| 24(1) | 5-913100 |
| D.J. Powrie | |
| (613) 957-2109 |
Attention: 19(1)
July 17, 1992
Dear Sirs:
Re: Paragraph 55(3)(b) of the Income Tax Act (the "Act")
We are writing in response to your letter of November 7, 1991 in which you requested our comments on the application of paragraph 55(3)(b) of the Act to the following situation.
Situation
All of the shares of a particular corporation ("PC") (as that term is used in paragraph 55(3)(b) of the Act) are owned by Xco. PC and Xco enter into the following series of transactions:
1. Xco incorporates Newco.
2. Xco transfers 20% (by value) of its shares in PC to Newco in exchange for shares of Newco.
3. PC transfers to Newco 20% (by value) of each type of its property in exchange for redeemable preferred shares in Newco having a redemption amount equal to the fair market value of the assets transferred.
4. Newco redeems the preferred shares and issues PC a note having a principal amount equal to the redemption amount of the preferred shares.
5. PC purchases for cancellation its shares held by Newco and issues Newco a note having a principal amount equal to the fair market value of the cancelled shares.
6. The transactions in paragraphs 4 and 5 give rise to deemed dividends under subsection 84(3) of the Act.
7. The notes issued in paragraphs 4 and 5 are set off against each other and cancelled.
8. PC is wound up into Xco and all its remaining property is distributed to Xco.
9. The shares of Newco are sold by Xco to a purchaser with whom Xco deals at arm's length.
You have asked the following questions:
1. Does the winding-up of PC into Xco prevent the pro-rata test in paragraph 55(3)(b) from being met?
2. Is the sale of Newco shares by Xco "in the course of a reorganization" which includes the transfer of property to Newco and, if so, does it result in Xco having received a disproportionate share of the property of PC?
Comments
In our view:
1. Both Newco and Xco have received the required percentage of the property of PC; immediately before the transfers began Newco and Xco had 20% and 80% (by value) of the shares of PC and they received 20% and 80% (by value) of each type of property owned by PC before the transfers. Thus the winding-up does not prevent the pro-rata test from being met.
2. The sale of Newco shares is in the course of a reorganization described in paragraph 55(3)(b) but it does not result in Xco receiving any more of the property of PC.
The foregoing comments are given in accordance with the practice referred to in paragraph 21 of Information Circular 70-6R2 dated September 28, 1990 and are not binding on Revenue Canada, Taxation.
Yours truly,
for DirectorReorganizations and Foreign DivisionRulings DirectorateLegislative and IntergovernmentalAffairs Branch