2003 Ruling 2003-0013493 - PATRONAGE DIVIDENDS MEMBERS AS AGENTS

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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CCRA.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.

Principal Issues:

1. Whether members of a cooperative are acting as agents of the cooperative when acquiring goods from a supplier.

2. Whether the supplier, another cooperative, is entitled to claim a deduction for patronage dividends paid to the cooperative.

Position:

1. It is a question of law whether the documentation is effective in establishing an agency relationship.

2. Yes, subject to the limitation in subsection 135(2) and provided the requirements of section 135 are otherwise met.

Reasons:

1. Provided that the members are acting as agents of the cooperative on the initial sale of goods from the supplier to the cooperative, the members are customers of the cooperative when the goods are resold to the members.

2. Our ruling is given on the proviso that the members are acting as agents of the cooperative with the result that the cooperative acquires the goods from the supplier.

XXXXXXXXXX 								2003-001349

XXXXXXXXXX, 2003

Dear Sirs:

Re: Advance Income Tax Ruling Request
XXXXXXXXXX
XXXXXXXXXX

This is in reply to your letter of XXXXXXXXXX in which you requested an advance income tax ruling on behalf of the above-noted taxpayers. We also acknowledge additional information provided in your letters of XXXXXXXXXX.

You advise that to the best of your knowledge and that of the taxpayers referred to above, none of the issues involved in the ruling request is:

i. in an earlier return of the taxpayers or related persons;

ii. being considered by a tax services office or taxation centre in connection with a previously filed return of the taxpayers or related persons;

iii. under objection by the taxpayers or related persons;

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 previous ruling issued by the Income Tax Rulings Directorate.

In this letter, unless otherwise stated, all statutory references are to the provisions of the Income Tax Act, R.S.C. 1985, 5th Supplement, c.1, as amended (the "Act") and all terms and conditions used herein that are defined in the Act have the meaning given to such definition unless otherwise indicated.

Our understanding of the relevant definitions, the facts, proposed transactions and their purposes is as follows:

DEFINITIONS

a) "ACO" means XXXXXXXXXX,

b) "ACO Members" means the members of ACO,

c) "BCO" means XXXXXXXXXX,

d) "BCO Members" means the members of BCO located in XXXXXXXXXX,

e) "CCO" means XXXXXXXXXX,

f) "CCRA" means Canada Customs and Revenue Agency,

g) "Consideration Share Recourse Amount" means an amount equal to $XXXXXXXXXX less the aggregate value of any Consideration Shares to which recourse has been made by ACO,

h) "Consideration Shares" means the XXXXXXXXXX Class XXXXXXXXXX Investment Shares of ACO that were issued to BCO as partial consideration for the Purchased Assets,

i) "DCO" means XXXXXXXXXX,

j) "Dealers" means the XXXXXXXXXX,

k) "ECO" means XXXXXXXXXX,

l) "XXXXXXXXXX Membership Agreement" means the agreement described in 13 below,

m) "Inter-Creditor Agreement" means the agreement described in 20 below,

n) "Master Agreement" means the proposed agreement described in 18 below,

o) "Member Patronage Share Recourse Amount" means the aggregate value of the Class XXXXXXXXXX Investment Shares which have been issued by ACO in connection with the payment of patronage dividends to BCO in respect of purchases made by BCO Members as BCO's agents from ACO, less any Class XXXXXXXXXX Investment Shares which have previously been redeemed by ACO, and

p) "Products" means consumer products.

FACTS

1) ACO is a corporation incorporated under the XXXXXXXXXX. It is a taxable Canadian corporation within the meaning of subsection 89(1). Its head office is located in XXXXXXXXXX. ACO's tax services office is the XXXXXXXXXX Tax Services Office and its taxation centre is the XXXXXXXXXX Taxation Centre.

2) ACO is a XXXXXXXXXX cooperative that is engaged in the business of distributing XXXXXXXXXX and related products to its customers. ACO's customers include both ACO Members and non-members of ACO. ACO currently distributes its Products to approximately XXXXXXXXXX retail locations in Canada.

3) The authorized share capital of ACO consists of Class XXXXXXXXXX Membership Shares, Class XXXXXXXXXX Investment Shares, Class XXXXXXXXXX Investment Shares, Class XXXXXXXXXX Investment Shares and Class XXXXXXXXXX Investment Shares. As of XXXXXXXXXX, the following shares of ACO were issued and outstanding: XXXXXXXXXX Class XXXXXXXXXX Membership Shares, XXXXXXXXXX Class XXXXXXXXXX Investment Shares and XXXXXXXXXX Class XXXXXXXXXX Investment Share. Class XXXXXXXXXX Membership Shares and Class XXXXXXXXXX Investment Shares have an issue price of $XXXXXXXXXX per share.

4) Individuals, partnerships and corporations who wish to become ACO Members must acquire and continue to hold XXXXXXXXXX Class XXXXXXXXXX Membership Shares and execute a membership agreement with ACO. Most ACO Members operate a single retail location XXXXXXXXXX. ACO Members buy Products from ACO and ACO pays patronage dividends to ACO Members pursuant to allocations in proportion to each ACO Member's patronage.

5) ACO has XXXXXXXXXX, being CCO, DCO and ECO. XXXXXXXXXX.

6) BCO is a corporation incorporated under the laws of XXXXXXXXXX. BCO carries on business as a federated cooperative. It carries on business through XXXXXXXXXX general divisions: XXXXXXXXXX.

7) BCO carries on business in XXXXXXXXXX. BCO's XXXXXXXXXX business comprises the following:

a) the XXXXXXXXXX supply of XXXXXXXXXX products to the BCO Members (which generated sales of approximately $XXXXXXXXXX during XXXXXXXXXX);

b) the purchase of Products by BCO from ACO and sale of such Products by BCO to the BCO Members (BCO's sale of Products to the BCO Members generated sales of $XXXXXXXXXX in XXXXXXXXXX);

c) the investment by BCO in XXXXXXXXXX (these investments generated dividends totalling $XXXXXXXXXX during XXXXXXXXXX);

d) the joint venture investment made by BCO in XXXXXXXXXX, a corporation which markets XXXXXXXXXX products to BCO Members (at the XXXXXXXXXX level) and to the public (at the XXXXXXXXXX level) (this investment generated dividends totalling approximately $XXXXXXXXXX in XXXXXXXXXX); and

e) on-going managerial, human resource, legal, accounting, marketing and other general support of BCO Members (e.g., the negotiation of group buying and selling agreements).

8) Prior to the sale of certain assets to ACO pursuant to an asset purchase agreement on XXXXXXXXXX, BCO acted as a XXXXXXXXXX of Products XXXXXXXXXX for the Dealers and the BCO Members. Following the sale of these assets, BCO's XXXXXXXXXX Products business XXXXXXXXXX has become limited to supplying BCO Members through the purchase of Products from ACO.

9) There are currently XXXXXXXXXX BCO Members. BCO pays patronage dividends to the BCO Members pursuant to allocations in proportion to each BCO Member's patronage.

10) In accordance with the terms and conditions of the asset purchase agreement referred to in 8 above, BCO sold the following assets ("Purchased Assets") to ACO as a going concern:

a) the assignment by BCO of certain contracts in connection with the operation of BCO's Products business XXXXXXXXXX, but excluding any contract by which BCO sold Products to any of the BCO Members;

b) substantially all of BCO's Products inventory in XXXXXXXXXX;

c) all of BCO's right, title and interest to certain intellectual property and a non-assignable, non-exclusive, royalty-free licence to use certain intellectual property;

d) the goodwill associated with BCO's Products business XXXXXXXXXX, including the exclusive right of ACO to represent itself as carrying on the business of selling and distributing Products XXXXXXXXXX to BCO and the Dealers, in its own name, in continuation of and in succession to BCO, but excluding the right to sell directly to BCO Members.

Through the acquisition of the Purchased Assets, ACO acquired, inter alia, the exclusive right to sell and distribute certain Products to BCO in order to allow BCO to satisfy orders received for such Products from the BCO Members.

11) In order to satisfy the purchase price for the Purchased Assets, ACO:

a) issued a cheque to BCO in the amount of $XXXXXXXXXX;

b) issued a promissory note to BCO in the amount of $XXXXXXXXXX repayable on or prior to XXXXXXXXXX;

c) issued XXXXXXXXXX Class XXXXXXXXXX Membership Shares, XXXXXXXXXX Class XXXXXXXXXX Investment Shares and XXXXXXXXXX Class XXXXXXXXXX Investment Share to BCO; and

d) assumed certain liabilities of BCO.

12) As a result of the acquisition of the XXXXXXXXXX Class XXXXXXXXXX Membership Shares, BCO became an ACO Member and is entitled, inter alia, to vote at all meetings of ACO Members and to receive dividends when, as and if declared by ACO's board of directors. The Class XXXXXXXXXX Investment Shares are redeemable at the option of ACO at a redemption price of $XXXXXXXXXX per share and are not entitled to any voting rights or dividends. As a holder of the Class XXXXXXXXXX Investment Share, BCO is entitled, inter alia, to elect XXXXXXXXXX to ACO's board of directors, subject to certain restrictions set forth in the asset purchase agreement referred to in 8 above. Holders of Class XXXXXXXXXX Investment Shares are not otherwise entitled to any voting rights or dividends.

13) BCO and ACO executed the XXXXXXXXXX Membership Agreement on XXXXXXXXXX. The XXXXXXXXXX Membership Agreement is intended to govern the on-going relationship between ACO, as a cooperative, and BCO, as a XXXXXXXXXX member of ACO. ACO's execution of the XXXXXXXXXX Membership Agreement (in conjunction with the issuance of a Class XXXXXXXXXX Investment Share) is an innovation in the way that it carries on its business. The introduction of the concept of a XXXXXXXXXX member and the concurrent creation of the Class XXXXXXXXXX Investment Shares is directed at providing ACO with the ability to access a broader market for its Products.

14) Pursuant to the XXXXXXXXXX Membership Agreement, ACO has agreed to sell its Products to BCO and to pay patronage dividends to BCO. Patronage dividends are to be generally paid on an annual basis, based on the volume and margins applicable to the Products purchased by BCO from ACO during each fiscal year.

15) Since BCO purchases the Products from ACO with a view to selling them to BCO Members, ACO agreed as part of the XXXXXXXXXX Membership Agreement to facilitate this process by furnishing invoicing, shipping and delivery services to BCO, or to BCO Members as directed by BCO, which ACO has agreed to do at prices reflecting the cost savings effected in ACO's operations as a result of the arrangements (see 25 below).

16) By entering into the XXXXXXXXXX Membership Agreement with ACO, BCO advises it is able to represent the collective interests of the BCO Members with respect to their dealings with BCO. In particular, the XXXXXXXXXX Membership Agreement, in conjunction with the ownership of the Class XXXXXXXXXX Investment Share, entitles BCO to representation on the ACO board of directors. In addition, BCO is entitled to receive patronage dividends, which amounts it may use for the benefit of its members in its own operations and/or distribute to its members as patronage dividends.

17) Since XXXXXXXXXX, ACO has been selling its Products and providing related services to BCO in order to enable BCO to satisfy orders that it has received for such Products from the BCO Members. Generally speaking, the Products are sold by BCO to the BCO Members at XXXXXXXXXX paid by BCO to ACO. ACO ships the Products directly to the BCO Members but legal and beneficial title to the Products is acquired by BCO from ACO prior to the Products being received by the BCO Member, at which point title to the Products passes to the BCO Member. ACO invoices BCO for all of its purchases and BCO pays ACO directly in respect of the Products it acquires. BCO, in turn, invoices the BCO Members in respect of the Products they acquire. BCO's obligation to pay ACO in respect of Products purchased under the existing arrangement is not in any way conditional on the payment by the BCO Member to BCO in respect of such Products.

PROPOSED TRANSACTIONS

18) ACO, BCO and the BCO Members will enter into the Master Agreement which governs the necessary aspects of the proposed buy-sell arrangement:

a) BCO appoints each BCO Member as its agent to perform, on behalf of BCO, the following activities:

i) ordering Products from ACO;

ii) arranging for the delivery and receipt of Products from ACO;

iii) inspecting and accepting Products delivered by ACO; and

iv) dealing directly with ACO regarding any claims arising in respect of Products delivered to such BCO Members pursuant to a Product order.

b) In the event that BCO revokes the appointment of a BCO Member as its agent, ACO is entitled to deal directly with the BCO Member as if the BCO Member were a direct member of ACO.

c) When a BCO Member, as agent and on behalf of BCO, places a Product order, the Product order will not be binding unless and until accepted by ACO. A contract of purchase and sale ("Sale Contract") between ACO and BCO will be created upon acceptance by ACO of a Product order.

d) Immediately following the creation of the Sale Contract and without any further action on the part of BCO or the BCO Member who placed the Product order, BCO will sell to the BCO Member and the BCO Member will buy from BCO, the Product sold to BCO under the Sale Contract.

e) When ACO ships the Product to the applicable BCO Member, ACO will issue an invoice to such BCO Member in respect of such Product. The invoice will provide the Product was initially sold to BCO, but that the Product has been re-sold to the BCO Member. The invoice amount will be owing by the BCO Member as a result of the assignment and assumption discussed in 18h) below.

f) The shipment of Product and issuance of an invoice by ACO will:

i) convey title to such Product from ACO to BCO;

ii) trigger an obligation of BCO to pay ACO for such Product;

iii) discharge the obligation of ACO to deliver such Product to BCO.

g) The delivery of Product to, and acceptance of such Product by, a BCO Member, will:

i) convey title to such Product from BCO to such BCO Member who placed the Product order;

ii) trigger an obligation of the BCO Member to pay BCO for such Product; and

iii) discharge the obligation of BCO to deliver such Product to the BCO Member who placed the order.

h) Immediately following the delivery and acceptance of Product by a BCO Member and without further action on the part of BCO or the BCO Member, BCO will assign to the BCO Member, and the BCO Member will assume from BCO:

i) BCO's obligation to pay for the Product and all related obligations due to ACO; and

ii) the right to receive the relevant Product and all related rights due from ACO.

i) The assumption by a BCO Member of the obligation due to ACO will fully satisfy the payment obligation owed by the BCO Member to BCO.

j) ACO agrees and acknowledges that:

i) BCO will not be required to obtain ACO's consent in respect of any assignment by BCO of its obligation to ACO or the right to receive the Product from ACO to a BCO Member; and

ii) except for the recourse rights described in 19 below and in accordance with the terms of the Inter-Creditor Agreement, BCO will have no further obligation or liability to ACO in respect of any assumed obligation and BCO will be fully discharged and released from any and all obligation or liability owed by BCO to ACO in connection therewith.

k) Notwithstanding that title to the Product is no longer in the name of ACO at the time such Product is shipped to the BCO Member who placed such Product order, ACO agrees that it will be obligated to insure, at its cost, such Product being shipped against loss, damage and theft in such limits as are commercially reasonable in the circumstances.

l) The implementation of the arrangements described in the Master Agreement will be on the earlier of:

i) XXXXXXXXXX days from the date of the receipt of a favourable advance tax ruling; and

ii) XXXXXXXXXX days after the date upon which BCO delivers notice to ACO that such arrangements should be implemented.

m) Each BCO Member agrees to enter into such security agreements and related arrangements as ACO will reasonably require in respect of any debt owing by the BCO Member to ACO as a result of the assumption by the BCO Member of the obligation.

n) ACO will have the sole, absolute and unfettered discretion to establish credit limits applicable to each BCO Member. ACO is entitled to reject a Product order placed by a BCO Member, as agent and on behalf of BCO, for any reason, including in the event that the credit limit set by ACO in respect of the BCO Member has been exceeded.

o) If at any time ACO determines that any amount owing to ACO by a BCO Member as a result of the assumption by the BCO Member of an obligation is uncollectible (an "Uncollectible Account"), ACO, in addition to any rights and remedies otherwise available to it in respect of the BCO Member, will have a limited right of recourse against BCO, as described in 19 below.

p) When ACO exercises its limited recourse rights, the parties will take the steps necessary to:

i) assign the applicable Uncollectible Account from ACO to BCO for consideration which is equal to the unpaid amount thereof;

ii) redeem, subject to the limits described in the asset purchase agreement (see 19 below), Class XXXXXXXXXX Investment Shares owned by BCO with an aggregate value that is equal to the unpaid amount; and

iii) set-off the redemption price payable by ACO to BCO as a result of the redemption against the amount payable by BCO to ACO in consideration of the assignment by ACO to BCO of the Uncollectible Account.

q) Neither ACO nor BCO will be required to obtain the consent of a BCO Member in respect of any assignment of an Uncollectible Account by ACO to BCO.

r) BCO will, in addition to all rights and remedies available to BCO under applicable law, but subject to the terms and conditions contained in the Inter-Creditor Agreement, have all rights and remedies available to it under any contract, agreement or arrangement between the BCO Member and BCO in respect of any Uncollectible Account assumed by BCO and owed by the BCO Member to BCO.

s) On a monthly basis, ACO will deliver a report to BCO setting forth the total purchases, GST and PST (if any) invoiced to BCO and to be paid by the BCO Members.

19) Pursuant to the terms of the Master Agreement, and as contemplated by the asset purchase agreement referred to in 8 above, ACO and BCO agree that ACO will have certain rights of recourse to the Class XXXXXXXXXX Investment Shares of ACO held by BCO in the event that there are uncollectible amounts due to ACO as a result of the assumption by a BCO Member of BCO's obligation to pay ACO. This right of recourse was negotiated by ACO and BCO on the basis that firstly, ACO was paying BCO $XXXXXXXXXX for the goodwill of the business to be generated from future transactions between ACO and the BCO Members and the Dealers and that secondly, credit risk was being assumed by ACO for purchases by BCO Members from BCO. More specifically, the terms and limitations with respect to ACO's right of recourse are as follows:

a) during the period up to XXXXXXXXXX and in respect of any uncollectible amounts due by a BCO Member or certain Dealers, to the aggregate of the Consideration Share Recourse Amount and the Member Patronage Share Recourse Amount, each as calculated from time to time; provided however, that the recourse rights of ACO in respect of a BCO Member will be limited to the amount specified in Schedule XXXXXXXXXX to the asset purchase agreement in respect of the BCO Member. Provided further that during this period, the recourse will be made first to the Consideration Shares (up to the amount of the Consideration Share Recourse Amount) and then to any Class XXXXXXXXXX Investment Shares of ACO which are held by BCO and which were issued to BCO in satisfaction of a patronage dividend payable by ACO to BCO (up to the amount of the Member Patronage Share Recourse Amount); and

b) during the period subsequent to XXXXXXXXXX, and in respect of any uncollectible amounts due by a BCO Member, to the number of Class XXXXXXXXXX Investment Shares of ACO held by BCO multiplied by a number equal to (i) the aggregate value of the Class XXXXXXXXXX Investment Shares that would have been issued by ACO to the BCO Member in satisfaction of patronage dividends payable by ACO had the BCO Member been an ACO Member; divided by (ii) the aggregate value of the Class XXXXXXXXXX Investment Shares that would have been issued by ACO to all BCO Members in satisfaction of patronage dividends payable by ACO had the BCO Members been ACO Members.

20) ACO and BCO will enter into an agreement (the "Inter-Creditor Agreement") which will clarify and set out the manner in which the realization on the security interests given by certain BCO Members who are parties to the Master Agreement to BCO and to ACO will be shared as between them. Subject to certain occurrences, in the event that either ACO or BCO realize on their respective security granted by a BCO Member in respect of the obligations of such BCO Member to either ACO or BCO, ACO and BCO will share the proceeds of the realization in proportion to the amount such BCO Member owes to each of ACO and BCO (regardless of who has a prior interest in the assets of a BCO Member).

21) ACO will record a sale to BCO at the time an invoice is created. BCO, upon receipt of the monthly report from ACO, will record the purchase from ACO and the corresponding obligation due to ACO, the sale to the BCO Member and the corresponding receivable from the BCO Member, and the assumption of the obligation due to ACO by the BCO Member.

22) ACO will pay annual patronage dividends to BCO in respect of the Products sold pursuant to the arrangement described in 18 above, calculated in accordance with the patronage dividend policy of ACO as determined by its board of directors, which policy may be amended from time to time. BCO will include the amount of all patronage dividends received from ACO in its income for the purposes of Part I of the Act. XXXXXXXXXX.

OTHER INFORMATION

23) You advise that ACO and BCO have discussed the possibility of a challenge by the CCRA with respect to the legal effectiveness of the Master Agreement. If the CCRA were to issue a reassessment to ACO in this regard and the courts were to dismiss any appeal by ACO, BCO has agreed to indemnify ACO for any resulting loss to ACO.

24) The CCRA has not considered and therefore expresses no opinion as to the tax implications related to the asset purchase agreement referred to in 8 and 10 above beyond the specific rulings provided below.

PURPOSE OF THE PROPOSED TRANSACTIONS

25) BCO has made a strategic business decision to exit the XXXXXXXXXX Products business XXXXXXXXXX. Recognizing that one of the important services provided by BCO to the BCO Members is the establishment and administration of group buying and selling arrangements, BCO negotiated a sale of its Product business assets to ACO, along with an arrangement pursuant to which the BCO Members would have access to such Products at competitive terms. In the absence of a coordinated effort led by BCO, the BCO Members would have been required to source their Product purchases elsewhere, on an individual rather than collective basis. This represents a business opportunity for ACO. Under the proposed buy-sell arrangement, ACO will be able to market its Products to the BCO Members (who might not otherwise have dealt with ACO), leveraging the goodwill which currently exists between BCO and BCO Members. ACO's overall purchasing volume will increase which will allow ACO to pass on larger rebates from suppliers and cost savings in the form of lower pricing and patronage dividends to its members including BCO. By acting as intermediary and entering into the proposed arrangement, BCO will become ACO's largest Products customer and will be able to represent and promote the collective interests of its members in its dealings with ACO.

26) The purpose of the proposed transactions is to facilitate and expedite the manner in which BCO and ACO conduct business under the XXXXXXXXXX Membership Agreement by simplifying the manner by which ACO sells Products to BCO which are then resold to the BCO Members. It is expected that the proposed transactions will generate a net cost savings to BCO and ACO.

RULINGS GIVEN

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, and provided that the Master Agreement is effective in law in establishing that the BCO Members initially purchase the Products from ACO as agents on behalf of BCO such that BCO holds title as principal and is subject to a clear legal obligation to pay ACO for the Products and that there is a subsequent sale of the same Products from BCO to the BCO Members such that BCO Members hold title and have a clear legal obligation to pay BCO for the Products, we confirm the following:

A. Provided that for a particular taxation year ACO held out the prospect that amounts would be credited to its customers in accordance with subsection 135(5), ACO will be entitled to deduct pursuant to paragraph 20(1)(u) and subsection 135(1), subject to the limitation in subsection 135(2), in computing its income for the year patronage dividends paid by ACO within the year or within 12 months thereafter to BCO as described in 22 above and such patronage dividends will be included in computing the income of BCO for the taxation year in which such amounts are paid pursuant to subsection 135(7).

B. For the purposes of section 135, the BCO Members will be BCO's "customers", within the meaning assigned by subsection 135(4), with respect to their purchases of Products from BCO that BCO has acquired from ACO in the course of the proposed transactions described in 18 above.

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

Yours truly,

XXXXXXXXXX
Manager
Financial Institutions Team
Financial Industries Division
Income Tax Rulings Directorate
Policy and Legislation Branch