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: This is a single-wing butterfly involving a farm corporation. According to the original ruling request, one of the shareholders would only transfer half of her shares in the farm corporation to a transferee corporation. This would not constitute a permitted exchange under section 55 of the Act because the conditions in subparagraphs (b)(ii) or (iii) of the definition of "permitted exchange" would not be met in respect of the transfer.
Position: The ruling request was modified so that the transfers complied with the definition of "permitted exchange". In other respects, this was a standard butterfly reorganization.
Reasons:
XXXXXXXXXX
XXXXXXXXXX 980008
XXXXXXXXXX
Attention: XXXXXXXXXX
XXXXXXXXXX, 1998
Dear Sirs:
Re: XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
Advance Income Tax Ruling
We are writing in response to your letter of XXXXXXXXXX wherein you requested an advance income tax ruling on behalf of the above-referenced taxpayers. In your letters of XXXXXXXXXX you provided additional information in respect of, and amendments to, the facts and proposed transactions described in your original letter. We also acknowledge the information provided during our various telephone conversations (XXXXXXXXXX).
To the best of your knowledge, and that of the taxpayers involved, none of the issues contained herein:
(i) is in an earlier return of the taxpayers or a related person;
(ii) is being considered by a tax services office or taxation centre in connection with a previously filed tax return of the taxpayers or a related person;
(iii) is under objection by the taxpayers or a related person; and
(iv) is before the courts or, if a judgement has been issued, the time limit for appeal to a higher court has not expired.
Unless otherwise stated all references to a statute are to the Income Tax Act (Canada), R.S.C. 1985 (5th Supp.), c.1, as amended, (the "Act").
In this letter, the following terms have the meanings specified:
(a) "adjusted cost base" ("ACB") has the meaning assigned to that term in section 54 of the Act;
(b) "BCA" means the Business Corporations Act (XXXXXXXXXX) and, where applicable, its predecessor statutes;
(c) "Canadian-controlled private corporation" ("CCPC") has the meaning assigned by subsection 125(7) of the Act;
(d) "capital dividend account" ("CDA") has the meaning assigned to that term by subsection 89(1) of the Act;
(e) "capital property" has the meaning assigned to that term in section 54 of the Act;
(f) "cost amount" has the meaning assigned to that term by subsection 248(1) of the Act;
(g) "depreciable property" has the meaning assigned by subsection 13(21) of the Act;
(h) "dividend refund" has the meaning assigned to that term in subsection 129(1) of the Act;
(i) "eligible property" has the meaning assigned to that term in subsection 85(1.1) of the Act;
(j) "paid-up capital" ("PUC") has the meaning assigned to that term by subsection 89(1) of the Act;
(k) "refundable dividend tax on hand" ("RDTOH") has the meaning assigned by subsection 129(3) of the Act;
(l) "specified financial institution" ("SFI") has the meaning assigned to that term by subsection 248(1) of the Act;
(m) "specified investment business" has the meaning assigned by subsection 125(7) of the Act;
(n) "taxable Canadian corporation" ("TCC") has the meaning assigned to that term by subsection 89(1) of the Act;
(o) "taxable dividend" has the meaning assigned to that term by subsection 89(1) of the Act; and
(p) "valuation day" ("V-Day") has the meaning assigned by section 24 of the Income Tax Application Rules.
Our understanding of the facts, proposed transactions and purpose of the proposed transactions is as follows:
FACTS
1. XXXXXXXXXX ("Farms") is a TCC and a CCPC which was incorporated on XXXXXXXXXX. It is governed by the provisions of the BCA. The taxation year of Farms ends on XXXXXXXXXX of each year. Farms is a closely held corporation which carries on a XXXXXXXXXX farming business in XXXXXXXXXX.
