2011 Ruling 2011-0399121R3 - Article IV(7)(b) and PUC Increase

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: Whether subparagraph 7(b) of Article IV of the Canada-U.S. Tax Convention will apply to deny treaty benefits where a corporation increases paid up capital and subsequently makes a payment that reduces paid up capital?

Position: No.

Reasons: Previous rulings given. Subsections 84(1) and 212(2) of the Act will apply on the increase of paid-up capital.

XXXXXXXXXX 2011-039912

XXXXXXXXXX , 2011

Dear Sir:

Re: Advance Income Tax Ruling Request
XXXXXXXXXX
XXXXXXXXXX

This is in response to your XXXXXXXXXX request for an advance income tax ruling on behalf of the above taxpayers. We acknowledge receipt of the amendments you made to the ruling request and the additional information that you provided.

All statutory references in this letter are references to the provisions of the Income Tax Act, R.S.C. 1985 (5th supp.) c. 1, as amended to the date of this advance income tax ruling ("Act").

For greater certainty, all the documents and correspondence submitted in support of your request are part of this letter only to the extent described herein, and any reference to these documents is provided solely for the convenience of the reader. The rulings given herein are based solely on the Facts, Proposed Transactions and the Purpose of the Proposed Transactions described below.

DEFINITION

In this letter, the following terms have the meanings specified:

(a) "Adjusted Cost Base" ("ACB") has, by virtue of subsection 248(1), the meaning assigned by section 54;
(b) "Companies Act" means the XXXXXXXXXX ;
(c) "CRA" means the Canada Revenue Agency;
(d) "EU Affiliates" have the meaning assigned in paragraph 8 below;
(e) "Foreign Affiliate" has, by virtue of subsection 248(1), the meaning assigned by subsection 95(1);
(f) "GAAP" means generally accepted accounting principles;
(g) "XXXXXXXXXX ULC" means XXXXXXXXXX , an unlimited liability corporation created on XXXXXXXXXX under the Companies Act in the province of XXXXXXXXXX ;
(h) "Paid-up Capital" ("PUC") has, by virtue of subsection 248(1), the meaning assigned by subsection 89(1);
(i) "Proceeds of Disposition" has the meaning assigned by section 54;
(j) "Redemption Amount" has the meaning assigned in paragraph 10 below.
(k) "Related Persons" has the meaning assigned by subsection 251(2);
(l) "Series A Preferred Shares" has the meaning assigned in paragraphs 9 and 10 below.
(m) "Stated Capital Account" has the meaning assigned by subsection 26(17) of the Companies Act;
(n) "Taxable Canadian Corporation" has, by virtue of subsection 248(1), the meaning assigned by subsection 89(1);
(o) "Taxable Dividend" has, by virtue of subsection 248(1), the meaning assigned by subsection 89(1);
(p) "Treaty" means the Convention between the United States of America and Canada with respect to Taxes on Income and on Capital signed on 26 September 1980, as Amended by the Protocols Signed on 14 June 1983, 28 March 1984, 17 March 1995, 29 July 1997 and 21 September 2007;
(q) "ULC" means a XXXXXXXXXX incorporated unlimited liability company;
(r) "US Holdco" means XXXXXXXXXX , a U.S. corporation formed under the General Corporation Law of XXXXXXXXXX ;
(s) "US Opco" means XXXXXXXXXX , a U.S. corporation formed under the General Corporation Law of XXXXXXXXXX ;
(t) "US Pubco" means XXXXXXXXXX , a U.S. corporation formed under the General Corporation Law of XXXXXXXXXX ;
(u) "US Subco" means XXXXXXXXXX , a U.S. corporation formed under the General Corporation Law of XXXXXXXXXX .

Our understanding of the Facts, Proposed Transactions and the Purpose of the Proposed Transactions is as follows:

FACTS

1) XXXXXXXXXX ULC is a Taxable Canadian Corporation. Its business account number is XXXXXXXXXX . It files its annual tax return at the XXXXXXXXXX Tax Centre located at XXXXXXXXXX . The XXXXXXXXXX ULC's address is XXXXXXXXXX .

