2003 Ruling 2002-0166673 - Reorganization of foreign affiliates

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CCRA.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.

Principal Issues: (1) Would any foreign accrual property income be generated as a result of the proposed transactions? (2) Would the proposed merger qualify as a "foreign merger" within the meaning of subsection 87(8.1)?

Position: (1) No, provided certain factual conditions are satisfied. (2) Yes.

XXXXXXXXXX
2002-016667
XXXXXXXXXX, 2003

Dear XXXXXXXXXX:

Re: XXXXXXXXXX
XXXXXXXXXX
Advance Income Tax Ruling Request

This is in reply to your letter of XXXXXXXXXX, in which you request an Advance Income Tax Ruling on behalf of the above named taxpayer. We also acknowledge the information provided in subsequent correspondence dated XXXXXXXXXX; our meeting with you on XXXXXXXXXX and during our various telephone conversations in connection with your request (XXXXXXXXXX).

We understand that, to the best of your knowledge and that of the taxpayers involved, none of the issues involved in the Ruling request:

(i) is in an earlier return of the taxpayer or a related person;

(ii) is being considered by a Tax Services Office or Taxation Center in connection with a previously filed tax return of the taxpayer or a related person;

(iii) is under objection by the taxpayer or a related person;

(iv) is before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has not expired; or

(v) is the subject of a Ruling previously issued by the Directorate.

Our understanding of the facts, proposed transactions and the purpose of the proposed transactions is as follows:

Definitions

In this letter, the following terms have the meanings specified:

(a) "Act" means the Income Tax Act, R.S.C. 1985 (5th Suppl.) c.1, as amended to the date hereof, and unless otherwise stated, every reference herein to a Part, section, subsection, paragraph or subparagraph is a reference to the relevant provision of the Act;

(b) "active business" has the meaning assigned to that term in subsection 95(1);

(c) "Canco" refers to XXXXXXXXXX;

(d) "Canco2" refers to XXXXXXXXXX;

(e) "controlled foreign affiliate" has the meaning assigned to that term in subsection 95(1);

(f) "excluded property" has the meaning assigned to that term in subsection 95(1);

(g) "FA1" refers to XXXXXXXXXX;

(h) "FA2" refers to XXXXXXXXXX;

(i) "FA3" refers to XXXXXXXXXX;

(j) "FA4" refers to XXXXXXXXXX;

(k) "FA5" refers to XXXXXXXXXX;

(l) "FA6" refers to XXXXXXXXXX;

(m) "foreign accrual property income" has the meaning assigned to that term in subsection 95(1);

(n) XXXXXXXXXX;

(o) "income from an active business" has the meaning assigned to that term in subsection 95(1);

(p) "New FA1" refers to XXXXXXXXXX;

(q) "public corporation" has the meaning assigned to that term in subsection 89(1);

(r) XXXXXXXXXX;

(s) "taxable Canadian corporation" has the meaning assigned to that term in subsection 89(1); and

(t) "USCo" refers to XXXXXXXXXX.

Facts

1. Canco is XXXXXXXXXX corporation governed by the Business Corporations Act XXXXXXXXXX. Canco is a taxable Canadian corporation and a public corporation that carries on business as XXXXXXXXXX company. Canco's fiscal year end is XXXXXXXXXX.

2. Prior to XXXXXXXXXX, Canco indirectly owned a XXXXXXXXXX% interest in a joint venture (the "JV") XXXXXXXXXX project XXXXXXXXXX. On XXXXXXXXXX, Canco indirectly acquired USCo. As a result of the USCo acquisition, Canco acquired an additional indirect XXXXXXXXXX % interest in the JV. The acquisition brought Canco's total indirect interest in the JV to XXXXXXXXXX%.

