24 March 2004 External T.I. 2003-0034311E5 - "liquidation and a dissolution": What does it mean

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.

Principal Issues: "liquidation and a dissolution": What does it mean?

Position: The meaning derived from Canadian Law

Reasons: Interpretation of the Income Tax Act

XXXXXXXXXX 						Pascal Tétrault
							2003-003431
March 24, 2004

Re: The meaning of "liquidation and a dissolution"

We are writing in response to your email of August 7, 2003 regarding the above captioned matter. More specifically, you have asked us to provide some guidance on the meaning of "liquidation and a dissolution" found in paragraph 95(2)(e.1) of the Income Tax Act (the "Act") in light of the Czech Republic's corporate law.

In your letter, you describe two types of processes by which a corporation can be "wound-up" in the Czech Republic. You describe the operation of Czech law as follows:

In the Czech Republic there appears to be a distinction between a wind-up with liquidation of a subsidiary and a wind-up of a subsidiary into its sole member/shareholder without liquidation where the business assets are transferred to its sole member.

Where there is a wind-up with liquidation, a liquidator is appointed, and the following steps have to be implemented in the course of the liquidation:

1. Any and all contractual relationships have to be terminated;

2. Any and all property of the company must be sold; and

3. Any and all other obligations and liabilities of the company in liquidation must be settled and satisfied.

The process of liquidation is terminated by the deletion of the company from the Commercial Register.

In contrast, on a "winding-up without liquidation" with a transfer of the business assets to the sole member/shareholder of the company, no liquidator is appointed and all of the assets and liabilities are transferred to the sole shareholder rather than being sold. The transfer of the business assets must be registered in the commercial register to be effective and the motion asking for the registration must be accompanied by, amongst other things, the agreement on the merger by acquisition. When the transfer is registered in the Commercial Register, the subsidiary company is deleted from the Commercial Register and legally ceases to exist.

QUESTION

You are asking for guidance on the meaning of "a liquidation and a dissolution" found in paragraph 95(2)(e.1) of the Act particularly as you say "in light of the fact that in the Czech Republic they appear to use the term liquidation very specifically and in fact make a distinction between a dissolution of a company where there has been a liquidation and a dissolution without a liquidation where the business is transferred to the sole shareholder."

COMMENTS

Written confirmation of the tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and are the subject matter of an Advance Income Tax Ruling request. Where the particular transactions are completed, the inquiry should be addressed to the relevant Tax Services Office. However, we are prepared to provide the following comments.

Using the expression "winding-up without liquidation" can be confusing in a Canadian context. However, this choice of words may be due to translation technicalities and this is why it maybe necessary to go beyond the words used in a foreign jurisdiction. The words "liquidation" and "dissolution" are to be given their meaning according to Canadian Law. It is therefore irrelevant if a foreign jurisdiction uses, under its applicable law, the word "liquidation" when the use of that word does not correspond to the concept of liquidation under Canadian Law. Foreign tax law is referred to in paragraph 95(2)(e.1) for the purposes of ascertaining whether a gain or loss was recognized but not for the purposes of providing the meaning of "liquidation and a dissolution".

The question to be answered is what does "a liquidation and a dissolution" mean under our law. Under Canadian Law, certain steps need to be taken in order to terminate the corporate existence which is generally referred to as the liquidation and dissolution of a corporation. For instance, Part XVIII of the Canada Business Corporation Act (the "CBCA") dealing with the procedure to bring an end to corporate life is entitled "Liquidation and Dissolution". Section 211 of the CBCA provides for the voluntary liquidation and dissolution and sections 213 and 214 of the CBCA provide for the judicial liquidation and dissolution. Under the voluntary liquidation and dissolution, a formal liquidator does not need to be appointed; it is the corporation that generally proceeds to the liquidation. The dissolution terminates the corporate existence and before the dissolution comes the liquidation. The liquidation refers to the act of satisfying the creditors and distributing the remaining assets to its shareholders.

Under our law, a corporation generally has to settle its debts and allocate the property to its shareholders in order to be dissolved. Even if that stage is not referred to as a liquidation under a particular enactment, where the property of the corporation is being distributed to the shareholder and the liabilities of the corporation are discharged, it will likely be qualified as a liquidation for the purposes of the Act.¹

On the issue of whether a liquidation has occurred in the context of the "winding-up without liquidation", one thing that needs to be looked at closer is what you refer to as the transfer of liabilities to the shareholders. We would consider that debts of a corporation are settled when there is a novation operating to substitute the shareholders in place of the corporation having the effect of discharging the corporation of its obligations. Accordingly, what you refer to as a "winding-up without liquidation" may be similar to what we consider a voluntary liquidation and dissolution under section 211 of the CBCA and provided that you have described Czech law accurately, it could be qualified as "a liquidation and a dissolution" for purposes of paragraph 95(2)(e.1) of the Act.

With respect to what you refer to as a "wind-up with liquidation" we have concerns with that fact that "any and all property of the company must be sold". Evidently, paragraph 95(2)(e.1) of the Act is not a provision that can be relied upon in circumstances where all of the property of an affiliate is sold to a third party and the proceeds are distributed to the parent company because this would logically trigger a realization of capital assets in the course of the liquidation and dissolution.

We trust that these comments will assist you.

Alain Godin
Section Manager
for Division Director
International and Trusts Division
Income Tax Rulings Directorate
Policy and Planning Branch
ENDNOTES

¹ See Dauphin Plains Credit Union Ltd. v. Xyloid Industries Ltd., [1980] 1 S.C.R. 1182 (S.C.C.).