13 May 2002 External T.I. 2002-0135575 - IFA 2002-Discussion of 86.1 Issues

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: Discussion of current issues on new section 86.1 (foreign spin-offs).

Position: See below.

Reasons: N/A

Question 2. Section 86.1 Issues

Section 86.1 of the Income Tax Act (the "Act") provides a Canadian resident with the opportunity for a tax deferral in respect of a distribution of common stock of a foreign corporation owned by another foreign corporation of which the Canadian resident is a shareholder (a "spin-off" distribution).

(a) In order to qualify for the tax deferral, the distribution must be an eligible distribution as defined by section 86.1 of the Act. Among other requirements, the distribution must consist solely of common shares of the common stock of a corporation that were owned by the corporation making the distribution immediately before their distribution to the taxpayer. We understand that the CCRA has been considering whether or not the provisions of this section can apply to a distribution of common shares with attached shareholder rights under a shareholders rights plan of the kind often referred to as a "poison pill" rights plan. A number of the U.S. public corporations who have made spin-off distributions have put in place shareholder rights plans (which duplicate the shareholder rights plan in place with respect to the distributing corporation) immediately before the distribution of the common shares. The CCRA has been taking the position that the receipt of the rights under the shareholder rights plan means that such a distribution includes something other than common shares and is therefore not an eligible distribution under section 86.1. This means that the Canadian shareholders of the distributing corporation are not entitled to elect for the tax deferral provided by section 86.1. We understand that the CCRA is currently reconsidering this position. Could you please comment on the status of the CCRA's review of this issue and also comment on the implications of the position taken for other Canadian rollovers.

(b) In order for a Canadian resident shareholder to be able to elect for the tax deferral it is necessary for the "particular corporation" (the distributing corporation) to provide to the Minister information satisfactory to the Minister establishing, among other things, that in the case of a distribution that is not prescribed, the distribution is not taxable under the U.S. Internal Revenue Code, and in other cases that it is not taxable under the laws of the relevant foreign country. Can you comment on what would constitute "information satisfactory to the Minister establishing" these facts. Would a foreign ruling be necessary, or would it be sufficient to provide an opinion from foreign counsel? Would it be sufficient to submit a copy of the prospectus or other similar document prepared in order to comply with applicable securities laws (assuming it contains a tax discussion on this point)?

(c) Will the CCRA accept elections for tax deferral under section 86.1 of the Act that are filed late by the Canadian resident shareholder?

CCRA's Response

(a) The International Fiscal Association is the first person or group to ask the Income Tax Rulings Directorate ("Rulings") for the CCRA's official interpretative position on this matter. To date, Rulings has not received any written requests for either non-binding interpretations or binding advance income tax rulings with respect to whether a foreign spin-off that includes a distribution of rights pursuant to a typical shareholder rights plan can qualify as an "eligible distribution".

At the present time, the CCRA does not intend to establish an administrative position with respect to the shareholder rights plan issue. The CCRA is concerned that there is no legal basis for such a position, given the restrictive nature of the words used in section 86.1 of the Act. In our view, the words used in section 86.1 suggest that the policy underlying the provision was that foreign spin-offs involving the distribution of anything other than common shares were not intended to benefit from the tax deferral provided. We note that as section 86.1 clearly contemplates that property other than common shares could be distributed as part of a particular foreign spin-off, and as it appears that the mere existence of such property prevents the foreign spin-off from being an "eligible distribution", the value of such property, whether nominal or not, is not relevant in the context of this provision. We acknowledge, however, that although the wording of section 86.1 is slightly different in this respect from other rollover provisions in the Act that require that only share consideration be received by the taxpayer (for example, subsections 51(1), 85.1(1) and 87(4) of the Act), the position we take on this matter may have an impact on our interpretation of such provisions.

In order to consider a particular foreign spin-off that includes rights under a shareholder rights plan to be an "eligible distribution", the CCRA will require legal support that either

(i) the particular "poison pill rights" are not property separate from the common shares being distributed; or

(ii) the issuance of the rights is not part of the particular distribution.

Our initial reaction to these arguments is that "poison pill rights" probably do constitute property separate from the common shares and that such rights are part of a particular distribution where the shareholder rights plan is put in place prior to the distribution. We plan to seek legal advice on these issues once we have a live file to review. We strongly recommend that anyone who has a client who will be receiving share rights pursuant to a particular foreign spin-off consider requesting an advance income tax ruling on the application of section 86.1 of the Act. We would give high priority to any such ruling request.

In conclusion, we will not provide any kind of administrative exception for "poison pill"-type rights in the context of section 86.1 of the Act, nor will we seek legal advice on this matter, until we have a live file to review that sets out all of the relevant facts of the foreign spin-off and includes a copy of the shareholder rights plan in question. The informal submissions that we have received to date have not convinced us that share rights issued in the context of a foreign spin-off are not property separate from the related common shares. There are a number of issues to clarify before we could accept such an argument. In particular, we would want to understand why, in the context of a spin-off transaction, the share rights plan has to be created immediately before the distribution. There may be U.S. considerations behind this particular ordering; if so, we would want to examine these considerations in the context of a particular proposed foreign spin-off.

(b) At the present time, the CCRA will accept only a ruling from the United States Internal Revenue Service (IRS) as "information satisfactory to the Minister establishing" that the distribution of the spin-off shares is not a taxable transaction in the United States. However, where such a ruling is not available, but a legal opinion from foreign counsel has been provided stating that the distribution is not taxable in the United States, the CCRA, through its function as Canadian Competent Authority and under the Exchange of Information provisions of the Canada-United States Income Tax Convention, will request the IRS, in its capacity as U.S. Competent Authority, to confirm that the distribution is not a taxable transaction in the United States. If no such confirmation is received from the IRS, then the spin-off will not be an eligible distribution for purposes of section 86.1 of the Act.

The legal opinion from foreign counsel may be separate from or incorporated within the documents related to the spin-off transaction prepared in order to comply with applicable U.S. securities laws. We note that in the case of a "prescribed distribution", similar criteria would apply, that is, either a ruling from the foreign taxing authority would be required or the CCRA would have to obtain confirmation that the distribution is not taxable in the foreign jurisdiction from the foreign taxing authority through the competent authority process.

(c) A legislative amendment has been made to the Income Tax Regulations to extend the application of the fairness provisions to the election which allows a tax deferral of eligible distributions of foreign spin-off shares. Among other things, the fairness legislation gives the Minister of National Revenue and her delegated officials discretion to allow late and amended elections, or to revoke them for taxation years dating back to 1985.

The Governor in Council, on the recommendation of the Minister of National Revenue, has amended section 600 of the Regulations to add paragraph 86.1(2)(f) to the list of elections set out in paragraph 600(c). As a result, the Minister of National Revenue may, under the fairness provisions of subsection 220(3.2) of the Act, extend the time for making the election for a tax deferral of eligible distributions of foreign spin-off shares.

Presenter: Jim Wilson
Prepared by: Eliza Erskine
Phone number: 952-1361
Division: Income Tax Rulings Directorate

May 13, 2002