2006 Ruling 2006-0173771R3 - Ceasing to be an Insurance Corporation

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. Will the taxpayer cease to be an insurance corporation for purposes of the Act, following a transfer of warranty contracts to a wholly-owned subsidiary?

2. If the taxpayer converts contributed surplus, received from its parent corporation, into PUC on the shares of the taxpayer held by the parent corporation, will paragraph 84(1)(c.3) of the Act apply such that the conversion will not result in a deemed dividend under subsection 84(1) of the Act?

3. Will subsection 245(2) of the Act apply?

Position: 1. Yes
2. Yes
3. No

Reasons: 1. Based on the facts provided, once the taxpayer has transferred the contracts to Newco, the taxpayer will not longer be party to any contracts to which subsection 138(1) would apply to deem the taxpayer to be carrying on an insurance business. As the taxpayer will not be carrying on an insurance business, it will not be an insurance corporation as defined in subsection 248(1) of the Act.

2. Based on the ruling that the taxpayer will no longer be an insurance corporation once the contracts have been transferred to Newco, then provided the taxpayer converts the contributed surplus into PUC on the shares held by its parent corporation after the "Effective Date" of the Agreement, then the conversion will fall within the scope of the words of paragraph 84(1)(c.3) of the Act.

3. Outcome is consistent with tax policy in this circumstance.

XXXXXXXXXX 								2006-017377

XXXXXXXXXX, 2006

Dear XXXXXXXXXX:

Re: Advance Income Tax Ruling Request
XXXXXXXXXX (the "Taxpayer") - BN/Registration Number XXXXXXXXXX

This is in reply to your letter of XXXXXXXXXX, and follow-up submission of XXXXXXXXXX. in which you request an Advance Income Tax Ruling on behalf of the above named taxpayer. We also acknowledge the information provided in subsequent correspondence and during our various telephone conversations in connection with your request (XXXXXXXXXX).

We understand that, to the best of your knowledge and that of the taxpayer referred to above, none of the issues involved in the Ruling request is:

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

(ii) being considered by a Tax Services Office or Taxation Center 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) before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has not expired; or

(v) the subject of a Ruling previously issued by the Directorate.

In this letter, unless otherwise indicated, all statutory references are to the provisions of the Income Tax Act, R.S.C. 1985, 5th Supplement, c.1, as amended, (the "Act").

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

Facts

1. The Taxpayer is a taxable Canadian corporation that carries on the business of XXXXXXXXXX. The Taxpayer files its returns at the XXXXXXXXXX Tax Centre and deals with the XXXXXXXXXX Tax Services Office.

2. As a consequence of a series of acquisition and reorganization transactions, the Taxpayer is the obligator under contracts entered into by a subsidiary corporation of the Taxpayer (the "Canadian Subsidiary"). These contracts (the "Canadian Extended Warranty Contracts") were sold for a fee to Canadian retail customers of the Taxpayer prior to XXXXXXXXXX. Under the Canadian Extended Warranty Contracts, the Taxpayer is obligated to repair or replace products purchased by customers of the Taxpayer for a certain period of time.

3. On XXXXXXXXXX, the Canadian Subsidiary ceased selling the Canadian Extended Warranty Contracts to customers. The Taxpayer has entered into a contract with an arm's length party under which the arm's length party agrees to sell extended warranties to retail customers who purchased merchandise from the Taxpayer after XXXXXXXXXX.

4. The arm's length party did not assume the obligations for the Canadian Extended Warranty Contracts. The Canadian Subsidiary that had sold the Canadian Extended Warranty Contracts continued to be a party to these contracts until it was wound-up into the Taxpayer on XXXXXXXXXX.

5. The Taxpayer has serviced the Canadian Extended Warranty Contracts as required, since that time.

6. The Canadian Extended Warranty Contracts have various lengths of term periods, depending on the nature of the product bought from the Taxpayer. The last of the Canadian Extended Warranty Contracts expires in XXXXXXXXXX.

7. The Taxpayer is also the obligator under extended warranty contracts (the "U.S. Extended Warranty Contracts") that had been sold to US retail customers of former affiliated entities of the Taxpayer (the "U.S. Affiliates"). Similar to the Canadian Extended Warranty Contracts, under the U.S. Extended Warranty Contracts customers paid a fee in exchange for an agreement to repair or replace products purchased by such customers for a certain period of time.

8. The Taxpayer assumed and became liable to perform all of the obligations of the U.S. Affiliates under the U.S. Extended Warranty Contracts as a consequence of transactions that took place on XXXXXXXXXX and in which the U.S. Affiliates were wound-up and dissolved.