2. The authorized share capital of Farms consists of XXXXXXXXXX Class A voting common shares.
3. The issued and outstanding share capital of Farms consists of XXXXXXXXXX Class A voting common shares which have an aggregate PUC of $XXXXXXXXXX. Farms has three (3) individual shareholders, all of whom are residents of Canada. XXXXXXXXXX ("Mrs. A") owns XXXXXXXXXX common shares, XXXXXXXXXX ("Mr. B") owns XXXXXXXXXX common shares, and XXXXXXXXXX ("Mr. C") owns XXXXXXXXXX common shares, for a total of XXXXXXXXXX common shares. Mr. B and Mr. C are brothers. Mrs. A is their mother.
The Class A common shares of Farms represent capital property to each of its shareholders. None of the shareholders of Farms has acquired any shares of Farms in contemplation of the proposed transactions described in this letter.
4. The assets of Farms includes cash and accounts receivable, prepaid expenses, XXXXXXXXXX inventory, land, buildings, an irrigation pipeline, machinery and equipment, patronage reserves and a stock investment in XXXXXXXXXX which relates to the farming business of Farms. The liabilities of Farms include accounts payable, XXXXXXXXXX advances, and long term debt relating to farm machinery.
5. As at XXXXXXXXXX Farms had a RDTOH balance of $XXXXXXXXXX, a non-capital loss carryforward of $XXXXXXXXXX, and no capital dividend account balance. A taxable dividend of about $XXXXXXXXXX was declared and paid as of XXXXXXXXXX so as to recover the RDTOH balance of $XXXXXXXXXX. This was done to avoid any circular RDTOH issues. At the end of their taxation years in which the proposed transactions are implemented, none of Farms, Newco A or Newco B will have any RDTOH.
6. The net income stabilization account ("NISA account") will be converted to cash prior to the proposed transactions. In this regard, an application for these funds has been made.
7. The shareholder loan was paid out on or before XXXXXXXXXX, out of cash.
PROPOSED TRANSACTIONS
8. Mrs. A and Mr. B will each incorporate a new corporation ("Newco A" and "Newco B") under the BCA. Mrs. A will be the sole shareholder of Newco A, and Mr. B will be the sole shareholder of Newco B.
The authorized share capital of both Newco A and Newco B will include voting common shares and at least one class of redeemable, retractable, non-cumulative, non-voting preferred shares ("Newco A Preferred Shares" and "Newco B Preferred Shares"), the redemption amount of which will be equal to the fair market value of the property received as consideration therefore, net of any liabilities assumed. At the time of incorporation, one (1) common share of Newco A will be issued to Mrs. A, and one (1) common share of Newco B will be issued to Mr. B, each for nominal consideration.
9. Mrs. A will transfer her common shares of Farms, which amount to a XXXXXXXXXX% interest in Farms, to Newco A in exchange for additional common shares of Newco A with a fair market value equivalent to the fair market value of the transferred shares of Farms. In the same fashion, Mr. B will transfer his common shares of Farms, which amount to a XXXXXXXXXX% interest in Farms, to Newco B in exchange for additional common shares of Newco B with a fair market value equivalent to the fair market value of the transferred shares of Farms. The common shares of Newco A and Newco B will be capital property to Mrs. A and Mr. B, respectively.
Mrs. A and Newco A, and Mr. B and Newco B will respectively elect, jointly and in prescribed form and within the time limits referred to in subsection 85(6) of the Act, to have the rules in subsection 85(1) of the Act apply to the transfer of the common shares of Farms as described herein to Newco A and Newco B, respectively. The agreed amount specified in each election will be equal to the ACB to Mrs. A and Mr. B of the transferred shares, which will be less than their fair market value at the time of transfer.
As a result of the acquisition of common shares of Farms, the stated capital of the Newco A common shares and the Newco B common shares will increase by an amount equal to the agreed amount in respect of each such transfer.
10. Immediately before the proposed transfers of property described in paragraph 12 below, the assets of Farms will be classified into three types of property for the purposes of the definition of "distribution" in subsection 55(1) of the Act, as follows:
(a) cash or near cash property, comprising all of the current assets of Farms. This category will include cash, accounts receivable, income receivable under the XXXXXXXXXX rights arising from the prepayment of certain expenses ("prepaid expenses"), and XXXXXXXXXX inventory;
(b) investment property, comprising all of the assets of Farms other than any cash or near cash property, any income from which would, for purposes of the Act, be income from property or from a specified investment business; and
(c) business property, comprising all of the assets of Farms other than any cash or near cash property, any income from which would, for purposes of the Act, be income from an active business carried on by Farms. This category will include land, buildings and equipment, as well as patronage reserves and the stock investment in XXXXXXXXXX.
For greater certainty, any tax accounts, such as the balance of any non-capital losses, RDTOH or CDA of Farms, will not be considered property for purposes of the proposed transactions described herein.
11. In determining the net fair market value of each type of property owned by Farms immediately before the proposed transfers of property described in paragraph 12 below, the liabilities of Farms will be allocated to, and deducted in the calculation of, the net fair market value of each type of property of Farms as follows:
(a) current liabilities of Farms (including the current portion of any long-term debt) will be allocated to cash or near cash property (including any accounts receivable, inventory and prepaid expenses) of Farms in the proportion that the fair market value of each such property is of the fair market value of all cash or near cash property of Farms. The allocation of current liabilities of Farms as described herein will not exceed the aggregate fair market value of the cash or near cash property of Farms;
(b) liabilities of Farms, other than current liabilities, that relate to a particular property will then be allocated to the particular property (and effectively to the type to which the particular property belongs) to the extent of its fair market value. The liabilities that pertain to a type of property, but not to a particular property will then be allocated to that type of property, but not in excess of the net fair market value of such type of property after the allocation of liabilities to a particular property, as described herein;
(c) if any liabilities remain after the allocations described in steps (a) and (b) above are made ("excess unallocated liabilities"), such excess unallocated liabilities will then be allocated to the cash or near cash property, investment property and business property of Farms based on the relative net fair market value of each type of property prior to the allocation of such excess unallocated liabilities.
For the purpose of calculating the net fair market value of the types of property of Farms, deferred taxes, if any, will be ignored.
12. Farms will then transfer to each of Newco A and Newco B a portion of its cash or near cash property, investment property and business property such that the net fair market value of each type of property so transferred to each of Newco A and Newco B (after allocating and deducting, in the manner described in paragraph 11 above, the liabilities of Farms which are to be assumed by each of Newco A and Newco B as described herein) will be equal to that proportion of the net fair market value of all property of Farms of that type determined immediately before such transfer that
(a) the aggregate fair market value, immediately before the transfer, of all of the shares of the capital stock of Farms owned by each of Newco A and Newco B, as the case may be, at that time
is of
(b) the aggregate fair market value, immediately before the transfer, of all of the issued and outstanding shares of the capital stock of Farms at that time.
As consideration for the property so transferred, each of Newco A and Newco B will:
(c) assume a portion of the liabilities of Farms (not to exceed Farms’ cost amount of the transferred property), such that the net fair market value of each type of property of Farms transferred to such transferee as described herein will be equal to its proportionate share, as determined by the formula described in (a) and (b) above, of the total net fair market value of that type of property owned by Farms immediately before such transfers, and
(d) issue to Farms Newco A Preferred Shares or Newco B Preferred Shares, as the case may be, having an aggregate fair market value and redemption amount equal to the amount by which the aggregate fair market value of the property transferred to Newco A or Newco B, as the case may be, exceeds the amount of the liabilities assumed by each such transferee as described in (c) above.
Each of Newco A and Newco B will add to the stated capital account in respect of the preferred shares it issues an amount equal to the cost to such transferee (as determined under section 85 of the Act, where relevant) of the property transferred to such transferee less any liabilities assumed by it.
13. In respect of the transfers described in paragraph 12 above, Farms and Newco A and Farms and Newco B will jointly elect pursuant to subsection 85(1), in prescribed form and within the time limits referred to in subsection 85(6), in respect of the transfer to each such transferee of each asset that is an eligible property. The amount agreed upon in such elections in respect of each of the eligible properties so transferred will be equal to:
(a) in the case of capital property (other than depreciable property of a prescribed class), an amount equal to the lesser of the amounts described in subparagraphs 85(1)(c.1)(i) and (ii) of the Act;
(b) in the case of depreciable property of a prescribed class, an amount equal to the least of the amounts described in subparagraphs 85(1)(e)(i), (ii) and (iii) of the Act;
(c) in the case of eligible capital property, an amount equal to the least of the amounts described in subparagraphs 85(1)(d)(i), (ii) and (iii) of the Act; and
(d) in the case of inventory, the amount described in paragraph 85(1)(c.2).
In each case, the agreed amount will not exceed the fair market value of the respective property, nor will it be less than the amount of any liabilities assumed by Newco A or Newco B, as the case may be, as consideration for the transfer of such property.
For the purposes of the joint election described herein, the reference to "the undepreciated capital cost to the taxpayer of all property of that class immediately before the disposition" found in paragraph 85(1)(e)(i) shall be interpreted to mean that proportion of the undepreciated capital cost to the taxpayer of all of the property of that class that the cost of the asset immediately before the disposition is of the cost of all property of that class immediately before the disposition.
The subsection 85(1) election referred to herein will exclude any cash, accounts receivable and prepaid expenses.
14. Newco A and Newco B will each redeem all of its preferred shares held by Farms at the respective aggregate redemption amount and will pay the particular aggregate redemption amount by issuing to Farms a non-interest bearing promissory note payable on demand having a principal amount and fair market value equal to the respective redemption amount of the preferred shares redeemed by Newco A and Newco B. Farms will accept the Newco A and Newco B promissory notes as full payment for the redemption amounts of the respective shares so redeemed.
Newco A and Newco B will, immediately before such share redemptions, be related to Farms within the meaning of subsection 251(2) and will be connected with Farms within the meaning assigned by subsections 186(2) and 186(4) of the Act.
15. Immediately following the foregoing preferred share redemptions, Farms will purchase for cancellation all of the common shares of Farms held by Newco A and Newco B at their fair market value. Farms will pay the purchase price for such shares by issuing a non-interest bearing promissory note payable on demand to each of Newco A and Newco B having a principal amount and fair market value equal to the fair market value of the respective common shares so purchased.
Farms will, immediately before the purchase of the common shares of Farms held by Newco A and Newco B, be related to Newco A and Newco B within the meaning of subsection 251(2) and will be connected with Newco A and Newco B within the meaning assigned by subsections 186(2) and 186(4) of the Act.
16. Immediately following the issuance of the promissory notes described in paragraphs 14 and 15 above, the promissory notes issued between Farms and Newco A and between Farms and Newco B will be offset by way of an offset agreement, respectively.
17. Immediately following the transfers described in paragraph 12 above, the redemptions described in paragraph 14 above, and the purchase described in paragraph 15 above, the net fair market value of the property retained by Farms, determined in the manner described in paragraph 10 above (after allocating and deducting liabilities, in the manner described in paragraph 11 above), will be equal to the proportion of the net fair market value of all of the property owned by Farms, determined in the manner described in paragraph 10 above (after allocating and deducting liabilities, in the manner described in paragraph 11 above), immediately before such transfers, that:
(a) the fair market value, immediately before the transfer, of all the shares of the capital stock of Farms, other than those owned by Newco A and Newco B, at that time
is of
(b) the fair market value, immediately before the transfer, of all the issued shares of the capital stock of Farms at that time.
18. Upon completion of the transactions described in paragraphs 8 through 17 above, Newco A will transfer one half of the property received by it as a result of these transactions to Newco B and one half to Farms. This property will be transferred pursuant to section 85 of the Act. As consideration for the property so transferred, each of Newco B and Farms will:
(a) assume a portion of the liabilities of Newco A (not to exceed Newco A’s cost amount of the transferred property), such that Newco B and Farms will each receive one half of the total net fair market value of the property owned by Newco A immediately before such transfers, and
(b) issue preferred shares to Newco A having an aggregate fair market value and redemption amount equal to the amount by which the aggregate fair market value of the property transferred to Newco B and Farms, as the case may be, exceeds the amount of the liabilities assumed by each such transferee as described in (a) above. If the authorized capital of Farms does not include preferred shares, Farms will, prior to the issue of such shares, amend its articles of incorporation to create that class of shares.
Each of Newco B and Farms will add to the stated capital account in respect of the preferred shares it issues an amount equal to the cost to such transferee (as determined under section 85 of the Act, where relevant) of the property transferred to such transferee less any liabilities assumed by it.
19. No assets have been or will be acquired by or disposed of by, and no liabilities have been or will be incurred by Farms in contemplation of and before the proposed transfers of property described in paragraph 12 above, except in the ordinary course of business or as described in this letter.
20. Except as described in this letter, Farms will not dispose of any of its assets as part of the proposed series of transactions, and neither Farms nor Newco B will dispose of any of its assets to an unrelated person subsequent to the proposed transactions.
21. None of the corporations referred to herein is, or will be at the time of the proposed transactions, an SFI.
22. None of the shares of Farms, Newco A or Newco B has been or will be, at any time during the implementation of the proposed transactions described herein:
(a) the subject of any undertaking or agreement that is referred to in subsection 112(2.2) of the Act as a "guarantee agreement";
(b) a share that is issued or acquired as part of a transaction, event or series of transactions or events of the type described in subsection 112(2.5) of the Act; or
(c) the subject of a dividend rental arrangement as that term is defined in subsection 248(1) of the Act.
23. Each of Farms, Newco A and Newco B will have the financial capacity to honour, upon presentation for payment, the amount payable under the promissory note issued by it as part of the proposed transactions.
PURPOSE OF THE PROPOSED TRANSACTIONS
24. The two brothers, Mr. B and Mr. C, have differing views as to how the farm should be operated and wish to go their separate ways so that they may operate their farms in the manner which is appropriate for each of them.
RULINGS GIVEN
Provided that the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, proposed transactions and purpose of the proposed transactions, and provided that the proposed transactions are completed in the manner described above, our rulings are as follows:
A. Subject to the application of the provisions of subsections 20(1.2) and 26(5) of the Income Tax Application Rules and to the application of paragraph 88(2.2)(b) of the Act, which applies for the purposes stated in the preamble to subsection 88(2.2) of the Act, and subject also to the application of subsection 85(5.1) of the Act as it may apply to the transfer referred to in (i) herein, the provisions of subsection 85(1) of the Act will apply to:
(i) the transfer of each eligible property by Farms to Newco A and Newco B which is the subject of an election under subsection 85(1) as described in paragraphs 12 and 13 above, and
(ii) the transfer of the common shares of Farms held by Mrs. A and Mr. B to Newco A and Newco B, respectively, as described in paragraph 9 above,
such that the agreed amounts in respect of each such transfer shall be deemed to be the transferor’s proceeds of disposition and the transferee’s cost thereof pursuant to paragraph 85(1)(a) of the Act. For greater certainty, paragraph 85(1)(e.2) of the Act will not apply to the transfers referred to herein.
B. As a result of the redemption by Newco A and Newco B of their preferred shares as described in paragraph 14 above and the consequential purchase for cancellation of the common shares of Farms as described in paragraph 15 above:
(a) By virtue of paragraphs 84(3)(a) and 84(3)(b) of the Act:
(i) Newco A and Newco B will be deemed to have paid, and Farms will be deemed to have received, a taxable dividend equal to the amount by which the amount paid in respect of the redemption of the Newco A and Newco B preferred shares exceeds the respective PUC thereof; and
(ii) Farms will be deemed to have paid, and Newco A and Newco B will be deemed to have received, a taxable dividend equal to the amount by which the amount paid in respect of the purchase for cancellation of the common shares of Farms exceeds the PUC thereof;
(b) Provided that none of Farms, Newco A or Newco B is entitled to a dividend refund in respect of its taxation year in which it is deemed to pay the dividend referred to in (a)(i) or (ii) herein, none of Farms, Newco A or Newco B will be subject to Part IV tax under subsection 186(1) of the Act in respect of such dividend; and
(c) The taxable dividends deemed to have been received by Farms, Newco A and Newco B as a result of the redemption and purchase for cancellation referred to in paragraph (a) herein will be deductible by each of them in computing its respective taxable income pursuant to subsection 112(1) of the Act. For greater certainty, the provisions of subsections 112(2.2) and (2.4) of the Act will not apply to deny the subsection 112(1) deduction in respect of such dividends.
C. Provided that as part of the series of transactions or events that includes the proposed transactions described herein, there is not:
(a) a disposition of property in the circumstances described in subparagraph 55(3.1)(b)(i);
(b) an acquisition of control in the circumstances described in subparagraph 55(3.1)(b)(ii);
(c) an acquisition of property in the circumstances described in paragraph 55(3.1)(c); or
(d) an acquisition of property in the circumstances described in paragraph 55(3.1)(d),
which has not been described herein, then by virtue of paragraph 55(3)(b) of the Act, subsection 55(2) of the Act will not apply to the taxable dividends referred to in the rulings given in subparagraph B(a) above and, for greater certainty, subsection 55(3.1) of the Act will not apply to deny the exemption under paragraph 55(3)(b) of the Act.
D. By virtue of paragraph 191(2)(a) of the Act, Farms will have a substantial interest in both Newco A and Newco B immediately before the redemption of the Newco A and Newco B preferred shares as described in paragraph 14 above and Newco A and Newco B will each have a substantial interest in Farms immediately before the purchase for cancellation of the common shares of Farms described in paragraph 15 above. Consequently, no tax will be payable under either section 187.2 or section 191.1 of the Act in respect of:
(i) the dividends deemed to have been paid by Newco A and Newco B to Farms upon the redemption of the Newco A and Newco B preferred shares since each such dividend will be an "excepted dividend" within the meaning of paragraph (b) of the definition of "excepted dividend" in section 187.1 of the Act in the capacity of Farms as the recipient of the particular dividends, and will be an "excluded dividend" within the meaning of paragraph (a) of the definition of "excluded dividend" in subsection 191(1) of the Act in the capacity of Newco A and Newco B as the payers of the particular dividends, or
(ii) the dividends deemed to have been paid by Farms to Newco A and Newco B upon the repurchase of the common shares of Farms since each such dividend will be an "excepted dividend" within the meaning assigned by paragraph (b) of the definition of "excepted dividend" in section 187.1 of the Act in the capacity of Newco A and Newco B as the recipients of the particular dividends, and will be an "excluded dividend" within the meaning of paragraph (a) of the definition of "excluded dividend" in subsection 191(1) of the Act in the capacity of Farms as the payer of the particular dividends.
E. The settlement of the Farms, Newco A and Newco B promissory notes as described in paragraph 16 above will not give rise to a "forgiven amount" within the meaning of subsection 80(1) or 80.01 of the Act.
F. The provisions of subsections 15(1), 56(2), and 246(1) of the Act will not apply to the proposed transactions described herein, in and by themselves.
G. As a result of the proposed transactions, in and by themselves, subsection 245(2) of the Act will not be applied to redetermine the tax consequences confirmed in the rulings given.
The above rulings are given subject to the limitations and qualifications set out in Information Circular 70-6R3 dated December 30, 1996 and are binding on Revenue Canada Customs, Excise and Taxation provided that the proposed transactions are completed by XXXXXXXXXX.
The above rulings are based on the law as it presently reads and do not take into account any proposed amendments to the Act which, if enacted into law, could have an effect on the rulings provided herein.
COMMENTS
Nothing in this ruling should be construed as implying that Revenue Canada, Customs, Excise and Taxation has agreed to or reviewed:
(a) the determination of the fair market value or ACB of any particular asset or the PUC of any shares referred to herein; or
(b) any tax consequences relating to the facts and proposed transactions described herein other than those specifically described in the rulings given above.
Yours truly,
for Director
Reorganizations and International Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch
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