30 April 2004 Internal T.I. 2004-0068251I7 - internal reorganizations

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: Whether subsection 69(5) applies to the series of transactions? Whether subsection 55(2) applies to the series of transactions?

Position: No. No.

Reasons: Subsection 84(3) applies to the redemption of the preferred shares and subsection 88(1) applies to the wind-up of Subco into Bco. Subsection 55(2) does not apply by virtue of the exemption under paragraph 55(3)(a).

April 30, 2004

XXXXXXXXXX Reorganizations and
Large File Case Manager Resources Division
XXXXXXXXXX Tax Services Office Fiona Harrison
(613) 998-5971

2004-006825

XXXXXXXXXX

This is in reply to your e-mail of March 22, 2004, wherein you requested our comments in respect of the following situation:

1. In XXXXXXXXXX ("Bco"), a taxable Canadian corporation, acquired control of XXXXXXXXXX ("Pco"), a taxable Canadian corporation. On XXXXXXXXXX, Bco owned XXXXXXXXXX% of Pco.

2. On XXXXXXXXXX, the directors of Bco, representing the majority of shareholders of Pco, passed a resolution to transfer all the assets of Pco to XXXXXXXXXX. ("Subco"), a wholly-owned subsidiary of Bco. Pursuant to the resolution, the transfer of assets was to take place on XXXXXXXXXX . At the same time the directors of XXXXXXXXXX, representing the sole shareholder of Subco, passed a resolution to wind-up Subco into Bco on XXXXXXXXXX.

3. On XXXXXXXXXX, all of the assets of Pco were transferred to and all the liabilities of Pco were assumed by Subco. As consideration, Subco issued XXXXXXXXXX First Preferred Shares. A joint election under subsection 85(1) of the Income Tax Act (the "Act") was filed by Subco and Pco in respect of the transfer of assets.

4. The directors of Subco passed a resolution to redeem the First Preferred Shares owned by Pco for a note issued by Subco.

5. Subco was wound-up into Bco. An election was made pursuant to subsection 80.01(4) of the Act regarding the debt that was outstanding prior to the transfer of the liabilities from Pco.

6. On Schedule XXXXXXXXXX of the Income Tax Return for the fiscal year ending XXXXXXXXXX, Bco reported a deemed dividend on the First Preferred Shares of Subco.

TSO Analysis

Your review of the documents of the taxpayers involved indicates that there was no resolution by the directors of Pco to transfer or sell the First Preferred Shares of Subco to Bco. Moreover, there was no resolution by the directors of Bco to purchase the First Preferred Shares of Subco.

Based upon a review of the working papers of Pco and Bco and a review of Bco's general ledger, you conclude that the First Preferred Shares were not transferred by Pco to Bco. Therefore, you question the validity of the deemed dividend reported by Bco.

It is your position that the redemption of the First Preferred Shares of Subco occurred on the "winding-up" of Subco and that, accordingly, the redemption was not subject to the provisions of subsection 84(3) of the Act since it qualified as a transaction described in subsection 84(2). However, you note that, pursuant to paragraph 88(1)(d.1), subsection 84(2) does not apply to the winding-up of a subsidiary. Therefore you conclude that subsection 69(5) will apply and Pco will be deemed to have disposed of property before the winding-up for proceeds equal to the fair market value. You propose to reassess Pco accordingly.

You note that the taxpayer's representative has advised that this series of transactions qualifies as a "butterfly". You have reviewed the transactions from this perspective and have concluded that the transactions do not meet the requirements under paragraph 55(3)(b). You are therefore considering a reassessment under subsection 55(2) as an alternative.

OUR POSITION

It is our view that the above-described series of transactions meets the requirements under paragraph 55(3)(a) and is therefore exempt from the application of subsection 55(2).

We feel that it would be difficult to support a reassessment of subsection 69(5) with respect to these transactions. In our view, the redemption of the First Preferred Shares by Subco was subject to the application of subsection 84(3) and resulted in a deemed dividend received by Pco. We confirm your view that Bco should not have reported a deemed dividend on the First Preferred Shares. Immediately before the winding-up which commenced on XXXXXXXXXX, Bco owned XXXXXXXXXX% of the only outstanding class of shares of Subco. Accordingly, subsection 88(1) was applicable with respect to the winding-up of Subco into Bco.

Pursuant to a telephone conversation, you advised us that it was the representative's position that Bco did not resolve to implement a direct wind-up of Pco, which was a wholly-owned subsidiary, because of certain corporate law provisions. However, you assert that, by transferring the resource properties of Pco to Subco in a transaction that was subject to subsection 85(1), Bco had unrestricted COGPE in respect of certain resource properties. We understand that the XXXXXXXXXX Tax Avoidance Section has reviewed the file and concluded that GAAR would not apply to redetermine the tax consequences of these transactions.

If you have any questions, please contact us.

Manager
Corporate Reorganizations Section
Reorganizations and Resources Division
Income Tax Rulings Directorate