11 May 1990 Income Tax Severed Letter RRRR378 - Review of the Case Study of the Corporate Reorganizations Course Material

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.

DATE May 11, 1990
TO
A FROM
D.R. Snider, Section Chief DE Specialty Rulings
Advanced Audit & Investigations Directorate
Training Programs Section S. Leung
Centre for Career Development 957-2116

Attention: D. Sturtevant FILE
DOSSIER 900501

SUBJECT: OBJET: Review of the Case Study of the Corporate Reorganizations Course Material

This memorandum is in response to your of April 3, 1990 wherein you requested our technical review of the Corporate Reorganizations Course Material. This memorandum contains our comments on the Case Study.

Our comments are as follows:

• 1. We suggest that the word "cost" be replaced with "the aggregate cost amount" in the sentence "At that date,the cost of its business assets less the liabilities, was $400,000.". This sentence is found in the second paragraph under the heading "Given" on page 1.1 of the Case Study.
• Similarly, the word "Cost" as used in the expressions "Cost of BBL assets", "Cost of FCL shares" and "Cost of FCL shares" in lines 2, 3 and 6, respectively, of the calculation of the bump in Part 1(A) of the Suggested Solution should be revised to "Cost amount".
• 2. In the first paragraph of Part 1(A) of the Suggested Solution with respect to the claim for a capital gains deduction of $500,000, technically the capital gains deduction pursuant to subsection 110.6(2.1) should be $500,000 X 3/4 or $375,000. This observation is also applicable to the claim for a capital gains deduction of $498,750 in the fourth paragraph of Part 1(C) of the Suggested Solution.
3. With respect to Part 1(B) of the Suggested Solution found on page 3.2 of he Answer Sheets we offer the following comments:
• (a) We assume that the agreed amounts for purposes of the subsection 85(1) elections referred to in paragraphs 1, 2 and 4 will be the adjusted cost base of the property.
• (b) In the third paragraph, we suggest that the following be added immediately before the last sentence:

"Assume that the transfer by BBL of its FCL shares meets the requirement regarding the pro rata distribution of each type of property of BBL pursuant to paragraph 55(3)(b)."

• We should, however, point out that this assumption may not be valid. Since BBL holds a minority interest in FCL the shares of FCL would constitute investment property to BBL for purposes of paragraph 55(3)(b) unless BBL has a significant influence, within the meaning of paragraph 3050.21 of the CICA Handbook, over that corporation. If BBL does not have a significant influence in FCL with the result that the FCL shares constitute investment property to BBL, the pro rata test in paragraph 55(3)(b) would not be met since Holdco will receive only investment property, and not its share of any cash or near cash property and business property, of BBL. Even if BBL does have a significant influence in FCL the pro rata test in paragraph 55(3)(b) will only be met if the types of property held by FCL (i.e. cash or near cash, business and investment) are in approximately the same proportion as the respective type of property held by BBL.
(c) It is our opinion that both the second transfer by Mr. Blue of his 900 BBL shares and the subsequent payment of a dividend by BBL to Holdco out of its safe income will be considered to be in the course of the same reorganization which includes the first transfer of FCL share by BBL. Since Holdco only owned 100 shares of BBL "immediately before the transfer" and in the course of the reorganization Holdco will have received the FCL shares plus $270,000 cash (i.e. the dividend out of safe income) the requirement regarding the pro rata distribution of each type of property owned by BBL immediately before the transfer as found in paragraph 55(3)(b) will not be met. The deemed dividend arising as a result of the redemption of the preferred shares of Holdco and the purchase of its common shares by BBL as well as the subsequent dividend paid by BBL will, therefore,be subject to subsection 55(2).
• 4. On page AN/3.4, we feel that it is better to show the dividend refunds of $286,025 and $238,360 under columns B and C respectively immediately after the line "Tax on dividend when (if) holding corporation is eventually wound up". This is because the holding corporation would only be entitled to the dividend refund once it has paid a taxable dividend to its shareholders. Before that time these amounts represent a refundable dividend tax on hand.
• 5. Under Note (a) of Part 1 regarding other alternatives, if the business assets are transferred on a tax-deferred basis under subsection 85(1) by BBL for shares of the holding corporation and if these shares are later redeemed to sever the tie between BBL and the holding corporation, subsection 55(2) would apply to the deemed dividends arising as a result of the redemption of the shares of the holding corporation. If, however, it is intended that it is BBL which sells the shares of the holding corporation, we suggest that this be clarified.

for Director Reorganizations and Non-Resident Division Specialty Rulings Directorate Legislative and Intergovernmental Affairs Branch