9. The Canadian Subsidiary from which the Taxpayer acquired the obligations under the Canadian Extended Warranty Contracts filed its tax returns for the taxation years prior to its winding up on the following basis:

i) the Canadian Extended Warranty Contracts were contracts described in subsection 138(1)(a),

ii) pursuant to subsection 138(1), the corporation was deemed to be carrying on an insurance business,

iii) the corporation was therefore an "insurance corporation" as defined in subsection 248(1), and;

iv) the corporation was entitled to, and did, claim a reserve under paragraph 20(7)(c) and Part XIV of the Income Tax Regulations.

10. Since the time that the Taxpayer acquired the obligations under the Canadian Extended Warranty Contracts, the Taxpayer has filed its tax returns on the same basis as did the Canadian Subsidiary and as set out in paragraph 9. Except for the activities of the Taxpayer which are related to its obligations under the Canadian Extended Warranty Contracts and the US Extended Warranty Contracts, you advise that the Taxpayer does not otherwise carry on an insurance business for purposes of subsection 138(1).

11. Neither the Canadian Subsidiary nor the Taxpayer have been subject to any federal or provincial registration requirements as an insurance corporation.

12. The Taxpayer is a wholly-owned subsidiary of XXXXXXXXXX ("U.S. Parent"), a resident of the United States.

13. The current paid up capital of the common shares of the Taxpayer is XXXXXXXXXX.

14. As part of its continued funding support of the Canadian operations, U.S. Parent advanced $XXXXXXXXXX from about XXXXXXXXXX to XXXXXXXXXX. These advances were made as a contribution of capital and recorded as contributed surplus on the financial statements of the Taxpayer. U.S. Parent did not subscribe for any additional common shares of the Taxpayer.

15. You advise that it is not practical to determine the amount of funds advanced as contributed surplus that were used to support the Canadian Extended Warranty Contract business.

Proposed Transactions

16. XXXXXXXXXX, ("Newco"), a newly incorporated wholly-owned subsidiary of the Taxpayer, will enter into an Assignment, Assumption and Administrative Services Agreement (the "Agreement"). Under the terms of the Agreement, Newco will fully assume all existing obligations under the Canadian Extended Warranty Contracts and U.S. Extended Warranty Contracts (the "Assumed Contracts") and indemnify the Taxpayer from any claims made thereunder. As consideration for Newco assuming the obligations under the Assumed Contracts from the Taxpayer, the Taxpayer will pay an amount equal to the present value of those obligations to Newco in cash and the Taxpayer will assign all of its rights under those contracts to Newco.

17. Under the terms of the Agreement, the Taxpayer will administer the Assumed Contracts for Newco, subject to and in accordance with the terms and conditions set out in the Agreement in exchange for a fair market value fee to be paid by Newco to the Taxpayer.

18. The Taxpayer will subscribe for such additional common shares of Newco as may be necessary to ensure that Newco will be adequately capitalized to assume and perform its obligations under the Agreement.

19. The Taxpayer will provide notice to all remaining customers with Assumed Contracts by mail at their last known address that Newco will fully assume their obligations. Customers will still be able to make claims as before, by returning to or sending the product to the Taxpayer which, in accordance with the Agreement, will act as agent for Newco in connection therewith.

20. The Agreement will be effective on the date that is no earlier than the day that is XXXXXXXXXX days after the day that the notices referred to in paragraph 19, are sent.

21. After the completion of the transactions described in the preceding paragraphs, the Taxpayer will convert the $XXXXXXXXXX of contributed surplus to stated capital under the relevant corporate law.

Purpose of the Proposed Transactions

22. The purpose of the Proposed Transactions is:

i) to ensure that the Taxpayer is not an "insurance corporation" at the time that it converts its contributed surplus into paid up capital so that a deemed dividend will not arise under subsection 84(1), and

ii) to permit the Taxpayer to convert its contributed surplus into stated capital so that the Taxpayer can thereafter pay an amount to U.S. Parent on the reduction of such capital as a return of capital (rather than as a dividend for tax purposes).

Rulings Provided

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

A. As of the Effective Date of the Agreement and provided the Assumed Contracts are in fact transferred to Newco, the Taxpayer's continued involvement in the administration of the Assumed Contracts as agent for Newco will not cause the Taxpayer to be regarded as an "insurance corporation" as defined in subsection 248(1) for purposes of the Act.

B. Paragraph 84(1)(c.3) will apply to the conversion, by the Taxpayer, of the contributed surplus to paid up capital as described in paragraph 21 above.

C. The provisions of subsection 245(2) will not be applied as a result of the Proposed Transactions, in and by themselves, to re-determine the tax consequences confirmed in the rulings given above.

The rulings are based on the Act in its present form and do not take into account the effect of any proposed amendments to the Act. The rulings are given subject to the general limitations and qualifications set forth in Information Circular 70-6R5, dated May 17, 2002, issued by the CRA, and are binding on the CRA provided the Proposed Transactions are completed on or before XXXXXXXXXX.

Yours truly,

XXXXXXXXXX
Manager
Charitable and Financial Institution Sectors
Financial Sector and Exempt Entities Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch