20 January 1998 External T.I. 9732385 - EXEMPTION FROM 55(2)

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:

1.whether proposed paragraph 55(3)(a) applies to a particular series of transactions

2.whether the shares which represent capital property to the transferor corporation will remain capital property when they are transferred under section 85 of the Act.

Position and Reasons:

1.the series of transactions is similar to that outlined in example 2 of the explanatory notes. The difference is that Profitco owns 50% of Target not 100%. The second difference is that Parentco has capital loss carry forwards. Therefore, the series of transactions involves a transfer of the shares of Target from Profitco to a Subco and the winding-up of Subco into Parentco.

All 5 tests in proposed paragraph 55(3)(a) appear to be met:

- the disposition of Target shares by Parentco to an unrelated person will be at fair market value

- Parentco and Subco are both related to Profitco, the dividend recipient.

- under proposed paragraph 55(3.01)(c), Parentco is deemed to be the same corporation as, and a continuation of, Subco.

2.It is the Department's position that the nature of the property should generally not change solely as a consequence of a transfer under section 85. This was stated at the 1984 Canadian Tax Foundation and reaffirmed at the 1995 APFF.

973238
XXXXXXXXXX F. Francis

Attention: XXXXXXXXXX

January 20, 1998

Dear Sirs:

Re: Proposed amendments to paragraph 55(3)(a) of the Income Tax Act (the "Act") contained in Bill C-28 which received first reading on December 10, 1997

This is in reply to your letter of December 8, 1997, wherein you requested a technical interpretation as to the application of proposed paragraph 55(3)(a) of the Act to the following situation:

- Parentco is a Canadian corporation within the meaning of the Act and owns a wholly-owned subsidiary Canadian corporation ("Profitco"). Profitco owns, among other things, 50% of the shares of a corporation ("Target") which it wishes to sell to an unrelated person. The fair market value of the shares of Target exceeds their adjusted cost base to Profitco. Parentco has capital loss carryforwards. Parentco wants the gain which will arise on the disposition of the shares of Target to be realized in Parentco rather than in Profitco. Parentco and Profitco have been affiliated and related, within the meaning of the Act, for a long period of time.

- It is contemplated that Profitco would transfer, on a tax-deferred basis under section 85 of the Act, the Target shares to another wholly-owned subsidiary of Parentco ("Subco") in consideration for High/Low Shares of Subco. Subco would then redeem its High/Low Shares which it had issued to Profitco with cash provided by Parentco.

- Subco would be wound-up into Parentco pursuant to the provisions of subsection 88(1) of the Act. Parentco would then sell some of the shares of Target to an unrelated person for proceeds of disposition equal to the fair market value of the shares.

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 70-6R3 dated December 30, 1996 issued by Revenue Canada. However, we can offer the following comments which we hope will be of assistance to you.

We concur that the dividends arising on the redemption by Subco of the High/Low Shares will not be subject to subsection 55(2) of the Act since they meet the exception in proposed paragraph 55(3)(a). We further note that it is the Department's position that, where a transfer of property occurs under subsection 85(1) of the Act between related members of a corporate group, the nature of the property transferred will generally not have changed solely as a result of the transfer.

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