3. The parties to the JV are FA1 as to XXXXXXXXXX% and FA2 as to XXXXXXXXXX%. FA2 is a wholly-owned indirect subsidiary of USCo. Each of FA1 and FA2 is a XXXXXXXXXX formed under the laws of XXXXXXXXXX and resident in XXXXXXXXXX, and each is a controlled foreign affiliate of Canco. FA2 has no other significant assets besides its XXXXXXXXXX% JV interest.

4. FA2 is also a wholly-owned indirect subsidiary and controlled foreign affiliate of Canco2, a taxable Canadian corporation. FA2 has one class of shares (ordinary shares of par value XXXXXXXXXX $XXXXXXXXXX per share) of which XXXXXXXXXX are issued and outstanding. The registered shareholders of FA2 are FA3 as to XXXXXXXXXX shares and Canco2 as to XXXXXXXXXX shares. Canco2 holds the XXXXXXXXXX shares for the benefit of FA3. At all material times (including, for greater certainty, at the times referred to in paragraphs 19(b), 20(g) and 26 of the Proposed Transactions), Canco2 will hold shares of FA2 registered in its name for the benefit of FA3.

5. FA3 also beneficially owns all the shares of XXXXXXXXXX company referred to as XXXXXXXXXX. XXXXXXXXXX owns XXXXXXXXXX but is not active. The shares of XXXXXXXXXX have nominal value. FA3 is wholly-owned by FA4. The sole asset of FA4 is the shares of FA3. The sole shareholder of FA4 is Canco2. Canco2, FA4, FA3 and FA2 are indirect wholly-owned subsidiaries of USCo that were acquired as part of the USCo acquisition.

6. FA1 has one class of shares (Class A ordinary shares of par value XXXXXXXXXX per share) of which XXXXXXXXXX are issued and outstanding. The registered shareholders of FA1 are FA5 as to XXXXXXXXXX shares and FA6, a wholly-owned indirect subsidiary and controlled foreign affiliate of Canco as to XXXXXXXXXX shares. FA6 holds the XXXXXXXXXX shares for the benefit of FA5. At all material times (including, for greater certainty, at the times referred to in paragraphs 15(b), 15(d), 20(e) and 26 of the Proposed Transactions), FA6 will hold shares of FA1 and shares of New FA1 and FA2 for the benefit of FA5. The FA1 shares are the only asset of FA5.

7. In addition to the XXXXXXXXXX % JV interest, FA1 owns XXXXXXXXXX . XXXXXXXXXX . FA1 also owns XXXXXXXXXX. FA1 also owns XXXXXXXXXX.

8. The parties to the JV have the right to XXXXXXXXXX. The joint venturers are XXXXXXXXXX.

9. The Canco group has announced its intention to XXXXXXXXXX. To satisfy the Project lending requirements, it is necessary to consolidate ownership of the JV in a single entity with one shareholder holding more than XXXXXXXXXX% of the shares of that entity. FA2, the XXXXXXXXXX JV participant, has been selected as the entity in which to consolidate ownership of the JV. The principal shareholder of FA2 following the Proposed Transactions described below will continue to be FA3. It is anticipated that the shares of FA3 will be pledged to creditors under the financing. XXXXXXXXXX, it is proposed that it be transferred with the XXXXXXXXXX% JV interest from FA1 to FA2 as described below, in anticipation that XXXXXXXXXX.

10. A third party valuator has estimated the fair market values of FA1's XXXXXXXXXX% JV interest and XXXXXXXXXX to be approximately US$XXXXXXXXXX and US$XXXXXXXXXX, respectively, as at the date of the Ruling request. The tax cost of these assets as determined for XXXXXXXXXX purposes is considerably lower (approximately US$XXXXXXXXXX in the aggregate). These assets represent approximately XXXXXXXXXX of FA1's current fair market value.

11. The JV interests and XXXXXXXXXX are XXXXXXXXXX and, consequently, are not "capital property" under the Act pursuant to subparagraph 39(1)(a)(ii.1). Each of FA1 and FA2 carries on an active business for purposes of the foreign affiliate rules and any gain on the disposition of a JV interest or XXXXXXXXXX would be income from an active business. In particular, the principal purpose of each of FA1's and FA2's business is to earn profits from XXXXXXXXXX owned by them and not to derive profits from the disposition of XXXXXXXXXX.

12. The shares of FA1 and FA2 are excluded property and are capital property to their holders and will be excluded property and capital property at the time of closing of the Proposed Transactions described herein. The "net surplus" of FA1 as that term is used in subsection 5902(6) of the Income Tax Regulations, as amended to the date hereof, is estimated to be nil as at the end of its taxation year ended XXXXXXXXXX. It is not anticipated that FA1 will have any "net surplus" as that term is used in subsection 5902(6) of the Income Tax Regulations, as amended to the date hereof, at the time of the closing of the Proposed Transactions described in paragraph 15 herein.

13. It is not currently contemplated, as part of the series of Proposed Transactions described herein or otherwise, that FA5 will dispose of the shares of FA1 or that FA1 will acquire any property that is not excluded property. We understand that FA1 may acquire and hold cash and/or cash equivalents from time to time as is necessary to carry on its active business.

14. In connection with the Proposed Transactions, FA2 has applied to the XXXXXXXXXX tax authorities for a XXXXXXXXXX.

Proposed Transactions

15. FA1 will undergo a "spin-off" transaction (the "Spin-Off") XXXXXXXXXX to create, by operation of law, a new corporation, New FA1. Immediately following the Spin-Off, the percentage shareholding of FA5 and FA6 in New FA1 will be the same as their percentage shareholdings in FA1 prior to the Spin-Off. The Spin-Off will be undertaken in conjunction with a change to the par value of all the issued capital of FA1. Prior to the completion of the Spin-Off, no transfer of assets or issuance of share capital will have occurred. The Spin-Off will not be valid for XXXXXXXXXX corporate law purposes unless and until the Minutes of a Shareholders' Meeting of FA1 in respect of the Spin-Off have been approved by the registered shareholders of FA1 (that is, FA5 and FA6) and all the Spin-Off steps have been completed. The Shareholders' Meeting Minutes will describe the following steps in the following order:

(a) FA1 will redeem and cancel XXXXXXXXXX Class A shares of par value XXXXXXXXXX $XXXXXXXXXX each held by FA5 and FA5 will receive in exchange therefor XXXXXXXXXX newly issued shares of FA1 of par value XXXXXXXXXX $XXXXXXXXXX per share, thereby effecting a par value change and a reduction in aggregate par value of XXXXXXXXXX $XXXXXXXXXX;

(b) FA1 will redeem and cancel XXXXXXXXXX Class A shares of par value XXXXXXXXXX $XXXXXXXXXX each registered in the name of FA6 and FA6 will receive in exchange therefor XXXXXXXXXX newly issued shares of FA1 of par value XXXXXXXXXX $XXXXXXXXXX per share thereby effecting a par value change and a reduction in the aggregate par value of XXXXXXXXXX $XXXXXXXXXX;

(c) the capital of New FA1 will be fixed at XXXXXXXXXX $XXXXXXXXXX represented by XXXXXXXXXX common shares of par value XXXXXXXXXX $XXXXXXXXXX each;

(d) the issuance by New FA1 to FA5 of XXXXXXXXXX shares of par value XXXXXXXXXX $XXXXXXXXXX each and to FA6 of XXXXXXXXXX of par value XXXXXXXXXX $XXXXXXXXXX will be approved. These share issuances will occur by operation of XXXXXXXXXX corporate law for no consideration paid to New FA1 directly from FA5 or FA6. As at this paragraph 15(d) and until completion of all the steps involved in the Spin-Off, the fair market value of the New FA1 shares will be nil;

(e) the assets and liabilities transferred under the Spin-Off by FA1 to New FA1 are the XXXXXXXXXX% JV interest, XXXXXXXXXX and related assets and certain indebtedness of FA1. In accordance with XXXXXXXXXX rules, and as outlined in the draft Spin-Off balance sheet that we have received, the amount of the indebtedness so assumed will be equal to the difference between the aggregate book value of the transferred assets and an amount equal to the capital of New FA1, which difference will be less than the fair market value of the transferred assets.

