2010 Ruling 2010-0374301R3 - Foreign Affiliate Reorganization

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. What is the transferee corporation's cost of the property it acquires from the distributing corporation? 2. What is the cost of the shares of the transferee corporation to each of its shareholders? 3. Does the divisive reorganization give rise to FAPI?

Position: 1. The fair market value of the property acquired. 2. The fair market value of the shares acquired. 3. No.

Reasons: 1. The transferee's cost will be equal to the fair market value of its shares issued to its shareholders. 2. The shareholders' cost of the shares of the transferee corporation will be equal to the fair market value of the property transferred to the transferee corporation by the distributing corporation. 3. No income arises that is described in the definition of FAPI.

XXXXXXXXXX 				2010-037430

XXXXXXXXXX , 2010

Dear XXXXXXXXXX :

Re: XXXXXXXXXX ("Parent")
Advance Income Tax Ruling Request_

This is in response to your XXXXXXXXXX request for an advance income tax ruling on behalf of Parent. We acknowledge receipt of the additional information provided to us in your XXXXXXXXXX e-mail and in our various telephone conversations (XXXXXXXXXX).

To the best of your knowledge and that of Parent, none of the proposed transactions issues included in this ruling is:

(i) dealt with in an earlier return of the taxpayer or a related person;
(ii) being considered by any tax services office or taxation centre in connection with a tax return previously filed by the taxpayer or a related person;
(iii) under objection by the taxpayer or by a related person; or
(iv) before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has expired.

Unless otherwise stated, all statutory references herein are to the Income Tax Act, R.S.C. 1985, c.1, (5th Supplement) (the "Act"), as amended to the date of this advance income tax ruling.

The rulings given herein are based solely on the facts, proposed transactions and the purpose of the proposed transactions described below. Facts and proposed transactions described in the documents submitted with your request that are not set out below do not form part of the facts and proposed transactions on which this ruling is based and any reference to these documents is provided solely for the convenience of the reader.

Definitions

(a) "Active Business Assets" means the XXXXXXXXXX ;

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

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

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

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

(f) "foreign accrual property income" ("FAPI") has the meaning assigned by subsection 95(1);

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

(h) "Foreignco" means XXXXXXXXXX ;

(i) "Foreign Country 1" means XXXXXXXXXX ;

(j) "Foreign Country 2" means XXXXXXXXXX ;

(k) "Foreign Stock Exchanges" means the XXXXXXXXXX ;

(l) "Holdco1" means XXXXXXXXXX ;

(m) "Holdco2" means XXXXXXXXXX ;

(n) "net surplus" has the meaning assigned by subsection 5907(1) of the Regulations;

(o) "Newco" means the new corporation described in paragraphs 11 and 12 below;

(p) "non-resident" has the meaning assigned by subsection 248(1);

(q) "Opco" means XXXXXXXXXX ;

(r) "paid-up capital" has the meaning assigned by subsection 89(1) of the Act;

(s) "Parent" means XXXXXXXXXX ;

(t) "Province" means XXXXXXXXXX ;

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

(v) "Reorganization" means the proposed divisive reorganization of Opco;

(w) "Subco1" means XXXXXXXXXX ;

(x) "Subco1 Shares" means XXXXXXXXXX % of its issued and outstanding common shares;

(y) "Subco2" means XXXXXXXXXX ;

(z) "Subco2 Shares" means XXXXXXXXXX of its U.S. dollar denominated redeemable preferred shares;

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

Facts

1. Foreignco is a non-resident corporation that controls a group of corporations that carry on XXXXXXXXXX . Foreignco's shares are traded on the Foreign Stock Exchanges.

2. Parent is a taxable Canadian corporation formed under the laws of the Province. Parent is a XXXXXXXXXX . Parent is an indirect subsidiary of Foreignco. Holdco1, Holdco2, Subco1 and Subco2 are each a foreign affiliate of Parent. XXXXXXXXXX .

3. Holdco1 is a corporation governed by the laws of Foreign Country 1. Holdco1 is a subsidiary wholly-owned corporation of Parent. Holdco1 is a non-resident for purposes of the Act.

4. Holdco2 is a corporation governed by the laws of Foreign Country 1. Holdco2 is a subsidiary wholly-owned corporation of Holdco1. Holdco2 is a non-resident for purposes of the Act.

5. Opco is a corporation governed by the laws of Foreign Country 2 and is a non-resident for purposes of the Act. Holdco1 owns XXXXXXXXXX of the issued and outstanding common shares of Opco and Holdco2 owns the remaining XXXXXXXXXX issued and outstanding common shares of Opco. The ACB and the legal paid-up capital of the common shares of Opco is US$XXXXXXXXXX . The fair market value of the common shares of Opco is estimated to be US$XXXXXXXXXX . The common shares of Opco are not excluded property to Holdco1 or Holdco2. The net surplus attributable to Opco's common shares has not yet been determined but it is expected to be nominal at the time of the divisive reorganization described below.

6. Opco uses the Active Business Assets in its XXXXXXXXXX business in Foreign Country 2. Opco also owns the Subco1 Shares and the Subco2 Shares. The Subco1 Shares and the Subco2 Shares are capital property to Opco. The Subco1 Shares and the Active Business Assets are excluded property to Opco. The Subco2 Shares are not excluded property to Opco. For purposes of subsection 5905(6) of the Regulations, Opco's calculating currency is the XXXXXXXXXX .

7. The fair market value of the Subco1 Shares is approximately US$XXXXXXXXXX . The ACB of the Subco1 Shares is approximately US$XXXXXXXXXX . The net surplus attributable to the Subco1 Shares has not yet been determined but it is expected to be nominal at the time of the proposed transactions described below.

8. The fair market value and the ACB of the Subco2 Shares is approximately US$XXXXXXXXXX . The net surplus attributable to the Subco2 Shares has not yet been determined but it is expected to be nominal at the time of the proposed transactions described below.

9. The Active Business Assets have an estimated fair market value, net of applicable liabilities, of approximately US$XXXXXXXXXX . The Foreign Country 2's tax cost of the Active Business Assets is approximately US$XXXXXXXXXX .

Proposed Transactions

10. Holdco1 and Holdco2 propose to carry out a divisive reorganization of Opco pursuant to the corporate law of Foreign Country 2. Holdco1 and Holdco2 will approve the proposed divisive reorganization at a shareholders' meeting. Thereafter, the proposed divisive reorganization will be legally executed in a notarized deed and an abstract thereof will be published in Foreign Country 2's Official Gazette and registered with the appropriate Registry of Commerce and the tax authority of Foreign Country 2. Under the corporate law of Foreign Country2, the proposed divisive reorganization will be a legal division of Opco into two legal entities.

11. Holdco1 and Holdco2 will incorporate Newco under the laws of Foreign Country 2. The deed of formation will specify that the Active Business Assets and related liabilities will be retained by Opco and that the Subco1 Shares, the Subco2 Shares and all of the other liabilities of Opco will be assigned to Newco at that time. By operation of corporate law in Foreign Country 2, Holdco1 and Holdco2's approval of the divisive reorganization will result in Holdco1 and Holdco2 becoming the shareholders of Newco with Holdco1 having an XXXXXXXXXX % ownership interest in Newco and Holdco2 having a XXXXXXXXXX % ownership interest in Newco. The deed of formation will also include a provision that limits the liability of each of Holdco1 and Holdco2 to the amount of their respective capital contribution to Newco. Newco will be a non-resident of Canada.

12. Other than the shares of Newco, none of Opco, Holdco1 or Holdco2 will receive any property as a result of the divisive reorganization.

13. On the same day, but subsequent to the assignment of the Subco1 Shares, the Subco2 Shares and all of the other liabilities of Opco to Newco, Opco will be converted from a corporation to a limited liability company pursuant to the corporate law of Foreign Country 2.

14. Holdco1 and Holdco2 will seek an arm's length purchaser for the shares of Opco after the divisive reorganization has been completed.

Additional Information

15. Contemporaneously with the assignment of property and liabilities to Newco, the paid-up capital and retained earnings of Opco will be reduced to reflect the carrying values of the Active Business Assets and related liabilities retained by Opco and the shareholders equity and retained earnings of Newco will reflect the carrying values of the Subco1 Shares, the Subco2 Shares and the liabilities assigned to Newco.

16. Opco will prepare financial statements as of the time of the divisive reorganization and a post-transfer balance sheet will be prepared for each of Opco and Newco and will be approved by external registered auditors.

17. Under the laws of Foreign Country 2, the reduction in the paid-up capital and retained earnings of Opco will not result in a redemption, disposition or cancellation of the shares of Opco, a dividend payment by Opco or Newco or any other form of distribution by Opco to Holdco1 or Holdco2.

18. No income or profit, as computed under Foreign Country 2's tax law, will arise as a consequence of Opco's assignment to Newco, nor will such law impose income tax on the reduction of the capital account and retained earnings of Opco. The divisive reorganization will not result in Opco having a deemed year end nor will Opco be required to file additional tax returns.

19. In computing its income for its first fiscal period, Newco will be deemed to have earned that portion of Opco's income that was earned after XXXXXXXXXX and prior to the divisive reorganization that is in proportion to the paid-up capital and retained earnings of Opco that is allocated to Newco.

Purpose of the Proposed Transactions

20. Holdco1 and Holdco2 wish to sell the Active Business Assets held by Opco. However, there are various agreements between Opco and its employees that prevent the direct sale of the Active Business Assets to an arm's length purchaser. The divisive reorganization will facilitate an indirect sale of the Active Business Assets and related agreements (through the sale of the shares of Opco) to an arm's length purchaser.

Rulings

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

A. The proposed divisive reorganization will not result in a "disposition" of the shares of Opco by Holdco1 or Holdco2.

B. Subparagraph 53(2)(b)(ii) of the Act will apply at the time that the shares of Newco are received by Holdco1 and Holdco2 to reduce the ACB of the shares of Opco held by each of Holdco1 and Holdco2. The total amount of the reduction will be equal to the fair market value, at that time, of the property transferred to Newco. Holdco1 and Holdco2's reduction in the ACB of their respective shares of Opco will be in proportion to their share ownership of Opco at that time.

C. If the reduction in the ACB of the shares of Opco owned by Holdco1 and Holdco2, as described in Ruling B, causes there to be an excess, as described in subsection 40(3) of the Act, and the shares of Opco are excluded property of Holdco1 and Holdco2 at that time:

(i) subsections 40(3), 93(1) and 93(1.1) of the Act and the relevant Regulations will cause the amount, as is prescribed under Regulation 5902(6), to be treated as a dividend received by Holdco1 and Holdco2 from Opco immediately before that time; and

(ii) the amount of the excess that is not treated as a dividend will be deemed to be a gain of Holdco1 and Holdco2 from the disposition of the Opco shares owned by Holdco1 and Holdco2 at that time.

D. The cost to Holdco1 and Holdco2 of the shares of Newco issued to each of them will be equal to the fair market value of those shares at the time referred to in paragraph 11 above.

E. The cost to Newco of the Subco1 Shares and the Subco2 Shares assigned to Newco by Opco, as described in paragraph 12 above, will be equal to the fair market value of such shares at the time of the assignment.

F. The proposed transactions will not give rise to FAPI to Parent except to the extent that Opco realizes a taxable capital gain from the disposition of a property that is not an excluded property of Opco.

G. Subsection 245(2) will not apply, as a result of the proposed transactions, in and by themselves, to re-determine the tax consequences described in the Rulings given above.

These rulings are given subject to the limitations and qualifications set out in Information Circular 70-6R5, issued by the CRA on May 17, 2002, and are binding on the CRA provided that the proposed transactions are entered into before XXXXXXXXXX .

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

Opinions

1. Provided that the draft amendments to the Act that were released by the Minister of Finance on February 27, 2004 (the "Draft Legislation") are, in respect of the proposed amendment to paragraphs 95(2)(c.1) to (c.3), enacted in substantially the same form as proposed in the Draft Legislation, our opinions are as follows:

Proposed paragraph 95(2)(c.2) of the Act will apply to Opco's disposition of the Subco1 Shares such that:

(a) pursuant to proposed subparagraph 95(2)(c.2)(i), Opco's proceeds of disposition (determined without reference to subsection 93(1) of the Act) from the disposition of the Subco1 Shares will be an amount equal to the amount determined under proposed clause 95(2)(c.2)(i)(A);

(b) pursuant to proposed subparagraph 95(2)(c.2)(iii), Newco's cost of the Subco1 Shares disposed of by Opco will be equal to their fair market value at the time of the disposition; and

(c) pursuant to proposed subparagraph 95(2)(c.2)(v), Opco will be deemed to have an unadjusted suspended gain in respect of the Subco1 Shares equal to the amount determined under that subparagraph.

2. Paragraph 69(1)(c) of the Act will apply to deem Opco to have disposed of, at fair market value, the Active Business Assets held by Opco at the time of its conversion from a corporation to a limited liability company if the conversion results in a disposition of the Active Business Assets under the tax laws of Foreign Country 2.

Caveats

Nothing in this ruling should be construed as implying that the CRA has considered, examined, agreed to or ruled on:

(a) whether any particular corporation described in this ruling is a foreign affiliate of Parent;

(b) whether any property described in the facts or the proposed transactions is excluded property of any person;

(c) the ACB or fair market value of any property described in the facts or proposed transactions;

(d) whether the conversion of Opco from a corporation to a limited liability company results in a disposition of the shares of Opco by Holdco1 and Holdco2 or a disposition of the Active Business Assets by Opco;

(e) any tax consequences relating to the facts and proposed transaction described herein other than those specifically described in the Rulings and Opinion given above.

Yours truly,

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