Principal Issues: 1) Whether section 84.1 applies to deem the Estate to have received a dividend on the disposition of shares to the new corporation or to reduce the PUC of the share of the new corporation received as.
Position: Favourable rulings provided.
Reasons: In accordance with the provisions of the Act and our previous positions.
XXXXXXXXXX
2021-087701
XXXXXXXXXX 2021
Subject: Request for Advance Income Tax Rulings
XXXXXXXXXX Estate
Dear Madam/Sir,
This is in response to your letter dated XXXXXXXXXX requesting advance income tax rulings on behalf of the XXXXXXXXXX Estate. We have also taken into account the information you have sent us by email as well as additional information submitted during telephone conversations (XXXXXXXXXX).
Unless otherwise indicated, all statutory references below are to the provisions of the Income Tax Act (Canada), R.S.C., 1985 c.1 (5th Supp.) (the "Act").
To the best of your knowledge and that of the parties involved in the transactions, none of the matters to which this request for advance rulings:
(i) relates to a tax return previously filed by the taxpayers or a person related to them
(ii) is under examination by a Tax Services Office or Tax Centre in connection with a tax return previously filed by the taxpayers or a person related to them;
(iii) is the subject of a notice of objection by the taxpayers or a person related to them;
(iv) is the subject of a pending or completed legal proceeding involving the taxpayers or a person related to them;
(v) is the subject of a ruling request previously reviewed by the Income Tax Rulings Directorate.
DEFINITIONS AND ABBREVIATIONS USED
In this letter, with the exception of paragraph 25, the names and corporate names of the taxpayers are replaced by the following names and corporate names:
"Child 1" means Mr. XXXXXXXXXX, son of Mr. X and Spouse;
"Child 2" refers to Mr XXXXXXXXXX, son of Mr. X and Spouse;
"Child 3" refers to Mr. XXXXXXXXXX, son of Mr. X and Spouse;
"Child 4" refers to Ms. XXXXXXXXXX, daughter of Mr. X and Spouse;
"Child 5" means Mr. XXXXXXXXXX, son of Mr. X and Spouse;
"Children" means collectively Child 1, Child 2, Child 3, Child 4 and Child 5;
"Estate" means the estate of Mr. X. governed by the terms of his Will;
"Executors" means Child 2 and Child 5;
"Heirs" means the Children and Spouse, who are heirs in equal shares to all of Mr.X.'s right, title and interest in Holdco.
"Holdco" means XXXXXXXXXX;
"Legal Representatives" means the Executors;
"Mr. X" means Mr. XXXXXXXXXX;
"Newco" means the corporation to be incorporated in connection with the Proposed Transactions;
"Spouse" means Ms. XXXXXXXXXX, spouse of Mr. X;
The following abbreviations, terms and expressions have the meanings defined below:
"ACB" means "adjusted cost base" as defined in section 54;
"Agreed Amount" has the meaning assigned by subsection 85(1);
"Capital Property" has the same meaning as in section 54;
"CBCA" means the Canada Business Corporations Act, R.S.C. 1985, C-44;
"CCPC" means "Canadian-controlled private corporation" as defined in subsection 125(7);
"CRA" means the Canada Revenue Agency;
"DR" means "dividend refund" as defined in subsection 129(1);
"ERDTOH" means "eligible refundable dividend tax on hand" as defined in subsection 129(4);
"fair market value" or "FMV" means the highest price, in dollars, that would be agreed upon in the open market by two knowledgeable and prudent parties dealing with each other at arm‘s length, neither of whom was under any compulsion to act;
"GRE" means "graduated rate estate" as defined in subsection 248(1);
"NERDTOH" means "non-eligible refundable dividend tax on hand" as defined in subsection 129(4);
"Proposed Transactions" means the transactions described in paragraphs 11 to 23;
"PUC" means "paid-up capital" as defined in subsection 89(1);
"QSBCS" means "qualified small business corporation share" as defined in subsection 110.6(1);
"Resident of Canada" means a resident of Canada for the purposes of the Act;
"Taxation Year" means "taxation year" as defined in subsection 249(1);
"TCC" means "taxable Canadian corporation" as defined in subsection 89(1);
"Will" means the last will and testament of Mr. X signed on XXXXXXXXXX.
RELEVANT FACTS
Facts about Holdco
1. Holdco is a CCPC and TCC incorporated on XXXXXXXXXX under the CBCA. Holdco's fiscal period end is XXXXXXXXXX.
2. The authorized capital stock of Holdco consists of an unlimited number of common shares and class A, B, C, D, E, and F preferred shares.
Immediately before Mr. X's death, the issued and outstanding capital stock of Holdco consisted of XXXXXXXXXX common shares, XXXXXXXXXX Class A preferred shares and XXXXXXXXXX Class C preferred shares. The main rights, privileges, conditions and restrictions of these shares are as follows:
- Common shares: voting and participating;
- Class A preferred shares: no par value, voting, non-participating, fixed annual non-cumulative dividend of XXXXXXXXXX%, calculated on the redemption value of such shares, redeemable at the option of the holder at a price equal to the amount paid into the stated capital account for such shares, plus a premium equal to the excess of the FMV of the consideration received by the corporation upon issuance of such shares and the amount paid into the stated capital account, plus, if applicable, declared and unpaid dividends on such shares.
- Class C preferred shares: no par value, voting, non-participating, annual non-cumulative dividend of XXXXXXXXXX%, calculated on the amount paid into the stated capital account, redeemable at the option of the holder at a price equal to the amount paid into the stated capital account, with priority with respect to the repayment of the amount paid into the stated capital account in the event of dissolution or winding-up, but after such payment to the holders of the Class D, E and F preferred shares.
3. Holdco carries on XXXXXXXXXX.
4. The amounts in the ERDTOH and NERDTOH accounts were $XXXXXXXXXX and $XXXXXXXXXX, respectively as of XXXXXXXXXX.
5. Before his death, Mr. X. had effective (de jure) control of Holdco for the purposes of the Act. Since his death, the Estate has had effective (de jure) control of Holdco for the purposes of the Act.
Facts about the Death of Mr. X
6. Mr. X died on XXXXXXXXXX. Immediately before his death, Mr. X was a resident of Canada.
7. At the time of his death, Mr. X held XXXXXXXXXX Class A Preferred Shares and XXXXXXXXXX Class C Preferred Shares of the capital stock of Holdco, which constituted Capital Property to Mr. X. In addition, the Children and Spouse each held and continue to hold XXXXXXXXXX common shares of the capital stock of Holdco.
The table below shows the tax characteristics of the shares in the capital stock of Holdco held by Mr. X immediately before his death:
Number Class ACB($) PUC($) FMV($)
XXXXX XXXXX XXXXX XXXXX XXXXX XXXXX
8. The provisions of the Will provide, inter alia, that the shares of the capital stock of Holdco held by Mr. X immediately before his death shall be bequeathed in equal shares among the Heirs, namely, XXXXXXXXXX Class A preferred shares and XXXXXXXXXX Class C preferred shares of the capital stock of Holdco, each.
9. As a result of Mr. X's death and pursuant to paragraph 70(5)(a), Mr. X was deemed to have disposed, immediately before his death, of all of the shares of the capital stock of Holdco owned by him and to have received as proceeds of disposition an amount equal to their FMV at that time, with the exception of the shares of the capital stock of Holdco bequeathed to Spouse.
This deemed disposition of the shares of the capital stock of Holdco resulted in a capital gain to Mr. X of $XXXXXXXXXX.
At the time of Mr. X's death, the Class A and C preferred shares of the capital stock of Holdco were not QSBCSs. Consequently, Mr. X (and his successors) have not claimed and will not claim a capital gains deduction pursuant to subsection 110.6(2.1) in computing his taxable income in respect of the taxable capital gain resulting from the deemed disposition of the Class A and C preferred shares of the capital stock of Holdco described above. In addition, no capital gains deduction pursuant to subsection 110.6(2.1) was claimed by Mr. X (or by an individual with whom Mr. X did not deal at arm's length) on a previous disposition of those shares or of a share for which those shares were substituted.
By virtue of paragraph 70(5)(b), the Estate was deemed to have acquired the Class A and C preferred shares of the capital stock of Holdco at a cost equal to their respective FMVs immediately before Mr. X's death, with the exception of the shares of the capital stock of Holdco bequeathed to the Spouse. Those shares acquired as a result of Mr. X's death constitute Capital Property to the Estate. The tax characteristics of the shares held by the Estate other than those bequeathed to the Spouse are as follows:
Number Class ACB($) PUC($) FMV($)
XXXXX XXXXX XXXXX XXXXX XXXXX XXXXX
10. The Estate is a resident of Canada and its first taxation year ends on XXXXXXXXXX.
PROPOSED TRANSACTIONS
11. The Estate will distribute for the benefit of the Spouse the XXXXXXXXXX Class A Preferred Shares and the XXXXXXXXXX Class C Preferred Shares of the capital stock of Holdco that are the subject of a testamentary bequest to her.
12. Spouse will exchange her XXXXXXXXXX Class A preferred shares of the capital stock of Holdco for XXXXXXXXXX new Class E preferred shares of the capital stock of Holdco. This exchange will occur pursuant to section 51 of the Act.
13. On XXXXXXXXXX, Holdco will redeem the XXXXXXXXXX Class C preferred shares of its capital stock for an amount equal to the redemption value of such shares. In exchange, Holdco will pay an amount equal to the redemption value of the Class C preferred shares of its capital stock to the Estate and the Spouse.
14. In the first taxation year of the Estate, Holdco will redeem XXXXXXXXXX Class A preferred shares of its capital stock held by the Estate. In exchange, Holdco will issue to the Estate a demand note in full and absolute payment for the redemption of such shares ("Note 1"). The principal amount of Note 1 will be equal to the FMV at that time of the shares so redeemed. Subsequently, Holdco will repay Note 1 by liquidating a portion of its investments.
Holdco will be deemed to have paid and the Estate will be deemed to have received a dividend pursuant to section 84(3). The total amount of this dividend will be the amount by which the amount paid for these shares exceeds their PUC.
As a result of this redemption, the Estate will sustain a capital loss equal to the difference between the proceeds of disposition defined in section 54 and the ACB to the Estate of the shares so redeemed. In this regard, the Legal Representatives will elect, pursuant to subsection 164(6), to treat the entire capital loss of the Estate resulting from the above disposition as a capital loss of Mr. X resulting from the disposition of those shares by him in his last taxation year.
In addition, pursuant to subsection 40(3.61), subsection 40(3.6) will not apply to the Estate to deem the above capital loss to be nil.
15. The Estate will proceed to incorporate Newco under the CBCA. Newco will, at all relevant times and for all purposes of the Act, be a CCPC and a TCC. The fiscal period end of Newco will be XXXXXXXXXX of each year.
16. The authorized capital stock of Newco will consist of an unlimited number of Class A, B, C, D, E and F shares without par value. The Class A share to be issued in paragraph 17 will be voting (XXXXXXXXXX vote per share) and participating.
17. The Estate will transfer to Newco the XXXXXXXXXX Class A preferred shares of the capital stock of Holdco. In return, Newco will issue to the Estate:
(a) a demand note ("Note 2") with a principal amount and FMV equal to the lesser of:
i. the ACB to the Estate of the Class A preferred shares of the capital stock of Holdco so transferred, less $XXXXXXXXXX; or
ii. the FMV on the date of transfer of the Class A preferred shares of the capital stock of Holdco so transferred, less $XXXXXXXXXX; and
(b) a Class A share of its capital stock having a FMV equal to the amount, if any, by which the FMV of the Class A preferred shares of Holdco's capital stock so transferred on the date of transfer exceeds the principal amount (and FMV) of Note 2.
The Estate will accept Note 2, together with the Class A share of the capital stock of Newco as full and absolute payment for the transfer of the XXXXXXXXXX Class A preferred shares of the capital stock of Holdco.
In addition, and for greater certainty, the total amount of the FMV represented by the Note 2 and the Class A shares of the capital stock of Newco issued upon such transfer will not exceed the FMV of the XXXXXXXXXX Class A preferred shares of the capital stock of Holdco so transferred.
The Estate and Newco will jointly make the election provided for in subsection 85(1) in the prescribed form and within the time provided for in subsection 85(6), in respect of the XXXXXXXXXX Class A preferred shares of the capital stock of Holdco to be transferred to Newco. The Agreed Amount of the Estate and Newco for the shares of the capital stock of Holdco so transferred will be equal to the lesser of the amounts described in subparagraphs 85(1)(c.1)(i) and (ii) (being, respectively, their FMV at the time of the transfer and the ACB, to the Estate, at the time of the transfer).
In addition, the Agreed Amount for the shares will not exceed their FMV at the time of transfer and will not be less than the amount set out in paragraph 85(1)(b).
The PUC of the Class A shares of the capital stock of Newco will be equal to the amount, if any, by which the ACB to the Estate of the XXXXXXXXXX Class A preferred shares of the capital stock of Holdco immediately prior to the disposition exceeds the principal amount of Note 2 payable by Newco immediately after the disposition.
As a result of these transfers, Holdco will be a "connected corporation" to Newco pursuant to subsection 186(4).
18. The sale agreement will contain a price adjustment clause to the effect that the parties have made the transfer described in paragraph 17 at FMV and that they will adjust the sale price and the consideration received if the CRA assesses the property at a different value suitable to the parties.
19. Holdco will remain a separate legal entity (i.e., Holdco will not be wound up or amalgamated with Newco or any other corporation) for a minimum period of XXXXXXXXXX years following the share transfer referred to in paragraph 17. In addition, during this same period, Holdco will continue the business it was carrying on at the date hereof. Furthermore, the Estate and the Heirs do not intend that Holdco should cease carrying on its business after this period of XXXXXXXXXX years.
20. After a period of at least one year following the transaction described in paragraph 17, Newco may progressively repay the Note 2 at the rate of one third of the principal amount of the Note 2 per year, i.e. an amount of $XXXXXXXXXX in XXXXXXXXXX.
21. In order for Newco to obtain the necessary liquidity to repay the Note 2, Holdco will redeem the Class A preferred shares of its capital stock.
22. After the expiry of the XXXXXXXXXX year period described in paragraph 19, Newco will be dissolved under the CBCA.
23. Holdco will continue to carry on its investment management business following the completion of the Proposed Transactions.
PURPOSE OF THE PROPOSED TRANSACTIONS
24. The purpose of the Proposed Transactions described above is to recover the Holdco ERDTOH and NERDTOH and to progressively transfer property into the hands of the Heirs with a FMV equal to the ACB, to the Estate, resulting from the application of subsection 70(5) to the shares of the capital stock of Holdco that were acquired as a result of the death of Mr. X.
ADDITIONAL INFORMATION
25. The main contact details for the taxpayers covered by the advance rulings are:
XXXXXXXXXX
RULING
Provided that the statement of Relevant Facts, the Proposed Transactions and the Additional Information constitute full disclosure of all relevant facts, and of all Proposed Transactions and that such Proposed Transactions are carried out as described above, our decisions are as follows:
A. To the extent that:
(a) the principal amount of the Note 2 payable by Newco will not exceed the ACB, to the Estate, of the XXXXXXXXXX Class A preferred shares of the capital stock of Holdco; and
(b) the PUC of the Class A share in the capital stock of Newco will not exceed the maximum amount that may be added to the PUC of that share pursuant to section 84.1(1)(a),
the provisions of section 84.1 will not apply to deem a dividend to be paid by Newco to the Estate and received by the Estate, or to reduce the PUC of the Class A share of the capital stock of Newco upon the disposition of such share described in paragraph 17 above.
B. The provisions of subsection 84(2) will not apply as a result of and by reason of the Proposed Transactions described above to deem Holdco to pay to the Estate or the Heirs, and the Heirs to receive, a dividend on the shares of the capital stock of Holdco.
C. The provisions of subsection 245(2) will not apply as a result of and by reason of the Proposed Transactions described above to redetermine the tax consequences confirmed in the rulings above.
These rulings are subject to the limitations and general conditions set out in Information Circular 70-6R11 dated April 1, 2021, issued by the CRA and are binding on the CRA provided that the Proposed Transactions described in paragraphs 11 to 17 are completed by XXXXXXXXXX. Subsequent Proposed Transactions described in paragraphs 19 to 23 must be completed within the timeframes set out herein, as described above. These decisions are based on the current Act and do not take into account the proposed amendments to the Act.
OTHER COMMENTS
In no event should the decisions rendered be construed as an acquiescence on the part of the CRA that:
(a) we have considered the other tax consequences that may result from the Proposed Transactions set out herein;
(b) the Estate qualifies as a GRE;
(c) the amount attributed to a property in the statement of Facts and Proposed Transactions truly represents the FMV or ACB of a property, or the PUC of a share; and
(d) the amount attributed to a corporation's ERDTOH or NERDTOH truly represents the ERDTOH or NERDTOH of such corporation.
In addition, since the application and operation of price adjustment clauses are not proposed transactions, we do not issue rulings on those clauses. Income Tax Folio S4-F3-C1, Price Adjustment Clauses, sets out the CRA's administrative position on price adjustment clauses.
A statement of our fees for the time spent on your file will be sent to you under separate cover.
Best regards,
XXXXXXXXXX
for the Director
Reorganizations Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch