31 October 2011 External T.I. 2011-0422981E5 F - Whether property is eligible for a bump
Principal Issues: 1. A parent would incorporate a corporation (the "subsidiary"). The subsidiary would acquire marketable securities. The parent would sell all the shares of the capital stock of the subsidiary to his child who would sell them afterwards to the parent corporation. At what time would the parent corporation be deemed to have last acquired control of the subsidiary for the purposes of the bump rules?
2. Would the marketable securities be eligible for a bump under paragraph 88(1)(c) if they are acquired a few hours or a few months after the time at which the parent would acquire control of the subsidiary?
3. If the marketable securities are transferred by the parent to the subsidiary and, as consideration for that transfer, the parent acquires shares of the subsidiary and, at the same time, control of the subsidiary (in a case, for example, where the parent would not have been the incorporator of the corporation), would the marketable securities be eligible for the bump under paragraph 88(1)(c)?
Position: 1. At the time the parent would acquire control of the subsidiary, that is at the time of its incorporation if the parent is the incorporator.
2. The marketable securities would not be eligible for the bump under paragraph 88(1)(c).
3. No. The marketable securities would be "ineligible property" under subparagraph 88(1)(c)(v).
Reasons: 1. Wording of paragraph 88(1)(d.2).
2. The marketable securities would not be held at the time the parent would acquire control of the subsidiary.
3. Wording of subparagraph 88(1)(c)(v).
XXXXXXXXXX 2011-042298 Sylvie Labarre, CA
October 31, 2011
Dear Sir,
Subject: Increase in the cost of a property during a winding-up
This is in response to your e-mail of September 29, 2011 in which you requested our opinion regarding the application of paragraphs 88(1)(c) and (d) of the Income Tax Act (the "Act") in the hypothetical situations described below.
Unless otherwise indicated, all statutory references are to provisions of the Act.
Base Hypothetical Situation
1. In XXXXXXXXXX 2000, an individual ("Parent") incorporated a holding corporation ("Parentco") by injecting $XXXXXXXXXX through a subscription for voting and participating shares in the capital stock of Parentco.
2. A few months after the share subscription, Parentco acquired marketable securities with a value of $XXXXXXXXXX.
3. In 2010, Parent sold all the shares of the capital stock of Parentco to his child for a cash consideration of $XXXXXXXXXX. Parent was taxed on the gain realized on the sale of the shares because he was not entitled to a deduction described in section 110.6.
4. At the time of the sale described in 3 above, the fair market value ("FMV") of the marketable securities was $XXXXXXXXXX. At that time, those marketable securities were the only asset of Parentco, which had no debt.
5. Shortly after acquiring the shares of the capital stock of Parentco, the child formed the child’s own holding corporation ("Childco") and transferred all the previously-acquired shares of the capital stock of Parentco in consideration for a $500,000 demand promissory note.
6. Parentco was then wound up into Childco and the rules in subsection 88(1) applied.
7. At the time of the winding-up, marketable securities valued at $XXXXXXXXXX were Parentco's only assets. Parentco had no debt and paid no dividend to Childco.
Questions
(a) Could Childco increase the cost of the marketable securities by $XXXXXXXXXX in order to obtain an adjusted cost base ("ACB") of $XXXXXXXXXX in applying the rules in paragraph 88(1)(d)?
(b) For the purposes of paragraphs 88(1)(c) and (d), when would Childco be deemed to have acquired control of Parentco for the last time?
(c) If marketable securities had been acquired by Parentco on the same day as Parent's subscription for shares of the capital stock of Parentco (for example, a few hours after subscription), would the answer to (a) be different?
(d) If Parent had acquired the shares of Parentco in consideration for the transfer of the marketable securities, would the answer to (a) be different?
(e) Instead of issuing voting and participating shares only to Parent in XXXXXXXXXX 2000, Parentco issue XXXXXXX% of the voting and participating shares of its share capital to Parent for consideration of $XXXXXXXXXX and XXXXXXXXXX% of the voting and participating shares of its capital stock to an unrelated third party for consideration of $XXXXXXXXXX. In 2010, the fair market value of the capital stock of Parentco was $XXXXXXXXXX and the child acquires all of those shares by paying $XXXXXXXXXX and $XXXXXXXXXX to an unrelated third party. Would the answers to the previous questions differ based on these new assumptions?
Our Comments
As stated in paragraph 22 of Information Circular 70-6R5 dated May 17, 2002, it is the practice of the Canada Revenue Agency (the "CRA") not to issue a written opinion regarding proposed transactions otherwise than by advance rulings. Furthermore, when it comes to determining whether a completed transaction has received appropriate tax treatment, that determination is made first by our Tax Services Offices as a result of their review of all facts and documents, which is usually performed as part of an audit engagement. However, we can offer the following general comments that we hope may be helpful to you. These comments may, however, under certain circumstances, not apply to your particular situation.
In certain circumstances, the cost of a subsidiary’s property distributed to the parent on a winding-up is deemed to be the deemed proceeds of disposition under paragraph 88(1)(a) plus the amount determined under paragraph 88(1)(d) in respect of that property pursuant to paragraph 88(1)(c).
However, not all property can benefit from such an increase. The property distributed to the parent must be a capital property other than an ineligible property of the subsidiary at the time that the parent last acquired control of the subsidiary and was owned by the subsidiary thereafter without interruption until such time as it was distributed to the parent corporation on the winding-up.
Response to Questions (a) and (b)
In your base hypothetical situation, it should first be determined whether the marketable securities were capital property. Next, the holding period of each capital property (each investment) must be determined in order to establish whether that property was owned by the subsidiary at the time the parent corporation last acquired control of the subsidiary and thereafter without interruption until such time as it was distributed to the parent corporation.
A review of the conditions under paragraph 88(1)(c), including the holding period test, must be done with respect to each investment and not on an aggregated basis for everything that was grouped under the heading "marketable securities" in the balance sheet.
For the purposes of paragraphs 88(1)(c), (d) and (d.2), paragraph 88(1)(d.2) is deemed to determine "the time the parent corporation last acquired control” where control of the subsidiary was acquired from another person or group of persons with whom the acquirer was not (otherwise than solely because of a right referred to in paragraph 251(5)(b)) dealing at arm's length. In your hypothetical base situation, Childco acquired the control of Parentco from the child, who was not dealing at arm's length with it. Furthermore, the child acquired the control of Parentco from Parent with whom the child was not dealing at arm's length. Consequently, for purposes of paragraphs 88(1)(c) and (d), the time that Childco last acquired the control of Parentco was deemed to be the time when Parent acquired the control of Parentco.
The time when Parent acquired control of Parentco could be before the issuance of the voting and participating shares of Parentco in XXXXXXXXXX 2000, being the time of the incorporation of Parentco, if Parent was the incorporator. The incorporator of a new corporation generally acquires its control at the moment of its incorporation if no share is issued at that time. This is reflected in our position expressed, inter alia, in the following technical interpretations: Nos. 9626315, 9700405, 9801425 and 2002-0118145.
In your base hypothetical situation, the marketable securities which were acquired several months later would not be eligible for the bump of 88(1)(d) given that they did not belong to Parentco at the time of the acquisition of control of Parentco by Parent (being when Parentco was incorporated if Parent was the incorporator or otherwise when the first issuance of shares occurred in XXXXXXXXXX 2000).
Response to Question (c)
The response to Question (c) would not be different from that given to Question (a) if the marketable securities were acquired several hours after the time when the control of Parentco was acquired by Parent since the marketable securities could not belong to the subsidiary at the time of its incorporation.
Response to Question (d)
If the time when Parentco's control was acquired by Parent was the time that Parentco was incorporated because Parent was the incorporator, the answer to Question (d) would not be different from that given for question a) since the marketable securities could not belong to the subsidiary at the time of its incorporation.
On the other hand, if the time when Parent acquired control of Parentco was not the time of incorporation but the time of the first issuance of shares (for example, if Parentco was a "shelf" company and had, therefore, been incorporated by a third party unrelated to Parent not acting as Parent's agent), the marketable securities that would have been transferred in consideration for the initial issuance of Parentco's share capital would be owned by Parentco at the time that it was last deemed to have acquired control of Parentco under paragraph 88 (1) (d.2). In addition to determining (as noted above) whether each investment is a capital property, it would then be necessary to determine whether that investment had been owned by the subsidiary continuously from that time until Parentco's distribution of that investment to Childco on the winding-up. It would also be necessary to consider whether each investment is ineligible under subparagraphs 88(1) (c)(iv) to (vi).
In the situation where Parent was not considered to have acquired control of Parentco on the incorporation of Parentco and the marketable securities belonged to Parentco at the time when Parent acquired the control of Parentco, subparagraph 88(1)(c)(v) would apply if the assumptions you described in your request are taken into account, as modified by those stated in question (d). In such a situation, the marketable securities would have been acquired by Parentco from a person (Parent) who did not deal at arm's length with Childco (pursuant to subsection 88 (1.7)) other than by reason of a right referred to in paragraph 251(5)(b) where the acquisition was made as part of a series of transactions or events in which Childco had last acquired control of Parentco. We are of the view that, in such a situation, the presumption in subsection 88(1)(d.2) (which brings Parentco's acquisition of control of Childco back to the time Parent acquired control of Parentco) would make it necessary to consider whether the acquisition of marketable securities was part of the same series of transactions or events as the issuance of shares of the capital stock of Parentco to Parent. Given that the acquisition of the marketable securities was made in consideration for this issuance of shares, it is difficult to consider that this acquisition was not part of the same series of transactions or events as the acquisition of control of Parentco by Parent. Consequently, the marketable securities transferred to Parentco in consideration for the issuance of the shares of Parentco appear to us to constitute ineligible property by virtue of subparagraph 88(1)(c)(v).
With respect to the foregoing, we are of the view that subsection 88(1.7) applies to deem Parent to not deal at arm's length with Childco even if they did not co-exist given that Parent did not deal at arm's length with Childco before the winding-up.
Furthermore, even if subparagraphs 88(1)(c)(iv) to (vi) did not apply to a particular situation and even if all the conditions for obtaining the bump in cost, provided for in 88(1)(d), were satisfied, the increase in the cost of the investments would be limited to the amount described in subparagraph 88(1)(d)(ii). Thus, the bump amount would be limited to the amount, if any, by which the FMV of the capital property at the time at which Childco last acquired the control of Parentco over the cost amount of that property to Parentco immediately before the winding-up.
Consequently, under the base assumptions as modified by Question (d), it is not be possible to add an amount to the amount calculated under subparagraph 88(1)(c)(ii) as a cost, for the parent corporation (Childco), to each property of the subsidiary (Parentco) distributed to the parent corporation upon winding-up.
Response to Question (e)
Based on the assumptions stated in Question (e), we understand, according to the facts, that the person who acquired control of Parentco was always Parent, whether upon the incorporation of Parentco, or upon the issuance of the voting and participating shares of the capital stock of Parentco. We understand that the child acquired control of Parentco from Parent and that Childco acquired control of Parentco from the child. Consequently, we are of the view that Parentco's control of Childco would be deemed, pursuant to paragraph 88(1)(d.2), for the purposes of paragraphs 88(1)(c) and (d), to have been last acquired at the same time as that stated in response to Question a) in respect of the base hypothetical situation.
Consequently, the comments in Questions (a), (b) and (c) would also apply, even taking into account the modified assumptions for the purposes of Question (e).
With respect to the answer to Question (d), there may be some changes in some of our comments if not all marketable securities were transferred by Parent on the issuance of the voting and participating shares of the capital stock of Parentco. However, we are of the view that we would still find that it would not be possible to add an amount to the amount calculated pursuant to subparagraph 88(1)(c)(ii) on the basis of any of the comments provided herein.
These comments are not advance income tax rulings and are not binding on the CRA with respect to a particular situation.
Best regards,
Stéphane Prud'Homme, Notary, M. Fisc.
for the Director
Corporate Reorganizations and Resource Industry Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch