XXXX K.H. Major (613) 995-1787
August 21, 1985
Dear Mr. XXXX
This is in reply to your letter of March 29, 1985 in which you request our views on the application of the Income Tax Act (the Act) and the Income Tax Regulations (the Regulations) in the following hypothetical situations:
Case A
1. Canco, a Canadian corporation, holds shares in F.A., a controlled foreign affiliate which carries on an active business in a foreign treaty country. The shares held by Canco in F.A. have a total cost of $100,000.
The active business assets of F.A. have a total cost of $100,000 and a fair market value of $500,000. F.A. has no other assets or liabilities.
2. F. A. is liquidated into Canco.
Case B
1. The same situation as Case A except that prior to F.A. being liquidated into Canco, F.A. transfers the business assets to Newfa (-a foreign affiliate of Canco situated in the same country as F.A.) in exchange for a debenture of $300,000 and shares having a fair market value of $200,000. The transfer is made on a tax-free basis in F.A.'s country of residence. F.A. is the sole shareholder of Newfa.
In respect to Case A it is our view that the gain on the disposition of the assets upon the liquidation of F.A. will give rise to exempt surplus since the assets constitute excluded properties and ignoring all other factors except those set out in this case an election under subsection 93(1) of the Act could be made in order to eliminate the capital gain realized by Canco on the disposition of F.A.'s shares.
In respect to Case B our views are as follows:
(i) The tax-free transfer of the assets of F.A. into Newfa will not give rise to exempt surplus in F.A. pursuant to provisions of subsection 5907(5.1) of the Regulations.
(ii) For the purpose of the Regulations and the computation of the exempt surplus of Newfa in respect of Canco, the cost to Newfa of the active business assets received as a result of the transfer will be $100,000 pursuant to the provisions of subsection 5907(5.1) of the Regulations.
(iii) The provisions of subsection 5907(5.1) of the Regulations do not provide rules to determine the cost of the property received by F.A. in exchange for assets either for the purposes of the Act or the Regulations. Therefore, the cost of such property would be determined in the normal manner. In this case, the cost of the debenture will be $300,000 and the cost of the shares of Newfa will be $200,000.
(iv) Pursuant to the provisions of subsection 88(3) of the Act upon the liquidation of F.A., F.A. will dispose of the shares of Newfa at their cost of $200,000 which is equal to their fair market value and the debentures at their fair market value of $300,000 which is equal to their cost. There will be no creation of exempt surplus or taxable surplus in F.A. as the result of its liquidation.
(v) As a result of the disposition of its shares in F.A., Canco will have realized a capital gain of $400,000 and there will be no surplus available to reduce the proceeds of disposition. Canco will have a taxable gain of $200,000.
We trust that this information will be of assistance to you.
Yours truly,
for Director Specialty Corporations Rulings Division Corporate Rulings Directorate Legislation Branch