1999 Ruling 9911123 - SINGLE WING BUTTERFLY

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)(b)

Position: Reorganization is Tax-Deferred

Reasons: 55(3)(b) requirements satisfied

XXXXXXXXXX
XXXXXXXXXX 991112
XXXXXXXXXX

Attention: XXXXXXXXXX

XXXXXXXXXX, 1999

Dear Sirs:

Re: XXXXXXXXXX ("Dco") - XXXXXXXXXX

XXXXXXXXXX ("Mr. X") - XXXXXXXXXX

XXXXXXXXXX ("Mr. Y") - 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 acknowledge receipt of your subsequent correspondence dated XXXXXXXXXX and the information provided 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 judgment 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, c,1 (5th Supp.), 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" 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) “Canadian-controlled private corporation" has the meaning assigned by subsection 125(7);

f) “Canadian corporation" has the meaning assigned by subsection 89(1);

g) "capital dividend account" has the meaning assigned by subsection 89(1)

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

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

j) "distribution" has the meaning assigned by subsection 55(1);

k) "dividend rental arrangement" has the meaning assigned by subsection 248(1);

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

m) "fair market value" means the highest price available in an open and unrestricted market between informed prudent parties acting at arm's length and under no compulsion to act and contracting for a taxable purchase and sale;

n) "financial intermediary corporation" means a corporation described in paragraphs (a) to (f) of the definition "financial intermediary corporation in subsection 191(1);

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

p) "refundable dividend tax on hand" (also referred to as "RDTOH") has the meaning assigned by subsection 129(3);

q) "series of transactions or events" includes the transactions or events described in subsection 248(10);

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

s) "specified investment business" has the meaning assigned by subsection 125(7);

t) "stated capital account" has the meaning assigned by section 26 of the BCA;

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

v) "taxable dividend" has the meaning assigned by subsection 248(1);

w) "term preferred share" has the meaning assigned by subsection 248(1); and

x) "undepreciated capital cost" has the meaning assigned by subsection 13(21)

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

Facts

1. Dco is a taxable Canadian corporation and a Canadian-controlled private corporation incorporated under the laws of XXXXXXXXXX on XXXXXXXXXX. Dco operates a XXXXXXXXXX business in XXXXXXXXXX. Dco's taxation year end is XXXXXXXXXX.

2. The issued share capital of Dco is comprised of XXXXXXXXXX Class A Common shares with an aggregate paid-up capital of approximately $XXXXXXXXXX. Mr. X owns XXXXXXXXXX of the Class A Common shares and Mr. Y owns XXXXXXXXXX of the Class A Common shares. None of the shares of Dco were acquired in contemplation of the proposed transactions described in paragraphs 9 to 20 below

3. The shares of Dco are capital property to each of Mr. X and Mr. Y. The adjusted cost base of the Class A Common shares of Dco owned by Mr. X is $XXXXXXXXXX and the adjusted cost base of the Class A Common shares of Dco owned by Mr. Y is

$XXXXXXXXXX.

4. Each of Mr. X and Mr. Y is a resident of Canada and each deals with the other at arm's length.

5. The property of Dco includes a building located in

XXXXXXXXXX.

6 The rental income from the XXXXXXXXXX building has been reported by Dco as income from a specified investment business. The building in XXXXXXXXXX is used in the XXXXXXXXXX business with the exception of XXXXXXXXXX% of the space which is rented to a third party. The portion of the XXXXXXXXXX building which is rented to a third party is incidental to the XXXXXXXXXX business operations. Consequently, this rental income has been reported by Dco as income from an active business.

XXXXXXXXXX

7. Dco's capital dividend account for the taxation year in which the proposed transactions will be implemented is expected to be nil. Dco will earn rental income in its taxation year ending in the year the proposed transactions are implemented which will result in refundable dividend tax on hand, the amount of which is not determinable at this time.

8. The fair market value of the goodwill in respect of the XXXXXXXXXX portion of the business and XXXXXXXXXX portion of the business is equal.

Proposed Transactions

9. Mr. Y will incorporate a new corporation ("Subco") under the BCA. Subco will be a taxable Canadian corporation.

10. Subco's authorized share capital will consist of an unlimited number of voting common shares and a unlimited number of preferred shares (“Subco Preferred Shares"), with each Subco Preferred Share having the following attributes:

(a) redeemable and retractable for a redemption amount equal to the fair market value of the property received therefor (net of liabilities assumed) at the time of issuance;

(b) entitled to a non-cumulative dividend at a rate to be fixed by the directors;

(c) entitled to a return of the redemption amount on a liquidation, dissolution, or winding-up of the corporation in preference to the common shares; and

(d) entitled to one vote per share at all meetings of the shareholders

There will be a restriction on the payment of dividends on other classes of shares so that no such dividends may be paid on any other class of shares of Subco so as to reduce the value of the Subco Preferred Shares then outstanding.

11. Mr. Y will subscribe for XXXXXXXXXX common shares of Subco upon incorporation for a nominal subscription price.

12. Mr. Y will transfer to Subco, at fair market value, all of the Class A Common shares of Dco owned by him and will receive, as sole consideration therefor, additional common shares of Subco.

13. Subco will add to the stated capital account maintained for its common shares an amount equal to the paid-up capital of the Class A Common shares of Dco acquired by Subco from Mr. Y.

14. Mr. Y and Subco will jointly elect, in prescribed form and within the time specified in subsection 85(6), to have the rules in subsection 85(1) apply to the transfer of the Dco shares described in paragraph 12 above. The agreed amount in respect of the Class A common shares so transferred will be equal to their adjusted cost base to Mr. Y immediately before the transfer, which amount will not exceed the fair market value of the shares.

15. Immediately before the transfers described in paragraph 16 below, the property owned by Dco will be classified into the following three categories:

(a) cash or near cash property, comprising all of the current assets of Dco including cash, bank deposits, accounts receivable, prepaid expenses, inventories and marketable securities and similar investments (other than marketable securities and similar instruments held as portfolio investments);

(b) business property, comprising all of the assets of Dco, other than cash or near cash property, any income from which would be income from a business (other than a specified investment business); and

(c) investment property, comprising all of the assets of Dco, other than any cash or near cash property, any income from which would be income from property or from a specified investment business (including marketable securities and similar instruments held as portfolio investments)

Any accounts receivable, prepaid expenses and inventory of Dco that are initially classified in accordance with paragraph (a) as cash or near cash property that will relate to a business that will be carried on by Dco or Subco and that will be collected, sold or consumed by such corporation in the ordinary course of that business, will be reclassified as business property and will not be included in the fair market value of cash or near cash property.

For greater certainty, the interests in the XXXXXXXXXX and the XXXXXXXXXX rental property will constitute investment property of Dco. The portion of the XXXXXXXXXX property which is rented to third parties will be classified as a business property of Dco. Any tax accounts of Dco, such as the balance of any losses available for carryforward and its RDTOH, if any, will not be considered property of Dco for purposes of the proposed distribution described herein.

16. Dco will transfer to Subco, at fair market value, a portion of its cash or near cash property, business property and investment property, (collectively the "Transferred Property") such that the gross fair market value of each type of property transferred to Subco as described herein will approximate that proportion (the "Subco Proportion") of the gross fair market value of all the property of Dco of that type determined immediately before such transfer that:

(a) the aggregate fair market value immediately before such transfer of all of the shares of Dco owned by Subco,

is of

(b) the aggregate fair market value immediately before such transfer of all of the issued and outstanding shares of Dco.

For the purpose of this paragraph, the expression “approximate that proportion" means that the discrepancy from the proportion, if any, would not exceed 1%, determined as a percentage of the fair market value of each type of property which Subco has received (or Dco has retained) as compared to what Subco would have received (or Dco would have retained) had it received (or retained) its pro rata share of the fair market value of that type of property. However, the aggregate fair market value of all property of Dco transferred to Subco as described herein will be equal to the proportion determined herein of the aggregate fair market value of all property of Dco immediately before the transfer. Dco expects to satisfy the above-noted requirements by transferring to Subco all of the assets relating to the XXXXXXXXXX operation, including all of the accounts receivable, inventory and prepaid expenses applicable thereto

In consideration for the Transferred Property, Subco will:

(c) assume the Subco Proportion of the liabilities of Dco which amount will not exceed the aggregate of the agreed amounts set out by Dco and Subco in their joint election under subsection 85(1) as described in paragraph 17 below; and

(d) issue Subco Preferred Shares to Dco having an aggregate redemption amount and fair market value equal to the fair market value of the Transferred Property less the amount of the liabilities assumed by Subco as described in (a).

