2011 Ruling 2010-0371461R3 - Settlement Payment

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) In a situation where there has been an acquisition, and following a series of amalgamations, the successor purchaser corporation has to pay the acquired (predecessor) corporation's tax liabilities arising prior to the acquisition, is an amount received by the purchaser as part of or under a settlement for breach of representations and warranties, subject to the provisions of paragraph 12(1)(x) of the Act?
2) If so, is subsection 12(2.2) available?

Position: 1) Yes. 2) Yes.

Reasons: The amount received is considered to fall within the general definition of a reimbursement for the purposes of subparagraph 12(1)(x)(iv).

XXXXXXXXXX
									2010-037146
XXXXXXXXXX , 2011

Dear XXXXXXXXXX :

Re: Advance Income Tax Ruling
XXXXXXXXXX ("Aco")
Business Number: XXXXXXXXXX

We are writing in response to your correspondence of XXXXXXXXXX , wherein you requested an advance income tax ruling on behalf of the above-named taxpayer.

This letter is based solely on the facts and proposed transactions described below. Any documentation submitted in respect of your request does not form part of the facts and proposed transactions and any references thereto are provided solely for the convenience of the reader.

To the best of your knowledge and that of the taxpayer involved, none of the issues contained in this ruling request are:

(i) dealt with in an earlier return of the taxpayer or a related person;

(ii) being considered by a Tax Services Office or Taxation Centre in connection with a previously filed tax return of the taxpayer or a related person;

(iii) under objection by the taxpayer or a related person;

(iv) subject to a ruling previously issued by the Income Tax Rulings Directorate to the taxpayer or a related person; or

(v) before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has expired.

Unless otherwise stated, statutory references in this letter are to the Income Tax Act, R.S.C. 1985 (5th Suppl.) c. 1, as amended to the date hereof (the "Act").

Our understanding of the facts and proposed transactions is as follows:

Definitions

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

(a) "Aco" means XXXXXXXXXX , a corporation formed by amalgamation on XXXXXXXXXX ;

(b) "Additional Federal Taxes" means the additional federal taxes and taxes payable to the agreeing provinces, and any related arrears and instalment interest and penalties, payable by Aco and/or its predecessors by amalgamation and which would not have been payable if the Representations and Warranties had been true, as described in 27 below;

(c) "Additional Provincial Taxes" means the additional XXXXXXXXXX provincial taxes, and any related arrears and instalment interest and penalties, payable by Aco and/or its predecessors by amalgamation, and which would not have been payable if the Representations and Warranties had been true, as described in 29 below;

(d) "Additional Taxes" means the Additional Federal Taxes and the Additional Provincial Taxes;

(e) "Agreement" means an agreement entered into for the purchase and sale of shares of Targetco1 and Targetco2 among Purchaserco and the Defendants, as more particularly described in 16 to 21 below;

(f) "Amalco 1" means XXXXXXXXXX , a corporation formed by amalgamation on XXXXXXXXXX ;

(g) "Amalco 2" means XXXXXXXXXX , a corporation formed by amalgamation on XXXXXXXXXX ;

(h) "Amalco 3" means XXXXXXXXXX , a corporation formed by amalgamation on XXXXXXXXXX ;

(i) "Amalco 4" means XXXXXXXXXX , a corporation formed by amalgamation on XXXXXXXXXX ;

(j) "Amalco 5" means XXXXXXXXXX , a corporation formed by amalgamation on XXXXXXXXXX ;

(k) "Amalco 6" means XXXXXXXXXX , a corporation formed by amalgamation on XXXXXXXXXX ;

(l) "Amalco 7" means XXXXXXXXXX , a corporation formed by amalgamation on XXXXXXXXXX ;

(m) "Annual Report" means the annual report issued by Targetco1, dated as of XXXXXXXXXX , including the management discussion and analysis contained therein;

(n) "Bco" means XXXXXXXXXX ;

(o) "CBCA" means the Canada Business Corporations Act, R.S.C. 1985, c. C 44, as amended;

(p) "Cco" means XXXXXXXXXX ;

(q) "Claim" means the statement of claim filed by Aco on XXXXXXXXXX with the Court, as amended by an amended statement of claim filed by Aco on XXXXXXXXXX ;

(r) "Closing" means the completion on XXXXXXXXXX of the purchase by Purchaserco of the Targetco1 Shares and the Targetco2 Shares from the Defendants

pursuant to the Agreement;

(s) "Court" means the XXXXXXXXXX ;

(t) "CRA" means the Canada Revenue Agency;

(u) "Dco" means XXXXXXXXXX ;

(v) "Defendants" means Bco, Cco, Dco, Eco and the Executives;

(w) "Eco" means XXXXXXXXXX ;

(x) "Executives" means Mr. A, Mr. B, Mr. C, Mr. D, Mr. E, Mr. F, Mr. G, Mr. H, Mr. I, Mr. J, and Mr. K;

(y) "Federal Reassessments" means the notices of reassessment issued by CRA as described in 23 and 24 below ;

(z) "Federal Settlement" means the agreement between Aco and CRA by which the Federal Reassessments are settled, as described in 26 below;

(aa) "GAAP" means those accounting principles which are recognized as being generally accepted in Canada from time to time as set out in the handbook published by the Canadian Institute of Chartered Accountants, consistently applied;

(bb) "Mr. A" means XXXXXXXXXX ;

(cc) "Mr. B" means XXXXXXXXXX ;

(dd) "Mr. C" means XXXXXXXXXX ;

(ee) "Mr. D" means XXXXXXXXXX ;

(ff) "Mr. E" means XXXXXXXXXX ;

(gg) "Mr. F" means XXXXXXXXXX ;

(hh) "Mr. G" means XXXXXXXXXX ;

(ii) "Mr. H" means XXXXXXXXXX ;

(jj) "Mr. I" means XXXXXXXXXX ;

(kk) "Mr. J" means XXXXXXXXXX ;

(ll) "Mr. K" means XXXXXXXXXX ;

(mm) XXXXXXXXXX ;

(nn) "Proceedings" means the proceedings in the Court between Aco, as plaintiff, and Bco, Cco, Dco, Eco and Mr. A, in his personal capacity and on behalf of the Executives, as defendants (Court File No. XXXXXXXXXX ), as described in 30 below ;

(oo) "Provincial Reassessments" means the notices of reassessment issued by the province of XXXXXXXXXX as described in 23 and 24 below;

(pp) "Purchaserco" means XXXXXXXXXX , a predecessor by amalgamation to Aco;

(qq) "Representations and Warranties" means those representations and warranties made by the Defendants in favour of Purchaserco under the Agreement, as described in 17 below;

(rr) "Settlement Payment" means a lump sum amount proposed to be paid by the Defendants to Aco, as described in 31 below;

(ss) "Subco" means XXXXXXXXXX , a corporation incorporated pursuant to the XXXXXXXXXX ;

(tt) "Targetco1" means XXXXXXXXXX , a corporation incorporated pursuant to the XXXXXXXXXX ;

(uu) "Targetco1 Class A Shares" means the Class A shares of Targetco1;

(vv) "Targetco1 Class B Shares" means the Class B shares of Targetco1;

(ww) "Targetco1 Shares" means the Targetco1 Class A Shares and the Targetco1 Class B Shares;

(xx) "Targetco2" means XXXXXXXXXX , a corporation incorporated pursuant to the XXXXXXXXXX ;

(yy) "Targetco2 Class A Shares" means the Class A shares of Targetco2;

(zz) "Targetco2 Class B Shares" means the Class B shares of Targetco2;

(aaa) "Targetco2 Shares" means the Targetco2 Class A Shares and the Targetco2 Class B Shares; and

(bbb) "taxable Canadian corporation" has the meaning assigned by subsection 89(1).

Facts

1. Aco is a taxable Canadian corporation that maintains offices in XXXXXXXXXX . Aco files its corporate income tax returns at the XXXXXXXXXX Taxation Centre and deals with the XXXXXXXXXX Tax Services Office of the CRA.

2. Purchaserco is a predecessor corporation by amalgamation to Aco.

3. Targetco1 is a predecessor corporation by amalgamation to Aco, the shares of which were acquired by Purchaserco pursuant to the Agreement.

4. Subco is a taxable Canadian corporation, XXXXXXXXXX % of the shares of which were, prior to XXXXXXXXXX , owned by Targetco1. Those shares were subsequently owned by Amalcos 1-7, and are now owned by Aco. The XXXXXXXXXX % of the shares of Subco have, at all times, been owned by a person dealing at arm's length with Targetco1 and Aco.

5. Targetco1 amalgamated with several other related taxable Canadian corporations on XXXXXXXXXX to form Amalco 1.

6. Amalco 1 amalgamated with several other related taxable Canadian corporations on XXXXXXXXXX to form Amalco 2.

7. Amalco 2 amalgamated with Purchaserco and XXXXXXXXXX other related taxable Canadian corporations on XXXXXXXXXX to form Amalco 3.

8. Amalco 3 amalgamated with several other related taxable Canadian corporations on XXXXXXXXXX to form Amalco 4.

9. Amalco 4 amalgamated with one or more other related taxable Canadian corporations on XXXXXXXXXX to form Amalco 5.

10. Amalco 5 amalgamated with one or more other related taxable Canadian corporations on XXXXXXXXXX to form Amalco 6.

11. Amalco 6 amalgamated with one or more other related taxable Canadian corporations on XXXXXXXXXX to form Amalco 7.

12. Amalco 7 amalgamated with one or more other related taxable Canadian corporations on XXXXXXXXXX to form Aco.

13. The Executives are former employees, directors or officers of Targetco1 and Targetco2.

14. Prior to the Closing, all the issued shares of Targetco1 were held by the Defendants as follows:

			Targetco1 Class A Shares      Targetco1 Class B Shares

Bco				XXXXXXXXXX 				XXXXXXXXXX
Cco				XXXXXXXXXX 				XXXXXXXXXX
Dco				XXXXXXXXXX 				XXXXXXXXXX
Eco				XXXXXXXXXX 				XXXXXXXXXX 

Executives
			XXXXXXXXXX
				XXXXXXXXXX 

15. Prior to the Closing, all the issued shares of Targetco2 were held by the Defendants as follows:

			Targetco2 Class A Shares	Targetco2 Class B Shares

Bco				XXXXXXXXXX 				XXXXXXXXXX
Cco				XXXXXXXXXX 				XXXXXXXXXX
Dco				XXXXXXXXXX 				XXXXXXXXXX
Eco				XXXXXXXXXX 				XXXXXXXXXX
Executives
			XXXXXXXXXX
				XXXXXXXXXX 

16. The Agreement was entered into on XXXXXXXXXX among Purchaserco, as purchaser, and the Defendants, as vendors. Under the Agreement, the Defendants agreed to sell, and Purchaserco agreed to purchase, all of the Targetco1 Shares and all of the Targetco2 Shares on the terms and conditions and for the consideration set out in the Agreement.

17. Under the Agreement, the Defendants represented and warranted severally, but not jointly (the "Representations and Warranties"), to Purchaserco, inter alia, that:

(a) the Defendants have furnished or have caused to be furnished to Purchaserco true and complete copies of the annual audited consolidated financial statements of Targetco1 and Targetco2 for the fiscal year ended XXXXXXXXXX , and the interim unaudited consolidated financial statements of Targetco1 and Targetco2 for the quarter years ended XXXXXXXXXX ;
(b) the above-noted financial statements have been prepared in accordance with GAAP;
(c) the balance sheets contained in the above-noted financial statements fairly represent the financial position of Targetco1 and Targetco2 as of their respective dates and the statements of earnings and retained earnings contained in the financial statements fairly present the results of operations for the periods indicated;
(d) the Defendants have furnished or caused to be furnished to Purchaserco the Annual Report;
(e) the Annual Report does not contain an untrue statement of a material fact relating to Targetco1 or omit to state a material fact that would be required to be stated or that is necessary to make a statement not misleading in light of the circumstances in which they were made;
(f) all returns, declarations, remittances, instalments, information returns and reports of every nature with respect to any "Taxes" [defined in 18 below] required to be filed, paid or remitted by or on behalf of Targetco1 and Targetco2 have been filed, paid or remitted;
(g) Targetco1 and Targetco2 have paid or reserved for all "Taxes" and all instalments with respect to "Taxes" in respect of any current taxation year and all other "Taxes" with respect to any period ending on or prior to the closing date established under the Agreement, whether shown on their tax returns or not; and
(h) the reserves reflected in the XXXXXXXXXX unconsolidated financial statements of Targetco1 and Targetco2 are sufficient for the payment by Targetco1 and Targetco2 of all unpaid "Taxes" which may become payable as a result of any audit, assessment or reassessment by any governmental authority or otherwise in respect of any period ending on or prior to XXXXXXXXXX .

18. "Taxes" is defined in the Agreement to mean "all Canadian or foreign taxes, charges, fees, levies, imposts and other assessments, including all income, sales, use, goods and services, value added, capital, large corporation, capital gains, alternative minimum, net worth, transfer, profits, withholding, payroll, employer health, excise, franchise, real property and personal property taxes, and any other taxes, customs duties, fees, assessments or similar charges in the nature of a tax including federal pension plan and provincial pension plan contributions, unemployment insurance payments and workers compensation premiums, together with any instalments with respect thereto, and any interest, fines and penalties, imposed by any governmental authority (including federal, state, provincial, municipal and foreign governmental authorities and including any interest, fines or penalties for failure to withhold, collect or remit any tax), and whether disputed or not."

19. At the Closing, Mr. A and Mr. D executed an officer's certificate on behalf of Targetco1 and Targetco2, certifying, among other things, that the Representations and Warranties were true and correct as at the Closing.

20. As a further condition of closing under the Agreement, it was agreed that Purchaserco would receive an officer's certificate in respect of Subco in the same form. At the Closing, Mr. A and Mr. D executed such an officer's certificate on behalf of Subco.

21. The Agreement also provides that the Defendants severally (on a pro rata basis in proportion to their respective shareholdings in Targetco1 immediately prior to closing) but not jointly, shall indemnify and hold Purchaserco, Purchaserco's directors, officers, employees, agents, representatives and affiliates and their respective directors, officers, employees, agents and representatives harmless in respect of any claim, demand, action, cause of action, damage, loss, cost, liability or expense which may be made or brought against it or which it may suffer or incur directly or indirectly as a result of, in respect of or arising out of: (i) any incorrectness in or breach of any representation or warranty of any of the vendors in the Agreement or the officer's certificates; and (ii) any breach of or any non-fulfillment of any covenant or agreement on the part of any of the vendors under the Agreement.

22. The Agreement further provides that the indemnity under the Agreement is the exclusive remedy for breaches of the Representations and Warranties.

23. Subsequent to the Closing, several taxation years of Targetco1 and Subco ending on or before the date of the Closing were reassessed by CRA, the province of XXXXXXXXXX to increase tax payable and to assess arrears interest, instalment interest and late filing penalties. This resulted in the issuance of the Federal Reassessments and the Provincial Reassessments.

24. As a result of the Federal Reassessments and Provincial Reassessments, Aco was assessed with additional federal and provincial incomes taxes, arrears and instalment interest and penalties ("Additional Taxes").

25. Aco objected to the Federal Reassessments and Provincial Reassessments.

26. A settlement of the objections to the Federal Reassessments, (the "Federal Settlement"), has been agreed to, in XXXXXXXXXX , by Aco and CRA.

27. Notices of reassessment have been issued to give effect to the Federal Settlement. As a result of the Federal Settlement and the notices of reassessment to give effect thereto, additional federal taxes and taxes payable to the agreeing provinces, which would not have been payable if the Representations and Warranties had been true, and related arrears and instalment interest and/or penalties, are or will become payable by Aco and/or its predecessors by amalgamation (the "Additional Federal Taxes").

28. Prior to the Federal Settlement, Aco paid an amount to CRA on account of the additional taxes, arrears and instalment interest and penalties owing under the Federal Reassessments. As a result of the Federal Settlement, Aco became entitled to refund interest in respect of this payment. This refund interest has been offset against arrears interest otherwise payable under section 161.1.

29. Aco expects to reach similar settlements with the province of XXXXXXXXXX with respect to the objections to the Provincial Reassessments. Whether or not there is a settlement of the Provincial Reassessments similar to the Federal Settlement, additional provincial taxes which would not have been payable if the Representations and Warranties had been true, and related arrears and instalment interest, will be payable by Aco and/or its predecessors by amalgamation (the "Additional Provincial Taxes").

30. On or about XXXXXXXXXX , Aco initiated legal proceedings (the "Proceedings") against the Defendants for breach of the Representations and Warranties (see 17 above) and for indemnity (see 21 above) under the Agreement in respect of such breach (the "Claim"). Aco claimed damages from the Defendants of $XXXXXXXXXX , pre-judgement and post-judgement interest and costs. A mediation with respect to the Proceedings will take place in XXXXXXXXXX . In light of the Federal Settlement, Aco has restated the amount of its claim against the Defendants for the purposes of the mediation as approximately $XXXXXXXXXX plus costs.

Proposed Transactions

31. It is proposed that the Defendants pay Aco an amount (the "Settlement Payment") in exchange for Aco providing the Defendants with a release from all claims, damages and liability in respect of the Claim, the Federal Reassessments, the Provincial Reassessments and any other matter relating to the Agreement. The amount of the Settlement Payment is not yet agreed upon.

32. Aco will elect under subsection 12(2.2) in respect of the portion of the Settlement Payment that is attributable to the Additional Taxes (the "Additional Taxes Settlement Amount") such that Aco's outlay or expense for the Additional Taxes is reduced by the elected amount.

Purpose of the Proposed Transactions

33. The purpose of the proposed transactions is to settle the Proceedings.

Ruling Given

Provided that the above-mentioned facts and proposed transactions are accurate and constitute complete disclosure of all the relevant facts and proposed transactions, we confirm that:

A. Aco will be required under paragraph 12(1)(x) of the Act to include in computing its income for the taxation year in which the Additional Taxes Settlement Amount is received, the amount, if any, by which the Additional Taxes Settlement Amount exceeds any amount validly elected by Aco under subsection 12(2.2) of the Act in respect of the Additional Taxes Settlement Amount.

B. Aco may elect under subsection 12(2.2) of the Act in respect of the Additional Taxes Settlement Amount such that Aco's outlay or expense for the Additional Taxes is reduced under subsection 12(2.2) by the amount validly elected.

The above rulings, which are based on the Act in its present form and do not take into account any proposed amendments thereto, are given subject to the general limitations and qualifications set forth in Information Circular 70-6R5, dated May 17, 2002, and are binding on the CRA provided the Settlement Payment is made on or before XXXXXXXXXX .

Comments

Nothing in this letter should be construed as implying that the CRA has reviewed or is making a determination or ruling in respect of any tax consequences in relation to any facts or proposed transactions referred to herein other than those specifically confirmed in the rulings given. Further, nothing in this letter should be construed as stating or implying that CRA has accepted, confirmed, reviewed or made any determination in respect of what portion of the Settlement Payment is attributable to the Additional Taxes. The portion of the Settlement Payment that is attributable to the Additional Taxes is a question of fact subject to review by CRA notwithstanding this letter. Nothing in this letter should be construed as stating or implying that CRA has confirmed, reviewed or made any determination in respect of the tax treatment to Aco of the portion of the Settlement Payment that is not attributable to the Additional Taxes.

Yours truly,

XXXXXXXXXX
For Director
Financial Sector and Exempt Entities Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch