2010 Ruling 2010-0365861R3 - XXXXXXXXXX ATR

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: (i) Whether the Pending Patent is a depreciable property or an eligible capital expenditure? (ii) Whether the payments of BCo Future Payment are deductible by Canco? (iii) Whether the payments of BCo Future Payments are subject to Canadian withholding tax?

Position: (i) No. (ii) No.

Reasons: (i) It is an interest or a right to acquire an intangible property that would be a depreciable property described in Class 44 of Schedule II when the particular patent relating to such Pending Patent is ultimately granted or issued. (ii) It relates to the acquisition of the BCo XXXXXXXXXX by Canco and should be included in the cost to Canco of such property. (iii) From the perspective of the recipients of the BCo Future Payments, the payments are royalties or similar payment based on use or production, however, they are exempt from Canadian tax under XXXXXXXXXX of the Canada-XXXXXXXXXX Treaty.

XXXXXXXXXX 								2010-036586

Attention: Mr. XXXXXXXXXX

XXXXXXXXXX , 2010

Dear Sirs or Madams:

Re: XXXXXXXXXX ("Canco")
Advance Income Tax Ruling

We are writing in reply to your letter of XXXXXXXXXX in which you requested an advance income tax ruling on behalf of the above-referenced taxpayer. We acknowledge the receipt of a revised advance income ruling request of XXXXXXXXXX .

Canco's tax affairs are administered by the XXXXXXXXXX Tax Services Office and it files its tax returns at the XXXXXXXXXX Taxation Centre under Account Number XXXXXXXXXX .

To the best of your knowledge and that of the taxpayer involved, none of the issues involved with this request:

(i) is involved in an earlier return of the taxpayer or a related person, except as described in paragraph 15 below;

(ii) is being considered by a tax services office or a taxation centre in connection with a tax return already filed by the taxpayer or a related person;

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

(iv) is before the courts or, if a judgement has been issued, the time limit for appeal has not expired.

This document is based solely on the facts and proposed transactions described below. The documentation submitted with 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.

Unless otherwise stated, all references to a statute are references to the provisions of the Income Tax Act, R.S.C. 1985 c.1 (5th Supp.) as amended to the date hereof (the "Act"), and every reference herein to a Part, section, subsection, paragraph or subparagraph is a reference to the relevant provisions of the Act.

Definitions

In this letter the following terms have the meanings specified:

(a) "ACo" means XXXXXXXXXX ;

(b) "active business" has the meaning assigned by subsection 95(1);

(c) "adjusted cost base" has the meaning assigned by section 54;

(d) "BCo" means XXXXXXXXXX ;

(e) "BCo Future Payments" refers to the future contingent consideration in respect of the DCo Acquisition which includes both defined event milestones and amounts described as royalties that are payable based on sales of commercially successful products;

(f) "BCo XXXXXXXXXX " consists of intangible assets owned by BCo related to the proprietary XXXXXXXXXX , the vast majority of which (in terms of value) is attributable to intellectual property that is the subject of XXXXXXXXXX patent applications globally for which no material patents have been issued to date;

(g) "Canada-XXXXXXXXXX Treaty" means XXXXXXXXXX ;

(h) "capital property" has the meaning assigned by section 54;

(i) "CCA" refers to capital cost allowance, being such part of the capital cost to the taxpayer of property, or such amount in respect of the capital cost to the taxpayer of property, if any, as is allowed by the Regulations, as provided under paragraph 20(1)(a);

(j) "CCo" means XXXXXXXXXX ;

(k) "Class 44 property" refers to property as described in Class 44 of Schedule II of the Regulations;

(l) "controlled foreign affiliate" has the meaning assigned by subsection 95(1);

(m) "cumulative eligible capital" has the meaning assigned by subsection 14(5);

(n) "DCo" means XXXXXXXXXX ;

(o) "DCo Acquisition" refers to the acquisition in XXXXXXXXXX of all of the shares of DCo XXXXXXXXXX , with BCo being the ultimate surviving corporation XXXXXXXXXX ;

(p) "depreciable property" has the meaning assigned by subsection 13(21);

(q) "ECo" means XXXXXXXXXX ;

(r) "eligible capital expenditure" has the meaning assigned by subsection 14(5);

(s) "eligible capital property" has the meaning assigned by section 54;

(t) "excluded property" has the meaning assigned by subsection 95(1);

(u) "exempt earnings" has the meaning assigned by subsection 5907(1) of the Regulations;

(v) "FAPI" refers to foreign accrual property income, as that term is defined in subsection 95(1);

(w) "FCo" means XXXXXXXXXX , a party dealing at arm's length with Canco and Canco's affiliates;

(x) "FMV" refers to fair market value;

(y) "foreign affiliate" has the meaning assigned by subsection 95(1);

(z) "functional currency" has the meaning assigned by subsection 261(1);

(aa) "GCo" means XXXXXXXXXX , a party dealing at arm's length with Canco and Canco's affiliates;

(bb) "Pending Patents" refers to the XXXXXXXXXX patent applications globally for which no material patents have been issued to date that forms part of the BCo XXXXXXXXXX as at the Transfer Date (each particular such patent is referred to as a "Pending Patent");

(cc) "Proposed Transactions" means those transactions described in paragraphs 16 to 20 below;

(dd) "XXXXXXXXXX corporation" has the meaning assigned by subsection 89(1);

(ee) "qualifying person" has the meaning assigned by XXXXXXXXXX of the Canada-XXXXXXXXXX Treaty;

(ff) "Regulations" means the Income Tax Regulations;

(gg) "taxable Canadian corporation" has the meaning assigned by subsection 89(1);

(hh) "taxable Canadian property" has the meaning assigned by subsection 248(1);

(ii) "Transfer Date" refers to the date on which the proposed transactions described in paragraphs 16 and 17 herein occur; and

(jj) "undepreciated capital cost" ("UCC") has the meaning assigned by subsection 13(21).

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

Facts

1. Canco is a company organized and existing under the laws of the Province of XXXXXXXXXX , Canada. Canco's headquarters are in XXXXXXXXXX . Its fiscal year end is XXXXXXXXXX .

2. XXXXXXXXXX . Canco is a XXXXXXXXXX corporation and a taxable Canadian corporation.

3. XXXXXXXXXX .

4. XXXXXXXXXX . Canco owns XXXXXXXXXX % of the shares of ACo, a corporation formed in XXXXXXXXXX and resident in XXXXXXXXXX . ACo, in turn, owns XXXXXXXXXX % of the shares of two XXXXXXXXXX subsidiaries, BCo and CCo. ACo, BCo and CCo are foreign affiliates and controlled foreign affiliates of Canco, and are residents of XXXXXXXXXX for purposes of the Act, the Regulations and the Canada-XXXXXXXXXX Treaty.

5. DCo was a XXXXXXXXXX incorporated under the XXXXXXXXXX on XXXXXXXXXX . To the best of Canco's knowledge, prior to the DCo Acquisition, Fco Transferred to DCo intellectual property that formed the underlying basis of the BCo XXXXXXXXXX . The shares of DCo that were the subject of the DCo Acquisition described below were not taxable Canadian property.

6. Prior to the DCo Acquisition, DCo dealt at arm's length with Canco and the affiliates of Canco.

7. In XXXXXXXXXX , Canco indirectly acquired DCo's proprietary XXXXXXXXXX (forming the initial base of the BCo XXXXXXXXXX ) by the merger of ECo, a newly-incorporated XXXXXXXXXX acquisition company wholly-owned by ACo, with and into DCo under XXXXXXXXXX , with BCo (formerly named DCo) being the surviving corporation for XXXXXXXXXX income tax purposes. Pursuant to such merger:

(a) all of the shares of DCo were exchanged for cash consideration from ECo of approximately XXXXXXXXXX plus a right to receive the BCo Future Payments; and

(b) the shares of ECo were converted into BCo shares, and the shares of DCo were cancelled.

8. The cash consideration paid by ECo was funded by Canco, which subscribed for approximately XXXXXXXXXX in shares of ACo, which in turn subscribed for an equivalent amount of shares of ECo.

9. Where BCo is unable to fulfil its obligation, Canco is obligated to pay XXXXXXXXXX any BCo Future Payments payable to the former shareholders of DCo. It was expected that such payments may continue to be funded in the same manner as the XXXXXXXXXX cash consideration paid to the former shareholders of DCo in XXXXXXXXXX (i.e. Canco expects to fund the BCo Future Payments by subscribing for shares of ACo, which in turn would subscribe for an equivalent amount of shares of BCo).

10. BCo has the right XXXXXXXXXX programs for the XXXXXXXXXX referred to in paragraph 7 above XXXXXXXXXX .

11. Canco's adjusted cost base in its ACo shares, and ACo's adjusted cost base in its BCo shares, are each determined to be approximately XXXXXXXXXX on the date of the DCo Acquisition. Each such adjusted cost base has increased to over XXXXXXXXXX since the DCo Acquisition due to subsequent capital funding by Canco.

12. GCo has a XXXXXXXXXX from BCo under the BCo XXXXXXXXXX in respect of any XXXXXXXXXX . Such XXXXXXXXXX dated XXXXXXXXXX was assigned by FCo to DCo as part of the DCo Acquisition.

13. BCo employs more than five full-time employees in the active conduct of its business, which focuses on the XXXXXXXXXX . BCo conducts its business in a manner consistent with this purpose, including XXXXXXXXXX .

14. Based on the nature of BCo's business, BCo owns and holds the BCo XXXXXXXXXX as capital property. BCo has deducted certain expenditures incurred in respect of XXXXXXXXXX of the BCo XXXXXXXXXX for XXXXXXXXXX tax purposes. BCo has cost or capital cost in respect of the BCo XXXXXXXXXX equal to or less than approximately XXXXXXXXXX for Canadian income tax purposes.

15. In XXXXXXXXXX , Canco acquired certain XXXXXXXXXX , for a one-time payment of XXXXXXXXXX . At the time of the acquisition, no patents had yet been issued for that XXXXXXXXXX .

Proposed Transactions

16. BCo will sell the BCo business which includes the BCo XXXXXXXXXX to ACo, which will require ACo to assume BCo's obligation to make the BCo Future Payments. The sale will occur at FMV, with the consideration payable by way of a non-interest bearing demand promissory note. The FMV will be determined based on a valuation report, with such value being apportioned among the BCo business assets which will include the various patent applications and other intangible property that forms part of the BCo XXXXXXXXXX . The FMV, to the extent that it is based on future sales, is reflective of any related BCo Future Payments. The sale of the BCo business from BCo to ACo will be subject to a price adjustment clause.

17. Immediately after the transfer described in paragraph 16 above, ACo will sell the BCo business which includes the BCo XXXXXXXXXX to Canco, which will require Canco to assume ACo's obligation to make the BCo Future Payments. The sale will occur at FMV (which will be the same FMV amount as that noted in paragraph 16 above and paragraph 18 below, and will be payable by way of a payment in cash). The sale of the BCo business from ACo to Canco will be subject to a price adjustment clause.

18. BCo currently plans to report, for XXXXXXXXXX tax purposes, the sale of the BCo business which includes the BCo XXXXXXXXXX at the amount which represents, to the best of its knowledge, the FMV as referred to in paragraph 16 above.

19. Canco is not in the business of buying or developing intellectual property for the purposes of selling such property without participating in its commercialization. From Canco's perspective, as a participant in the XXXXXXXXXX , the Pending Patents that form part of the BCo XXXXXXXXXX will represent a XXXXXXXXXX business asset of Canco.

20. Current employees of BCo in XXXXXXXXXX will continue to be employed by BCo. Under a service agreement with Canco, BCo will provide, for a fee, certain services to Canco in regards to the XXXXXXXXXX of the BCo XXXXXXXXXX , focusing primarily on XXXXXXXXXX .

Purpose of the Proposed Transactions

21. Due to XXXXXXXXXX conditions and XXXXXXXXXX , Canco and its group of affiliates initiated a XXXXXXXXXX process that has included the XXXXXXXXXX . A primary objective of the XXXXXXXXXX . In connection with this XXXXXXXXXX process, XXXXXXXXXX .

22. With its headquarters and key strategic personnel and resources located in XXXXXXXXXX , Canco would like to obtain a direct ownership in the BCo XXXXXXXXXX and continue its XXXXXXXXXX from Canada. To accomplish this vision, Canco will be required to invest XXXXXXXXXX dollars into XXXXXXXXXX .

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. In computing BCo's capital gain, capital loss, taxable capital gain or allowable capital loss from its sale of any property comprising the BCo XXXXXXXXXX (including any property for which the property comprising the BCo XXXXXXXXXX was substituted) to ACo, paragraph 95(2)(f.1) will apply such that any portion of such amount that can reasonably be considered to have accrued up to the time that was immediately prior to the DCo Acquisition would be excluded.

B. In respect of BCo's capital gain, capital loss, taxable capital gain or allowable capital loss from the sale of any property comprising the BCo XXXXXXXXXX to ACo referred to Ruling A above, the property comprising the BCo XXXXXXXXXX will constitute excluded property of BCo. Provided that none of the paragraphs 95(2)(c), 95(2)(d) and 95(2)(e) will apply to the sale of the property comprising the BCo XXXXXXXXXX , BCo's capital gain, capital loss, taxable capital gain or allowable capital loss from the sale of such property to ACo will be included in computing BCo's exempt earnings or exempt loss, and no part of any such amount will be included in computing BCo's FAPI.

C. No FAPI will be included in computing the income of ACo with respect to the sale of the BCo business to Canco as described in paragraphs 16 and 17 above.

D. Provided that Canco acquires the BCo XXXXXXXXXX from ACo for the purpose described in paragraphs 19 and 22 above, the amount of cash consideration to be paid by Canco to ACo as described in paragraph 17 that is attributable to a particular Pending Patent will be considered as the acquisition cost of a capital property that is an interest in, or a right to acquire, an intangible property that would be a depreciable property described in Class 44 of Schedule II when the particular patent relating to such Pending Patent is ultimately granted or issued. Subject to the limitations and restrictions contained in Part XI and Schedule II of the Regulations, Canco will be able to claim CCA under paragraph 20(1)(a) in respect of the cost of a particular Pending Patent when the particular patent relating to that Pending Patent is granted or issued and becomes available for use.

E. Where Canco has determined that it is no longer feasible to commercially develop a particular Pending Patent referred to in Ruling D and has completely abandoned any further development and patent application of that Pending Patent prior to any patent being issued or granted, Canco's accumulated costs relating to that Pending Patent will, to the extent that such costs have not otherwise been deducted, constitute an eligible capital expenditure made by Canco in the taxation year of abandonment, which can be included in computing the amount that can be added to Canco's cumulative eligible capital for the purpose of determining a deduction under paragraph 20(1)(b).

F. To the extent that Canco is required to pay any amount under the BCo Future Payments assumed by it as described in paragraph 17, such amount or portion thereof, to the extent that such amount was assumed as consideration for the acquisition of Pending Patents included in the BCo XXXXXXXXXX , will constitute part of the cost or capital cost of the particular property or properties described in Ruling D to which such amount or portion thereof reasonably relates or will constitute an eligible capital expenditure if such amount or portion thereof is in respect of a Pending Patent referred to in Ruling E the development and patent application of which has been completely abandoned. For greater certainty, to the extent that an amount required to be paid by Canco under the BCo Future Payments relates to a particular property that is a depreciable property described in Class 44, such amount will be added to the UCC of that Class as an addition to the capital cost of that particular property.

G. To the extent that Canco is required to pay any amount under the BCo Future Payments assumed by it as described in paragraph 17 to a former shareholder of DCo who is a resident of XXXXXXXXXX and a qualifying person for the purposes of the Canada-XXXXXXXXXX Treaty, such payment will be exempt from Part XIII withholding tax pursuant to XXXXXXXXXX of the Canada-XXXXXXXXXX Treaty.

H. Subparagraph 13(7)(e)(ii) will not apply to the Pending Patents to be acquired by Canco from ACo as part of the BCo XXXXXXXXXX as the Pending Patents are not depreciable property to Canco.

I. Paragraph 95(2)(b) will apply to income derived from the fee earned by BCo from Canco referred to in paragraph 20 above.

J. None of the provisions of subsection 15(1), 56(2), 69(1) or 246(1) of the Act will apply to the Proposed Transactions, in and by themselves.

K. Subsection 245(2) of the Act will not apply to the Proposed Transactions, in and by themselves, to re-determine the tax consequences confirmed in Rulings D to F above.

The above rulings are given subject to the general limitations and qualifications set out in Information Circular 70-6R5 dated May 17, 2002, and are binding on the Canada Revenue Agency ("CRA") provided that the proposed transactions are completed by XXXXXXXXXX .

These rulings are based on the Act in the present form and do not take into account amendments to the Act which, if enacted into law, could have an effect on the rulings provided herein.

Opinion

It is our opinion that the fact that Canco's consideration for the BCo XXXXXXXXXX described in paragraph 17 is accorded the capital treatment referred to in Rulings D and E will not, in and of itself, prevent Canco from deducting, in computing its income for a taxation year, other outlays or expenses (other than those described in paragraph 17).

Other Comments

Nothing in this ruling should be construed as implying that the CRA 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. In particular, nothing in this ruling should be construed as implying that the CRA has agreed to or reviewed the following:

(i) the classification of any of the entities described in this ruling letter;

(ii) the determination of the adjusted cost base, capital cost or FMV of any property described herein, except as otherwise provided in Rulings D, F and H; or

(iii) the tax consequences of the DCo Acquisition described in paragraphs 7 and 8 above.

Nothing in this letter should be construed as confirmation, express or implied, that, for the purpose of any of the rulings given above, any adjustment to the FMV of the properties transferred, whether pursuant to a price adjustment clause or otherwise, will be effective retroactively to the time of the transfer. Furthermore, none of the rulings given in this letter are intended to apply to the operation of a price adjustment clause, since such adjustment will be due to circumstances that do not constitute proposed transactions that are seriously contemplated. The general position of the CRA with respect to price adjustment clauses is stated in Interpretation Bulletin IT-169.

Yours truly,

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