1998 Ruling 9730943 - 21-YEAR RULE

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:

Proposed reorganization to mitigate the tax consequences of the 21-year deemed disposition rule that would otherwise apply on XXXXXXXXXX to a testamentary trust which owns all the common shares of a private corporation . The proposed transactions will result in the creation of voting participating dividend paying shares and non-voting non-participating non-dividend paying shares followed by the distribution by the trust of the non-voting non-participating non-dividend paying shares and the streaming of the ACB and PUC to one class of shares using 85(1)(g).

1. Will the proposed reorganization of the share capital of the company wholly owned by a trust result in the transfer of the trust's ACB in the existing common shares to the class B preferred shares pursuant to 85(1)(g)?

2. Will the disclaimer by the widow of a portion of her interest in the trust result in any tax consequences to her?

3. Will the variation of the trust constitute a disposition by the trust to a new trust?

4. Will the variation of the trust constitute a disposition of any beneficial interest in the trust?

5. Will the distribution of the preferred shares (with all the accrued gains) to the beneficiaries be deemed to occur at the cost amount pursuant to 107(2)?

6. Will GAAR apply?

Position:

1. Yes 2. The widow will be considered not to have received any proceeds of disposition for the purpose of sections 106 and 107 of the Act. 3. No disposition of the trust property. 4. No disposition of the beneficiary's interest for the purposes of sections 106 and 107 of the Act. 5. Yes. 6. No.

Reasons:

1. 85(1)(g) specifically provides that the cost is allocated first to any preferred shares. 2. Release or surrender without any direction. 3-4. The variation to permit the trustees to distribute property at any time is not significant enough in nature to result in any disposition of the trust property of the beneficiary's interest in the trust. 5. Distribution by the trust in satisfaction of the beneficiary's capital interest in the trust. 6. 85(1)(g) specifically provides that the cost is allocated first to any preferred shares. Distribution of the preferred shares with all the accrued gains to the beneficiaries not offensive given that any gain would be realized when the beneficiaires subsequently disposed of or are deemed to dispose of the shares. This result was contemplated when the 21 year rule was re-enacted in 1995.

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XXXXXXXXXX 3-973094
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Attention: XXXXXXXXXX

XXXXXXXXXX, 1998

Dear Sirs:

Re: The Testamentary Trust (XXXXXXXXXX)
XXXXXXXXXX
Advance Income Tax Ruling

This is in reply to your letter of XXXXXXXXXX, in which you requested an advance income tax ruling on behalf of the above-noted trust and beneficiaries under the trust in respect of the income tax consequences arising out of the proposed transactions described below. We also acknowledge your correspondence of XXXXXXXXXX.

We understand that to the best of your knowledge, and that of the taxpayers involved, none of the matters considered in this ruling request are:

(a) in an earlier return of the taxpayers or related persons;

(b) being considered by a tax services office or tax centre in connection with a previously filed tax return of the taxpayers or related persons;

(c) under objection by the taxpayers or related persons;

(d) before the courts; or

(e) the subject of a ruling previously issued by this Directorate to the taxpayers or related persons.

In this letter, unless otherwise indicated, all statute references are to the Canadian Income Tax Act and Regulations (R.S.C. 1985, 5th Supplement, c.1, as amended) (the "Act"), and the following terms have the meanings specified:

a) "Adjusted cost base" has the meaning assigned by section 54 of the Act;

b) XXXXXXXXXX;

c) "Capital property" has the meaning assigned by section 54 of the Act;

d) "Cost amount" has the meaning assigned by subsection 248(1) of the Act unless otherwise specified;

e) "Grandchildren" currently means XXXXXXXXXX collectively;

f) "Inheriting Child" currently means XXXXXXXXXX individually;

g) "Inheriting Children" currently means XXXXXXXXXX collectively;

h) "ITAR" refers to the Income Tax Application Rules;

i) "Mr. A" means XXXXXXXXXX;

j) "Opco" means XXXXXXXXXX Ltd;

k) "Paid-up capital" has the meaning assigned by subsection 89(1) of the Act;

l) "Set of Grandchildren" means the children of an Inheriting Child;

m) "Taxable Canadian corporation" has the meaning assigned by subsection 89(1) of the Act;

n) "Trust" means the Trust created by the terms of the XXXXXXXXXX last will;

o) "Trustees" means XXXXXXXXXX collectively;

p) "V-day" means the expression "valuation day" and has the meaning assigned by section 24 of the ITAR; and

q) "Widow" means XXXXXXXXXX surviving spouse, XXXXXXXXXX.

The names and addresses of the taxpayers who are parties to this ruling request, as well as the tax services office or tax centre where their returns are filed, are listed in Schedule A.

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

FACTS

1. Mr. A died on XXXXXXXXXX.

2. Probate of Mr. A's will dated XXXXXXXXXX, was granted to the Trustees by the XXXXXXXXXX.

3. The terms of Mr. A's will provide that the residue of the Mr. A's estate is to be held in the Trust upon the following terms:

a) until the remarriage or death of the Widow, to pay the income therefrom to her;

b) upon the remarriage of the Widow, XXXXXXXXXX of the income is to be paid to her and XXXXXXXXXX of the income is to be paid in equal shares to the Inheriting Children; provided, however, that if the Widow subsequently ceases to be married, the totality of the income will again be paid to the Widow;

c) on the death of the Widow, the Trust property then remaining shall be held in equal shares for the Inheriting Children. The income from each Inheriting Child's share shall be paid to the Inheriting Child and XXXXXXXXXX. If an Inheriting Child predeceases the Widow or surviving her dies before attaining the age of XXXXXXXXXX, the share of such deceased Inheriting Child shall be distributed to the children of such deceased Inheriting Child, if any, or, if none, to the issue of Mr. A then alive in equal shares per stirpes;

d) during the lifetime of the Widow, the Trustees may encroach upon the capital of the Trust property for the benefit of the Widow to maintain her standard of living and to defray the expense of any illness or unforeseen contingency; and

e) at any time, including during the lifetime of the Widow, the Trustees may advance to the Inheriting Children a portion of their respective expectant share in the Trust property; however, the power of advancement can only be exercised if and to the extent that the Inheriting Children require financial assistance.

4. The Trust is resident in Canada, is a "testamentary trust" as defined in subsection 108(1) of the Act and is a "personal trust" as defined in subsection 248(1) of the Act.

5. The Widow is presently XXXXXXXXXX years of age. The Inheriting Children are currently between ages XXXXXXXXXX. The Grandchildren are presently less than XXXXXXXXXX years of age.

6. The Inheriting Children and the Grandchildren are residents of Canada.

7. The Trust property consists of XXXXXXXXXX common shares in the authorized capital of Opco, which have an aggregate paid-up capital of $XXXXXXXXXX. The XXXXXXXXXX common shares in Opco are capital property to the Trust that were acquired by the Trust on the death of Mr. A. Those shares were held by Mr. A on V-day. Opco is a taxable Canadian corporation which owns XXXXXXXXXX.

8. An appraisal conducted by XXXXXXXXXX has determined that the fair market value ("FMV") of the shares in Opco as of XXXXXXXXXX, is $XXXXXXXXXX. XXXXXXXXXX will be consulted to determine if any adjustment to the FMV of the shares in Opco is necessary before the Trust enters into the proposed transactions below.

9. The adjusted cost base ("ACB") of the XXXXXXXXXX common shares in Opco owned by the Trust is $XXXXXXXXXX.

10. Pursuant to subsection 104(5.3) of the Act, the Trust has, within the prescribed time, filed an election to defer the deemed disposition of the XXXXXXXXXX common shares in Opco that would otherwise have occurred on XXXXXXXXXX. The election was filed before XXXXXXXXXX.

11. Pursuant to subsection 104(4) of the Act, the Trust will be deemed to have disposed of its XXXXXXXXXX common shares in Opco on XXXXXXXXXX (the "deemed disposition day").

PROPOSED TRANSACTIONS

12. The authorized capital of Opco will be altered as follows:

a) by redesignating the existing common shares as class D common shares;

b) by creating XXXXXXXXXX class A voting common shares, which will have no par value, which will be entitled to dividends but no dividends will be paid if such payment will impair the ability of Opco to redeem any of the preferred shares then outstanding;

c) by creating XXXXXXXXXX class B non-voting redeemable retractable preferred shares, which will have a par value of $XXXXXXXXXX each and which will be entitled to cumulative preferential dividends at the rate of XXXXXXXXXX% of the redemption price ($XXXXXXXXXXper share issued) but no dividends will be paid if such payment will impair the ability of Opco to redeem any of the preferred shares then outstanding; and

d) by creating XXXXXXXXXX class C non-voting redeemable retractable preferred shares, which will have a par value of $XXXXXXXXXX each, an aggregate redemption price equal to the aggregate FMV received by Opco as consideration for the issuance of such shares less the value of any non-share consideration paid by Opco as partial or total consideration for the assets (subject to a price adjustment clause) and which will not be entitled to dividends.

13.

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14. The Trust will transfer its XXXXXXXXXX class D common shares in Opco to Opco in consideration for XXXXXXXXXX class B preferred and XXXXXXXXXX class A common shares in Opco pursuant to subsection 85(1) of the Act. The Trust and Opco will jointly elect for the transfer to occur at the amount (the "elected amount") that is equal to the Trust's ACB of the class D common shares immediately before the transfer. The directors of Opco will determine the aggregate redemption price of the XXXXXXXXXX class B preferred shares issued to the Trust to be equal to the elected amount.

15. The Trust will then transfer its XXXXXXXXXX class A common shares in Opco to Opco in consideration for XXXXXXXXXX class C preferred shares in Opco. The Trust and Opco will file an election pursuant to subsection 85(1) of the Act electing for the transfer to occur at $XXXXXXXXXX.

16. The Trust will then subscribe for XXXXXXXXXX class A common shares for an aggregate subscription price of $XXXXXXXXXX.

17. At the conclusion of the transactions described above the Trust will own the following shares in Opco having the following attributes:

Shares				     ACB		      FMV

XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX

18. The Widow will execute a Deed of Disclaimer to release or surrender part of her income interest and discretionary capital interest in the Trust for no consideration. She will not direct in any manner who is entitled to receive the benefits under the Trust. The text of the operative part of the Deed of Disclaimer will be:

"I, the Widow, do hereby expressly disclaim, release and surrender now and forever for myself and for my heirs, all of the right, title and interest to or in the class C preferred shares and all of the right, title and interest in and to the net income or the capital of the Trust which derives or is comprised of the class C preferred shares of Opco."

The Widow will seek and receive independant legal advice in connection with the Deed of Disclaimer before the execution thereof. The Disclaimer is subject to approval of the XXXXXXXXXX.

19. An application will be made to the XXXXXXXXXX to vary the terms of the Trust to permit the Trustees to encroach on the capital of the Trust at any time in order to distribute part of the Trust property prior to the deemed disposition day. Since the Grandchildren are contingent beneficiaries under the Trust it is expected that the court will require a portion of the Trust property to be set aside for them.

20. Pursuant to the variation of the Trust, three new trusts will be created for each Set of Grandchildren. The new trusts will be resident in Canada.

21. Each new trust for a Set of Grandchildren will have the following terms:

a) until the date of death of the Widow, the income derived from the new trust will be paid to such Set of Grandchildren in equal shares if more than one; provided that if the Inheriting Child has no children, the income will be accumulated and added to the capital of the new trust; and

b) upon the date of death of the Widow, the property of the new trust will be distributed to such Set of Grandchildren in equal shares if more than one; provided that if the Inheriting Child has no children living at the date of death of the Widow, the property of the new trust will be distributed to the Inheriting Child; provided further that if the Inheriting Child predeceases the Widow, leaving no children living at the date of death of the Widow, the property of the new trust will be distributed to the Inheriting Children then living, in equal shares per stirpes.

22. The fair market value of the Grandchildren's interests in the Trust will be determined, after obtaining a valuation by a qualified actuary, pursuant to negotiations with the Public Trustee of XXXXXXXXXX.

23. Once court approval is obtained, the Trust will cause Opco to redeem some of its class C preferred shares and the after tax redemption proceeds will be used to fund the three new trusts as described in paragraph 25 below.

24. Once court approval is obtained, the class C preferred shares in Opco remaining in the Trust subsequent to the redemption in paragraph 23 above will be distributed to the Inheriting Children in equal shares in satisfaction of their interests in the Trust prior to the Trust's deemed disposition day.

25. Once court approval is obtained, the three new trusts will initially be settled with a nominal amount by the Trustees of the Trust. Subsequent to the distribution in paragraph 24 above, an additional amount will be distributed by the Trustees to the three new trusts in satisfaction of the Grandchildren's interests in the Trust. The aggregate amount distributed to the three new trusts will be equal to the fair market value of the Grandchildren's interests in the Trust as determined pursuant to negotiations with the Public Trustee of XXXXXXXXXX.

26. The class A common shares in Opco (which will have a nominal value but will represent voting control and the future growth in the value of Opco) will continue to be held in the Trust, under its present form. The class B preferred shares (which will have an ACB and an aggregate redemption price of $XXXXXXXXXX) will also continue to be held by the Trust under its present form.

27. All transactions will be completed prior to XXXXXXXXXX.

PURPOSE OF THE PROPOSED TRANSACTIONS

28. The objectives of the proposed transactions are to ensure that (1) the Widow receives an income stream equivalent to what she had before the series of transactions, (2) the Trust provides a base ($XXXXXXXXXX) for capital encroachments in favour of the Widow if necessary, (3) the Trustees continue to manage and control the Trust property, (4) the tax consequences of the deemed disposition of the Trust property on the deemed disposition day pursuant to subsection 104(4) of the Act are mitigated by distributing property representing the accrued gains to the Inheriting Children under subsection 107(2), (5) the Inheriting Children do not receive the right to participate directly in the future growth of Opco before the death of the Widow, and (6) on the death of the Widow, the Inheriting Children receive the remaining assets of the Trust in accordance with the terms of Mr. A's will.

29. The purpose of the three new trusts is to reflect the fact that the value of the interests of each Set of Grandchildren is different. The value of the interest in the Trust of each Set of Grandchildren depends upon the probability of the parent of that Set of Grandchildren predeceasing the Widow.

RULINGS GIVEN

Provided that the above statements are accurate and constitute complete disclosure of all the relevant facts, proposed transactions and purpose thereof and the proposed transactions are carried out as described herein, our advance income tax rulings are as follows:

A. Provided that joint elections are filed in prescribed form within the time set forth in subsection 85(6) of the Act and subject to the application of the provisions in subsection 26(5) of the ITAR, the provisions of subsection 85(1) will apply to:

the transfer of the XXXXXXXXXX class D common shares of Opco held by the Trust to Opco as described in paragraph 14 above;

with the result that the amount agreed upon by the Trust and Opco in their joint election in respect of the transferred shares will be deemed pursuant to paragraph 85(1)(a) of the Act to be the proceeds of disposition thereof to the Trust and cost thereof to Opco.

B. The cost to the Trust of the class B preferred shares of Opco received as partial consideration for the transfer of the class D common shares to Opco as described in paragraph 14 above will be deemed by paragraph 85(1)(g) of the Act to be equal to the deemed proceeds of disposition to the Trust of the transferred shares as referred to in ruling A.

C. The Widow will not be considered to have received any proceeds of disposition for the purposes of sections 106 and 107 of the Act as a result of executing the Deed of Disclaimer described in paragraph 18 above.

D. The variation of the Trust to permit the Trustees to encroach on the capital of the Trust in order to distribute Trust property to the Inheriting Children and to pay amounts to the three new trusts in satisfaction of the Grandchildren's interests, if so approved by the court will not, in and by itself, result in a disposition for income tax purposes of any property of the Trust or any beneficiary's interest in the Trust for purposes of sections 106 or 107 of the Act.

E. The distribution of the Trust property held by the Trust to the Inheriting Children will be subject to the provisions of subsection 107(2) of the Act.

F. Subsection 245(2) of the Act will not be applied to redetermine the tax consequences of rulings A to E above as a result of the proposed transactions described herein.

The above rulings are given subject to the general limitations and qualifications set out in Information Circular 70-6R3, Advance Income Tax Rulings, and are binding on Revenue Canada provided that the Deed of Disclaimer is worded and executed as described in paragraph 18 above, court approval of the variation is obtained and the proposed transactions are completed and effective before XXXXXXXXXX.

COMMENTS

1. Nothing in this letter should be construed as implying that Revenue Canada has agreed to or accepted:

a) The determination of the FMV, ACB, or V-day value of any property referred to herein or the paid-up capital of any shares referred to herein; or

b) Any tax consequences arising from the facts or proposed transactions described above other than those specifically confirmed in the rulings given.

2. Nothing in this letter should be construed as confirming that, for the purposes of any of the rulings given herein, any adjustment to the redemption price of the preferred shares referred to in paragraph 12 pursuant to the operation of the price adjustment clause will be effective retroactively to the time of the exchange of the class A common shares for class C preferred shares of Opco.

The operation of a price adjustment clause is not a proposed transaction and, consequently, advance income tax rulings are not given by the Department in respect thereof. The Department's general position with respect to price adjustment clauses is as stated in Interpretation Bulletin IT-169 issued by Revenue Canada, Customs, Excise and Taxation.

Yours truly,

for Director
Resources, Partnerships and Trusts Division
Income Tax Rulings and Interpretations Directorate
Policy and Legislation Branch

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