| 19(1) | File No. 5-9500 |
| Firoz Ahmed | |
| (613) 957-2092 |
March 15, 1990
Dear Sirs:
Re: Paragraph 55(3)(b) of the Income Tax Act (Canada) (the "Act"):
This is in response to your letter of January 17, 1990 in which you requested our views as to-the application of paragraph 55(3)(b) of the Act to the situation described herein.
Facts
1. A shareholder corporation ("Parentco") owns 100 common shares of an operating corporation ("Opco") which constitute all of the issued and outstanding shares of Opco. All of the assets of Opco constitute business, property for purposes of paragraph 55(3)(b).
2. Parentco incorporates a sister corporation ("Sisterco") and transfers 2 common shares of Opco to Sisterco on a tax-deferred basis in exchange for common shares of Sisterco.
3. Opco subsequently transfers 2% of its net assets to Sisterco in exchange for redeemable, retractable preferred shares of Sisterco which have a fair market value, equal to the value of the assets received A subsection 85(1) election is filed by Opco and Sisterco in respect of the transfer so that the transfer occurs on a tax-deferred basis.
4. Sisterco redeems its preferred shares and Opco purchases its common shares held by Sisterco for cancellation. As a result of these transactions both Sisterco and Opco are deemed to receive dividends by virtue of paragraph 84(3)(b) of the Act.
5. Sisterco is wound up into Parentco as part of the reorganization which included the transfer of property by Opco to Sisterco.
6. The dividends referred to in paragraph 4 above are assumed not to be exempt from the application of subsection 55(2) by virtue of paragraph 55(3)(a) of the Act.
Opinions
In our, view, the dividends referred to in paragraph 4 above would not be exempt from the application of subsection 55(2) by virtue of the provisions of paragraph 55(3)(b). As the winding-up of Sisterco into Parentco occurs in the course of the same reorganization as the receipt of such dividends, property "would have been indirectly transferred by Opco, the particular corporation within the meaning of paragraph 55(3)(b), to Parentco. As this property would constitute 2% of the business property of Opco and as Parentco owned 98% of the shares of Opco immediately before the transfer of the property by Opco, Parentco, a transferee within the meaning of paragraph 55(3)(b), would not have received its share of the business property of Opco. Thus the dividends referred to in paragraph 4 above would not have been received in the course of a reorganization described in paragraph 55(3)(b). As you note, similar views, are expressed on page 18:20 of the paper presented by Robin Read at the, 1988 Canadian Tax Foundation Conference (the "Read Paper").
You are of the view that a similar example is given on page 18:16 of the Read Paper which supports the conclusion that the reorganization described herein complies with the requirements of paragraph 55(3)(b) of the Act. We do not agree with this view for the reasons described below.
The example contained on page 18:16 of the Read Paper is similar to the situation described herein in that it involves an indirect transfer of property of the particular corporation. However, the similarity ends there. The example on page 18:16 of the ReadPaper involves an indirect transfer of property of the particular corporation to the shareholder corporation by way of an initial transfer of such property to a subsidiary of the shareholder corporation and the winding-up of the subsidiary into the shareholder. Note that the proportionate distribution requirements of paragraph 55(3)(b) are satisfied since the shareholder corporation receives the correct proportion of each type of property of the particular corporation based on its share ownership of the particular corporation immediately before the transfer by the particular corporation. In the situation described herein, the ultimate transferee (Parentco) receives too small a proportion of the property of the particular corporation (Opco), i.e., 2% as compared to its 98% share ownership.
For sake of completeness, we note that the purpose of the example on page 18:16 is to distinguish between an amalgamation of the subsidiary with the shareholder and the winding-up of the subsidiary into the shareholder corporation. While the winding-up is acceptable for the reasons discussed above, the amalgamation of the subsidiary and the shareholder results in an indirect transfer of property of the particular corporation to the amalgamated corporation. As the amalgamated corporation is considered to be 1 new corporation, by virtue of paragraph 87(2)(a) of the Act, it would not have hold any shares of the particular corporation immediately before the transfer of property. Thus the proportionate distribution requirements in paragraph 53(3)(b) of the Act would not be satisfied as the amalgamated corporation would have received too large a share of the property of the particular corporation.
Yours truly,
for DirectorReorganizations and Non-Resident DivisionSpecialty Rulings DirectorateLegislative and Intergovernmental Affairs Branch