2010 Ruling 2010-0374141R3 - Stock dividend from CFA & PUC

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: 1. Whether the distribution of a stock dividend payable from the share premium account of a controlled foreign affiliate ("CFA") governed by the Companies Law of XXXXXXXXXX will be a "stock dividend" within the meaning of subsection 248(1) of the Act? 2. Whether subsection 95(7) will deem the amount of the stock dividend to be nil for the purposes of subdivision i, Division B, Part I of the Act? Whether subsection 52(3) of the Act will apply such that the adjusted cost base ("ACB") of the new shares in the CFA received by the taxpayer will be nil?

Position: 1. Yes. 2. Yes. 3. Yes

Reasons: See below.

XXXXXXXXXX
									2010-037414
									XXXXXXXXXX
	

XXXXXXXXXX , 2010

Dear XXXXXXXXXX :

Re: XXXXXXXXXX
Advance Income Tax Ruling

This is in reply to your letter dated XXXXXXXXXX in which you request an advance income tax ruling on behalf of XXXXXXXXXX .

The rulings given herein are based solely on the facts, proposed transactions and purposes of the proposed transactions described below. We acknowledge your additional submissions received by email on XXXXXXXXXX .

I. DEFINITIONS

In this ruling, unless otherwise expressly stated:

(a) "Act" means the Income Tax Act, R.S.C. 1985, Chapter 1 (5th Supp.), as amended and, unless otherwise stated, every reference in this ruling letter to a part, section, subsection, paragraph, subparagraph, clause or sub-clause is a reference to the relevant provision of the Act;

(b) "Adjusted Cost Base" ("ACB") has the meaning assigned by subsection 248(1);

(c) "Canco" means XXXXXXXXXX ;

(d) "Canco's Foreign Subsidiaries" means Canco's regulated XXXXXXXXXX subsidiaries, including Forco2;

(e) "Canco Short-Term Loan" has the meaning described in paragraph 49 of this ruling letter;

(f) "Consideration Shares" has the meaning described in paragraph 21 of this ruling letter;

(g) "Controlled Foreign Affiliate" has the meaning assigned by subsection 95(1);

(h) "CRA" means the Canada Revenue Agency, together with its predecessors, the Canada Customs and Revenue Agency and Revenue Canada;

(i) "Forco1" means XXXXXXXXXX ;

(j) "Forco2" means XXXXXXXXXX ;

(k) "Forco3" means XXXXXXXXXX ;

(l) "Forco4" means XXXXXXXXXX , a corporation established under the laws of Foreign Country1;

(m) "Forco5" means XXXXXXXXXX , a corporation established under the laws of Foreign Country1;

(n) "Forco6" means XXXXXXXXXX , a corporation established under the laws of Foreign Country1;

(o) "Forco7" means XXXXXXXXXX , a corporation established under the laws of Foreign Country2;

(p) "Forco3 Loan" has the meaning assigned by paragraph 16 of this ruling letter;

(q) "Foreign Affiliate" has the meaning assigned by subsection 95(1);

(r) "Foreign Companies Law" means the XXXXXXXXXX of Foreign Country2;

(s) "Foreign Country1" means XXXXXXXXXX ;

(t) "Foreign Country2" means XXXXXXXXXX ;

(u) "Foreign Court" means the XXXXXXXXXX of XXXXXXXXXX ;

(v) "GAAP" means the Canadian Generally Accepted Accounting Principles;

(w) "New Shares" has the meaning assigned by paragraph 54 of this ruling letter;

(x) "Ordinary Shares" means the Ordinary Shares of Forco1with a par value of XXXXXXXXXX per share, which carry one vote per share, are entitled to dividends as and when declared by the board of directors of Forco1 and are entitled to the surplus assets on liquidation of Forco1 after the rights of holders of the Preferred Shares of Forco1 have been satisfied and all debts have been paid. The Ordinary Shares include the Consideration Shares described in paragraph 21 of this ruling letter and the New Shares described in paragraph 54 of this ruling letter;

(y) "Paid-Up Capital" ("PUC") has the meaning assigned by subsection 89(1);

(z) "Preferred Shares of Forco1" means convertible redeemable preferred shares of Forco1;

(aa) "Repatriation" has the meaning assigned by paragraph 48 of this ruling letter;

(bb) "Stock Dividend" has the meaning assigned by paragraph 54 of this ruling letter;

(cc) "Taxable Surplus" has the meaning assigned by subsection 5907(1) of the Regulations to the Act;

(dd) "Transferred Foreign Affiliate" has the meaning assigned by paragraph 21 and paragraph 25 of this ruling letter; and

(ee) "Term Preferred Shares" has the meaning assigned by subsection 248(1).

FACTS

Canco

1. Canco is a "taxable Canadian corporation" and a "public corporation", as defined in the Act.

2. Canco is a XXXXXXXXXX for purposes of the XXXXXXXXXX .

3. Canco's activities are regulated by the XXXXXXXXXX .

4. XXXXXXXXXX

Forco1

5. Forco1 is a corporation established pursuant to the laws of the Foreign Country2 and resident in Foreign Country2 for purposes of the Act.

6. Forco1 was formed in XXXXXXXXXX and acts as the principal holding company for Canco's Foreign Subsidiaries.

7. Forco1 is a wholly-owned Foreign Affiliate and Controlled Foreign Affiliate of Canco.

8. Forco1's taxation year ends on XXXXXXXXXX of each year;

9. Forco1 and its subsidiaries carry on all of their businesses and activities outside of Canada.

Forco2

10. Forco2 is a corporation established pursuant to the laws of Foreign Country1.

11. Forco2 is XXXXXXXXXX .

12. Following the transactions described in paragraph 25 of this ruling letter, approximately XXXXXXXXXX % of Forco2's shares are owned by Forco1, while the remaining XXXXXXXXXX % are owned by XXXXXXXXXX .

Forco3

13. Forco3 is a corporation established under the laws of Foreign Country1.

14. Following the transactions described in paragraph 25 of this ruling letter, Forco3 became a wholly owned subsidiary of Forco1.

15. Forco3 provides XXXXXXXXXX to Canco's Foreign Subsidiaries.

16. In XXXXXXXXXX , Forco3 loaned C$XXXXXXXXXX to Canco on an interest free basis ("Forco3 Loan") in order XXXXXXXXXX .

17. The stated capital of Forco3 is maintained in XXXXXXXXXX for accounting purposes and the purposes of the corporate laws of Foreign Country1. All subscriptions for shares of Forco3 are expressed in XXXXXXXXXX .

Historical Issuances of the Ordinary Shares

18. Since its incorporation date, Forco1 has issued XXXXXXXXXX fully-paid Ordinary Shares with an aggregate issue price of US$XXXXXXXXXX .

19. In particular, XXXXXXXXXX Ordinary Shares with an aggregate issue price of approximately US$XXXXXXXXXX were issued for cash and the Canadian dollar equivalent of such amount at the time of the subscription was added to the ACB of such Ordinary Shares owned by Canco.

20. The Canadian dollar equivalent of US$XXXXXXXXXX exceeds the amount of the proposed reduction of the share capital of Forco1 as described in paragraph 55 of this ruling letter.

21. A further XXXXXXXXXX Ordinary Shares (the "Consideration Shares") with an issue price of US$XXXXXXXXXX were issued as consideration for the transfer of shares of other Foreign Affiliates (the "Transferred Foreign Affiliates" more specifically identified in paragraph 25 of this ruling letter) in transactions to which subsection 85.1(3) applied.

22. The issue price of the Consideration Shares generally corresponded to the XXXXXXXXXX .

23. Each Transferred Foreign Affiliate was a Controlled Foreign Affiliate and wholly-owned subsidiary of Canco, with the exception of Forco2.

24. As described in paragraph 25 of this ruling letter, Canco transferred all of its shares in Forco2, Forco3, Forco4, Forco5 and Forco6 to Forco1. The consideration paid by Forco1 to Canco consisted entirely of the Consideration Shares.

25. Each of the following was a Transferred Foreign Affiliate:

a. In the year XXXXXXXXXX , all of Canco's shareholding in Forco2 was transferred to Forco1 in exchange for XXXXXXXXXX Consideration Shares with an issue price of approximately US$XXXXXXXXXX ;

b. In the year XXXXXXXXXX , Forco3 was transferred to Forco1 in exchange for XXXXXXXXXX Consideration Shares with an issue price of approximately US$XXXXXXXXXX ;

c. In the year XXXXXXXXXX , Forco4 was transferred to Forco1 in exchange for XXXXXXXXXX Consideration Shares with an issue price of approximately US$XXXXXXXXXX ;

d. In the year XXXXXXXXXX , Forco5 was transferred to Forco1 in exchange for XXXXXXXXXX Consideration Shares with an issue price of approximately US$XXXXXXXXXX ;

e. In the year XXXXXXXXXX , Forco6 was transferred to Forco1 in exchange for XXXXXXXXXX Consideration Shares with an issue price of approximately US$XXXXXXXXXX ;

f. In the year XXXXXXXXXX , Forco7 was transferred to Forco1 in exchange for XXXXXXXXXX Consideration Shares with an issue price of approximately US$XXXXXXXXXX .

26. All of the issued and outstanding Ordinary Shares of Forco1 are owned by Canco.

27. XXXXXXXXXX

28. All of the Ordinary Shares have been issued to and owned by Canco continuously since their issuance and Canco has owned XXXXXXXXXX % of the issued and outstanding shares of Forco1 since the latter's formation.

29. XXXXXXXXXX

30. The Ordinary Shares are capital property to Canco for purposes of the Act.

Preferred Shares

31. Since its incorporation date, Forco1 issued XXXXXXXXXX Preferred Shares for an issue price of US$XXXXXXXXXX paid entirely in cash. The par value of each Preferred Share was US $XXXXXXXXXX and US$XXXXXXXXXX was added to the Preferred Share capital account while the remainder (i.e. US $XXXXXXXXXX ) was added to the Preferred Share premium account.

32. All of the issued and outstanding Preferred Shares are owned by Canco.

33. XXXXXXXXXX

34. All of the Preferred Shares have been issued to and owned by Canco continuously since their issuance and Canco has owned XXXXXXXXXX % of the issued and outstanding Preferred Shares of Forco1 since the latter's formation.

35. XXXXXXXXXX

36. The Preferred Shares are capital property to Canco for purposes of the Act.

Foreign Companies Law and share capital accounts of Forco1

37. The Foreign Companies Law provides that, where a corporation issues shares at a "premium", the aggregate amount of the premium shall be transferred to the "share premium account". The premium represents the difference between the issue price of a share and the par value of such share. The issue price of a share is equal to the amount of money or value received or to be received by the corporation as consideration for the issuance of the share. The par value of the share is added to the "share capital account", which represents the paid-up share capital (i.e. legal stated capital of the corporation).

38. Both the share capital account and share premium account of Forco1 are maintained in U.S. dollars.

39. The aggregate issue price paid by Canco on the issuance of the XXXXXXXXXX fully-paid Ordinary Shares was US $XXXXXXXXXX . The amount added to the share capital account of Forco1 was US $XXXXXXXXXX per share, for an aggregate par value of US $XXXXXXXXXX . The difference between the aggregate issue price and the aggregate par value was recorded in Forco1's share premium account (computed as US $XXXXXXXXXX issue price, minus US $XXXXXXXXXX par value, for a net amount of US $XXXXXXXXXX ). The entire US $XXXXXXXXXX recorded in Forco1's share premium account represents funds which were invested by Canco in Forco1.

40. The ACB of the Ordinary Shares to Canco is approximately C$XXXXXXXXXX .

41. The Foreign Companies Law does not permit a corporation to simply transfer some or all of the balance in the share premium account into the share capital account. The Foreign Companies Law provides that, subject to any provisions in the corporation's constitutional documents, the share premium account may be applied by the corporation to pay dividends to shareholders: (i) in cash; (ii) by distributing the corporation's property to the shareholder; or (iii) by issuing new shares of the corporation to shareholders. No dividend may be paid out to shareholders out of the share premium account unless, immediately following the date on which the dividend is proposed to be paid, the corporation will be able to pay its debts as they fall due in the ordinary course of business. Provided this requirement is met, such dividend paid
out of the share premium account may be implemented by directors' resolution without confirmation by the Foreign Court.

42. Currently, Forco1's articles of association provide only for dividends being paid in cash or other corporate property.

43. The Foreign Companies Law provides that, subject to confirmation by the Foreign Court, a corporation having a share capital account, may, by special resolution of its shareholders, reduce its share capital account in any way, including by returning share capital to its shareholders.

44. In its audited financial statements prepared in accordance with GAAP, Forco1 maintains a separate and distinct account for "retained earnings", which includes the accumulation of all earnings and profits from Forco1's operations and activities since its inception.

45. A dividend paid from the share premium account, whether paid in cash or through the issuance of additional ordinary shares, would not affect the balance in Forco1's retained earnings account.

46. The current balance in Forco1's share premium account arose entirely from the issuance of shares by Forco1 to Canco, XXXXXXXXXX .

Share capital account of Forco3

47. During the XXXXXXXXXX through XXXXXXXXXX years, Forco1 subscribed for a total of XXXXXXXXXX common shares of Forco3 with stated capital of XXXXXXXXXX in exchange for cash. XXXXXXXXXX was added to the PUC of the common shares of Forco3. Forco3 used all such share subscription proceeds XXXXXXXXXX . On XXXXXXXXXX , one such subsidiary repaid XXXXXXXXXX of the principal amount of the loan payable to Forco3. Forco3 immediately used the loan repayment funds to make the Forco3 loan to Canco.

PROPOSED TRANSACTIONS

48. Forco1 proposes to repatriate the US dollar equivalent of C$XXXXXXXXXX ("Repatriation").

49. Canco will borrow C$XXXXXXXXXX on a short-term basis XXXXXXXXXX ("Canco Short-Term Loan") and use such funds to repay the Forco3 Loan. The C$XXXXXXXXXX will be deposited in Forco3's bank account.

50. Forco3 will use the funds to reduce the PUC of its own common shares and will distribute C$XXXXXXXXXX to a bank account in the name of Forco1.

51. The reduction of Forco3's PUC will permanently reduce Forco3's net assets.

52. In order to effect the Repatriation, Forco1 will first increase the number of shares that the company is authorized to issue from XXXXXXXXXX shares to XXXXXXXXXX shares each with a par value of US$XXXXXXXXXX per share.

53. Forco1 will amend its articles of association to provide that the shareholders may receive newly issued Ordinary Shares in satisfaction of dividends paid from the share premium account.

54. Following the amendments to Forco1's articles of association, the directors of Forco1 will pass a resolution declaring a dividend ("Stock Dividend") payable on the Ordinary Shares from the share premium account in the amount of US$XXXXXXXXXX to be paid through the issuance, at par, of XXXXXXXXXX new Ordinary Shares with par value of US$XXXXXXXXXX per share (the "New Shares"). The aggregate par value of the New Shares (US$XXXXXXXXXX ) will be transferred from the share premium account to the share capital account of Forco1.

55. Following the issuance of the New Shares at par and the increase in the share capital account, and subject to confirmation by the Foreign Court, Forco1 will reduce the share capital account by the US dollar equivalent of C$XXXXXXXXXX by: (i) reducing the par value of each Ordinary Share such that the aggregate par value of all the Ordinary Shares is reduced by the US dollar equivalent of C$XXXXXXXXXX ; and (ii) distributing C$XXXXXXXXXX cash to Canco.

56. None of Forco1's Ordinary Shares or Preferred Shares will be redeemed, cancelled or repurchased as a result of the reduction of the share capital account. Moreover, the reduction in the par value of the Ordinary Shares will not affect the residual rights of holders of Ordinary Shares on a winding up of Forco1, which holders will still hold the same number of Ordinary Shares, have the right to share in the distribution of assets on the liquidation of Forco1 (subject to the prior rights of holders of Preferred Shares) and have the right to be repaid their share capital in accordance with the articles of association of Forco1.

57. Further, the reduction of the par value of the Ordinary Shares will not affect the rights of Canco to be repaid the remaining par value of each such share at the time of a winding up of Forco1.

58. Canco will use the C$XXXXXXXXXX to repay the Canco Short-Term Loan.

PURPOSE OF THE PROPOSED TRANSACTIONS

59. The purpose of the proposed transactions is to eliminate the Forco3 Loan from the books of Canco. The funds from the Forco3 Loan had been used by Canco (in XXXXXXXXXX ) to repay XXXXXXXXXX . The proposed transactions will allow Canco to reduce its liabilities by repaying the Forco3 Loan XXXXXXXXXX .

60. The purpose of the Proposed Transactions described in paragraphs 52 to 55 of this ruling letter, is to arrange the Repatriation such that it qualifies as a reduction of the PUC of the Ordinary Shares in the manner contemplated by subparagraph 53(2)(b)(ii).

61. The sole purpose of the Stock Dividend payable on the Ordinary Shares is to transfer US$XXXXXXXXXX from the share premium account to the share capital account in respect of the Ordinary Shares, such that the new balance in the share capital account could subsequently be used for a reduction of the PUC in respect of the Ordinary Shares.

RULINGS GIVEN

Provided that the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, proposed transactions and purpose of the proposed transactions, and provided that the proposed transactions are completed in the manner described above, our rulings are as follows:

A. Pursuant to subparagraph 53(2)(b)(ii), in computing the ACB of the common shares of Forco3 to Forco 1, there shall be deducted the amount received by Forco1 on the reduction of the PUC of the common shares of Forco3 .

B. The Stock Dividend will satisfy the definition of "stock dividend" in subsection 248(1).

C. The ACB of the New Shares received by Canco (by way of the Stock Dividend) will be nil by virtue of subsection 52(3).

D. Subsection 95(7) will apply such that the amount of the Stock Dividend will be deemed to be nil for purposes of subdivision i, Division B, Part I of the Act. As a result, in computing Canco's income for the taxation year that includes the receipt of the New Shares, no amount will be included under section 90 in respect of such New Shares by Canco.

E. Pursuant to subsection 5907(7) of the Regulations, there will be no adjustments to Forco1's surplus accounts under Part LIX of the Regulations as a result of the Stock Dividend.

F. In respect of the transaction whereby Canco receives the New Shares:

a. no amount will be included as a benefit conferred on Canco under subsection 15(1) by virtue of the exception for stock dividends in paragraph 15(1)(b); and
b. no amount will be included in computing the income of Canco under subsection 15(1.1).

G. Provided that the Ordinary Shares of Forco1 were not acquired by Canco in the ordinary course of the business carried on by Canco, pursuant to subsection 258(4), no amount will be included in Canco's income under paragraph 258(3)(a).

H. Provided the Ordinary Shares held by Canco would not be "guaranteed shares" or "collateralized preferred shares" dividends upon which would have been subject to subsection 112(2.1) or (2.4), if Forco 1 had been a taxable Canadian corporation, no amount will be included in Canco's income pursuant to subsection 258(5).

I. For the purpose of computing the PUC of the Ordinary Shares in accordance with subsection 89(1), the Canadian dollar equivalent (computed using the exchange rate in effect at the time the Stock Dividend is declared) of the amount transferred from the share premium account (i.e. US$XXXXXXXXXX ) and added to the share capital account of Forco1 in respect of the Stock Dividend will be added to the PUC of the Ordinary Shares.

J. In computing Canco's income for the taxation year that includes the reduction of the share capital account of the Ordinary Shares of Forco1, such reduction will not be treated as a "dividend" for purposes of the Act and no amount will be included under section 90 in respect of the reduction of the share capital account.

K. Provided the Ordinary Shares of Forco1 were not acquired in the ordinary course of Canco's business, subsection 84(4.2) of the Act will not apply to deem the C$XXXXXXXXXX received by Canco on the reduction of the PUC of the Ordinary Shares to be a dividend.

L. Pursuant to subparagraph 53(2)(b)(ii), in computing the ACB of the Ordinary Shares of Forco1 to Canco there shall be deducted the C$XXXXXXXXXX received by Canco on the reduction of the PUC of the Ordinary Shares of Forco1.

M. In respect of the transaction whereby Forco1's PUC is reduced, no amount shall be included as a benefit conferred on Canco under subsection 15(1), by virtue of the exception in paragraph 15(1)(a).

N. None of the transactions contemplated herein and, in particular, neither

a. the amendment of the articles of association of Forco1 to include the ability to receive stock dividends in addition to cash dividends; nor
b. the reduction of the PUC of Forco1

will give rise to a disposition of the Ordinary Shares of Forco1 held by Canco for purposes of the Act and no capital gain will be realized by Canco as a consequence of the Repatriation, provided that the ACB of the Ordinary Shares to Canco immediately before the Repatriation exceeds C$XXXXXXXXXX .

O. Any income earned, loss incurred or capital gain or capital loss realized by Forco1, because of a fluctuation in the value of a currency of a country other than Canada relative to the value of the Canadian currency, as a result of the reduction of the PUC of its Ordinary Shares, will be deemed to be nil by virtue of paragraph 95(2)(g).

II. Caveats

The above-noted rulings are based on the Act in their present form and do not take into account any proposed amendments which, if enacted, could have an effect on the rulings provided herein.

The rulings are based solely on the facts and proposed transactions described above and are subject to the limitation and qualifications set forth in Information Circular 70-6R5 issued on May 17, 2002. The rulings are binding on the Canada Revenue Agency provided that the proposed transactions are completed before XXXXXXXXXX .

Nothing in this letter should be construed as implying that the Canada Revenue Agency has agreed to or reviewed any tax consequences relating to the facts and proposed transactions described herein other than those specifically described in the rulings given above.

Yours truly,

XXXXXXXXXX
Section Manager
for Division Director
International and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch