28 March 1990 Income Tax Severed Letter AC74599 - Recent Issues — OECD Working Party No. 6

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.

March 28, 1990

Provincial & International Specialty Rulings
Relations Division Directorate
H.K. Tilak
David R. Senecal 957-2122
Your file: HBW 6593-7 (WP6)

• 7- 6399

Re: Recent Issues
OECD Working Party No. 6

We are writing to you in response to your memorandum dated December 19, 1989 in which you asked for our assistance in preparing your reply to a note entitled "Tax Aspects of Cross-Frontier Mergers, Acquisitions and Demergers"

24(1)
specifically, you have asked our comments regarding the current
position under the Income Tax Act (the "Act") in the context of
various scenarios of relevance to the Working Party's
deliberations.

Assumptions

Cur comments below assume that

• (1) Shareholder B deals at arm's length with each of Shareholder A, ACo and ABCo,
• (2) immediately after the merger or acquisition, Shareholder B will not control ACo or ABCo or own shares of ACo or ABCo having a fair market value of more than 50% of the fair market value of all of the issued and outstanding shares of ACo or ABCo,
• (3) immediately before the demerger, Shareholder B owns at least 25% of the issued shares of at least one class of the capital stock of ABCo,
• (4) a corporation is incorporated in the jurisdiction in which it is resident, and
• (5) all of the income of ACo, BCo and ABCo is active business income and is not property income (or "passive" income) and all of the property of ACo, BCo and ABCo is property used or held principally for the purpose or gaining or producing such income.

I. Example A.1 - Domestic merger where the acquired corporation has a p/e in another country (See paragraphs 13 to 15 of the Note)

Scenario

This scenario deals with two corporations (ACo & BCo) both of which are resident in Country X. BCo has a p/e in Country Y. ACo is wholly-owned by Shareholder A who is a resident of Country X. BCo is wholly-owned by Shareholder B who may be a resident of Country X, Country Y or a third country, Country Z. BCo is merged into ACo so that the former p/e of BCo becomes a p/e of ACo and Shareholder B receives only shares of ACo in exchange for his shares of BCo.

Our comments

• 1. This scenario contemplates a merger in which one of the two merging corporations (ACo) is the surviving corporation and in which the other merging corporation (BCo) ceases to exist.
2. A merger such as is described in paragraph 1 above may take place under the domestic laws of Canada as follows:
• (i) ACo acquires the shares of BCo from Shareholder B and issues shares of ACo to Shareholder B; and
• (ii) BCo is liquidated into ACo and, on such liquidation, all of the property of BCo is distributed to ACo and all of the liabilities of BCo are either discharged or are assumed by ACo.
3. Assuming that Country X is Canada and that the merger takes place as described in paragraph 2 above,
• (i) Shareholder B will be considered to have alienated his shares BCo at their tax cost and to have acquired the shares of ACo at that cost,
• (ii) alternatively, Shareholder B and ACo may jointly elect at a higher amount (but not exceeding the fair market value of the shares of BCo) and Shareholder B will be considered to have alienated his shares of BCo at such elected amount and to have acquired the shares of ACoat that amount,
• (iii) on the liquidation of BCo, BCo will be considered to have alienated all of its property at its tax cost of such property and, subject to subparagraph (iv) hereof, ACo will be considered to have acquired such property at that tax cost, and
• (iv) ACo may increase its tax cost of any capital property (other than depreciable property) distributed to it on the liquidation of BCo to the fair market value thereof provided that the aggregate tax cost of all of the property of BCo so distributed to ACo does not exceed the tax Cost to ACo of the shares of BCo.
4. Assuming that Country Y is Canada and that the results of the merger are as described in paragraph 1 above,
• (i) BCo will be considered to have alienated the property of the p/e of BCo at its fair market value,
• (ii) any income or gain realized by BCo on such alienation of property will be subject to tax in Canada,
• (iii) ACo will be considered to have acquired the property of the p/e of BCo at its fair market value,
• (iv) Shareholder B will be considered to have alienated his shares of BCo for an amount equal to the fair market value of the shares of ACo received in exchange therefor,
• (v) if Shareholder B is not a resident of Canada, Shareholder B will generally not be taxable in Canada in respect of any gain realized by him on such alienation of his shares of BCo unless such shares of BCo are taxable Canadian property of Shareholder B.

We have also assumed that, if Shareholder B is a resident of Canada, Shareholder B will not own 10% or more of the issued shares of any class of the capital stock of ACo immediately after the exchange described in subparagraph 2(i) above.

II. Example B.1 - Merger of corporations resident in different countries (See paragraphs 16 to 19 of the Note)

Scenario

This scenario deals with too corporations, one of which (ACo) is resident in Country X and the other one of which (BCo) is resident in Country Y. ACo is wholly-owned by Shareholder A who may be a resident of Country X, Country Y or a third country, Country Z.

BCo is wholly-owned by Shareholder B who may be a resident of Country X, Country Y or a third country, Country Z. BCo is merged into ACo so that the former business and property of BCo becomes the business and property of a p/e of ACo in Country Y and Shareholder B receives only shares of ACo in exchange for his shares of BCo.

Our comments

• 5. This scenario contemplates a merger of too corporations in which the too corporations are resident in different countries and in which one of the two merging corporations (ACo) is the surviving corporation (ABCo) and in which the other merging corporation (BCo) ceases to exist.
6. Assuming that Country X is Canada, a merger such as is described in paragraph 5 above may take place under the domestic laws of Canada either as described in paragraph 2 above or as follows:
• (i) BCo emigrates to the Jurisdiction under whose laws ACo was incorporated by way of articles of continuance granted in that Jurisdiction and becomes resident in that Jurisdiction,
• (ii) ACo and BCo merge under the relevant corporate laws in such manner that (A) ACo and BCo continue as one corporation (ABCo), and

(B) all of the property of,. and all of the liabilities of, ACo and of BCo become the property of, and the liabilities of, ABCo.

7. Assuming that Country X is Canada and the merger takes place as described in paragraph 2 above,
• (i) Shareholder B will be considered to have alienated his shares of BCo at their tax cost and to have acquired the shares of ACo at that cost,
• (ii) alternatively, Shareholder B and ACo may Jointly elect at a higher amount (but not exceeding the fair market value of the shares of BCo) and Shareholder B will be considered to have alienated his shares of BCo at such elected amount and to have acquired the shares of ACo at that amount,
• (iii) on the liquidation of BCo, BCo will be considered to have alienated all of its property at its fair market value and ACo will be considered to have acquired such property at that fair market value.

B. Assuming that Country X is Canada and the merger takes place as described in paragraph 6 above,

• (i) on its immigration to Canada, BCo will be considered to have acquired its property at the fair market value of that property at that time, and
• (ii) each of Shareholder A and Shareholder B will be considered to have alienated his shares of ACo or BCo, as the case may be, and to have acquired the shares of ABCo held by him immediately after such merger at the fair market value of such shares of ABCo.

The tax consequences under the Act to ACo and BCo of such a merger are not clear and ACo and BCo may be considered to have alienated any property that becomes a property of ABCo as a result of the merger at the fair market value of such property and -Co may be considered to be a new corporation that acquired such property at a tax cost equal to the fair market value thereof. Such a result would be consistent with our understanding of the tax consequences of a merger under the laws of the United States and European countries.

9. Assuming that Country y is Canada and that the results of the merger are as described in paragraph 5-above,
• (i) Shareholder B will be considered to have alienated his shares of BCo for an amount equal- to the fair market value of the shares of ABCo received by Shareholder B by virtue of the merger,
• (ii) BCo will be considered CO have alienated all of its property at its fair market value and ABCo will be considered to have acquired such property at that fair market value, and
• (iii) any income or gain realized by BCo on such alienation of property will be subject to tax-in Canada.
10. Assuming that Country Y is Canada and that BCo emigrates from Canada to Country X by way of articles of continuance (or similar corporate constitutional documents) granted in Country X so that BCo thereby becomes a resident of Country X before the merger takes place with the results described in paragraph 5 above,
• (i) BCo will be considered to have alienated its property immediately before the emigration and to have reacquired such property immediately after the emigration at the fair market value thereof,
• (ii) Shareholder B will be considered to have alienated his shares of BCo and to have acquired the shares of ABCo held by him immediately after such merger at the fair market value of such shares of ABCo, and
• (iii) ABCo will be taxable in Canada on its income from carrying on the business of the p/e and will also be subject to an additional tax (generally referred to as the "branch tax") which is designed to be approximately equal to the withholding tax that would be payable if the property and business of the p/e were the property and business of a subsidiary corporation that was a resident of Canada and that distributed all of the income of the p/e, other than any such income that was invested in prescribed property in Canada.

III. Example C.1 - Take-over of a foreign corporation through the acquisition of its shares (See paragraphs 20 to 23 of the Note)

Scenario

This scenario deals with a take-over of one corporation (BCo) by another (ACo). ACo is resident in Country x ind BCo is resident in Country Y. ACo is wholly-owned by Shareholder A who maybe a resident of Country X, Country Y or a third country, Country Z. BCo is wholly-owned by Shareholder B who may be a resident of Country X, Country Y or, a third country, Country Z. Shareholder B exchanges his shares of BCo for shares of ACo and, possibly, some cash compensation so that BCo becomes a wholly-owned subsidiary corporation of ACo. Our comments

11. Assuming that Country X is Canada,
• (i) where Shareholder B receives no cash compensation and the election described in subparagraph (iii) hereof is not made, Shareholder B will be considered to have alienated his shares of BCo at their tax cost and to have acquired the shares of ACo at a tax cost equal to the tax cost of such shares of BCo and ACo will be considered to have acquired the shares of BCo at a tax cost equal to the lesser of the fair market value and the capital of such shares of BCo,
• (ii) where Shareholder B receives some cash compensation and the election described in subparagraph (iii) hereof is not made, Shareholder B will be considered to have alienated his shares of BCo and to have acquired he shares of ACo at the fair market value of such shares of BCo and ACo will be considered to have acquired the shares of BCo at a tax cost equal, to that fair market value, and
• (iii) Shareholder B and ACo may, jointly elect at an amount higher than the tax cost to Shareholder B of his shares of BCo (but not exceeding the fair market value of such shares) and Shareholder B will be considered to have alienated his shares of BCo at such elected amount and to have acquired the shares of ACo at a tax cost equal to the excess of such elected amount over the amount of any cash compensation and ACo will be considered to have acquired the shares of BCo at a tax cost equal to such elected amount.
12. Assuming that Country Y is Canada,
• (i) Shareholder B will be considered to have alienated his shares of BCo at their fair market value and to have acquired the shares of ACo at a tax cost equal to the fair market value of such shares of BCo,
• (ii) ACo will be considered to have acquired the shares of BCo at a tax cost equal to the fair market value of such shares of BCo, and
• (iii) Shareholder B will be taxable in Canada in respect of any gain realized by him on such exchange of shares of ACo for his shares of BCo.

IV. Example D.1 -Domestic demerger where the corporation has ap/e in another country (See paragraphs 25 to 27 of the Note)

Scenario This scenario deals with a division of one corporation (ABCo) into two corporations (ACo, being the same corporation as ABCo, and BCo) ABCo is, and ACo and BCo will be, resident in Country X. ABCo has a p/e in Country Y and that p/e will become a pie of BCo after the division of ABCo. ABCo is wholly- owned by Shareholder A and Shareholder B and ACo and BCo will be wholly-owned by Shareholder A and Shareholder B, respectively, after the division of ABCo. Shareholder A is a resident of Country R. Shareholder B may be a resident of Country X, Country Y or a third country, Country Z.

Our comments

• 13. The division of ABCo into ACo and BCo contemplated in this scenario may be accomplished in certain specified circumstances by a transfer by Shareholder B of his shares of ABCo to BCo for shares of BCo, followed by a-transfer of property by ABCo to BCo and cancellation of the shares of ABCo held by BCo.
14. Assuming Country X is Canada and the division of ABCo takes place as described in paragraph 13 above,
• (i) such a division of ABCo may be accomplished on a tax-free basis provided that, immediately after such division, ACo and BCo each own the appropriate proportion (based on the relative fair market value of the shares of ABCo owned by Shareholder A and Shareholder B immediately before such division) of each type of property of ABCo immediately before such division,
• (ii) if Country Y does not permit a tax-free transfer of property from ABCo to BCo, ABCo and BCo may jointly elect to step up the tax cost to BCo and to have ABCo realize all or any part of the gain on any such property,
• (iii) subject to subparagraph (iv) hereof, Shareholder B and BCo may jointly elect so that Shareholder B will be considered to have alienated his shares of ABCo at their tax cost and to have acquired the shares of BCo at a tax cost equal to the tax cost of such shares of ABCo,
• (iv) If the country in which Shareholder B is resident does not permit a tax-free transfer by Shareholder B of the shires of o to BCo, Shareholder B and BCo may Jointly elect to deem the alienation of the shares of ABCo to be at a higher amount (but not greater than the fair market value of such shires of ABCo) and Shareholder B will be considered to have acquired the shares of BCo at that higher amount, and
• (v) shareholder B will be taxable in Canada in respect of any gain realized by him on the-alienation of shares of ABCo.
15. Assuming Country Y is Canada,
• (i) any property of ABCo that becomes property of BCo will be considered to have been alienated by ABCo it its fair market value ind to have been acquired by BCo it a tax cost equal to that fair market value, and
• (ii) any income or gain realized by ABCo on such alienation of property will be subject to tax in Canada.

We have assumed that, if Shareholder B is a resident of Canada, Shareholder B does not own 101 or more of the issued shares of any class of the capital stock of ABCo immediately before his shares of ABCo ire transferred to BCo.

V. Example D.2 - Demerger of corporation that has a p/e in another country into two corporations one of which is resident in the other country (See paragraphs 28 to 30 of the Note)

Scenario

This scenario deals with a division of one corporation (ABCo) into too corporations (ACo and BCo). ABCo is, and ACo will be, resident in Country X and BCo will be resident in Country y. ABCo has a p/e in Country Y and the property and business of that p/e will become the property and business of BCo after the division of ABCo. ABCo is wholly-owned by Shareholder A and Shareholder B and ACo and BCo will be wholly-owned by Shareholder A and Shareholder B, respectively, after the division of ABCo. Shareholder A may be a resident of Country X, Country Y or a third country, Country Z. Shareholder B may be a resident of Country X, Country Y or a third country, Country Z.

Our comments

16. The division of ABCo into ACo and BCo contemplated in this scenario may be accomplished
• (i) assuming Country X is Canada, by a division of ABCo into ACo and BCo is described in paragraph 13 above followed by in emigration of BCo to Country Y by way of articles of continuance (or similar corporate constitutional documents) granted in Country Y so that BCo thereby becomes a resident of Country Y, or
• (ii) assuming Country Y is Canada, by a transfer by ABCo of the property and business of, the p/e in Canada to BCo, a corporation that is a resident of Canada, for shares of BCo, followed by an exchange by Shareholder B of his shares of ABCo for the shares of BCo.
17. Assuming Country X is Canada and the division of ABCo takes place as described in subparagraph 16(1) above,
• (i) such a division of ABCo will give rise to the tax consequences described in paragraph 14 above, and
• (ii) BCo will be considered to have alienated all of its property immediately before its emigration to Country Y at the fair market value of such property and any income or gain realized by BCo on such alienation of property will be subject to tax in Canada.
18. Assuming Country Y is Canada and the division of ABCo takes place as described in subparagraph 16(ii) above,
• (i) Shareholder B will be considered to have acquired the shares of BCo at the fair market value thereof,
• (ii) ABCo and BCo may jointly, elect at an amount not less than the tax cost to ABCo of the property of the p/e so transferred to BCo and not greater than the fair market value of such property and ABCo will be considered to have alienated such property, and BCo will be considered to have acquired such property, at that elected amount, and
• (iii) any income or gain realized by ABCo on such alienation of property will be subject to tax in Canada.

M.A. Hiltz
for Director General
Specialty Rulings Directorate
Legislative and Intergovernmental
Affairs Branch

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