1998 Ruling 9808523 - DIVISIVE 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: application of paragraph 55(3)(a)

Position: 55(3)(a) applies

Reasons: there will be no disposition or increase in interest described in paragraph 55(3)(a)

XXXXXXXXXX
XXXXXXXXXX 980852
XXXXXXXXXX

Attention: XXXXXXXXXX

XXXXXXXXXX, 1998

Dear Sirs:

Re: XXXXXXXXXX ("Holdco") - XXXXXXXXXX
XXXXXXXXXX (the "Trust") - XXXXXXXXXX
XXXXXXXXXX ("X") -XXXXXXXXXX
XXXXXXXXXX ("Y") - XXXXXXXXXX
XXXXXXXXXX ("Z") - 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-noted taxpayers. We also acknowledge receipt of the additional information provided in your letters of XXXXXXXXXX and during our telephone conversations.

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

(i) dealt with 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) subject to a ruling previously issued by the Income Tax Rulings & Interpretations Directorate; or

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

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

(a) "Act" means the Income Tax Act, R.S.C. 1985 (5th Supp.) c.1, as amended to the date hereof, and, unless otherwise stated, every reference herein to a Part, section, subsection, paragraph or subparagraph is a reference to the relevant provision of the Act;

(b) "adjusted cost base" (also referred to as "ACB") has the meaning assigned by section 54;

(c) "agreed amount" in respect of a property means the amount that the transferor and the transferee of the property have agreed upon in their election under subsection 85(1) in respect of the property;

(d) "BCA" means the Business Corporations Act (XXXXXXXXXX);

(e) "capital dividend account" (also referred to as "CDA") has the meaning assigned by section 83;

(f) "capital property" has the meaning assigned by section 54;

(g) "cost amount" has the meaning assigned by subsection 248(1);

(h) "designated person" has the meaning assigned by subsection 74.5(5);

(i) "eligible property" has the meaning assigned by subsection 85(1.1);

(j) "paid-up capital" (also referred to as "PUC") has the meaning assigned by subsection 89(1);

(k) "private corporation" has the meaning assigned by subsection 89(1);

(l) "public corporation" has the meaning assigned by subsection 89(1);

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

(n) "registered charity" has the meaning assigned by subsection 248(1);

(o) "restricted financial institution" has the meaning assigned by subsection 248(1);

(p) "series of transactions or events" includes the transactions or events referred to in subsection 248(10);

(q) "specified financial institution" has the meaning assigned by subsection 248(1);

(r) "stated capital" and "stated capital account" have the meanings assigned by the BCA;

(s) "taxable Canadian corporation" has the meaning assigned by subsection 89(1); and

(t) "taxable dividend" has the meaning assigned by subsection 89(1).

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

FACTS

1. Holdco is a taxable Canadian corporation and a private corporation, incorporated on XXXXXXXXXX pursuant to the BCA. Holdco's taxation year end is XXXXXXXXXX.

2. The shareholders of Holdco are X and a discretionary trust (the "Trust"). The income and capital beneficiaries of the Trust are Y and Z, both of whom are children of X.

3. The Trust was settled by X on XXXXXXXXXX with a contribution of $XXXXXXXXXX. Under the terms of the Trust, the trustees have the discretion to pay or apply the income and capital of the Trust to or for the benefit of the beneficiaries in such proportions as the trustees may determine. The trustees are required to distribute the remaining property of the Trust no later than the "time of distribution" which is defined as the earlier of the date on which the particular beneficiary becomes XXXXXXXXXX years of age and the date determined by the trustees. The Trust Deed also provides that at the "time of division", which is defined as the earlier of the date on which the youngest of the children attains the age of XXXXXXXXXX and the date determined by the trustees, the trustees are required to divide the corpus of the Trust into shares for each child. If a child dies between the time of division and the time of distribution or if a child dies prior to the time of division, the Trust provides for the distribution of the Trust property to the issue of the deceased child. As a result, all the potential beneficiaries under the Trust are related to X within the meaning of paragraph 251(2)(a).

4. The trustees of the Trust are X and X's solicitor, both of whom are resident in Canada for purposes of the Act. The Trust is a personal trust as defined in subsection 248(1).

5. Holdco's authorized share capital consists of:

• Class A non-voting Preferred shares, redeemable and retractable at $XXXXXXXXXX per share
• Class B voting redeemable and retractable Preferred shares
• Class C voting Preferred shares, redeemable and retractable at $XXXXXXXXXX per share
• Class D voting Preferred shares, redeemable and retractable at $XXXXXXXXXX per share
• Class E voting Preferred shares, redeemable and retractable at $XXXXXXXXXX per share
• Fully participating Common shares

The Class A, B, C and D Preferred shares are not entitled to dividends. The Class E shares are entitled to a non-cumulative discretionary annual dividend at the rate of XXXXXXXXXX% of the redemption amount. The Class C and E Preferred shares are entitled to 1 vote per share. The Class D Preferred shares are entitled to XXXXXXXXXX votes per share.

6. The holders of the issued and outstanding shares of Holdco are as follows:

Shareholder Class # of Shares

X Class A Preferred XXXXXXXXXX
X Class D Preferred XXXXXXXXXX
X Class E Preferred XXXXXXXXXX
The Trust Common XXXXXXXXXX

None of the Holdco shares were acquired by X or the Trust in contemplation of the proposed transactions set forth below. The Holdco shares represent capital property to each of X and the Trust. The fair market value of each class of shares equals or exceeds the adjusted cost base of the shares to X and the Trust.

7. The assets of Holdco consist of cash, shares of a public corporation and XXXXXXXXXX% of the shares of a private corporation. The assets of the private corporation consist of shares of a public corporation.

8. X controls Holdco and will control both Newco Y and Newco Z (described below). There are no contemplated transactions which would affect X's control of Holdco, Newco Y or Newco Z.

PROPOSED TRANSACTIONS

9. Before the end of its taxation year ending on XXXXXXXXXX, Holdco will redeem a specified number of Class E Preferred shares with an aggregate redemption amount of approximately $XXXXXXXXXX. The redemption will result in the payment by Holdco of a deemed dividend sufficient to generate a dividend refund equal to the balance in Holdco's RDTOH account at its taxation year end.

10. Following the taxation year end of Holdco referred to in paragraph 9, two new corporations, "Newco Y" and "Newco Z" (collectively, the "Transferee Corporations") will be incorporated pursuant to the BCA. No shares will be issued on incorporation. The authorized share capital of each of Newco Y and Newco Z will include:

• an unlimited number of voting, participating, no par value Common shares
• an unlimited number of First Preferred, voting shares, redeemable and retractable at $XXXXXXXXXX per share
• an unlimited number of Second Preferred, redeemable, retractable, voting shares
• an unlimited number of Third Preferred, redeemable, retractable, non-voting shares
• an unlimited number of Fourth Preferred, redeemable, retractable, non-voting shares

None of the Preferred shares will be entitled to dividends. The First and Second Preferred shares will rank in preference to the Third and Fourth Preferred shares. All of the Preferred shares will be entitled to preference over the Common shares on liquidation, dissolution or winding-up. The Articles of Incorporation will contain a prohibition on the payment of dividends on the Common shares to the extent that such payment would result in the corporation having insufficient assets to redeem any class of the Preferred shares at their redemption amount. A two-thirds majority vote of the holders of any class of Preferred shares will be required to amend any preference, right, condition or limitation attaching to such shares.

11. X will transfer one-half (1/2) of each class of Holdco shares owned by her to each of Newco Y and Newco Z. As sole consideration for the Holdco shares, Newco Y and Newco Z will issue XXXXXXXXXX First Preferred shares to X with an aggregate redemption amount and fair market value equal to the aggregate fair market value of the Class A and D Preferred shares and a specified number of Second Preferred shares with an aggregate redemption amount and fair market value equal to the fair market value of X's Holdco shares less the redemption amount of the First Preferred shares. X will jointly elect with each of Newco Y and Newco Z in prescribed form and within the time period referred to in subsection 85(6) to have the provisions of subsection 85(1) apply to the transfers. The agreed amount in respect of the Holdco shares so transferred will be equal to their adjusted cost base to X immediately before the transfer.

12. Each of Newco Y and Newco Z will add to the stated capital account in respect of its First and Second Preferred shares issued to X an amount, in aggregate, which does not exceed the aggregate paid-up capital of X's Holdco shares acquired by each of Newco Y and Newco Z.

13. The Trust will transfer one-half (1/2) of its Common shares of Holdco to Newco Y in exchange for XXXXXXXXXX Common shares of Newco Y. The Trust and Newco Y will jointly elect in prescribed form and within the time period referred to in subsection 85(6) to have the provisions of subsection 85(1) apply to the transfer. The agreed amount in respect of the shares so transferred will be equal to their adjusted cost base to the Trust immediately before the transfer.

14. The Trust will transfer its remaining Common shares of Holdco to Newco Z in exchange for XXXXXXXXXX Common shares of Newco Z. The Trust and Newco Z will jointly elect in prescribed form and within the time period referred to in subsection 85(6) to have the provisions of subsection 85(1) apply to the transfer. The agreed amount in respect of the shares so transferred will be equal to their adjusted cost base to the Trust immediately before the transfer.

15. Each of Newco Y and Newco Z will add to the stated capital account in respect of the Common shares issued to the Trust an amount which does not exceed the paid-up capital of the Common shares of Holdco acquired by each corporation.

16. Holdco will then transfer assets representing one-half (1/2) of the fair market value of all its assets to each of Newco Y and Newco Z in exchange for Third Preferred shares of each corporation (collectively, the "Newco Preferred Shares") with an aggregate redemption amount and fair market value equal to the fair market value of the assets transferred to such corporation.

17. Holdco and each of Newco Y and Newco Z will jointly elect in prescribed form and within the time period referred to in subsection 85(6) to have the provisions of subsection 85(1) apply to the transfer of each property that is an eligible property. The agreed amount in respect of each eligible property so transferred will be equal to the lesser of its cost amount to Holdco immediately before the transfer and its fair market value.

18. Each of Newco Y and Newco Z will add to the stated capital account in respect of the Newco Preferred Shares issued by it to Holdco an amount which does not exceed the particular transferee's cost (as determined under section 85, where relevant) of the property transferred by Holdco to each corporation.

19. Newco Y and Newco Z will redeem the Newco Preferred Shares issued by it and, in consideration, Newco Y and Newco Z will each issue a demand promissory note to Holdco (the "Y Note" and the "Z Note" respectively - collectively referred to as the "Holdco Notes"). The Y Note and the Z Note will each have a principal amount and fair market value equal to the aggregate redemption amount of the Newco Preferred Shares redeemed by Newco Y and Newco Z, as the case may be. Holdco will accept the Holdco Notes as full payment of the redemption amount of the Newco Preferred Shares.

20. Thereafter, Newco Y and Newco Z, as the shareholders of Holdco, will, by special resolution, resolve to liquidate and dissolve Holdco pursuant to the provisions of the BCA. Under the terms of the winding-up, Holdco will assign and distribute the Y Note to Newco Y and the Z Note to Newco Z. As a result of the assignment and distribution of the Holdco Notes, the obligations under the notes will be cancelled. On the winding-up of Holdco, any dividend refund to which it becomes entitled as a result of the proposed transactions described herein will be distributed equally to each of Newco Y and Newco Z (such proportion being equal to that proportion of the issued and outstanding Common shares of Holdco owned by each corporation). Following the distribution of all its property, including its dividend refund, Articles of Dissolution will be filed and Holdco will be dissolved.

21. X will settle a trust (the "Y Trust") by transferring a precious metal coin to Y and two persons dealing at arm's length with Y, as trustees. The sole beneficiaries of the Y Trust will be Y, Z, Z's spouse, Z's issue and a class of beneficiaries which qualify as registered charities. The Y Trust will be a "personal trust" as defined in subsection 248(1). Subject to the restrictions set out in paragraph 26 below, the terms of the Y Trust will confer on the trustees the discretion to determine the beneficiaries to whom distributions of income and capital will be made.

22. X will settle a trust (the "Z Trust") by transferring a precious metal coin to Z and two persons dealing at arm's length with Z, as trustees. The beneficiaries of the Z Trust will be Z, Z's spouse, Z's issue and a class of beneficiaries which qualify as registered charities. Y will be a contingent beneficiary entitled to income and capital only in the event that all of the individual beneficiaries die prior to termination of the trust. The Z Trust will be a "personal trust" as defined in subsection 248(1). Subject to the restrictions set out in paragraph 26 below, the terms of the Z Trust will confer on the trustees the discretion to determine the beneficiaries to whom distributions of income and capital will be made.

23. All of the beneficiaries of the Y Trust and the Z Trust (except any beneficiary which is a registered charity) will be related to X for the purposes of section 55 and, as a result, X will be related to the Y Trust and the Z Trust pursuant to subparagraph 55(5)(e)(ii). There are no contemplated amendments to the terms of either the Y Trust or the Z Trust which would result in the addition of any beneficiaries thereunder.

24. The Trust will exchange, pursuant to subsection 86(1), all of its Common shares in Newco Y for Fourth Preferred shares of Newco Y having an aggregate redemption amount and fair market value equal to the fair market value of the Common shares. Newco Y will add to the stated capital account of its Fourth Preferred shares an amount equal to the aggregate paid-up capital of the Common shares cancelled on the exchange. Concurrent with the exchange, the Y Trust will subscribe for XXXXXXXXXX Common shares of Newco Y for a subscription price of $XXXXXXXXXX per share which will be funded by the trust's borrowing the subscription amount from an arm's length person.

25. The Trust will exchange, pursuant to subsection 86(1), all of its Common shares in Newco Z for Fourth Preferred shares of Newco Z having an aggregate redemption amount and fair market value equal to the fair market value of the Common shares. Newco Z will add to the stated capital account of its Fourth Preferred shares an amount equal to the aggregate paid-up capital of the Common shares cancelled on the exchange. Concurrent with the exchange, the Z Trust will subscribe for XXXXXXXXXX Common shares of Newco Z for a subscription price of $XXXXXXXXXX per share which will be funded by the trust's borrowing the subscription amount from an arm's length person.

26. The Y Trust and the Z Trust will contain limitations which expressly prohibit:

(a) any beneficiary who is the spouse or issue of Z from receiving or otherwise obtaining the use of any income or capital of the trust while the person is a designated person in respect of Z;

(b) the making of any preferred beneficiary election in respect of any beneficiary who is the spouse or issue of Z while such a person is a designated person in respect of Z; and

(c) the use of any property of the trust by a person who is the spouse or issue of Z for less than fair market value consideration.

27. Each of the Y Trust and the Z Trust will be irrevocable and no part of the income or capital of the trusts shall revert to or for the benefit of the settlor. In addition, the settlor will be prohibited from becoming a beneficiary or trustee of either trust.

ADDITIONAL INFORMATION

28. Holdco will have a nil balance in its refundable dividend tax on hand account at the end of its taxation year that includes the transactions set out herein.

29. Holdco does not expect to have any liabilities (other than a nominal amount of income tax, if any), at the time of the transfers described in paragraph 16. Any income taxes owing by Holdco will be offset by the dividend refund payable to Holdco pursuant to subsection 129(1). In addition, pursuant to the terms of the winding up, each of Newco Y and Newco Z will assume any unsatisfied liabilities of Holdco.

30. None of the corporations referred to herein is a specified financial institution or a restricted financial institution and none of the dividends received by Holdco or by either of the Transferee Corporations as a consequence of the proposed transactions will be received in the ordinary course of the recipient corporation's business.

31. None of the issued shares referred to herein (including the shares to be issued as part of the proposed transactions) is or will be subject to a guarantee agreement within the meaning referred to in subsection 112(2.2).

32. None of the issued shares referred to herein (including the shares to be issued as part of the proposed transactions) is or will be part of a dividend rental arrangement within the meaning referred to in subsection 112(2.3).

33. The Common shares of Holdco referred to herein are not, and will not, as a result of the proposed transactions, be term preferred shares or taxable preferred shares within the meaning assigned by subsection 248(1).

34. None of the issued shares referred to herein (including the shares to be issued as part of the proposed transactions) has been or will be issued or acquired as part of a transaction or event or series of transactions or events of the type described in subsection 112(2.5).

35. X will control each of Newco Y and Newco Z to ensure the assets acquired from Holdco continue to be managed in accordance with her wishes and to protect the value of her investment.

PURPOSE OF THE PROPOSED TRANSACTIONS

36. The purpose of the proposed transactions is to divide the assets of Holdco equally between Newco Y and Newco Z to facilitate independent estate planning on behalf of Y and Z.

RULINGS GIVEN

Provided that the preceding statements constitute a complete and accurate disclosure of all of 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. The provisions of subsection 85(1) will apply, subject to the application of subsection 26(5) of the Income Tax Application Rules, to the transfers of the shares of Holdco by X to Newco Y and Newco Z as described in paragraph 11 in respect of which an election under subsection 85(1) is made, such that the agreed amount in respect of each transfer will be deemed to be X's proceeds of disposition and the cost thereof to Newco Y and Newco Z pursuant to paragraph 85(1)(a).

For greater certainty, paragraph 85(1)(e.2) will not apply to the transfers.

B. The provisions of subsection 85(1) will apply, subject to the application of subsection 69(11) and subsection 26(5) of the Income Tax Application Rules, to the transfer of the Holdco shares by the Trust to Newco Y and Newco Z, as described in paragraphs 13 and 14, in respect of which an election under subsection 85(1) is made, such that the agreed amount in respect of each transfer will be deemed to be the Trust's proceeds of disposition and the cost thereof to Newco Y and Newco Z pursuant to paragraph 85(1)(a).

For greater certainty, paragraph 85(1)(e.2) will not apply to the transfers.

C. The provisions of subsection 85(1) will apply, subject to the application of subsection 40(3.3) and subsection 26(5) of the Income Tax Application Rules, to the transfer of each eligible property by Holdco to each of Newco Y and Newco Z as described in paragraph 16, in respect of which an election under subsection 85(1) is made, such that the agreed amount in respect of each property will be deemed to be Holdco's proceeds of disposition and the cost thereof to each of Newco Y and Newco Z pursuant to paragraph 85(1)(a).

For greater certainty, paragraph 85(1)(e.2) will not apply to the transfers.

D. That on the redemption by Newco Y and Newco Z of the Newco Preferred Shares and as a result of the distributions by Holdco in the course of its winding-up:

(a) by virtue of paragraphs 84(3)(a) and 84(3)(b), each of Newco Y and Newco Z will be deemed to have paid, and Holdco will be deemed to have received, a taxable dividend at that time equal to the amount, if any, by which the amount paid by such corporation to redeem its Newco Preferred Shares exceeds the PUC of those shares immediately before the redemption; and

(b) (i) pursuant to paragraph 88(2)(b) and subsection 84(2), but subject to (ii) to (iv) herein, each of Newco Y and Newco Z will be deemed to have received a dividend (the "winding-up dividend") on its shares of Holdco equal to the proportion of the amount by which the aggregate fair market value of the property of Holdco distributed by Holdco on the winding-up in consideration for the cancellation of its shares exceeds the PUC thereof that the number of shares of each class held by each of Newco Y and Newco Z is of the number of shares cancelled;

(ii) pursuant to subparagraph 88(2)(b)(ii), such portion of the winding-up dividend referred to in (b)(i) as does not exceed Holdco's CDA determined immediately before the payment of the winding-up dividend shall be deemed to be the full amount of a separate dividend;

(iii) pursuant to subparagraph 88(2)(b)(ii), the portion of the winding-up dividend that is equal to the lesser of:

(A) Holdco's pre-1972 capital surplus on hand as determined immediately before the payment of the winding-up dividend, and

(B) the amount by which the winding-up dividend exceeds the portion, if any, in respect of which Holdco will elect under subsection 83(2)

shall be deemed not to be a dividend; and

(iv) pursuant to subparagraph 88(2)(b)(iii), the winding-up dividend, to the extent that it exceeds the portion thereof referred to in (ii) herein that is deemed to be a separate dividend and the portion referred to in (iii) herein that is deemed not to be a dividend, shall be deemed to be a separate dividend that is a taxable dividend;

(c) to the extent that the deemed dividends described in (a) and (b) above are taxable dividends, such dividends will, pursuant to subsection 112(1), be deductible in computing the taxable income of the recipient corporation for the year in which the dividends are deemed to have been received and such deduction will not be denied by any of the provisions of subsections 112(2.1), (2.2), (2.3) or (2.4);

(d) the amount of the deemed dividends described in (a) and (b) above will be excluded from the proceeds of disposition of the shares and any loss arising from such disposition of those shares will be reduced by the amount of such dividends pursuant to subsection 112(3); and

(e) by virtue of subsections 186(2) and 186(4), each of Newco Y and Newco Z will be connected with Holdco and Holdco will be connected with each of the Transferee Corporations. Consequently, the Transferee Corporations and Holdco will not be subject to tax in respect of the dividends referred to in (a) and (b) above, under Part IV of the Act except as provided for in paragraph 186(1)(b).

E. By virtue of paragraph 55(3)(a), the provisions of subsection 55(2) will not apply to the taxable dividends referred to in Ruling D, provided there is not a disposition of property or an increase in interest described in any of subparagraphs 55(3)(a)(i) to (v) which is part of the series of transactions or events that includes the proposed transactions.

For greater certainty, the proposed transactions described in paragraphs 9 to 27, in and by themselves, will not be considered to result in any of the events described in subparagraphs 55(3)(a)(i) to (v).

F. The provisions of subsection 86(1) will apply to the exchange of the Common shares of Newco Y and Newco Z owned by the Trust, as described in paragraphs 24 and 25, such that the proceeds of disposition of the Common shares to the Trust will be equal to the adjusted cost base of such shares immediately before the exchange and the cost to the Trust of the Fourth Preferred shares issued on the exchange will be determined in accordance with paragraph 86(1)(b).

G. By virtue of subsection 74.4(4), subsection 74.4(2) will not apply to the transfer of the shares by X or the Trust to Newco Y and Newco Z as described in paragraphs 11, 24 and 25.

H. The provisions of subsections 15(1), 56(2), 69(4) and 246(1) will not apply to the proposed transactions described herein, in and by themselves.

I. As a result of the proposed transactions described herein, 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 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.

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, other than the dissolution of Holdco, are completed by XXXXXXXXXX.

CAVEAT

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;

(b) the determination of the balance of the capital dividend account or the refundable dividend tax on hand; or

(c) 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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