2008 Ruling 2008-0279781R3 - Subsections 85(1) and 55(3)

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 transaction is exempt from application of subsection 55(2) by virtue of subsection 55(3)(a).

Position: Yes

Reasons: Wording of the provision

XXXXXXXXXX 							2008-027978

XXXXXXXXXX , 2008

Dear XXXXXXXXXX :

Re: Advance Income Tax Ruling Request
XXXXXXXXXX

This is in reply to your letter of XXXXXXXXXX , wherein you requested an Advance Income Tax Ruling on behalf of the above-noted taxpayers. We also acknowledge the information provided in subsequent correspondence and various telephone conversations in connection with your request. The documents submitted with your request are part of this document only to the extent described herein.

We understand that, to the best of your knowledge and that of the taxpayers involved, none of the issues involved in this Ruling request:

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

(ii) is being considered by a Tax Services Office or Taxation Centre in connection with a previously filed tax return of the taxpayers or a related person;

(iii) is under objection by the taxpayers or a related person;

(iv) is before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has not expired; or

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

We also understand that an application has been made to the Canadian Competent Authority pursuant to section 115.1 of the Income Tax Act (Canada) and Article XIII(8) of the Canada-United States Tax Convention (1980) in connection with the transactions described herein.

DEFINITIONS

The following terms have the meanings specified:

"A Co" means XXXXXXXXXX , a private corporation and a taxable Canadian corporation incorporated under the laws of XXXXXXXXXX , all the shares of which are owned by H Co. A Co owns certain G Co Core Assets and certain G Co Non-Core Assets. A Co's mailing address is XXXXXXXXXX and its business number is XXXXXXXXXX . A Co's Tax Services Office is the XXXXXXXXXX Tax Services Office;

"Act" means the Income Tax Act (Canada), R.S.C. 1985 (5th Supp.), c.1, including the regulations promulgated thereunder, as amended to the date hereof, and unless otherwise stated, every reference herein to a part, section, subsection, paragraph or subparagraph is a reference to the relevant provision of the Act;

"adjusted cost base" has the meaning assigned by subsection 248(1);

"agreed amount" has the meaning assigned by subsection 85(1);

"arm's length" has the meaning assigned by subsection 251(1);

"B Co" means XXXXXXXXXX , a private corporation and a taxable Canadian corporation incorporated under the laws of XXXXXXXXXX , all the shares of which are owned by A Co. B Co's mailing address is XXXXXXXXXX and its business number is XXXXXXXXXX . B Co's Tax Services Office is the XXXXXXXXXX Tax Services Office;

"C Co" means XXXXXXXXXX , a private corporation and a taxable Canadian corporation incorporated under the laws of XXXXXXXXXX , all the shares of which are owned by A Co. C Co's mailing address is XXXXXXXXXX and its business number is XXXXXXXXXX . C Co's Tax Services Office is the XXXXXXXXXX Tax Services Office;

"Canadian Competent Authority" means the Competent Authority for Canada defined pursuant to subparagraph 1(g)(i) of Article III of the Convention;

XXXXXXXXXX ;

"Code" means the Internal Revenue Code of 1986, 26 U.S.C., and the regulations promulgated thereunder, as amended;

"Controlled" means the newly formed QSSS incorporated by E Co as described in paragraph 33;

"Convention" or "Canada-United States Tax Convention (1980)" means the Convention between Canada and the United Slates of America with Respect to Taxes on Income and Capital signed on September 26, 1980, as amended by the Protocols signed June 14, 1983, March 28, 1984, March 17, 1995, July 29, 1997, and September 21, 2007;

"CRA" means the Canada Revenue Agency;

"D Co" means XXXXXXXXXX , a private corporation and a taxable Canadian corporation incorporated under the laws of XXXXXXXXXX , all the shares of which are owned by G Co. D Co's mailing address is XXXXXXXXXX and its business number is XXXXXXXXXX . D Co's Tax Services Office is the XXXXXXXXXX Tax Services Office;

"disposition" has the meaning assigned by subsection 248(1);

"dividend rental arrangement" has the meaning assigned by subsection 248(1);

"E Co" means XXXXXXXXXX ;

"E Co Group" means E Co and the various corporations and other business organizations controlled by E Co, including G Co and H Co;

"E Co Shareholders" means XXXXXXXXXX ;

"eligible property" has the meaning assigned by subsection 85(1.1);

"F Co" means XXXXXXXXXX , a private corporation and a taxable Canadian corporation incorporated under the laws of XXXXXXXXXX , all the shares of which are owned by G Co. F Co's mailing address is XXXXXXXXXX and its business number is XXXXXXXXXX . F Co's Tax Services Office is the XXXXXXXXXX Tax Services Office;

"FMV" means fair market value and is the highest price available in an open and unrestricted market between informed prudent parties acting at arm's length;

"forgiven amount" has the meaning assigned by subsections 80(1) and 80.01(1);

"G Co" means XXXXXXXXXX , a company created pursuant to the provisions of XXXXXXXXXX . G Co is a private corporation and a taxable Canadian corporation, all of the shares of which are owned by H Co. G Co's mailing address is XXXXXXXXXX and its business number is XXXXXXXXXX . G Co's Tax Services Office is the XXXXXXXXXX Tax Services Office;

XXXXXXXXXX

"G Co Core Assets" means the legal and beneficial title XXXXXXXXXX ;

"G Co Non-Core Assets" means any assets of G Co not falling within the above definition of G Co Core Assets, including: the shares of two XXXXXXXXXX corporations (F Co and D Co); XXXXXXXXXX ;

"guarantee agreement" has the meaning assigned by subsection 112(2.2);

"H Co" means XXXXXXXXXX , a corporation governed by the laws of XXXXXXXXXX , all the shares of which are owned by E Co;

"H Co Core Assets" means the shares of G Co, and the legal and beneficial title XXXXXXXXXX ;

"H Co Non-Core Assets" means any assets of H Co not falling within the definition of H Co Core Assets;

"I Co" means XXXXXXXXXX , a private corporation and a taxable Canadian corporation incorporated under the laws of XXXXXXXXXX , all the shares of which are owned by G Co. I Co's mailing address is XXXXXXXXXX and its business number is XXXXXXXXXX . I. Co's Tax Services Office is the XXXXXXXXXX Tax Services Office;

"Minister" means the Minister of National Revenue;

"N1" means a wholly-owned Unlimited Liability Company and taxable Canadian corporation incorporated by G Co under the laws of XXXXXXXXXX . The authorized capital of N1 will include a class of voting common shares and a class of non-voting, retractable and redeemable preferred shares. The preferred shares of N1 will entitle the holder to non-cumulative dividends as the directors may declare, but not exceeding a reasonable rate stated as a percentage of the aggregate redemption amount of such shares. The aggregate redemption amount for the preferred shares will be set by the directors at the time of issuance and will be equal to the fair market value of the property received by N1 for the issuance of such shares less any debt issued or liabilities assumed by N1 on their issuance. The redemption amount for the preferred shares will be subject to a price adjustment clause;

"N2" means a wholly-owned Unlimited Liability Company and taxable Canadian corporation incorporated by H Co under the laws of XXXXXXXXXX . The authorized capital of N2 will include a class of voting common shares and a class of non-voting, retractable and redeemable preferred shares. The preferred shares of N2 will entitle the holder to non-cumulative dividends as the directors may declare, but not exceeding a reasonable rate stated as a percentage of the aggregate redemption amount of such shares. The aggregate redemption amount for the preferred shares will be set by the directors at the time of issuance and will be equal to the fair market value of the property received by N2 for the issuance of such shares less any debt issued or liabilities assumed by N2 on their issuance. The redemption amount for the preferred shares will be subject to a price adjustment clause;

"paid-up capital" has the meaning assigned by subsection 89(1);

"principal amount" has the meaning assigned by subsection 248(1);

"private corporation" has the meaning assigned by subsection 89(1);

"proceeds of disposition" has the meaning assigned by section 54;

"Proposed Transactions" means the transactions described in paragraphs 18.1 to 37;

"QSSS" means qualified sub-chapter S subsidiary corporation, and has the meaning assigned to that term by the Code;

"QSub1" means the newly formed QSSS incorporated by E Co as described in paragraph 18.1;

"QSub election" means an election to be a QSSS for purposes of the Code;

"related persons" has the meaning assigned by subsection 251(2);

"series of transactions or events" includes the transactions or events described in subsection 248(10);

"taxable Canadian corporation" has the meaning assigned by subsection 89(1);

"taxable Canadian property" has the meaning assigned by subsection 248(1);

"taxable dividend" has the meaning assigned by subsection 89(1); and

"United States" has the meaning stated in paragraph 1(b) of Article III of the Convention;

FACTS

1. E Co is a qualified sub-chapter S corporation governed by the laws of XXXXXXXXXX . E Co is a resident of the United States ("U.S.") for purposes of the Code and the Convention.

2. H Co is a corporation governed by the laws of the state of XXXXXXXXXX and is a wholly-owned subsidiary of E Co. H Co is a resident of the U.S. for purposes of the Code, and is a non-resident of Canada for purposes of the Act. H Co, G Co and other U.S. subsidiaries of E Co are QSSSs.

3. H Co holds all the issued and outstanding shares of G Co, which holds the legal and beneficial title XXXXXXXXXX .

4. H Co also holds the legal and beneficial title to the H Co Core Assets and the H Co Non-Core Assets.

5. In addition to G Co's interest in XXXXXXXXXX and other G Co Core Assets, G Co and A Co also own all of the G Co Non-Core Assets with an aggregate value estimated to be approximately USDXXXXXXXXXX .

6. The value of the G Co Core Assets and the G Co Non-Core Assets are both principally attributable to real property situated in Canada.

7. The E Co Shareholders XXXXXXXXXX are related persons.

7.1. The E Co Shareholders are residents of the U.S. for purposes of the Code and the Convention.

8. E Co is wholly-owned by the E Co Shareholders.

9. [deleted]

10. G Co and A Co are wholly-owned subsidiaries of H Co.

11. D Co, F Co and I Co are wholly-owned subsidiaries of G Co.

12. B Co and C Co are wholly-owned subsidiaries of A Co.

13. H Co and G Co require funding for capital expenditures and related projects in connection with XXXXXXXXXX as well as for general corporate purposes.

ADDITIONAL INFORMATION

14. E Co, on behalf of H Co, has been in discussions with XXXXXXXXXX regarding financing for its business. XXXXXXXXXX has advised that in order for E Co or H Co to borrow on the best terms possible, G Co and H Co should be bankruptcy remote. In other words, G Co and H Co should not hold assets other than the G Co Core Assets and the H Co Core Assets.

15. Based on the advice of XXXXXXXXXX , E Co does not want the G Co Core Assets and the H Co Core Assets to be at risk for amounts borrowed to finance certain capital expenditures or for other obligations which may arise in the course of E Co's other businesses. Accordingly, the assets of G Co and H Co will be reorganized to separate their respective core assets from their non-core assets into separate legal entities. For this purpose, the Proposed Transactions will be undertaken.

16. Following the transactions described in paragraphs 21 to 26 below, the G Co Non-Core Assets will be owned by N1, which will in turn be wholly-owned by N2. N2 will be a taxable Canadian corporation, and H Co will hold all of the common and preferred shares in the capital stock of N2.

17. Various other restructuring steps will be undertaken to further separate the core assets from the non-core assets and will involve a Canadian Competent Authority request to defer any Canadian income tax upon the transfer by H Co of the common and preferred shares of N2 to QSub1 as described in paragraph 29 below.

18. [deleted]

PROPOSED TRANSACTIONS

18.1. E Co will form QSub1, a new wholly-owned U.S. corporation, and will file a QSub election for U.S. tax purposes effective from inception. After the Proposed Transactions are completed, QSub1 will hold all the shares of N2.

19. H Co will transfer all of the shares of A Co to G Co in exchange for additional common shares of G Co. H Co and G Co will jointly elect, in prescribed form and within the time limits referred to in subsection 85(6), to have the provisions of subsection 85(1) apply in respect of the transfer of the A Co shares. The agreed amount in the joint election will be equal to the adjusted cost base of the A Co shares to H Co immediately before the transfer. The agreed amount will not exceed the FMV of the transferred A Co shares. A section 116 certificate will be requested by H Co in respect of the transfer.

20. A Co will be wound-up into G Co. A Co cannot be amalgamated with G Co under XXXXXXXXXX .

21. G Co, which has already formed and transferred nominal capital to N1 in exchange for N1 common shares, will transfer the G Co Non-Core Assets to N1 in exchange for the assumption of related debt and preferred shares of N1. G Co and N1 will jointly elect, in prescribed form and within the time limits referred to in subsection 85(6), to have the provisions of subsection 85(1) apply in respect of the transfer.

As a result of the transactions described in paragraphs 19 through 21, all of the G Co Core Assets will be held by G Co, and all of the G Co Non-Core Assets will be held by N1.

22. H Co, which has already formed and transferred nominal capital to N2 in exchange for N2 common shares, will transfer XXXXXXXXXX common shares of G Co to N2 in consideration for preferred shares. H Co and N2 will jointly elect, in prescribed form and within the time limits referred to in subsection 85(6), to have the provisions of subsection 85(1) apply in respect of the transfer of the G Co common shares. The agreed amount in each joint election will be equal to the adjusted cost base of XXXXXXXXXX common shares of G Co to H Co immediately before the transfer, which will not exceed the FMV of such shares. A section 116 certificate will be requested by H Co in respect of the transfer.

23. G Co will transfer all of the common and preferred shares in N1 to N2 in consideration for preferred shares of N2. G Co and N2 will jointly elect, in prescribed form and within the time limits referred to in subsection 85(6), to have the provisions of subsection 85(1) apply in respect of the transfer of the N1 common and preferred shares. The agreed amount in each joint election will be equal to the adjusted cost base of the common and preferred shares in N1 to G Co immediately before the transfer, which will not exceed the FMV of such shares.

24. G Co will repurchase its XXXXXXXXXX common shares held by N2 by issuing a demand promissory note ("G Co Note") having a principal amount and FMV equal to the FMV of the XXXXXXXXXX common shares of G Co.

25. N2 will redeem all of its preferred shares held by G Co by issuing a demand promissory note ("N2 Note") having a principal amount and FMV equal to the FMV of the redeemed preferred shares.

26. The principal amount owing by G Co under the G Co Note and the principal amount owing by N2 under the N2 Note will be set-off in full against each other and each such note will be marked paid-in-full and cancelled.

Paragraphs 21 through 26 describe the divisive reorganization of G Co Core Assets and G Co Non-Core Assets such that G Co Core Assets will be held by G Co and the G Co Non-Core Assets will be held by N2, through its wholly-owned subsidiary, N1.

The following transactions are being undertaken to separate the H Co Core Assets (including the shares of G Co) and H Co Non-Core Assets (including the shares of N2 owned by H Co)

27. [deleted]

28. E Co will transfer XXXXXXXXXX common shares of H Co to QSub1 in consideration for additional common shares of QSub1. The value of the XXXXXXXXXX common shares of H Co so transferred will be equal to the FMV of the N2 shares.

29. H Co will transfer all the shares of N2 to QSubl in consideration for additional common shares of QSubl. A section 116 certificate will be requested by H Co in respect of the transfer. H Co has also made a separate request to the Canadian Competent Authority under Article XIII(8) of the Convention to defer Canadian income tax in respect of the transfer.

30. H Co will repurchase its XXXXXXXXXX common shares held by QSub1 by issuing a demand promissory note ("H Co Note") having a principal amount and FMV equal to the FMV of XXXXXXXXXX common shares of H Co.

31. QSub1 will repurchase its common shares held by H Co by issuing a demand promissory note ("QSub1 Note") having a principal amount and FMV equal to the FMV of the common shares of QSub1.

32. The principal amount owing by H Co under the H Co Note and the principal amount owing by QSub1 under the QSub1 Note will be set-off against each other and each such note will be marked paid-in-full and cancelled.

33. E Co will form Controlled, a new, wholly-owned U.S. corporation, and will file a QSub election for U.S. tax purposes effective from inception. Controlled will become a qualified sub-chapter S corporation, and will no longer be a QSSS, after the series of transactions described below. E Co will transfer all of its remaining XXXXXXXXXX common shares of H Co to Controlled in consideration for additional common shares with a FMV equal to the value of the XXXXXXXXXX H Co common shares transferred.

34. The E Co Shareholders will transfer XXXXXXXXXX common shares of E Co equal to the value of the H Co shares transferred in paragraph 33 to Controlled in consideration for additional Controlled common shares of the same value. The common shares of Controlled taken back will have a FMV equal to the value of the H Co shares transferred in paragraph 33.

35. E Co will repurchase its XXXXXXXXXX common shares held by Controlled by issuing a demand promissory note ("E Co Note") having a principal amount and FMV equal to the FMV of XXXXXXXXXX common shares of E Co.

36. Controlled will repurchase its common shares held by E Co by issuing a demand promissory note ("Controlled Note") having a principal amount and FMV equal to the FMV of the common shares of Controlled.

37. The principal amount owing by E Co under the E Co Note and the principal amount owing by Controlled under the Controlled Note will be set-off against each other and each such note will be marked paid-in-full and cancelled.

38. At no time throughout the series of transactions that includes the Proposed Transactions, will any of the shares of G Co or N2 be:

(a) the subject of a dividend rental arrangement;

(b) the subject of a guarantee agreement;

(c) the subject of any secured undertaking of the type described in paragraph 112(2.4)(a);

(d) issued for consideration that is or includes:

(i) an obligation of the type described in subparagraph 112(2.4)(b)(i), other than an obligation of a corporation that is related (otherwise than by reason of a right referred to in paragraph 251(5)(b)); or

(ii) any right of the type described in subparagraph 112(2.4)(b)(ii); or

(e) issued or acquired as part of a transaction or event or series of transactions or events of the type described in subsection 112(2.5).

PURPOSE OF THE PROPOSED TRANSACTIONS

39. The purpose of the Proposed Transactions is to restructure the E Co Group in order to achieve the necessary bankruptcy remote structure for G Co and H Co.

40. The Proposed Transactions are not being completed in contemplation of any subsequent direct or indirect disposition of the N2 shares nor any disposition of property that derives its value, whether in whole or in part from the N2 shares held by H Co, QSub1 or any entity that does not deal at arm's length with H Co or QSub1.

RULINGS

Provided that the preceding statements constitute a complete and accurate disclosure of all the relevant facts, Proposed Transactions and the purposes of the Proposed Transactions, we confirm the following:

A. Provided the appropriate joint elections are filed in the prescribed form and manner within the time specified in subsection 85(6), the provisions of subsection 85(1) will apply to:

(a) the transfer of the shares of A Co owned by H Co to G Co as described in paragraph 19;

(b) the transfer of the XXXXXXXXXX common shares of G Co owned by H Co to N2 as described in paragraph 22; and

(c) the transfer of the shares of N1 owned by G Co to N2 as described in paragraph 23;

such that the agreed amount in respect of each transfer of property that is eligible property will be deemed to be the transferor's proceeds of disposition of the particular property and the transferee's cost thereof pursuant to paragraph 85(1)(a). For greater certainty, paragraph 85(1)(e.2) will not apply to the transfers referred to above.

B. The provisions of subsection 88(1) will apply to the winding-up of A Co into G Co, as described in paragraph 20, such that:

(a) A Co will be deemed, pursuant to paragraph 88(1)(a), to have disposed of its assets for an amount equal to the cost amount of the particular asset immediately before the winding-up;

(b) G Co will be deemed, pursuant to paragraph 88(1)(b), to have disposed of its common shares of A Co such that its proceeds of disposition will be equal to the greater of the amounts described in subparagraphs 88(l)(b)(i) and(ii); and

(c) G Co will be deemed, pursuant to paragraph 88(1)(c), to have acquired the assets of A Co that are distributed on the winding-up, for an amount equal to the proceeds of disposition to A Co of each property distributed.

C. As a result of the repurchase by G Co of its XXXXXXXXXX common shares as described in paragraph 24 and the redemption by N2 of its preferred shares as described in paragraph 25, by virtue of subsection 84(3);

(a) G Co will be deemed to have paid and N2 will be deemed to have received, a taxable dividend equal to the amount by which the amount paid by G Co in respect of its repurchase of the common shares owned by N2 exceeds the paid-up capital attributable to such common shares immediately before the repurchase; and

(b) N2 will be deemed to have paid, and G Co will be deemed to have received, a taxable dividend equal to the amount by which the amount paid by N2 in respect of its redemption of the preferred shares owned by G Co exceeds the paid-up capital attributable to such preferred shares immediately before the redemption; and

(c) The taxable dividends described in (a) and (b) above:

(i) will be included in computing the income, pursuant to subsection 82(1) and paragraph 12(1)(j), of the person deemed to have received such dividend;

(ii) will be deductible by the recipient pursuant to subsection 112(1) in computing its taxable income in the year in which such a dividend is deemed to have been received, and, for greater certainty, their deductibility will not be prohibited by subsections 112(2.1), (2.2), (2.3) or (2.4);

(iii) will be excluded in determining the proceeds of disposition to the recipient of the shares so redeemed, purchased or cancelled pursuant to paragraph (j) of the definition of "proceeds of disposition" in section 54;

(iv) will, by virtue of subsection 112(3), reduce the loss, if any, in respect of the disposition of the shares on which the dividend is deemed to be received;

(v) will not be subject to tax under Part IV except to the extent that the payer corporation is entitled to a dividend refund for its taxation year in which it paid such dividend; and

(vi) will not be subject to tax under Part IV.1 or VI.1.

D. By virtue of paragraph 55(3)(a), the provisions of subsection 55(2) will not apply to any of the taxable dividends referred to in Ruling C, provided that there is no disposition or increase in interest described in any of subparagraphs 55(3)(a)(i) to (v) as part of a series of transactions or events that includes the transactions described herein. For greater certainty, the Proposed Transactions, in and by themselves, will not be considered to result in a disposition or increase in interest described in subparagraphs 55(3)(a)(i) to (v) of the Act.

E. The mutual set-off and cancellation of the G Co Note and the N2 Note as described in paragraph 26 will not give rise to a forgiven amount, and G Co and N2 will not otherwise realize any gain or incur any loss as a result thereof.

F. The provisions of subsections 15(1), 69(1), and 246(1) will not apply to the Proposed Transactions in and by themselves.

G. H Co will be treated as a resident of the United States for purposes of the Convention.

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. 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 CRA provided that the Proposed Transactions are completed within six months of the date of this letter.

COMMENTS

Nothing in this Advance Income Tax Ruling should be construed as implying that the CRA:

(a) has agreed to the determination of the PUC of any share or the FMV or adjusted cost base of any property;

(b) has agreed to the classification of any property as eligible property;

(c) has agreed that any property is, or is not, taxable Canadian property;

(d) has reviewed any tax consequences relating to the Facts and Proposed Transactions described herein other than those described in the Rulings given above.

The above Rulings are not intended to apply to the operation of the price adjustment clauses described in the definitions of N1 and N2, since their coming into effect will be due to circumstances that do not constitute proposed transactions that are seriously contemplated. The general position of the CRA with respect to price adjustment clauses is stated in Interpretation Bulletin IT-169.

Yours truly,

XXXXXXXXXX
Manager
Corporate Reorganizations Section
Reorganizations and Resources Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch