29 May 2007 Internal T.I. 2007-0223381I7 F - Capital Dividend Account -- translation

Principal Issues: In a given fact situation, where a wholly-owned subsidiary is wound-up in its parent corporation and both parent and subsidiary have a CDA immediately before the winding-up, whether the parent must take into consideration the different amounts of its subsiduary's CDA in computing its CDA immediately after the wind-up.

Position: Yes.

Reasons: The Law.

 							May 29, 2007

Ms. Denise Arsenault				Corporate Reorganizations and 
Montérégie-Rive South TSO	 		Resource Industries Division
3250 Lapinière Blvd.	 			

Brossard QC  J4Z 3T8				Marc LeBlond
                                          (613) 946-3261

							2007-022338

Definition of "Capital Dividend Account" in subsection 89(1).

This is in response to your email of February 6, 2007, in which you requested our comments on the above subject in relation the situation described below. This also is in response to telephone conversations (M. LeBlond/D. Arsenault) in which additional information and/or changes to the present file were communicated to us.

Unless otherwise indicated, all statutory references herein are to provisions of the Income Tax Act.

The Situation

• XXXXXXXXXX. (Aco) and XXXXXXXXXX (Bco) (collectively, the "Corporations") are "taxable Canadian corporations" and "private corporations" as defined in subsection 89(1).
• Aco is the sole shareholder of Bco.
• Aco has incurred or made "eligible capital expenditures", as defined in subsection 14(5), in the amount of $XXXXXXXXXX according to its financial statements.
• According to the Corporations' representative, the amount of Aco's and Bco's "capital dividend account", as defined in subsection 89(1) (CDA), is $XXXXXXXXXX and $XXXXXXXXXX, respectively. The amount of Aco’s CDA is entirely attributable to the application of paragraph (a) of the definition of CDA. With respect to Bco's CDA amount, it is calculated as follows: for the purposes of paragraph (a) of the definition of CDA, the negative amount of $XXXXXXXXXX, representing the amount by which the amount calculated in subparagraph (a)(ii) exceeds the amount calculated in subparagraph (a)(i), is to be disregarded; for the purposes of paragraph (c.2) of the definition of CDA, $XXXXXXXXXX is included, which is the amount included under paragraph 14(1)(b) in computing its income for the taxation year XXXXXXXXXX; and, for the purposes of paragraph (f) of the definition of CDA, $XXXXXXXXXX is included.
• The Corporations' representative is preparing to wind up Bco into Aco and in this regard asks you to confirm that the CDA amount of Aco immediately after the wind-up should be $XXXXXXXXXX.
• In your opinion, the CDA amount of Aco immediately after the winding-up should be $XXXXXXXXXX.

Your questions and your position

You asked us whether, in the situation you have presented, the amount of Aco's CDA immediately after the winding up of Bco should be $XXXXXXXXXX or $XXXXXXXXXX. In particular, in this regard, you asked whether the amount of $XXXXXXXXXX could be included in the calculation of Aco's CDA immediately after the winding up of Bco, pursuant to paragraph (c.2) of the definition of CDA.

In your view, the amount of $XXXXXXXXXX could not be included in the calculation of Aco's CDA immediately after the winding-up of Bco in XXXXXXXXXX since it was Bco, not Aco, that had a gain from the disposition of eligible capital property and included that gain in computing its income for the taxation year XXXXXXXXXX, pursuant to paragraph 14(1)(b).

In addition, you asked whether, in general, the "cumulative eligible capital" (CEC) amount, as defined in subsection 14(5), is relevant in determining the amount of the CDA only where the corporation is required to include an amount in computing its income under paragraph 14(1)(b) in respect of the disposition of eligible capital property.

Our Comments

In our view, the amount of Aco's CDA immediately after the winding up of Bco would be $XXXXXXXXXX. Our conclusion is based on the following observations.

In a situation such as the one you have presented, section 88(1) applies. For the purposes of this letter, the relevant parts of that section are as follows:

Winding-up

88 (1) Where a taxable Canadian corporation (in this subsection referred to as the “subsidiary”) has been wound up after May 6, 1974 and not less than 90% of the issued shares of each class of the capital stock of the subsidiary were, immediately before the winding-up, owned by another taxable Canadian corporation (in this subsection referred to as the “parent”) and all of the shares of the subsidiary that were not owned by the parent immediately before the winding-up were owned at that time by persons with whom the parent was dealing at arm’s length, notwithstanding any other provision of this Act other than subsection 69(11), the following rules apply:

[...]

(e.2) paragraphs 87(2)(c), (d.1), (e.1), (e.3), (g) to (l), (l.3) to (u), (x), (z.1), (z.2), (aa), (cc), (ll), (nn), (pp), (rr) and (tt) to (ww), subsection 87(6) and, subject to section 78, subsection 87(7) apply to the winding-up as if the references in those provisions to

(i) “amalgamation” were read as “winding-up”,

(ii) “predecessor corporation” were read as “subsidiary”,

(iii) “new corporation” were read as “parent”,

[...]
[emphasis added]

In the situation you have presented, subsection 88(1) applies because Bco is a "taxable Canadian corporation" and, immediately before the wind-up, Aco (another "taxable Canadian corporation") owned XXXXXXXXXX% of the issued shares of each class of the capital stock of Bco.

Section 87(2)(z.1) reads as follows:

Capital dividend account

(z.1) for the purposes of computing the capital dividend account of the new corporation [Parent], it shall be deemed to be the same corporation as, and a continuation of, each predecessor corporation [subsidiary], other than a predecessor corporation [subsidiary] to which subsection 83(2.1) would, if a dividend were paid immediately before the amalgamation and an election were made under subsection 83(2) in respect of the full amount of that dividend, apply to deem any portion of the dividend to be paid by the predecessor corporation [subsidiary] as a taxable dividend;

[Emphasis added]

Paragraph 87(2)(z.1) was replaced by S.C. 1994, c. 7, Sch. II, s. 65(7), applicable to amalgamations occurring after July 13, 1990, and to windings-up commencing after that date. The explanatory notes to Bill C-18 (Royal Assent: December 17, 1991, S.C. 1991, c. 49) [Released: May 1991] Part I - Income Tax Act, s. 65(7), relating to this change read as follows:

The amendment to paragraph 87(2)(z.1), which applies to the computation of capital dividend accounts for amalgamations occurring after July 13, 1990, treats the new corporation formed on an amalgamation to be the same corporation for the purpose of computing the new corporation's capital dividend account. The purpose of this amendment is to ensure that a "negative balance" in a predecessor corporation's capital dividend account (that is, deductions that are in excess of the additions made in computing that corporation's account before the amalgamation) flows through to the new corporation, thereby preventing an overstatement of its capital dividend account and an overpayment of tax-free capital dividends. ...

[Emphasis added]

It follows from paragraph 87(2)(z.1) (as modified by paragraph 88(1)(e.2)) that, in calculating the amount of a parent's CDA after the winding-up of its subsidiary, the parent must take into account the various amounts that make up the wound-up subsidiary's CDA.

Consequently, in the submitted situation, the amount of Aco's CDA immediately after the liquidation of Bco would be $XXXXXXXXXX calculated as follows:

With respect to your second question, we are of the view that, in general, CEC is relevant in determining the amount of a corporation's CDA only where a corporation is required to include an amount in computing its income under paragraph 14(1)(b) in respect of the disposition of eligible capital property.

We hope you find our comments of assistance and thank you for bringing these issues to our attention. Should you require any additional information regarding this matter, please do not hesitate to contact us.

Maurice Bisson, CGA
Manager
Corporate Reorganizations and Resource Industries Section
Corporate Reorganizations and Resource Industries Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch.