act for dividends received in certain related party transactions. In particular, proposed subparagraph 55(3)(a)(ii) provides that the exemption in paragraph 55(3) (a) will not apply to dividends received by a corporation if, as part of a transaction or event or series of transactions or events in which the dividend was received, there was at any particular time an increase in the total direct interest in any corporation of one or more persons who were unrelated persons immediately before the particular time, unless the increase resulted from a disposition of shares of a corporation for proceeds of disposition that are not less than the fair market value of those shares at the time of the increase.

In the situation described above, we note that Mr. D. will not be related to VCO, the dividend recipient. Accordingly, by virtue of proposed paragraph 55(3.01)(a), Mr. D. is an unrelated person. Consequently, in our view, proposed paragraph 55(3)(a) will not apply because Mr. D., an unrelated person, will increase his direct interest in Holdco. The deemed dividends arising on the redemption of the 400,000 preference shares by Newco will therefore be subject to the provisions of subsection 55(2) of the Act. Further, the additional facts contained in questions b) and c) above will not affect this response.

We trust our comments will be of assistance to you.

Yours truly,

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