1999 Ruling 9803933 - 55(3)(A) 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.

XXXXXXXXXX 980393

XXXXXXXXXX, 1999

Dear Sir:

Re: 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 taxpayers. We also acknowledge the additional information provided in your facsimiles of XXXXXXXXXX, and in our various telephone conversations (XXXXXXXXXX).

To the best of your knowledge, and that of the taxpayers involved, none of the issues contained herein is:

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

(ii) 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) under objection by the taxpayers or a related person;

(iv) before the courts or, if a judgement has been issued, the time limit for appeal to a higher court has not expired; or

(v) the subject of a ruling previously issued by the Directorate.

Definitions

In this letter, the following terms have the meanings specified:

(a) Unless otherwise indicated, all references to statute are to the Income Tax Act (Canada), R.S.C. 1985 (5th Supp.), c.1, as amended (the "Act");

(b) "adjusted cost base" has the meaning assigned by section 54 of the Act;

(c) "agreed amount" has the meaning assigned by subsection 85(1) of the Act;

(d) "BCA" means the Business Corporations Act (XXXXXXXXXX), and, where applicable, its predecessor statutes;

(e) "Child1" means XXXXXXXXXX;

(f) "Child2" means XXXXXXXXXX;

(g) "Childco1" means XXXXXXXXXX;

(h) "Childco2" means XXXXXXXXXX;

(i) "cost amount" has the meaning assigned by subsection 248(1) of the Act;

(j) "depreciable property" has the meaning assigned by subsection 13(21) of the Act;

(k) "Divisionco" means XXXXXXXXXX;

(l) "Father" means XXXXXXXXXX;

(m) "Fatherco" means XXXXXXXXXX, namely a taxable Canadian corporation and a private corporation all the issued and outstanding shares of which are owned by Father;

(n) "Holdco" means XXXXXXXXXX;

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

(p) "private corporation" has the meaning assigned by subsection 89(1) of the Act;

(q) "refundable dividend tax on hand" has the meaning assigned by subsection 129(3) of the Act;

(r) "related" has the meaning assigned by section 251 of the Act;

(s) "Subco1" means XXXXXXXXXX;

(t) "Subco2" means XXXXXXXXXX;

(u) "Subco3" means XXXXXXXXXX; and

(v) "taxable Canadian corporation" has the meaning assigned by subsection 89(1) of the Act.

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

Facts

1. Father and his two adult children, Child1 and Child2, are resident in Canada.

2. Holdco is a taxable Canadian corporation and a private corporation which is governed by the provisions of the Canada Business Corporations Act.

The issued and outstanding shares of Holdco consist of the following:

a) XXXXXXXXXX Class A voting, redeemable/retractable shares having a total redemption amount, a total adjusted cost base and a total paid-up capital of $XXXXXXXXXX;

b) XXXXXXXXXX Class B voting (at XXXXXXXXXX votes per share), redeemable/retractable shares having a total redemption amount of $XXXXXXXXXX, a total adjusted cost base of $XXXXXXXXXX and a total paid-up capital of $XXXXXXXXXX;

c) XXXXXXXXXX common shares having a total adjusted cost base and a total paid-up capital of $XXXXXXXXXX.

All of the issued and outstanding Class A shares of Holdco are owned by Father. The issued and outstanding common shares and Class B shares of Holdco are owned equally by Childco1 and Childco2. As a result of his ownership of the Class A shares, Father controls Holdco.

Father began working for Holdco on a full-time basis in XXXXXXXXXX. He became President and CEO of the company in XXXXXXXXXX. At that time, he owned XXXXXXXXXX of the shares of Holdco, while his siblings owned the otherXXXXXXXXXX. Unlike Father, Father's siblings were never active in Holdco's business and Father acquired their shares over a number of years until he became sole owner.

In XXXXXXXXXX, Father executed an estate freeze in respect of Holdco under which he exchanged his common shares in Holdco on a tax-deferred basis pursuant to section 85 of the Act for the XXXXXXXXXX Class A shares described above and Class B special shares. At that time, both the XXXXXXXXXX common and XXXXXXXXXX Class B shares of Holdco described above were issued in equal proportions by Holdco to Child1 and Child2. In XXXXXXXXXX , Father's Class B special shares of Holdco were transferred to Fatherco and then redeemed by Holdco, leaving Father with only the XXXXXXXXXX Class A shares. In XXXXXXXXXX, Child1 and Child2 transferred all their shares in Holdco on a tax-deferred basis pursuant to section 85 of the Act to Childco1 and Childco2.

The assets of Holdco consist of all the shares of Subco1 and Subco2, XXXXXXXXXX% of the shares of Subco3 and XXXXXXXXXX common shares of Divisionco, as well as receivables from related companies.

3. Childco1 and Childco2 are taxable Canadian corporations and private corporations governed by the provisions of the BCA. Child1 owns all the shares of Childco1 and Child2 owns all the shares of Childco2.

The issued and outstanding shares of Childco1 and Childco2 each consist of the following:

a) XXXXXXXXXX common shares having a total adjusted cost base and a total paid-up capital of $XXXXXXXXXX; and

b) 1 Class A special share redeemable for $XXXXXXXXXX with an adjusted cost base and paid-up capital of $XXXXXXXXXX.

4. Subco1 is a taxable Canadian corporation and a private corporation which is governed by the provisions of the BCA. Holdco owns all the issued and outstanding shares of Subco1, which consist of :

a) XXXXXXXXXX common shares having a total adjusted cost base of $XXXXXXXXXX and a total paid-up capital of $XXXXXXXXXX; and

b) XXXXXXXXXX Class A special shares having a total adjusted cost base and a total paid-up capital of $XXXXXXXXXX.

Subco1 carries on an active business in Canada consisting of the manufacture and sale of XXXXXXXXXX. Prior to the transfer of certain of the assets relating to its XXXXXXXXXX business as described in paragraph 7 below, Subco1 also carried on the XXXXXXXXXX business in Canada. Subco1 has approximately $XXXXXXXXXX of refundable dividend tax on hand.

5. Subco2 is a company incorporated and carrying on business in the United States. Holdco owns all the issued and outstanding shares of Subco2. Subco2 manufactures and sells XXXXXXXXXX.

6. Subco3 is a company incorporated and carrying on business in XXXXXXXXXX . Holdco owns XXXXXXXXXX of the XXXXXXXXXX issued and outstanding shares of Subco3. Child1, Child2, Subco1 and Fatherco each own XXXXXXXXXX shares of Subco3. Subco3 manufactures and sells XXXXXXXXXX.

7. Divisionco is a taxable Canadian corporation and a private corporation which is governed by the provisions of the BCA. The authorized share capital of Divisionco consists of:

a) an unlimited number of common shares;

b) an unlimited number of Class A voting special shares, redeemable/retractable at, and with a paid-up capital of, XXXXXXXXXX per share;

c) an unlimited number of Class B voting special shares, redeemable/retractable at $XXXXXXXXXX per share; and

d) an unlimited number of Class C and D voting special shares, redeemable/retractable at a specified amount.

The issued and outstanding shares of Divisionco consist of the following :

e) XXXXXXXXXX common shares having a total adjusted cost base and a total paid-up capital of $XXXXXXXXXX; and

f) XXXXXXXXXX Class D special shares redeemable/retractable for $XXXXXXXXXX in total and with a total adjusted cost base and a total paid-up capital of $XXXXXXXXXX.

Holdco controls Divisionco through its ownership of the XXXXXXXXXX common shares described above. The Class D special shares of Divisionco are owned by Subco1.

Since its incorporation in XXXXXXXXXX, Divisionco has been carrying on Subco1's XXXXXXXXXX business. This was accomplished through Divisionco's purchase of Subco1's inventory of XXXXXXXXXX, at cost, and its lease of Subco1's equipment used in the manufacture of XXXXXXXXXX. In addition, the goodwill associated with Subco1'sXXXXXXXXXX business was transferred to Divisionco under section 85 of the Act in exchange for the XXXXXXXXXX Class D special shares described above. The goodwill had an estimated fair market value of $XXXXXXXXXX and a cost of $XXXXXXXXXX. The elected amount on its transfer to Divisionco was $XXXXXXXXXX.

Proposed Transactions

8. In order to simplify the corporate group's organizational structure, each of Child1, Child2, Fatherco and Subco1 will sell their one common share in Subco3 to Holdco for fair market value. Holdco will then own all the shares of Subco3.

9. Holdco will borrow $XXXXXXXXXX from a bank and use this money to subscribe for an additional XXXXXXXXXX common shares of Divisionco.

10. Subco1 will transfer the depreciable property (i.e. equipment, vehicles and computers) formerly used in its manufacture of XXXXXXXXXX to Divisionco electing under section 85 of the Act, in exchange for XXXXXXXXXX Class C special shares of Divisionco having a total fair market value equal to the fair market value of the property so transferred to Divisionco. These shares will be redeemable and retractable at a total redemption price equal to the fair market value of the transferred depreciable property and will have a total adjusted cost base and a total paid-up capital equal to the total of the agreed amounts elected on the transfer. The agreed amount elected for each of the depreciable properties so transferred to Divisionco will be the cost amount of the property.

11. Divisionco will redeem at fair market value its XXXXXXXXXX Class C special shares and its XXXXXXXXXX Class D special shares held by Subco1, which redemptions will result in deemed dividends to Subco1. Divisionco will pay for the shares redeemed with the funds received from Holdco on its subscription for shares of Divisionco.

12. Subco1 will use the funds received from Divisionco to purchase for cancellation, in proportion to their relative fair market values immediately before such purchase, some of its common shares and Class A special shares held by Holdco. The total fair market value of the shares so purchased will be equal to the total amount payable to Subco1 for the redemption of its XXXXXXXXXX Class C and XXXXXXXXXX Class D special shares of Divisionco, as described in paragraph 11 above. This purchase for cancellation will result in a deemed dividend to Holdco. Holdco will use the purchase proceeds to repay the bank loan.

The foregoing deemed dividend will result in a refund to Subco1 of its refundable dividend tax on hand. This, in turn, will cause Holdco to be liable for tax under Part IV of the Act. Holdco's Part IV tax liability will create refundable dividend tax on hand in Holdco.

After these transactions are completed, Subco1's XXXXXXXXXX business will have been transferred to Divisionco. Subco1 will then manufacture and sell XXXXXXXXXX.

13. Holdco will incorporate a new company (herein referred to as "Newco"). Newco will be a taxable Canadian corporation and a private corporation governed by the provisions of the BCA. Newco will have the following authorized share capital :

a) an unlimited number of common shares;

b) an unlimited number of Class A voting special shares, redeemable/retractable at, and with a paid-up capital of, XXXXXXXXXX per share;

c) an unlimited number of Class B voting special shares, redeemable/retractable at $XXXXXXXXXX per share; and

d) an unlimited number of Class C and D voting special shares, redeemable/retractable at a specified amount.

14. Father will then transfer XXXXXXXXXX of his XXXXXXXXXX Class A special shares of Holdco to Newco electing at their adjusted cost base under section 85 of the Act, in exchange for XXXXXXXXXX Class A voting special shares of Newco. The Newco Class A voting special shares will have the same fair market value and paid-up capital as the Class A special shares of Holdco so transferred.

15. Childco1 will transfer its XXXXXXXXXX common shares of Holdco to Newco electing at their adjusted cost base under section 85 of the Act, in exchange for XXXXXXXXXX common shares of Newco. The Newco common shares will have the same fair market value and paid-up capital as the common shares of Holdco so transferred. Childco1 will also transfer its 1 Class B special share in Holdco to Newco electing at its adjusted cost base under section 85 of the Act, in exchange for 1 Newco Class B special share. The fair market value and paid-up capital of the Newco Class B special share will be the same as that of the Class B special share of Holdco so transferred.

16. Holdco will transfer its remaining common shares and Class A special shares of Subco1 to Newco electing at their adjusted cost base under section 85 of the Act, in exchange for, respectively, an equivalent number of Class C and Class D special shares of Newco having a fair market value equal to the fair market value of the Subco1 shares for which they were exchanged. The Class C special shares of Newco will be redeemable at a total redemption price equal to the fair market value of the common shares of Subco1 so transferred and will have a paid-up capital equal to the paid-up capital of such common shares. The Class D special shares of Newco will be redeemable and retractable at, and will have a paid-up capital equal to, the fair market value of the Class A special shares of Subco1 so transferred.

17. Newco will redeem from Holdco, at fair market value, its Class C special shares, which redemption will result in a deemed dividend to Holdco. Newco will also redeem at fair market value from Holdco its Class D special shares. In consideration for the redeemed shares, Newco will issue a demand promissory note to Holdco (the "Newco Note") having a principal amount and a fair market value equal to the total of the redemption prices of its Class C and D special shares so redeemed. Immediately after the Class C and D special shares are redeemed, but before the share redemptions described in paragraph 18, Newco will cause its taxation year to end.

18. On the day following the end of Newco's first taxation year, Holdco will purchase for cancellation from Newco its XXXXXXXXXX common shares and redeem its 1 Class B special share, which purchase or redemption, as the case may be, will result in deemed dividends to Newco. Holdco will also redeem from Newco its XXXXXXXXXX Class A special shares. In consideration for the purchased/redeemed shares, Holdco will issue a demand promissory note to Newco (the "Holdco Note") having a principal amount and a fair market value equal to the total of the fair market value of the common shares so purchased and the redemption amounts of the Class A and Class B special shares. The foregoing deemed dividends will result in a refund to Holdco of its refundable dividend tax on hand. This, in turn, will cause Newco to be liable for tax under Part IV of the Act. Newco's Part IV tax liability will create refundable dividend tax on hand in Newco.

19. The principal amount of the Newco Note will then be set-off on a dollar for dollar basis against the principal amount of the Holdco Note. After such set-off, a balance under the Holdco Note will be owing to Newco. Although the Holdco Note is payable on demand, it is expected that it will be paid over XXXXXXXXXX years and will not bear interest.

After the above series of transactions, Newco, which is owned by Father and Child1 through Childco1, will own all the shares of Subco1, a company that manufactures and sells XXXXXXXXXX. Holdco will then be owned by Father and Child2 through Childco2, and will own all the shares of the companies that manufacture and sell XXXXXXXXXX, namely Subco2, Subco3 and Divisionco. Father will control both Holdco and Newco, just as he controlsthe entire corporate group today through his ownership of shares of Holdco.

Purpose of the Proposed Transactions

20. The purpose of the proposed transactions is to separate the XXXXXXXXXX business from the XXXXXXXXXX business so that each of Child1 and Child2 can carry on, through their respective holding companies, their own business after Father has passed on.

Rulings

Provided that the preceding statements constitute a complete and accurate disclosure of all the relevant facts, proposed transactions and the purpose of the proposed transactions and provided that the proposed transactions are completed in the manner described above, our rulings are as follows:

A. By virtue of paragraph 55(3)(a) of the Act, the provisions of subsection 55(2) of the Act will not apply to the deemed dividends referred to in paragraphs 11, 12, 17 and 18 above provided that there is no disposition or increase in interest described in any of subparagraphs 55(3)(a)(i) to (v) as part of a series of transactions or events which includes the redemption by Divisionco of its Class C or D special shares held by Subco1, the purchase for cancellation by Subco1 of its common shares and Class A special shares held by Holdco, the purchase for cancellation by Holdco of its common shares and the redemption by Holdco of its Class A or Class B special shares held by Newco, or the redemption by Newco of its Class C or Class D special shares held by Holdco. For greater certainty, the proposed transactions described in paragraphs 8 to 19 above, in and by themselves, will not be considered to result in any disposition or increase in interest described in any of subparagraphs 55(3)(a)(i) to (v).

B. Subsection 85(1) of the Act will apply to the transfer by Subco1 of the depreciable property formerly used in its manufacture of XXXXXXXXXX to Divisionco, as described in paragraph 10 above.

These rulings are given subject to the limitations and qualifications set out in Information Circular 70-6R3 issued by Revenue Canada, Customs, Excise and Taxation on December 30, 1996 and are binding provided that the proposed transactions are completed by XXXXXXXXXX.

The above rulings are based on the Act in its present form and do not take into account any proposed amendments to the Act which, if enacted, 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, adjusted cost base or V-day value of any particular asset or share or the paid-up capital 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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