Principal Issues: (1) Whether section 84.1 applies to deem the estate to have received a dividend on the disposition of shares in a corporation to the new corporation or to reduce the PUC of the shares of the new corporation received as a consideration for the disposition of shares in the corporation; (2) Whether subsection 84(2) applies to the proposed transactions; (3) Whether subsection 245(2) applies to the proposed transactions.
Position: (1) No; (2) No; (3) No.
Reasons: The proposed transactions comply with the applicable provisions of the Act, and CRA's administrative positions pertaining to post mortem hybrid pipelines.
XXXXXXXXXX 2022-095545
XXXXXXXXXX
Dear Sir,
Re: Request for Advance Income Tax Rulings XXXXXXXXXX and XXXXXXXXXX Estate
This is in response to the letter written by Ms. XXXXXXXXXX, Canadian Tax Manager with your firm, dated XXXXXXXXXX and received on XXXXXXXXXX, requesting advance income tax rulings on behalf of your clients, XXXXXXXXXX and XXXXXXXXXX (the "Taxpayers"). We have also taken into account the information that you and Ms. XXXXXXXXXX sent to us by email for the purposes of preparing this document.
Unless otherwise indicated, all legislative references below are to the provisions of the Income Tax Act, R.S.C. 1985, c. 1, (5th Supp.) (the "Act"). To the best of your knowledge and that of the parties involved in the Proposed Transactions, none of the matters involved in this request for advance income tax rulings:
(i) relates to any tax return previously filed by the Taxpayers or a related person;
(ii) is being considered by a Tax Services Office or Taxation Centre in connection with a previously-filed tax return of the Taxpayers or a related person;
(iii) is under objection by the Taxpayers or a related person;
(iv) is the subject of a current or completed court process involving the Taxpayers or a related person;
(v) is the subject of a ruling request previously considered by the Income Tax Rulings Directorate.
DEFINITIONS AND ABBREVIATIONS USED:
In this document, the following abbreviations and terms have the meanings described below:
"ACB" means "adjusted cost base" as defined in section 54;
"Agreed Amount" has the meaning assigned by subsection 85(1);
"Amalco" means the corporation resulting from the amalgamation of Investco and Newco as described in paragraph 44;
"Amalgamation" means the amalgamation of Investco and Newco as described in Paragraph 44;
"Capital Dividend" means a dividend in respect of which an election under subsection 83(2) has been made;
"Capital Loss" has the meaning set out in paragraph 39(1)(b);
"Capital Property" has the meaning set out in section 54;
"CCPC" means "Canadian-controlled private corporation" as defined in subsection 125(7);
"CDA" means "capital dividend account" as defined in subsection 89(1);
"Child 1" means XXXXXXXXXX, who is the daughter of X;
"Child 2" means XXXXXXXXXX, who is the daughter of X and the sister of Child 1;
"Dividend Repayment" has the meaning set out in subsection 129(1);
"Dividend" means the dividend that Investco will be deemed to have paid to the Estate on the Redemption as described in Paragraphs 28 to 30;
"Eligible Dividend" has the meaning set out in subsection 89(1);
"ERDTOH" means "eligible refundable dividend tax on hand" as defined in subsection 129(4);
"Estate" means the estate of X governed by the terms of the Will, which will be designated as a GRE in its return of income for its first taxation year ending no later than March 7, 2023;
"Executors" means Child 1, Child 2 and XXXXXXXXXX acting jointly as executors of the Estate;
"FMV" means the highest price, in dollars, that would be agreed upon in the open market between two arm's length parties who are knowledgeable, informed and prudent, neither of whom is under any compulsion to act;
"GRE" means "graduated rate estate" as defined in subsection 248(1);
"GRIP" means "general rate income pool" as defined in subsection 89(1);
"Heirs" means Child 1 and Child 2;
"Investco" means XXXXXXXXXX;
"NERDTOH" means "non-eligible refundable dividend tax on hand" as defined in subsection 129(4);
"Newco" refers to the new corporation formed by the Executors as described in Paragraph 37;
"Note 1" means the note issued by Investco in consideration for the redemption of XXXXXXXXXX Class C Shares held by the Estate of the capital stock of Investco as described in Paragraph 28;
"Note 2" means the note issued by Newco in partial consideration for the transfer by the Estate to Newco of the XXXXXXXXXX Class A Shares and the XXXXXXXXXX Class B Shares held by the Estate of the capital stock of Investco as described in Paragraph 40;
"Paragraph" refers to a paragraph of this letter;
"Proceeds of Disposition" has the meaning set forth in Section 54;
"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);
"Redeemed Shares" means the XXXXXXXXXX Class C shares of the capital stock of Investco subject to the Redemption;
"Redemption" means the redemption of the Class C Shares held by the Estate of the capital stock of Investco as described in Paragraph 28;
"Share Exchange" means the exchange of XXXXXXXXXX Class B shares of the capital stock of Investco held by the Estate in consideration for XXXXXXXXXX Class C shares of the capital stock of Investco as described in paragraph 20;
"TCC" means "taxable Canadian corporation" as defined in subsection 89(1);
"Transfer" means the disposition by the Estate of the Transferred Shares to Newco as described in Paragraph 40;
"Transferred Shares" means the XXXXXXXXXX Class A shares and the XXXXXXXXXX Class B shares of the capital stock of Investco that the Estate will transfer to Newco upon the Transfer;
"Transitional Period" means the period commencing on the date of the Transfer and ending on the date of the Amalgamation;
"Will" means the will of X dated XXXXXXXXXX;
"X" means Mr. XXXXXXXXXX, who is a resident of Canada for the purposes of the Act.
XXXXXXXXXX;
RELEVANT FACTS:
Facts relating to X
1. X died XXXXXXXXXX.
2. At the time of his death, X held XXXXXXXXXX Class A shares and XXXXXXXXXX Class B shares of the capital stock of Investco, which shares represented all of its issued and outstanding share capital.
3. X held the XXXXXXXXXX Class A shares and the XXXXXXXXXX Class B shares of the capital stock of Investco as Capital Property.
4. Under the terms of the Will, the XXXXXXXXXX Class A shares and the XXXXXXXXXX Class B shares of the capital stock of Investco formed part of the residue of the Estate which will be the subject of a universal legacy in equal shares in favour of Child 1 and Child 2.
5. The tax characteristics of the shares held by X in the capital stock of Investco immediately before his death were as follows:
Shareholder Number Class ACB PUC FMV/JVM/RV
X XXXXX A XXXXX XXXXX XXXXX
XXXXX B XXXXX XXXXX XXXXX6. Pursuant to paragraph 70(5)(a), X was deemed to have disposed, immediately before his death, of all of the shares he held of the capital stock of Investco, and to have received proceeds of disposition equal to their respective FMVs immediately before his death.
7. X realized a capital gain of $XXXXXXXXXX, and a taxable capital gain of $XXXXXXXXXX as a result of the deemed disposition of the XXXXXXXXXX Class A Shares and XXXXXXXXXX Class B Shares he held of the capital stock of Investco.
8. X did not claim a capital gains deduction under subsection 110.6(2.1) in respect of the taxable capital gain realized on the deemed disposition of the XXXXXXXXXX Class A shares and the XXXXXXXXXX Class B shares that he held of the capital stock of Investco since those shares were not QSBCSs at the time of his death.
9. Pursuant to paragraph 70(5)(b), the Estate was deemed to have acquired the XXXXXXXXXX Class A shares and the XXXXXXXXXX Class B shares that X held of the capital stock of Investco at a cost equal to their FMV immediately before X's death.
10. The tax characteristics of the shares of the capital stock of Investco that the Estate is deemed to have acquired at the time of X's death were as follows:
Shareholder Number Class ACB PUC FMV/RV
Estate XXXXX A XXXXX XXXXX XXXXX
XXXXX B XXXXX XXXXX XXXXX11. The shares of the capital stock of Investco were Capital Property to the Estate.
Facts about Investco
12. Investco is a TCC and CCPC incorporated on XXXXXXXXXX under the XXXXXXXXXX with a fiscal period ending on XXXXXXXXXX in each year.
13. The authorized share capital of Investco consists of an unlimited number of Class A, B, C and D shares with the following conditions and restrictions:
- Each Class A share is voting (XXXXXXXXXX votes per share) and participating;
- Each Class B share (i) is non-voting and non-participating, (ii) entitles its holder to receive annually, pari passu with the holders of Class C shares, a non-cumulative dividend preferential to any dividend declared on the Class A and D shares in an amount equal to XXXXXXXXXX% of its redemption value, and (iii) may be redeemed at the option of the Corporation or its holder for an amount generally equal to the sum of the quotient of the FMV of the consideration received by the Corporation on the issue of Class B shares divided by the number of Class B shares issued by the Corporation and the quotient of the amount of any declared and unpaid dividends on the Class B shares divided by the number of Class B shares issued by the Corporation;
- Each Class C share: (i) is non-voting and non-participating, (ii) entitles its holder to receive annually, pari passu with the holders of Class C shares, a non-cumulative dividend preferential to any dividend declared on Class A and D shares in an amount equal to XXXXXXXXXX% of its redemption value, and (iii) may be redeemed at the option of the Corporation or its holder for an amount generally equal to the sum of the quotient of the FMV of the consideration received by the Corporation on the issue of Class C shares divided by the number of Class C shares issued by the Corporation and the quotient of the amount of any declared and unpaid dividends on the Class C shares divided by the number of Class C shares issued by the Corporation;
- Each Class D share: (i) is non-voting and non-participating, (ii) entitles its holder to receive annually a dividend preferential to any dividend declared on the Class A shares in an amount equal to XXXXXXXXXX% of the quotient of the amount of capital issued and paid for the Class D shares divided by the number of Class D shares issued by the Corporation, and (iii) may be redeemed at the option of the Corporation or its holder for an amount equal to the quotient of the issued and paid-up capital of the Class D shares divided by the number of Class D shares issued and of the amount of any declared and unpaid dividends on the Class D shares divided by the number of Class D shares issued by the Corporation;
14. Since XXXXXXXXXX, Investco has only managed an investment portfolio.
15. Prior to XXXXXXXXXX, Investco also carried on a XXXXXXXXXX.
16. Since XXXXXXXXXX, the net book value respectively attributed to the Capital Property used in the transportation business and to the assets of the investment business were as follows:
Assets XXXX XXXX XXXX XXXX XXXX XXXX
Net value of the XXXX XXXX XXXX XXXX XXXX XXXX
capital property of
the XXXXX business
Values of Investment XXXX XXXX XXXX XXXX XXXX XXXX
17. On XXXXXXXXXX, the assets held by Investco were as follows:
Assets $ %
Cash XXXXXX XXXXXX
Mutual fund investments XXXXXX XXXXXX
Market-linked guaranteed investments XXXXXX XXXXXX
Term investments XXXXXX XXXXXX
Tax receivable XXXXXX XXXXXX
18. The vast majority of term investments mature in more than XXXXXXXXXX years. In addition, premature redemption of guaranteed investment certificates would result in penalties. Investco's investments are managed by an independent advisor pursuant to an investment policy.
19. As at XXXXXXXXXX, the balances in Investco's tax accounts were as follows:
GRIP ERDTOH NERDTOH CDA
XXXXX XXXXX XXXXX XXXXX
Proposed Transactions
Exchange of Class B shares of the capital stock of Investco
20. On or about XXXXXXXXXX, Investco will exchange XXXXXXXXXX Class B shares held by the Estate having an ACB of $XXXXXXXXXX and a FMV of $XXXXXXXXXX for XXXXXXXXXX Class C shares having an ACB of $XXXXXXXXXX, a PUC of $XXXXXXXXXX and a FMV of $XXXXXXXXXX pursuant to subsection 51(1) (the "Share Exchange").
21. Following the Share Exchange, the Estate will hold the following shares of the capital stock of Investco:
Shareholder Number Class ACB PUC FMV/RV
Succession XXXXX A XXXXX XXXXX XXXXX
XXXXX B XXXXX XXXXX XXXXX
XXXXX C XXXXX XXXXX XXXXXIncrease in the PUC of the Class C shares of the share capital of Investco
22. After XXXXXXXXXX, Investco will increase the PUC of the Class C shares of its capital stock held by the Estate by an amount equal to $XXXXXXXXXX other than by way of one of the transactions described in paragraphs 84(1)(a), (b), (c), (c.1), (c.2) and (c.3) (the "PUC Increase").
23. Pursuant to subsection 84(1), Investco will be deemed to pay a dividend on the Class C shares of its share capital in an amount equal to the amount of the PUC Increase.
24. Investco will elect under subsection 83(2) in a timely manner and in the manner prescribed by the Income Tax Regulations so that the dividend described in Paragraph 23 will be deemed to be a Capital Dividend.
25. Pursuant to subsection 84(1), the Estate will also be deemed to receive a dividend equal to the amount of the PUC Increase.
26. In accordance with paragraph 53(1)(b), the ACB of the Class C Shares held by the Estate will be increased by an amount equal to the amount of the dividend that will be deemed to be paid by Investco and received by the Estate as a result of the PUC Increase.
27. Following the PUC Increase, the Estate will hold XXXXXXXXXX Class C shares of the capital stock of Investco having an ACB of $XXXXXXXXXX, a PUC of $XXXXXXXXXX and a FMV of $XXXXXXXXXX.
Redemption of Class C shares of the capital stock of Investco
28. Following the PUC Increase, Investco will redeem XXXXXXXXXX Class C shares held by the Estate of the capital stock of Investco (the "Redemption") in consideration for the issuance of a non-interest bearing demand note with a principal amount equal to the FMV of the Redeemed Shares ("Note 1").
29. The Estate will accept Note 1 as full and absolute payment of the amount payable by Investco for the Redemption.
30. In accordance with subsection 84(3), a dividend equal to the excess of the amount to be paid by Investco to the Estate on the Redemption over the PUC of the Redeemed Shares will be deemed to be paid by Investco and received by the Estate by virtue of the Redemption (the "Dividend").
31. A portion of the Dividend equal to the balance of the GRIP of Investco on payment of the Dividend will be designated pursuant to subsection 89(14) so that the portion so designated qualifies as an Eligible Dividend.
32. The excess of the amount of the Dividend over that of the Eligible Dividend will be a dividend other than an Eligible Dividend.
33. Payment of the Dividend will entitle Investco to claim a Dividend Refund to the extent, if any, of the balances in Investco's ERDTOH and NERDTOH accounts at the end of the taxation year in which the Dividend is paid.
34. The Redemption will also result in a disposition of the Redeemed Shares and the Estate will realize a Capital Loss in an amount equal to the excess of the Proceeds of Disposition as defined in Section 54 over the ACB of the Redeemed Shares.
35. Subject to the application of subsection 112(3.2), the Executors of the Estate will make the election provided for in subsection 164(6) during the Estate's first taxation year, in the manner provided for in the Income Tax Regulations, to have the entire Capital Loss realized by the Estate treated as a Capital Loss of X resulting from the disposition of the Redeemed Shares during his last taxation year.
36. Pursuant to subsection 40(3.61), subsection 40(3.6) will not apply to deem the Capital Loss realized by the Estate from the disposition of the Redeemed Shares to be nil.
Formation of Newco
37. Following the Redemption, the Executors will incorporate Newco pursuant to the XXXXXXXXXX.
38. Newco will be a TCC and CCPC with a taxation year ending on XXXXXXXXXX in each year.
39. The authorized share capital of Newco will consist of an unlimited number of Class A shares, which will be voting and participating shares.
Transfer of Class A and Class B Shares from the Capital Stock of Investco to Newco
40. On or about XXXXXXXXXX, the Estate will transfer the XXXXXXXXXX Class A shares and the XXXXXXXXXX Class B shares that it holds of the capital stock of Investco (the "Transferred Shares") to Newco pursuant to the rules set out in subsection 85(1) (the "Transfer") in consideration for a non-interest bearing demand promissory note with a principal amount of XXXXXXXXXX equaling the Agreed Amount less an amount of $XXXXXXXXXX ("Note 2"), and XXXXXXXXXX Class A shares of the capital stock of Newco with the following tax attributes:
Newco shares ACB PUC FMV FMV/share
XXXXXXXXXXXX
Class A shares XXXXX XXXXXX XXXXXX XXXXXX
The Estate will accept Note 2 and the XXXXXXXXXX Class A shares of the capital stock of Newco as full and absolute payment of the consideration payable by Newco for the acquisition of the Transferred Shares.
The Estate and Newco will make the election provided for in subsection 85(1), in the prescribed form and within the period provided for in subsection 85(6), in respect of the Transferred Shares to be disposed of by the Estate. For greater certainty, the Agreed Amount determined by the Estate and Newco for the Transferred Shares 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 their ACB, to the Estate, at the time of the Transfer). In addition, the Agreed Amount will not exceed the FMV of the Transferred Shares at the time of the Transfer and will not be less than the amount set out in paragraph 85(1)(b).
The amount that Newco will add to the PUC of the Class A shares of its share capital issued to the Estate in consideration for the Transferred Shares will be equal to the amount by which the Agreed Amount exceeds the principal amount of Note 2. For greater certainty, the PUC of the Class A shares of the capital stock of Newco issued in consideration for the Transferred Shares will not exceed the maximum amount that may be added to the PUC pursuant to the provisions of paragraph 84.1(1)(a) at the time of the Transfer.
41. Investco will be connected to Newco by virtue of paragraph 186(4)(a) and subsection 186(2) following the Transfer.
42. Investco will not be wound up into Newco or any other corporation, and will not be amalgamated with Newco or any other corporation for a period of at least XXXXXXXXXX years from the date of the Transfer.
43. During the Transitional Period, Investco will be a separate entity which continues to operate in the same manner and in accordance with the terms of its investment policy.
Amalgamation of Investco and Newco
44. On or about XXXXXXXXXX, at the end of a period of at least one year from the date of the Transfer, Investco will amalgamate with Newco pursuant to subsection 87(1) to form Amalco.
45. From and after the date of the Amalgamation, Amalco will continue to carry on the business of Investco though exploiting the investments of Investco which will have become the investments of Amalco as a result of the Amalgamation.
Note 2 Repayment
46. Amalco will proceed with the gradual repayment of Note 2, ensuring however that the amounts paid quarterly to the Estate during the year following the date of the Amalgamation do not exceed XXXXXXXXXX% of the principal amount of Note 2:
(a) XXXXXXXXXX% of the principal amount of Note 2;
(b) XXXXXXXXXX% of the principal amount of Note 2;
(c) XXXXXXXXXX% of the principal amount of Note 2;
(d) XXXXXXXXXX% of the principal amount of Note 2.
47. Amalco will not cease to carry on its investment business until the principal amount of Note 2 has been repaid in full.
48. At the appropriate time, the Estate will be able to distribute the funds from the redemption of the principal of Note 1 and Note 2 to the Heirs.
PURPOSE OF THE PROPOSED TRANSACTIONS:
The purpose of the Proposed Transactions described is to enable the Estate to: (i) maximize the use of Investco's tax account balances, and (ii) gradually distribute to the Heirs property with a FMV equal to the ACB of the Class A and Class B shares of the capital stock of Investco, as determined pursuant to paragraph 70(5)(b), that it acquired as a result of X's death.
The main contact details for the taxpayers affected by the advance rulings are:
XXXXXXXXXX
ADVANCE RULINGS ISSUED:
Provided that the statement of Facts, Proposed Transactions and Additional Information constitutes full disclosure of all relevant facts and all proposed transactions and that the Proposed Transactions are carried out as described above, our rulings are as follows:
A. To the extent that:
(a) the principal amount of Note 2 payable by Newco does not exceed the Agreed Amount, to the Estate, of the Transferred Shares; and
b) the PUC of the XXXXXXXXXX Class A shares of the capital stock of Newco issued to the Estate does not exceed the maximum amount that may be added to the PUC of such shares pursuant to paragraph 84.1(1)(a),
the provisions of Section 84.1 will not apply so as to deem a dividend to be paid by Newco to the Estate and received by the Estate, or so as to reduce the PUC of the XXXXXXXXXX Class A shares of the capital stock of Newco at the time of the Transfer described in Paragraph 40.
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 Investco to have paid to the Estate, and the Estate to have received, a dividend on the Class A and B shares of the capital stock of Investco.
C. The provisions of subsection 245(2) will not apply as a result of and because of the Proposed Transactions described above to redetermine the tax consequences confirmed in the rulings above.
These rulings are subject to the restrictions and general conditions set out in Information Circular 70-6R12 dated April 1, 2022, published by the Canada Revenue Agency and are binding on the Canada Revenue Agency provided that the Proposed Transactions described in paragraphs 20 to 43 are completed before XXXXXXXXXX.
As for the subsequent Proposed Transactions set out in Paragraphs 44 to 48, they 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 thereto.
OTHER COMMENTS:
The rulings should in no way be construed as an acquiescence on the part of the Canada Revenue Agency that:
(a) the terms of the Will allow the Executors to proceed with the transactions described in the Proposed Transactions in order to reduce the income taxes otherwise payable in respect of the property it held following X's death;
(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 amount of a share;
(d) the amount allocated to the CDA, GRIP, ERDTOH or NERDTOH of Investco truly represents the CDC, GRIP, ERDTOH or NERDTOH of such corporation; and that
(e) we have considered the other tax consequences that may result from the Proposed Transactions set out in this letter.
A statement of our fees for the time spent reviewing 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