16. The first taxation year of New FA1 will commence upon the Spin-Off. New FA1 will have a XXXXXXXXXX year-end. FA1 will not have a taxation year-end as a result of the Spin-Off. FA1's year-end will continue to be XXXXXXXXXX.

17. The Spin-Off is intended to be tax-free to FA1 and FA5 under XXXXXXXXXX. Pursuant to these provisions, FA1 will be deemed to dispose of the transferred assets for proceeds of disposition equal to their respective tax costs as determined for XXXXXXXXXX tax purposes and the respective tax costs to New FA1 of the transferred assets immediately after the Spin-Off will be equal to their respective tax costs to FA1 immediately prior to the Spin-Off. We understand that in order for the Spin-Off transaction to occur on this tax-deferred basis for XXXXXXXXXX purposes, FA1 must reduce its equity; therefore it cannot receive consideration from New FA1 for the assets transferred that has a value that is more than the book value of such assets.

18. In connection with the dispositions to FA1 of the Class A shares of FA1 described in paragraph 15(a) and paragraph 15(b) above, Canco will not claim an amount greater than the adjusted cost base of those shares to the disposing foreign affiliate as the relevant cost base of those shares for purposes of paragraph 95(2)(c). The shares of FA1 will continue to be excluded property immediately after the completion of the steps described in paragraph 15 above.

19. Following the transactions described in paragraph 15 above and before the merger described in paragraph 20 below, FA2 will undertake the following transactions in order to change the par value of all of its issued share capital.

(a) FA2 will cancel XXXXXXXXXX shares of par value XXXXXXXXXX $XXXXXXXXXX each held by FA3 and FA3 will receive in exchange therefor XXXXXXXXXX newly issued shares of FA2 of par value XXXXXXXXXX $XXXXXXXXXX each; and

(b) FA2 will cancel XXXXXXXXXX shares of par value XXXXXXXXXX $XXXXXXXXXX each registered in the name of Canco2 and Canco2 will receive in exchange therefor XXXXXXXXXX newly issued shares of par value XXXXXXXXXX $XXXXXXXXXX each.

In connection with the disposition to FA2 of the shares of FA2 described in paragraph 19(a) and paragraph 19(b) above, neither Canco nor Canco2 will claim an amount greater than the adjusted cost base of those shares to the disposing foreign affiliate as the relevant cost base of those shares for purposes of paragraph 95(2)(c).

20. Following the transactions described in paragraph 19 above and on or before XXXXXXXXXX, New FA1 will merge into FA2 in an absorptive merger transaction (the "Merger") governed by XXXXXXXXXX. The shares of FA2 and New FA1 will be capital property to their holders at the time of the Merger. The Merger Agreement to be entered into between New FA1 and FA2 and which will govern the Merger will provide, in effect, as follows:

(a) As a result of the Merger, New FA1 will dissolve (without being liquidated) and FA2 will be the survivor;

(b) All the property owned by New FA1 and FA2 immediately before the Merger (other than amounts, if any, receivable from FA2 and New FA1, respectively) will become property of FA2 as a consequence of the Merger;

(c) All the liabilities of New FA1 and FA2 immediately before the Merger (other than amounts, if any, payable to FA2 or New FA1, respectively) will become liabilities of FA2 as a consequence of the Merger;

(d) As a consequence of the Merger, the XXXXXXXXXX shares of the capital stock of New FA1 owned by FA5 immediately before the merger will be cancelled and exchanged for (i) XXXXXXXXXX new common shares of FA2 of par value XXXXXXXXXX $XXXXXXXXXX each and (ii) common shares issued from the treasury of FA3, the controlling shareholder of FA2;

(e) The XXXXXXXXXX e of the capital stock of New FA1 registered in the name of FA6 will be cancelled and exchanged XXXXXXXXXX of FA2 of par value XXXXXXXXXX $XXXXXXXXXX;

(f) The XXXXXXXXXX shares of the capital stock of FA2 held by FA3 will continue to be held by FA3 (no new shares will be issued to FA3); and

(g) The XXXXXXXXXX shares of the capital stock of FA2 registered in the name of Canco2 will continue to be registered in the name of Canco2 (no new shares will be issued to Canco2).

21. The number of common shares to be issued by FA3 to FA5 in paragraph 20(d) above shall have an aggregate fair market value immediately after the Merger equal to the aggregate fair market value immediately before the Merger of the shares of New FA1 beneficially owned by FA5 less the fair market value immediately after the Merger of the shares of FA2 issued to FA5 and FA6 upon the Merger.

22. The aggregate par value of the common shares to be issued by FA3 to FA5 in paragraph 20(d) above shall not exceed US$XXXXXXXXXX. The aggregate par value of the FA3 shares currently held by FA4 will not change as a result of the Merger.

23. As a result of the Merger, the taxation year of New FA1 will end immediately prior to the Merger. FA2 will not have a taxation year-end as a result of the Merger and its taxation year-end will continue to be XXXXXXXXXX.

24. In connection with Merger, neither Canco (nor Canco2 in the case of the FA2 shares held by FA3) will elect an amount greater than the adjusted cost base of the New FA1 shares and the FA2 shares to the respective disposing foreign affiliate as the relevant cost base of such shares for purposes of applying paragraph 95(2)(d).

25. The Merger is intended to be tax-free to New FA1, FA2 and their shareholders underXXXXXXXXXX. Pursuant to these provisions, New FA1 will be deemed to have disposed of all its assets for proceeds of disposition equal to the respective tax costs as determined for XXXXXXXXXX tax purposes of those assets to it and the respective tax costs to FA2 immediately after the Merger of the assets of New FA1 will be equal to their respective tax costs to New FA1 immediately prior to the Merger.

26. XXXXXXXXXX. As a general matter, it is easier to undertake a book value merger because no revaluation or certificate is required and certifying precise fair market values is difficult especially with respect to certain types of assets. In the case of the Merger of New FA1 and FA2, substantially all the assets of New FA1 and FA2 will be XXXXXXXXXX and it was recognized in planning for the Merger that, for the accountants (following accountancy principles applicable in XXXXXXXXXX), it would be very difficult to revalue XXXXXXXXXX and certify such revaluation for purposes of the Merger balance sheet. Accordingly, the Merger of New FA1 and FA2 will be undertaken by increasing the corporate capital of FA2 based on the book value of New FA1. The corporate capital of FA2 before the Merger on a book value basis will be XXXXXXXXXX $XXXXXXXXXX represented by XXXXXXXXXX common shares with a par value of XXXXXXXXXX $XXXXXXXXXX each held by FA3 and Canco2. The corporate capital of New FA1 before the Merger on a book value basis will be XXXXXXXXXX $XXXXXXXXXX represented by XXXXXXXXXX common shares with a par value of XXXXXXXXXX $XXXXXXXXXX each held by FA5 and FA6. Therefore, since the shares of FA2 to be issued to the shareholders of New FA1 are shares of the same class as are held by FA3 and Canco2 (that is, common shares with a par value of XXXXXXXXXX $XXXXXXXXXX each), the maximum number of such common shares that can be issued to the shareholders of New FA1 is XXXXXXXXXX shares.