2) US Pubco and its global subsidiaries are engaged in the business of XXXXXXXXXX .

3) US Pubco is a U.S.-resident corporation for the purposes of the Act and the Treaty. It is not a limited liability corporation and is subject to tax in the U.S. on its worldwide income. It is a "qualifying person" within the meaning of subparagraph 2(c) of Article XXIX-A of the Treaty as its principal class of shares is primarily and regularly traded on the XXXXXXXXXX stock exchange.

4) US Pubco owns all of the issued and outstanding common shares of US Holdco. US Holdco owns all of the issued and outstanding common shares of US Subco.

5) US Holdco and US Subco are also U.S.-resident corporations for the purposes of the Act and the Treaty. They are not limited liability corporations and are subject to tax in the U.S. on their worldwide income. Based on paragraph 3, they are "qualifying persons" within the meaning of subparagraph 2(d) of Article XXIX-A of the Treaty.

6) XXXXXXXXXX ULC is disregarded as an entity separate from its shareholders for U.S. income tax purposes and is therefore fiscally transparent under the taxation laws of the U.S. for purposes of the Treaty.

7) The authorized share capital of XXXXXXXXXX ULC consists of XXXXXXXXXX common shares without nominal or par value, of which XXXXXXXXXX are issued and outstanding. All outstanding common shares are owned by US Subco.

8) US Opco is a U.S.-resident corporation for the purposes of the Act and the Treaty. It is not a limited liability corporation and is subject to tax in the U.S. on its worldwide income. Based on paragraph 3, it is a "qualifying person" within the meaning of subparagraph 2(d) of Article XXIX-A of the Treaty. It owns, directly or indirectly, all or substantially all of the shares of a large number of entities responsible for the European XXXXXXXXXX activities of the U.S. Pubco group (the "EU Affiliates").

9) The authorized share capital of US Opco consists of:

a) XXXXXXXXXX common shares of which XXXXXXXXXX are issued and outstanding. All outstanding common shares are owned by US Subco.

b) XXXXXXXXXX preferred shares which are designated as Series A preferred shares (the "Series A Preferred Shares"). All of the authorized Series A Preferred Shares are issued and outstanding and are owned by XXXXXXXXXX ULC.

10) The Series A Preferred Shares have the following attributes:

a) redeemable and retractable no sooner than XXXXXXXXXX years after the day following the date of issue for an amount (the "Redemption Amount") equal to $XXXXXXXXXX US in aggregate;

b) voting, with a fixed cumulative annually-compounding dividend equal to XXXXXXXXXX % of the Redemption Amount plus any unpaid dividends from all prior years - no dividend may be paid on any other class of shares which would impair US Opco's ability to redeem the Series A Preferred Shares at the Redemption Amount.

11) The ACB of the Series A Preferred Shares is equal to the elected amount that was claimed under a section 85 election in respect of the transfer of XXXXXXXXXX Foreign Affiliates by XXXXXXXXXX ULC to US Opco at the time of the issuance of the shares. The elected amount in total equaled $XXXXXXXXXX Cdn. The book value of the shares for purposes of GAAP, however, is only $XXXXXXXXXX US. There is therefore inherent value in the Series A Preferred Shares that is not reflected on the XXXXXXXXXX ULC's balance sheet.

12) The Series A Preferred Shares were created as part of a reorganization undertaken by the U.S. group in XXXXXXXXXX . As part of a series of transactions, the shares of the EU Affiliates, which were previously owned by a Canadian corporation, were indirectly transferred to US Opco in exchange for the Series A Preferred Shares. By having the Series A Preferred Shares owned by XXXXXXXXXX ULC, no U.S. withholding tax arises on the payment of dividends by US Opco as XXXXXXXXXX ULC is disregarded for U.S. tax purposes. The dividends are therefore considered to be paid by US Opco to US Subco for U.S. tax purposes. Additionally, the issuance of the Series A Preferred Shares in exchange for the shares of the EU Affiliates effectively froze the value of the affiliates in the hands of XXXXXXXXXX ULC at their fair market value at that time. Accordingly, any future growth in the value of the EU Affiliates accrues to the U.S. group through the common shares of US Opco. XXXXXXXXXX .

13) Over the past XXXXXXXXXX years, the XXXXXXXXXX ULC's only source of income has been from the U.S. dollar denominated dividends it receives from US Opco in respect of the Series A Preferred Shares. The funds from such dividends are then used almost exclusively by XXXXXXXXXX ULC to pay dividends on its common shares (net of Canadian withholding tax). The dividends paid to US Subco are paid immediately after XXXXXXXXXX ULC receives the dividends from US Opco in order to mitigate any foreign exchange exposure in XXXXXXXXXX ULC. Dividends have been paid regularly in this manner since XXXXXXXXXX .

14) Each of XXXXXXXXXX ULC, US Opco and US Subco has a XXXXXXXXXX year end.

15) At XXXXXXXXXX , the retained earnings (deficit) of the XXXXXXXXXX ULC is XXXXXXXXXX $XXXXXXXXXX US. XXXXXXXXXX has arisen as a result of miscellaneous expenses incurred and foreign exchange fluctuations experienced over the past XXXXXXXXXX years. XXXXXXXXXX ULC has not previously recorded any amount of contributed surplus on its financial statements.

16) In XXXXXXXXXX , XXXXXXXXXX ULC increased its legal Stated Capital Account in an amount of $XXXXXXXXXX US in anticipation of the changes coming into effect in 2010 as a result of the ratification of the 5th Protocol of the Treaty. This increase in stated capital resulted in a deemed dividend for Canadian tax purposes, and the XXXXXXXXXX ULC remitted the required 5% withholding tax thereon. For GAAP purposes, the increase in stated capital was reflected as a debit to the deficit balance, and a credit to share capital. XXXXXXXXXX .

17) In XXXXXXXXXX , the XXXXXXXXXX ULC received its annual dividend from US Opco in the amount of $XXXXXXXXXX US. However, instead of paying out a cash dividend to US Subco as has been the case in the past, the XXXXXXXXXX ULC instead simply returned capital in that same amount to US Subco. This return of capital was reflected as a decrease in share capital on the financial statements. XXXXXXXXXX .

18) In XXXXXXXXXX , the same transactions are expected to take place - ie. the XXXXXXXXXX ULC will receive its annual dividend from US Opco in the amount of $XXXXXXXXXX US and will return capital in that same amount to US Subco. The dividend will result in an increase to retained earnings, and the return of capital will be reflected as a decrease in share capital on the financial statements.

19) US Subco is the beneficial owner of any dividends paid or other distributions made on the common shares of XXXXXXXXXX ULC.

20) For U.S. tax purposes, the dividends paid by US Opco to XXXXXXXXXX ULC are effectively treated as being paid directly by US Opco to US Subco. US Subco records the dividend in its income for tax purposes, but also is entitled to claim a dividend received deduction. As such, the intercorporate dividends are not ultimately taxable in the U.S. consolidated group.

21) US Pubco and US Holdco are part of a group of corporations that is permitted to file a consolidated income tax return as contemplated by section 1501 of the Internal Revenue Code.

22) We understand that, to the best of your knowledge and that of US Subco and XXXXXXXXXX ULC, no issue involved in this ruling letter:

a) is in an earlier return of US Subco, XXXXXXXXXX ULC or a Related Person,
b) is being considered by a Tax Services Office or Taxation Centre in connection with a previously filed tax return of US Subco, XXXXXXXXXX ULC or a Related Person,
c) is under objection by US Subco, XXXXXXXXXX ULC or a Related Person,
d) is before the courts, or
e) is the subject of a ruling previously issued by the Income Tax Rulings Directorate.

PROPOSED TRANSACTIONS

Sale of Series A Preferred Shares

23) Prior to XXXXXXXXXX ,XXXXXXXXXX ULC will sell a minimum of XXXXXXXXXX % of the Series A Preferred Shares of US Opco to US Subco for proceeds of disposition equal to the then fair market value of the shares. This will be a taxable transaction under the Act. For GAAP purposes, the cash received will be offset by a credit to a contributed surplus account included in shareholder's equity to reflect the inherent accounting gain on the disposition of the shares. The timing and number of shares sold will be dependent upon the U.S. consolidated group's foreign tax credit position. It is expected that all of the shares will be sold by XXXXXXXXXX ULC within XXXXXXXXXX years.

24) As soon as practicable after the sale of Series A Preferred Shares referred to in paragraph 23, in lieu of paying and declaring a cash dividend, XXXXXXXXXX ULC will:

(a) increase, in accordance with the provisions of the Company Act, its Stated Capital Account in respect of its common shares by an amount equal to the cash received from the sale of the Series A Preferred Shares as indicated in paragraph 23, and will reduce the contributed surplus account by the same amount;

(b) reduce, as soon as practicable after the increase referred to in paragraph 24(a), the stated capital of its common shares in accordance with the provisions of the Company Act by an amount equal to the amount of the increase described in Paragraph 24(a); and

(c) distribute to US Subco, as a return of capital on its common shares, an amount of cash equal to the reduction referred to in Paragraph 24(b).

Dividend Payment

25) On or before XXXXXXXXXX , US Opco will declare and pay a dividend on its Series A Preferred Shares owned by XXXXXXXXXX ULC in an amount equal to $XXXXXXXXXX US, or such lower amount as is applicable based on the ownership of the Series A Preferred Shares at that time. XXXXXXXXXX ULC will then credit income and retained earnings for an equivalent amount.

26) As soon as practicable after receiving the dividend referred to in paragraph 25, in lieu of paying and declaring a cash dividend, XXXXXXXXXX ULC will:

(a) increase, in accordance with the provisions of the Company Act, its Stated Capital Account in respect of its common shares by an amount equal to the amount of dividend received from US Opco as indicated in paragraph 25, and will reduce the contributed surplus account by the same amount;

(b) reduce, as soon as practicable after the increase referred to in paragraph 26(a), the stated capital of its common shares in accordance with the provisions of the Company Act by an amount equal to the amount of the increase described in Paragraph 26(a); and

(c) distribute to US Subco, as a return of capital on its shares, an amount of cash equal to the reduction referred to in paragraph 26(b).

PURPOSE OF THE PROPOSED TRANSACTION

27) The purpose of the Proposed Transactions is to distribute earnings from XXXXXXXXXX ULC to US Subco in a manner that avoids the application of subparagraph 7(b) of Article IV of the Treaty.

28) The purpose of the Proposed Transactions relating to the sale of the preferred shares to a related U.S. company is to simplify the corporate structure of the group and to reduce compliance costs. The EU Affiliates owned by US Opco are all Foreign Affiliates of XXXXXXXXXX ULC due to its ownership of the preferred shares, requiring the filing of T1134 information forms each year and other related compliance obligations. By removing these entities from underneath the XXXXXXXXXX ULC, the group should reduce its annual compliance costs associated with the ownership of the Foreign Affiliates.

29) The purpose of the Proposed Transactions relating to the payment of dividends is to make dividend distributions to US Subco in a manner that allows the 5% treaty withholding tax rate to apply, as in the past.

ADDITIONAL INFORMATION

Notwithstanding that the Proposed Transactions described in paragraphs 24(a) and 26(a) will result in deemed dividends on the common shares of XXXXXXXXXX ULC owned by US Subco under subsection 84(1), no income, profit or gain will arise or will be recognized under the taxation laws of the U.S. as a result of the transactions described in paragraphs 24(a), 24(b), 26(a) and 26(b). Similarly, no amount of income, profit or gain would arise or be recognized under the taxation laws of the U.S. as a result of those transactions if XXXXXXXXXX ULC were not fiscally transparent under the taxation laws of the United States.

The Proposed Transactions described in paragraphs 24(a), 24(b), 26(a) and 26(b) will not affect the tax treatment in the U. S. of any subsequent distribution on the XXXXXXXXXX ULC shares owned by US Subco, including the return of PUC referred to in paragraphs 24(c) and 26(c).

RULINGS GIVEN

Provided that:

(a) the preceding statements constitute a complete and accurate disclosure of all of the relevant Facts, Proposed Transactions and the Purpose of the Proposed Transactions;

(b) the Proposed Transactions are completed in the manner described above; and

(c) there are no other transactions which may be relevant to the rulings requested,

our rulings are as follows:

A. To the extent that XXXXXXXXXX ULC is deemed to have paid, and US Subco is deemed to have received, a dividend pursuant to subsection 84(1) as described in paragraphs 24(a) and 26(a), that dividend will be a Taxable Dividend subject to paragraph 212(2)(a).

B. For the purposes of applying Article X of the Convention, the amount of the dividend referred to in Ruling A will be considered to be income as described in the definition of "dividends" in Article X(3) of the Convention.

C. Article IV(7)(b) of the Convention will not apply to treat the dividend referred to in Ruling A as not having been paid to US Subco.

D. The dividends referred to in Ruling A will be subject to Part XIII tax at a rate of 5% pursuant to Article X(2)(a) of the Convention.

E. Pursuant to paragraph 53(1)(b), the ACB of the common share of XXXXXXXXXX ULC held by US Subco will be increased by the amount of the Taxable Dividend described in Ruling A that is deemed to be received by US Subco pursuant to subsection 84(1).

F. Subsection 245(2) will not apply to re-determine the tax consequences confirmed in the rulings given above.

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

CAVEAT

Finally, nothing in this letter should be construed as implying that the CRA has agreed to or accepted any of the tax consequences relating to the Facts and Proposed Transactions described herein except as expressly stated in the rulings. Without restricting the generality of the preceding statement, it should be noted that nothing in this letter should be interpreted as confirming, either expressly or implicitly, that the CRA has agreed to, reviewed or has made any determination in respect of ACB or PUC of any share of any of the corporations mentioned above, and whether the Facts and Proposed Transactions described herein are, or would be undertaken for fair market value considerations.

Nothing in this letter should be construed as implying that the CRA has agreed to or reviewed:

(a) the determination of the ACB, the PUC, as defined in subsection 89(1), or the fair market value of any shares or other property referred to herein;
(b) the amount of any dividend that will be deemed to be paid by XXXXXXXXXX ULC as a consequence of a transaction described in paragraphs 24 and 26;
(c) whether XXXXXXXXXX ULC is fiscally transparent under the taxation laws of the U.S. for the purposes of the Treaty;
(d) whether the dividend that will be deemed to be paid by XXXXXXXXXX ULC as a consequence of the Proposed Transactions referred to in paragraphs 24(a) and 26(a) are disregarded under the taxation laws of the U.S. or would be disregarded if XXXXXXXXXX ULC were not fiscally transparent under the taxation laws of the U.S. for the purposes of the Treaty;
(e) whether US Subco is the beneficial owner of dividends paid or distribution made on the common share of XXXXXXXXXX ULC; and
(f) whether any person referred to herein is a "qualifying person" as defined in paragraph 2 of Article XXIX-A of the Treaty;
(g) any tax consequences relating to the Facts and Proposed Transactions described herein other than those described in the rulings given above.

These rulings are based solely on the Facts, the Proposed Transactions and Additional Information described above and are subject to the limitations and qualifications set forth in Information Circular 70-6R5 issued on May 17, 2002. These rulings are binding on the CRA provided that the Proposed Transactions are completed as stated on or before XXXXXXXXXX .

We trust the above comments will be of some assistance.

Yours truly,

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