Immediately following the transfers set out in this paragraph, Dco will be connected to Subco on the basis that it will own more than 10% but less than 50% of the issued share capital of Subco which have full voting rights under all circumstances and which have a fair market value which exceeds more than 10% of the fair market value of all the issued shares of the capital stock of Subco.

For the purposes of subsection 191(4) , the terms and conditions of the Subco Preferred Shares will, at the time of their issue to Dco, specify an amount in respect of each share, including an amount for which the share is to be redeemed, acquired or canceled. The amount to be specified in respect of each Subco Preferred Share will be expressed as a dollar amount, will not be determined by a formula and will be equal to the fair market value of the property received by Subco as consideration for the share,

17. Subco and Dco will jointly elect, in prescribed form within the time referred to in subsection 85(6), to transfer each property that is an eligible property at the following agreed amounts, expressed in dollars:

(a) in the case of depreciable property of a prescribed class, an amount which is not less than the least of the amounts specified in subparagraphs 85(1)(e)(i) to 85(1)(e)(iii) and not greater than the fair market value of the property; and

(b) in the case of any other property, the lesser of the cost amount to Dco of the property and the fair market value thereof.

18. Subco will redeem the Subco Preferred Shares owned by Dco and, in consideration therefor, will issue to Dco a demand non-interest bearing promissory note (the "Subco Note") having a principal amount and a fair market value equal to the fair market value of the Subco Preferred Shares so redeemed. Subco will select this day as its first taxation year end such that the redemption of the Subco Preferred Shares will occur in the first taxation year of Subco. Dco will accept the Subco Note in full satisfaction of the redemption price of the Subco Preferred Shares.

19. On the day following the transactions described in paragraph 18, Dco will purchase for cancellation its Class A Common shares owned by Subco and, in consideration therefor, will issue to Subco a demand non-interest bearing promissory note (the "Dco Note") having a principal amount and fair market value equal to the fair market value of the Class A Common shares so purchased. Subco will accept the Dco Note in full satisfaction of the purchase price of the Dco Class A Common shares.

20. The Subco Note and the Dco Note will be set-off and canceled in full satisfaction of the obligations under each note.

Additional Information

21. 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).

22. 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).

23. None of the issued shares referred to herein (including the shares to be issued as part of the proposed transactions) is 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).

24. The Class A Common shares of Dco are not, and will not, as a result of the proposed transactions, be term preferred shares.

25. Neither Dco nor Subco is, or will be, at any time before the completion of the proposed transactions described herein, a specified financial institution or a financial intermediary corporation.

26. No property has or will become property of Dco and no liabilities (other than those incurred in relation to fees and expenses of the proposed transactions) have been or will be incurred by Dco in contemplation of and before the proposed transanctions, except in the ordinary course of the business of that corporation.

27. Neither Dco nor Subco is contemplating transferring any property to a partnership or to a person who is not related to Dco or Subco, as the case may be, as part of the series of transactions or events which includes the proposed transactions, other than as described herein, or in the ordinary course of the business of the corporation.

28. The proposed transactions will have no effect on any outstanding tax liabilities of any of the taxpayers.

Purpose of the Proposed Transactions

29. The purpose of the proposed transactions is to facilitate the division of Dco’s XXXXXXXXXX business (the “Business”) XXXXXXXXXX such that Mr. X will own and operate the XXXXXXXXXX portion of the Business while Mr. Y will own and operate the XXXXXXXXXX portion of the Business. By separating the Business, each of Mr. X and Mr. Y can focus on the future growth and development of the Business in a specific area and pursue his own financial and business objectives.

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 complete in the manner described above, our rulings are as set forth below.

A. The provisions of subsection 85(1) will apply to the transfer of the Class A Common shares of Dco by Mr. Y to Subco, as described in paragraph 12 above, in respect of which an election under subsection 85(1) is made, such that the agreed amount in respect of the transfer of such shares will be deemed to be Mr. Y’s proceeds of disposition and Subco’s cost thereof pursuant to paragraph 85(1)(a).

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

B. The provisions of subsection 85(1) will apply, subject to the application of subsection 69(11), to the transfer of each eligible property by Dco to Subco, as described in paragraph 16 above, in respect of which an election under subsection 85(1) is made, such that the agreed amount in respect of each transfer of such property will be deemed to be Dco's proceeds of disposition and the cost thereof to Subco and, in respect of depreciable property, Subco's cost of such property will be determined in accordance with subsection 85(5).

For the purpose of the joint election described in paragraph 17, the reference to "the undepreciated capital cost to the taxpayer of all the property of that class immediately before the disposition." in subparagraph 85(1)(e)(i) will be read as "the proportion of the undepreciated capital cost to the taxpayer of all property of that class that the capital cost of the property immediately before the disposition is of the capital cost of all property of that class immediately before the disposition."

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

C. Subsection 84(3) will apply:

(a) on the redemption of the Subco Preferred Shares owned by Dco as described in paragraph 18 to deem Subco to have paid and Dco to have received; and

(b) on the purchase for cancellation of the Class A Common shares owned by Subco as described in paragraph 19 to deem Dco to have paid and Subco to have received,

a taxable dividend on such shares equal to the amount, if any, by which the aggregate amount paid upon such redemption or cancellation exceeds the aggregate paid-up capital in respect of such shares immediately before such redemption or cancellation, and any such dividend:

(c) will be included in computing the income, pursuant to subsection 82(1) and paragraph 12(1)(j), of the recipient corporation deemed to have received such dividend;

(d) will be deductible by the recipient corporation pursuant to subsection 112(1) in computing its taxable income for the year in which such dividend is deemed to have been received, and such deduction will not be prohibited by any of subsections 112(2.1),(2.2), (2.3) or (2.4); and

(e) will be excluded in determining the proceeds of disposition to the recipient corporation of the shares so redeemed of canceled pursuant to paragraph (j) of the definition of "proceeds of disposition" in section 54.

D. With respect to the taxable dividends described in Ruling C:

(a) The dividends described in C(a) and (b) will not be subject to tax under Part IV.1 as such dividends will be excepted dividends by virtue of paragraph (c) of the definition of "excepted dividend" in section 187.1;

(b) provided that the amount paid on the redemption of the Subco Preferred Shares is equal to the amount specified in respect of such shares as described in paragraph 16 above, the dividend described in C(a) will not be subject to tax under Part VI.1 on the basis that such dividend will be a dividend deemed by paragraph 191(4)(d) to be an "excluded dividend" as defined in subsection 191(1); and

(c) the dividend described in C(b) will not be subject to tax under Part VI.1 on the basis that such dividend will be an excluded dividend by virtue of paragraph (a) of the definition of "excluded dividend" in subsection 191(1).

E. The taxable dividends described in Ruling C will not be subject to tax under subsection 186(1) except as provided in paragraph 186(1)(b).

F. Provided that as part of the series of transactions or events that includes the proposed transactions, 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), subsection 55(2) will not apply to the taxable dividends referred to in Ruling C above, and for greater certainty, subsection 55(3.1) will not apply to deny the exemption from subsection 55(2) provided by paragraph 55(3)(b)

G. The settlement of the Subco Note and the Dco Note as described in paragraph 20 above, will not give rise to a "forgiven amount" within the meaning of subsection 80(1).

H. The provisions of 15(1), 56(2), 69(1), 69(4) and 246(1) will not apply as a result of the proposed transactions, in and by themselves.

I. Subsection 245(2) will not be applied as a result of the proposed transactions, in and by themselves, to redetermine the tax consequences requested to be confirmed in the rulings requested.

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.

Caveat

Nothing in this ruling should be construed as implying that Revenue Canada, Customs, Excise and Taxation is making a determination or ruling in respect of:

(a) the cost or fair market value of any particular asset (in particular, we are not making any determination in respect of the fair market value of the goodwill relating to the XXXXXXXXXX or XXXXXXXXXX divisions of Dco referred to in paragraph 8, above);

(b) the paid-up capital of any shares referred to herein;

(c) the balance of the capital dividend account or the refundable dividend tax on hand of any corporation; or

(d) any tax consequences relating to the 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