27. The issuance of shares by FA3 to FA5 on the Merger is not required by XXXXXXXXXX corporate law. However, the Merger Agreement as well as the minutes of the shareholders' meeting approving the Merger will state that FA3 shall issue shares to FA5 as part consideration for the cancellation of New FA1 share on the Merger. We understand that both the Merger Agreement and the minutes of the shareholders' meeting approving the Merger will have to be approved and registered with the XXXXXXXXXX companies' registrar.

28. FA2 has applied to the XXXXXXXXXX for XXXXXXXXXX to confirm that the Merger carried out pursuant to the Merger Agreement will occur on a tax-deferred basis under XXXXXXXXXX.

Purpose of the proposed transactions

29. The purpose of the Proposed Transactions is to facilitate XXXXXXXXXX financing XXXXXXXXXX of the Project by consolidating Canco's indirect interest in the JV and XXXXXXXXXX in a single corporate entity, FA2, with one shareholder owning more than XXXXXXXXXX% of the shares of FA2.

Rulings requested and given

Provided that the preceding statements constitute a complete and accurate disclosure of all the relevant facts, proposed transactions, and purpose of the proposed transactions, and provided further that the proposed transactions are carried out as described above, we confirm the following:

A. Paragraph 95(2)(c) will apply in respect of FA5 on the Proposed Transactions described in paragraph 15(a) and paragraph 15(b) above provided that, at the time such transactions occur, the shares of FA1 beneficially owned by FA5 are capital property to FA5.

B. Paragraph 95(2)(c) will apply in respect of FA3 on the Proposed Transactions described in paragraph 19(a) and paragraph 19(b) above provided that, at the time such transactions occur, the shares of FA2 beneficially owned by FA3 are capital property to FA3.

C. The Proposed Transactions described in paragraph 20(a) to paragraph 20(g) and paragraph 21 above will qualify as a "foreign merger" within the meaning of subsection 87(8.1).

D. Paragraph 95(2)(d) will apply in respect of the shareholders of New FA1 and FA2 on the Proposed Transactions described in paragraph 20(d) to paragraph 20(g) above.

E. Provided that, at all relevant times:

(i) the shares of FA1, New FA1 and FA2 are capital property to their holders and are excluded property;

(ii) neither Canco nor Canco2 elects an amount higher than the adjusted cost base of shares of an affiliate that are disposed of in Proposed Transactions to which paragraph 95(2)(c) or paragraph 95(2)(d) applies as the relevant cost base of such shares for purposes of paragraph 95(2)(c) or paragraph 95(2)(d);

(iii) each of FA1 and New FA1 carries on an active business; and

(iv) any gain on the disposition of assets transferred by FA1 to New FA1 or by New FA1 to FA2 because of the Proposed Transactions would be income from an active business,

then no amount will be included in computing the foreign accrual property income of a foreign affiliate of Canco or Canco2 solely as a consequence of one or more of the Proposed Transactions in and by themselves.

F. Subsection 245(2) will not apply to one or more of the Proposed Transactions to redetermine the consequences thereof.

The above Rulings are given subject to the limitations and qualifications set out in Information Circular 70-6R5 and are binding on the Canada Customs and Revenue Agency (the CCRA) provided that the proposed transactions are completed before XXXXXXXXXX.

The above Rulings are based on the Act and the Income Tax Regulations in its present form and does not take into account any proposed amendments to the Act and the Income Tax Regulations which, if enacted into law, could have an effect on the Rulings provide herein.

Other Comments

Nothing in this Advance Income Tax Ruling should be construed as implying that the CCRA has agreed to or reviewed any tax consequences relating to the facts and proposed transactions described herein, other than those specifically described in the Rulings given above. In particular, nothing in this letter should be construed as confirmation, express or implied, of the fair market value or adjusted cost base of any property referred to herein, or that New FA1 carries on an active business during the period of its existence.

Yours truly,

XXXXXXXXXX
Section Manager
For Division Director
International and Trust Division
Income Tax Rulings Directorate
Policy and Legislation Branch