2004 Ruling 2003-0051381R3 - Steps to avoid gain - 21 yr

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. Does 86(1) apply to the reorganization of Holdco? 2. Does 84(1), 83(2) and 53(1)(b) apply to the subsequent increase in the PUC? 3. Does 107(2) apply to the distribution of shares from the trust? 4. Does 15(1), 105, 246(1) or GAAR apply to proposed transactions?

Position: 1 & 2. Yes. 3. Provided that the trustee does not elect under subsection 107(2.001), yes. 4. No.

Reasons: 1 to 4. Consistent with prior rulings.

XXXXXXXXXX 							2003-005138

XXXXXXXXXX, 2004

Dear XXXXXXXXXX:

Re: XXXXXXXXXX
Advance Income Tax Ruling

This is in reply to your letter of XXXXXXXXXX, as amended by your letter of XXXXXXXXXX, in which you requested an advance income tax ruling in respect of the income tax consequences arising out of the proposed transactions described below. We also acknowledge our correspondence concerning your request.

We understand that to the best of your knowledge, and that of the taxpayers involved, none of the matters considered in this ruling request are:

(a) in an earlier return of the taxpayers or related persons;

(b) being considered by a tax services office or tax centre in connection with a previously filed tax return of the taxpayers or related persons;

(c) under objection by the taxpayers or related persons;

(d) before the courts; or

(e) the subject of a ruling previously issued by this Directorate to the taxpayers or related persons.

In this letter the following terms have the meanings specified:

"Act" means the Income Tax Act (Canada), R.S.C. 1985 (5th Supp.), c.1, as amended to the date hereof.

"Beneficiary" means the beneficiary of the Secondary Trust and of the Secondary Estate Trust, namely XXXXXXXXXX. His social insurance number is XXXXXXXXXX. He files his tax return with the XXXXXXXXXX Tax Office and resides in the area serviced by the XXXXXXXXXX Tax Service Office. His address is XXXXXXXXXX.

"Children" means the children of the Widow, namely XXXXXXXXXX.

"Contingent Beneficiaries" means the issue of the Beneficiary and if he dies leaving no issue, the other Children, should their contingent interests in the Secondary Trust become absolute. The Beneficiary currently has no issue.

"Holdco" means XXXXXXXXXX, a Canadian-controlled private corporation and a taxable Canadian corporation. Holdco currently has XXXXXXXXXX common shares issued and outstanding. Its address is XXXXXXXXXX. Its business number is XXXXXXXXXX. It files its tax returns with the XXXXXXXXXX Tax Centre and is located within the area serviced by the XXXXXXXXXX Tax Services Office.

"Deed" means the deed of settlement dated XXXXXXXXXX. The Deed governs the Main Trust, the Secondary Trust and the trusts for the Beneficiary's siblings.

"Estate Trust" means the trust created upon the death of the Widow, which occurred on XXXXXXXXXX. The trustees of the Estate Trust are XXXXXXXXXX. The address of the Estate Trust is XXXXXXXXXX. The Estate Trust files its returns with the XXXXXXXXXX and resides in the area serviced by the XXXXXXXXXX Tax Services Office.

"First Anniversary Date" means the date when the Beneficiary reached the age of XXXXXXXXXX, being XXXXXXXXXX.

"Main Trust" means the trust created by Deed upon the transfer of $XXXXXXXXXX by the Settlor to the XXXXXXXXXX as trustee and is known as "XXXXXXXXXX" The current trustees of the Main Trust are XXXXXXXXXX. The Main Trust's account number is XXXXXXXXXX and its address is XXXXXXXXXX. The Main Trust files its returns with the XXXXXXXXXX and resides in the area serviced by the XXXXXXXXXX Tax Services Office. The beneficiaries of the Main Trust are the Children and their issue. On the Widow's passing, the assets of the Main Trust were divided into XXXXXXXXXX equal shares and each share is held in a separate trust for the benefit of each of the Children.

"Opco" means XXXXXXXXXX

"Preferred 1 Shares" means the Class XXXXXXXXXX preference shares of the share capital of Holdco, non-voting, retractable and redeemable at $XXXXXXXXXX per share, with a non-cumulative XXXXXXXXXX% per annum dividend entitlement per share, based on the redemption amount. There are currently XXXXXXXXXX Class XXXXXXXXXX preference shares issued and outstanding.

"Preferred 2 Shares" means the Class XXXXXXXXXX preference shares of the share capital of Holdco, having the terms set out in paragraph 8 below.

"Second Anniversary Date" means the date when the Beneficiary reaches the age of XXXXXXXXXX, being XXXXXXXXXX or should the Beneficiary die before attaining the age of XXXXXXXXXX, the date when a Contingent Beneficiary reaches the age of XXXXXXXXXX.

"Secondary Trust" means the trust created for the benefit of the Beneficiary or the Contingent Beneficiaries by the trustees of the Main Trust by setting aside XXXXXXXXXX of the assets of the Main Trust, as required by the Deed on the Widow's passing. The Secondary Trust is known as The Sub-trust of the XXXXXXXXXX for XXXXXXXXXX. The trustees of the Secondary Trust have always been the same as the trustees of the Main Trust. The address of the Secondary Trust is XXXXXXXXXX and its account number is XXXXXXXXXX.

"Secondary Estate Trust" means the trust created for the benefit of the Beneficiary or the Contingent Beneficiaries by the trustees of the Estate Trust by setting aside XXXXXXXXXX of the assets of the Estate Trust, as they were required to do by the Will. The account number of the Secondary Estate Trust is XXXXXXXXXX.

"Settlor" means the late XXXXXXXXXX.

"Third Anniversary Date" means the date when the Beneficiary reaches the age of XXXXXXXXXX, being XXXXXXXXXX or should the Beneficiary die before attaining the age of XXXXXXXXXX, the date when a Contingent Beneficiary reaches the age of XXXXXXXXXX.

"Widow" means the late XXXXXXXXXX who passed away on XXXXXXXXXX.

"Will" means the last will of the Widow, dated XXXXXXXXXX.

FACTS

1. The Main Trust, the Estate Trust, the Secondary Trust and the Secondary Estate Trust all reside in Canada and are personal trusts as defined in subsection 248(1) of the Act. The Beneficiary of the Secondary Trust and the Secondary Estate Trust resides in Canada.

2. The assets of the Secondary Trust consist of the common shares of Holdco. The common shares of Holdco were issued to the trustees of the Secondary Trust from treasury in XXXXXXXXXX in exchange for XXXXXXXXXX shares of XXXXXXXXXX, a predecessor company to Opco. The XXXXXXXXXX shares of XXXXXXXXXX were issued from treasury in XXXXXXXXXX for cash consideration. Pursuant to the Deed, the trustees may, in their absolute discretion, encroach upon the capital of the Secondary Trust for the benefit of any beneficiary. Clause XXXXXXXXXX of the Deed specifies that this discretion includes the right to acquire and furnish and to permit the occupancy of a dwelling and the establishment in business for any beneficiary, but that no power of encroachment for the purpose of investment by any beneficiary shall be inferred.

3. The Deed and the Will provide that the trustees of the Secondary Trust and the Secondary Estate Trust will transfer XXXXXXXXXX of the balance of the assets under their control to the Beneficiary upon the First Anniversary Date, XXXXXXXXXX of the remaining assets to the Beneficiary upon the Second Anniversary Date and the remaining assets to the Beneficiary upon the Third Anniversary Date.

4. On the First Anniversary Date, the trustees of the Secondary Trust distributed XXXXXXXXXX common shares of Holdco to the Beneficiary. The Secondary Trust owns the remaining outstanding XXXXXXXXXX common shares of Holdco with nominal paid-up capital ("PUC") and nominal adjusted cost base ("ACB"). The common shares of Holdco are capital property to both the Beneficiary and the Secondary Trust.

5. On the First Anniversary Date, the trustees of the Secondary Estate Trust distributed XXXXXXXXXX Preferred 1 Shares of Holdco to the Beneficiary. The Secondary Estate Trust owns the remaining outstanding XXXXXXXXXX Preferred 1 Shares of Holdco with a redemption value and ACB of $XXXXXXXXXX and nominal PUC.

6. Holdco is an investment holding company. It owns XXXXXXXXXX of the issued common shares of Opco in addition to a portfolio of marketable securities. It is expected that the capital dividend account of Holdco will be approximately equal to $XXXXXXXXXX at the time of the exchanges in paragraphs 9 and 10 below and that the balance in the capital dividend account of Holdco does not include any amount that is described in paragraphs 83(2.2)(a) to (d) of the Act.

7. Subsection 75(2) of the Act has never been applicable at any time in respect of any of the property of either the Main Trust or the Secondary Trust.

PROPOSED TRANSACTIONS

8. Holdco will deliver Articles of Amendment to the XXXXXXXXXX. The Articles of Amendment will result in the addition to the authorized share capital of the company of the following classes of shares:

? An unlimited number of Class 1 common shares, giving right to XXXXXXXXXX votes per share and convertible into Class 2 common shares on a 1 for 1 basis;

? An unlimited number of Class 2 common shares, giving right to 1 vote per share, ranking equal to the Class 1 common shares in the event of the liquidation, dissolution or winding-up of Holdco or other distribution of assets of Holdco; and

? An unlimited number of Preferred 2 Shares, non-voting, redeemable but not retractable, with a XXXXXXXXXX% per annum cumulative dividend entitlement, based on their redemption amount of $XXXXXXXXXX per share.

9. In the course of the reorganization of the capital of Holdco, the Secondary Trust will exchange its XXXXXXXXXX common shares of Holdco (the "XXXXXXXXXX Exchanged Common Shares"), for such number of Preferred 2 Shares having an aggregate redemption value equal to the amount determined in this paragraph and XXXXXXXXXX Class 1 common shares. The Secondary Trust and Holdco will not elect pursuant to subsection 85(1) of the Act in respect of this exchange of shares. Holdco will cancel the XXXXXXXXXX Exchanged Common Shares immediately after the exchange. The fair market value and redemption value of the Preferred 2 Shares issued will be equal to the aggregate fair market value of the XXXXXXXXXX Exchanged Common Shares less XXXXXXXXXX% of the balance of the capital dividend account of Holdco at the time of the exchange. The fair market value of the Class 1 common shares issued will be equal to XXXXXXXXXX% of the balance of the capital dividend account of Holdco at the time of the exchange. The aggregate stated capital of the Class 1 common shares and the Preferred 2 Shares issued will be equal to the aggregate stated capital of the XXXXXXXXXX Exchanged Common Shares.

10. In the course of the reorganization of the capital of Holdco and concurrently with the exchange described in paragraph 9 above, the Beneficiary will exchange his XXXXXXXXXX common shares of Holdco (the "XXXXXXXXXX Exchanged Common Shares"), for such number of Preferred 2 Shares equal to XXXXXXXXXX of the Preferred 2 Shares issued in paragraph 9 above and XXXXXXXXXX Class 2 common shares. The Beneficiary and Holdco will not elect pursuant to subsection 85(1) of the Act in respect of this exchange of shares. Holdco will cancel the XXXXXXXXXX Exchanged Common Shares immediately after the exchange. The aggregate fair market value of the Preferred 2 Shares and of the Class 2 common shares issued in this transaction will be equal to the fair market value of the XXXXXXXXXX Exchanged Common Shares. The fair market value and redemption value of the Preferred 2 shares issued will be equal to the aggregate fair market value of the XXXXXXXXXX Exchanged Common Shares less XXXXXXXXXX% of the balance of the capital dividend account of Holdco at the time of the exchange. The fair market value of the Class 2 common shares issued will be equal to XXXXXXXXXX% of the balance of the capital dividend account of Holdco at the time of the exchange. The aggregate stated capital of the Class 2 common shares and Preferred 2 Shares issued will be equal to the aggregate stated capital of the XXXXXXXXXX Exchanged Common Shares.

11. The trustees of the Secondary Trust will exercise their discretion to encroach on the capital of the trust and will distribute the Preferred 2 Shares of Holdco to the Beneficiary. Such encroachment is within their powers and no authorization from the XXXXXXXXXX Children Lawyer or any other entity is required in order to implement the proposed transactions.

12. Holdco will concurrently effect an increase in each of the stated capital of Holdco Class 1 and Class 2 common shares, which will be equal to XXXXXXXXXX% and XXXXXXXXXX%, respectively, of the balance in Holdco's capital dividend account immediately before the time of the commencement of such stated capital increases. Holdco will elect, in prescribed form and within the time referred to in subsection 83(2) of the Act, to have the rules in subsection 83(2) of the Act apply to the full amount of any resulting deemed dividends.

13. The Beneficiary will enter into an agreement with the other Children. In that agreement, the Beneficiary will agree to draft his will to provide that in the event of his death, the shares he owns in Holdco will be left to the Contingent Beneficiaries or a trust for the benefit of the Contingent Beneficiaries.

14. The Beneficiary, the trustees of the Secondary Trust and Holdco are discussing entering into a shareholders' agreement dealing with the redemption of the Preferred 2 Shares.

15. On the Second Anniversary Date, Holdco will convert XXXXXXXXXX Class 1 common shares held by the trustees of the Secondary Trust into XXXXXXXXXX Class 2 common shares. The trustees of the Secondary Trust will distribute the XXXXXXXXXX Class 2 common shares to the Beneficiary or to the Contingent Beneficiaries as a distribution in part satisfaction of their capital interest in the Secondary Trust.

16. On the Third Anniversary Date, the trustees of the Secondary Trust will distribute the remaining XXXXXXXXXX Class 1 common shares to the Beneficiary or to the Contingent Beneficiaries as a distribution in satisfaction of their capital interest in the Secondary Trust.

PURPOSE OF PROPOSED TRANSACTIONS

17. The purpose of the proposed transactions is to provide the trustees of the Secondary Trust with an effective method of encroaching on the capital of the Secondary Trust, while maintaining the objectives provided for in the Deed to the maximum extent possible.

The Main Trust was settled on XXXXXXXXXX. Since the Secondary Trust was settled by the transfer of capital property by the Main Trust in the circumstances described in subsection 104(5.8) of the Act, it is deemed to have been settled on that same date for the purposes of subsection 104(4) of the Act. Accordingly, the Secondary Trust will be deemed to have disposed of its capital property on XXXXXXXXXX under subsection 104(4) of the Act. Given the significant income tax cost that would be incurred by the trust on a deemed disposition of its common shares of Holdco if the trustees did not take any action prior to that date, the trustees of the Secondary Trust have concluded that this is an appropriate time to distribute the value of its common shares of Holdco to the Beneficiary.

The trustees wish to make such a distribution in a manner that will permit them to retain control of Holdco until such time as the Beneficiary attains the age of XXXXXXXXXX, as stipulated by the Deed. In addition, the proposed transactions ensure that the Secondary Trust retains the maximum value of Holdco without giving rise to adverse tax consequences.

RULINGS

You have represented that the proposed distribution set out in paragraph 11 above is within the powers of the trustees and that no authorization from the XXXXXXXXXX Children Lawyer or any other entity is required in order to implement the proposed transactions. In providing this ruling letter, we emphasize that we have relied specifically on that representation. Consequently, provided that the preceding statements are accurate and constitute complete disclosure of all relevant facts, proposed transactions and purpose thereof, the proposed transactions are carried out as herein described, and provided that the proposed distribution is within the power of the trustees without authorization from any entity, our advance income tax rulings are as follows:

A. Subsection 86(1) of the Act will apply to the transactions described in paragraphs 9 and 10 above with the result that:

(i) the cost to the Secondary Trust of the Class 1 common shares and the Preferred 2 Shares of Holdco received on the exchange will equal the ACB to the Secondary Trust of the XXXXXXXXXX Exchanged Common Shares immediately before the exchange, in proportion to the relative fair market value immediately after the exchange of each class of shares received;

(ii) the cost to the Beneficiary of the Class 2 common shares and the Preferred 2 Shares of Holdco received on the exchange will equal the ACB to the Beneficiary of the XXXXXXXXXX Exchanged Common Shares immediately before the exchange, in proportion to the relative fair market value immediately after the exchange of each class of shares received;

(iii) the Secondary Trust will be deemed to have disposed of its XXXXXXXXXX Exchanged Common Shares of Holdco for proceeds of disposition equal to the aggregate ACB to it of the Class 1 common shares and Preferred 2 Shares received on the exchange; and

(iv) the Beneficiary will be deemed to have disposed of his XXXXXXXXXX Exchanged Common Shares of Holdco for proceeds of disposition equal to the aggregate ACB to him of the Class 2 common shares and Preferred 2 Shares received on the exchange.

B. The provisions of section 105 and subsections 15(1) and 246(1) of the Act will not apply to the proposed transactions in and by themselves.

C. Subject to subsection 107(2.001), subsection 107(2) of the Act will apply to the distribution described in paragraph 11 above by the Secondary Trust to the Beneficiary of the Preferred 2 Shares, such that the application of subsection 107(2), in conjunction with subsection 107(1) and paragraph (a) of the definition of 'cost amount' in subsection 108(1) of the Act, will give rise to the following tax consequences:

(i) the Secondary Trust will be deemed to have disposed of the Preferred 2 Shares for proceeds of disposition equal to their cost amount immediately before the distribution;

(ii) the Beneficiary will be deemed to have acquired the Preferred 2 Shares so distributed at a cost equal to the aggregate of the cost amount of the Preferred 2 Shares to the Secondary Trust immediately before the distribution and the amount, if any, by which the ACB of such part of the capital interest exceeds the cost amount to him of such part of the capital interest immediately before the distribution. The ACB of such part of the capital interest will be nil; therefore, the Beneficiary will be deemed to have acquired the Preferred 2 Shares at a cost equal to the cost amount of the Preferred 2 Shares to the Secondary Trust; and

(iii) the Beneficiary will be deemed to have disposed of such part of his capital interest in the Secondary Trust for proceeds equal to the amount, if any, by which the cost of the Preferred 2 Shares received as determined in (ii) above exceeds the total of all amounts, each of which is an eligible offset of the Beneficiary at that time in respect of such part of the capital interest.

D. Subject to the application of subsections 83(2.1) of the Act, the provisions of subsection 84(1), subsection 83(2) and paragraph 53(1)(b) of the Act will apply to the increase in the paid-up capital of the Holdco Class 1 common shares and the Holdco Class 2 common shares as described in paragraph 12 described above such that:

(i) in each of the stated capital of the Holdco Class 1 common shares and the Holdco Class 2 common shares, as described in paragraph 12 above, Holdco will be deemed to have paid to each of the Secondary Trust and the Beneficiary, and each of the Secondary Trust and the Beneficiary will be deemed to have received, a dividend pursuant to subsection 84(1) of the Act equal to the increase in the paid-up capital of the Holdco Class 1 common shares owned by the Secondary Trust and the Holdco Class 2 common shares owned by the Beneficiary, respectively. Provided that Holdco elects pursuant to subsection 83(2) of the Act in respect of the full amount of such dividend as described above, such dividend will be deemed to be a capital dividend; and

(ii) the provisions of paragraph 53(1)(b) of the Act will apply to increase the ACB of the Secondary Trust's Holdco Class 1 common shares and the ACB of the Beneficiary's Holdco Class 2 common shares, as the case may be, by the amount of the dividend deemed to have been received on the shares as described in (i) above.

E. The provisions of subsection 245(2) of the Act will not apply to the proposed transactions in and of themselves.

These rulings are given subject to the limitations and qualifications set forth in Information Circular 70-6R5 issued on May 17, 2002, and are binding on the Canada Revenue Agency (CRA) provided that the proposed distribution in paragraph 11 above is completed before the end of XXXXXXXXXX.

The above 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.

COMMENTS

Nothing in this letter should be construed as implying that the CRA has agreed to or reviewed:

a. the determination of the FMV, ACB or PUC of any property referred to in this letter;

b. the computation of the capital dividend account of Holdco; or

c. any tax consequences arising from the facts or proposed transactions described above other than those specifically confirmed in the rulings given.

XXXXXXXXXX
Director
International and Trusts Division
Income Tax Rulings Directorate
Policy and Planning Branch