Principal Issues: Whether 88(1)(c.3)(ii) would apply in the situation described in the letter?
Position: No.
Reasons: Wording of 88(1)(c.3)(ii) and purpose of the provision.
XXXXXXXXXX 2004-006482
R. Gagnon
November 16, 2004
Dear Sir,
Subject: Non-qualifying property under subparagraph 88(1)(c)(vi)
This is in response to your letter of March 1, 2004 in which you asked us about the situation described below.
Unless otherwise indicated, all statutory references herein are to provisions of the Income Tax Act (the "Act"). We apologize for the delay in responding to your request.
Facts
1. Holdco, Opco and Opco1 are "taxable Canadian corporations" as defined in subsection 89(1) and "Canadian-controlled private corporations" as defined in subsection 125(7).
2. Holdco holds all of the issued and outstanding common shares of the capital stock of Opco. The issued and outstanding capital stock of Opco consists of one class of common shares.
3. Opco holds all of the issued and outstanding shares of the capital stock of Opco1. The issued and outstanding capital of Opco1 consists of only one class of common shares. The common shares of Opco1 are the only property held by Opco.
4. The fair market value of the issued and outstanding common shares of the capital stock of Opco1 is greater than the adjusted cost base (as defined in section 54) of such shares to Opco.
5. Buyco is a "taxable Canadian corporation" as defined in subsection 89(1).
6. Buyco wishes to acquire a 70% stake in Opco.
7. Buyco will subscribe for a number of new (treasury) common shares of Opco, equal to 70% of the number of common shares of the capital stock of Opco currently held by Holdco. The subscription price for the new Opco common shares will be paid in cash. Holdco will then continue to have effective (de jure) control of Opco for the purposes of the Act.
8. Opco will use all of the funds received from Buyco from the issuance of common shares of its capital stock to purchase for cancellation 70% of the common shares of Opco held by Holdco. There will then be an acquisition of effective control of Opco by Buyco for the purposes of the Act, because Buyco and Holdco will hold 70% and 30%, respectively, of the issued and outstanding common shares of the capital stock of Opco.
The issued and outstanding common shares of the capital stock of Opco1 will constitute capital property to Opco upon the acquisition of control of Opco by Buyco.
The fair market value of the issued and outstanding shares of the capital stock of Opco1 held by Opco will then still exceed the adjusted cost base (as defined in section 54) of the shares to Opco.
9. The following transactions will be effected in order to increase the adjusted cost base of the issued and outstanding shares of the capital stock of Opco1, through the application of paragraphs 88(1)(c) and (d)
10. A new corporation ("Newco") will be incorporated. Newco will be a "taxable Canadian corporation" as defined in subsection 89(1).
11. Buyco and Holdco will transfer to Newco all of their common shares of Opco, and will receive as consideration only common shares of the capital stock of Newco. The number of common shares of Newco received by Buyco and Holdco will correspond to the number of common shares of Opco transferred by Buyco and Holdco, respectively.
Buyco and Holdco will each make an election with Newco in the prescribed form and within the prescribed time set out in section 85(6) in respect of the Opco common shares. The amount agreed to by Buyco and Holdco will be the respective amounts of their ACB.
12. Opco will then be wound up into Newco. Newco will make a designation to increase the ACB of its common shares of Opco1 pursuant to paragraphs 88(1)(c) and (d).
The issued and outstanding common shares of the capital stock of Opco1 will be held by Opco without interruption until they are distributed to Newco upon the winding-up of Opco.
13. The transactions described in paragraphs 7 to 12 above will form part of a series of transactions or events (within the meaning of section 248(10)) that includes the winding-up of Opco for the purposes of subparagraph 88(1)(c)(vi).
14. Holdco is not and will not be related to Buyco and Newco, pursuant to subsection 251(2). Holdco will cease to be related (within the meaning of section 251(2)) to Opco and Opco1 upon Opco's purchase of a portion of the common shares of its capital stock, as described in paragraph 8 above. Holdco deals and will deal at arm's length with Buyco and Newco, within the meaning of paragraph 251(1)(c). Holdco will cease to deal at arm's length (within the meaning of paragraph 251(1)(c)) with Opco and Opco1 upon Opco's purchase of a portion of the common shares of its capital stock, as described in paragraph 8 above.
Your Questions
1. In the situation described above, for the purposes of clause 88(1)(c)(vi)(A), will Newco acquire control of Opco upon the share exchange described in paragraph 11 above?
2. In the situation described above, will Holdco be a person described in subclause 88(1)(c)(vi)(B)(I), having acquired a "substituted property" (the Newco shares) described in subparagraph 88(1)(c.3)(ii) in replacement for the Opco shares?
3. In the situation described above, what is the distinction between the application of subparagraphs 88(1)(c.3)(i) and (ii) with respect to the Newco shares held by Holdco?
4. In the situation described above, will Newco be able to obtain an increase in the ACB of the common shares of Opco1 pursuant to paragraphs 88(1)(c) and (d) on the winding-up of Opco?
5. What is the tax policy underlying the shares of the purchaser that are acquired by the vendor in exchange for shares of the subsidiary being caught by subparagraph 88(1)(c.3)(ii) when they are specifically excluded under subparagraph 88(1)(c.4)(i)? In addition, you wish us to identify a situation where the acquisition of shares of a parent corporation by the vendor would not be caught by subparagraph 88(1)(c.3)(i) (given the concept of specified property in subparagraph 88(1)(c.4)(i)), but would be caught by subparagraph 88(1)(c.3)(ii).
6. Is it necessary for a person described in subclause 88(1)(c)(vi)(B)(I) to acquire control of a parent corporation in order for a property acquired in lieu of shares of a subsidiary corporation to fall within subparagraph 88(1)(c.3)(ii)?
Our Comments
It appears to us that the situation described in your letter may be an actual situation involving taxpayers. The Canada Revenue Agency ("CRA") does not generally provide written opinions on proposed transactions otherwise than by way of advance ruling. Furthermore, it is the responsibility of the relevant Tax Services Office to determine whether completed transactions have received appropriate tax treatment. We can, however, offer the following general comments which may not apply in full to the situation submitted.
Question 1
For the purposes of clause 88(1)(c)(vi)(A), it is necessary to determine whether the parent has acquired effective (de jure) control of the subsidiary, without reference to paragraphs 88(1)(d.2) and 88(1)(d.3) and subsection 256(7).
In our view, in a situation as described above, there would generally be an acquisition of control of Opco by Newco, in part because of the application of section 256(6.1).
Question 2
In a situation as described above, it appears to us that Holdco would be a person described in subclause 88(1)(c)(vi)(B)(I). However, the CRA would generally take the position that the Newco shares to be acquired by Holdco would not be subparagraph 88(1)(c.3)(ii) property. We are of the view that subparagraph 88(1)(c.3)(ii) would not apply in such a situation.
Question 3
In a situation such as the one described above, subparagraph 88(1)(c.3)(i) would not apply because of the exception for specified property. In particular, the Newco common shares held by Holdco would be specified property pursuant to subparagraph 88(1)(c.4)(i). There is no exception for specified property under subparagraph 88(1)(c.3)(ii). However, as noted above, the CRA would not generally apply subparagraph 88(1)(c.3)(ii) to such a situation.
Question 4
Given the complexity of the provisions of, inter alia, paragraphs 88(1)(c) to 88(1)(d.3), it is not possible for us to express an opinion on whether Newco could obtain an increase in the ACB of Opco1's common shares based solely on the information available above. If you have an actual situation to report, you may wish to make an advance ruling request in that regard.
Question 5
Our understanding of the tax policy underlying subparagraph 88(1)(c.3)(ii) is that this provision is intended to address situations of the type described in the Department of Finance's December 1997 Income Tax Explanatory Notes, which state:
“An example of a property the fair market value of which is determinable primarily by reference to the fair market value of a particular property would be a share or debt the terms of which provide for a value that is dependent upon or tracks the proceeds from the disposition of the particular property. In addition, in a situation where at the end of the series the vendor holds a majority of the shares of a corporation substantially all of the value of which is attributable to property distributed on the winding-up, the value of those shares will be considered to be determinable primarily by reference to the fair market value of that property.”
For more information on tax policy, you should contact the Department of Finance.
The second example dealing with paragraph 88(1)(c.3) in the text of Richard S. Biscaro's lecture "Current Issues in Rulings and Interpretations" on page 74:2 of the “congrès de 1996 de l'ACÉF” conference volume presents a situation where the acquisition of shares of a parent corporation by the vendor would not be covered by subparagraph 88(1)(c.3)(i) (given the concept of specified property in subparagraph 88(1)(c.4)(i)) but would fall within subparagraph 88(1)(c.3)(ii). This example was also reproduced in Income Tax Technical News No. 9 (archived):
“Example 2
X owns all of the shares of Targetco. Targetco owns all the shares of Keepco, which have a value of $10 million, and all the shares of Sellco, which have a value of $5 million. Y wishes to buy Sellco. The following transactions are carried out:
Y incorporates Buyco and subscribes for $5 million of voting redeemable preferred shares of Buyco.
Buyco acquires all of X's shares of Targetco in consideration for $5 million in cash and common shares of Buyco.
Buyco winds up Targetco and, but for subparagraph 88(1)(c)(vi), would bump the cost of the shares of Sellco and Keepco to their fair market value.
Buyco redeems the preferred shares held by Y and, in satisfaction of the redemption price, transfers to Y its shares of Sellco.
The result of these transactions is that part of Targetco's assets, its shares of Sellco, has been sold to an arm's-length buyer. X retains its interest in Keepco, not by buying back Keepco from Buyco directly, but rather by acquiring the common shares of Buyco from which Y then extracts the assets which Y wishes to acquire. But for subparagraph 88(1)(c)(vi), the transactions could be carried out without incurring corporate-level tax. The transactions seek to achieve the result that subparagraph 88(1)(c)(vi) was designed to prevent. In such circumstances, we would consider the value of the common shares of Buyco acquired by X to be "determinable primarily by reference to" property distributed to Buyco on the winding-up of Targetco, such that subparagraph 88(1)(c.3)(ii) would apply. This view is supported by the Department of Finance Explanatory Notes.”
Question 6
We are of the view that for the purposes of subparagraph 88(1)(c.3)(ii), it is not essential that a person described in clause 88(1)(c)(vi)(B)(I) acquire control of the parent corporation.
Please note that this opinion is not an advance ruling and, as stated in paragraph 22 of Information Circular 70-6R5 dated May 17, 2002, is not binding on the CRA with respect to any particular factual situation.
Best regards,
Maurice Bisson, CGA
for the Director
Corporate Reorganizations and Resource Industries Division
Income Tax Rulings Directorate
Planning and Policy Branch