2005 Ruling 2005-0140221R3 - Disposition of Taxable Canadian Property

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.

Principal Issues: Whether paragraph 4 of Article XIII of the Canada-US Treaty will apply to the disposition of taxable Canadian property (shares) by a US partnership that has elected to be treated as a corporation for US income tax purposes.

Position: Yes.

Reasons: The US partnership will be considered to be a "resident" of the US, within the meaning thereof in Article IV of the Canada-US Treaty, such that paragraph 4 of Article XIII will apply to the disposition of the shares.

XXXXXXXXXX 						2005-014022

XXXXXXXXXX, 2005

Dear XXXXXXXXXX:

Re: Advance Income Tax Ruling
XXXXXXXXXX

XXXXXXXXXX.

XXXXXXXXXX.

XXXXXXXXXX.

XXXXXXXXXX.

This is in response to your XXXXXXXXXX request for an advance income tax ruling on behalf of the above taxpayers. We acknowledge receipt of the additional information provided in the XXXXXXXXXX.

Unless otherwise stated, all references herein to a statute are to the Income Tax Act R.S.C. 1985 (5th Supplement), c.1, as amended, (the "Act") to the date of this advance income tax ruling and all terms and conditions used herein that are defined in the Act have the meaning given in such definitions unless otherwise indicated.

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

Definitions

(a) "CRA" is the Canada Revenue Agency.

(b) "Foreign Parent" is XXXXXXXXXX.

(c) "Foreign Sub1" is XXXXXXXXXX.

(d) "Foreign Sub2" is XXXXXXXXXX.

(e) "Foreign Sub3" is XXXXXXXXXX.

(f) "Foreign LLC" is XXXXXXXXXX.

(g) "Partnership" is a limited partnership of which the partners are Foreign Sub2 and Foreign LLC.

(h) "Canco" is XXXXXXXXXX.

(i) "Can Sub1" XXXXXXXXXX.

(j) "Can Sub2" is XXXXXXXXXX.

(k) "Holdco" is the proposed, newly formed, US corporation which will initially be a wholly-owned subsidiary of Foreign Sub1.

(l) "US" is the United States of America.

(m) "Code" is the United States Internal Revenue Code.

(n) "Corporations Act" is the Business Corporations Act of XXXXXXXXXX.

(o) "Partnership Act" is the XXXXXXXXXX.

(p) "Treaty" is the Convention between Canada and the United States of America with Respect to Taxes on Income and Capital.

(q) "taxable Canadian corporation" has the meaning assigned by subsection 89(1) of the Act.

(r) "taxable Canadian property" has the meaning assigned by subsection 248(1) of the Act.

Facts

1. Foreign Parent is a publicly traded US "C" corporation. Foreign Parent, together with all of its subsidiaries (the "Group"), is XXXXXXXXXX. Foreign Parent is a resident of the US.

2. Foreign Sub1 is a XXXXXXXXXX "C" corporation. Foreign Sub1 is controlled by Foreign Parent. Foreign Sub1 is a resident of the US for purposes of the Treaty. Foreign Sub1 acquired the shares of Can Sub2 in XXXXXXXXXX when it acquired certain assets and shares from Can Sub2's former parent corporation.

3. Foreign Sub2 is a XXXXXXXXXX "C" corporation. Foreign Sub2 is controlled by Foreign Sub1. Foreign Sub2 is a resident of the US for purposes of the Treaty.

4. Foreign Sub3 was a XXXXXXXXXX "C" corporation. For purposes of the Treaty, Foreign Sub3 was a resident of the US at the time it was merged into the Partnership. (See paragraph 9 below) Foreign Sub3 acquired the shares of Can Sub1 at the time of Can Sub1's incorporation in XXXXXXXXXX.

5. Foreign LLC is a XXXXXXXXXX limited liability company and a wholly-owned subsidiary of Foreign Sub2. Foreign LLC is a disregarded entity, and therefore not treated as a corporation, for purposes of the Code. Based on the CRA's general position on US LLCs, Foreign LLC is not a resident of the US for purposes of the Treaty.

6. The Partnership is a XXXXXXXXXX limited partnership formed pursuant to the Partnership Act. The Partnership was formed as of XXXXXXXXXX. The certificate of formation was filed with the XXXXXXXXXX Department of State on XXXXXXXXXX to form the Partnership effective XXXXXXXXXX. Under XXXXXXXXXX commercial law, a limited partnership governed by the Partnership Act is a separate legal entity formed by the execution and filing of a certificate of limited partnership in the Department of State. It cannot be formed by a limited partnership agreement. The Partnership owns its own assets and has its own liabilities. The assets of the Partnership are not owned by the partners of the Partnership. If the Partnership does not pay its liabilities, any general partner is fully liable, but any limited partner has certain limited liability protection. Interests in the Partnership are assignable to the extent provided for in the Partnership Act and not restricted by the limited partnership agreement governing the Partnership.

7. The Partnership has one general partner, Foreign Sub2 and one limited partner, Foreign LLC. Foreign Sub2 has a XXXXXXXXXX% interest in the Partnership and Foreign LLC has a XXXXXXXXXX% interest in the Partnership. The Partnership is managed by Foreign Sub2. The Partnership received its current name on XXXXXXXXXX. However, there was no change to the ownership interests in the Partnership at that time.

8. The partnership filed an election under section 301.7701-3 of the Code to be treated as a corporation for US income tax purposes effective XXXXXXXXXX. This election is still in effect. Because the Partnership is treated as a corporation formed in the US for US income tax purposes, the Partnership, not each of the partners, is liable to tax in the US on its worldwide income. The Partnership does not have a permanent establishment in Canada, within the meaning of that expression in Article V of the Treaty.

9. Simultaneously with the formation of the Partnership on XXXXXXXXXX, Foreign Sub3 was merged into the Partnership with the Partnership as the surviving entity. As a result of the merger, the Partnership acquired the shares of Can Sub1.

10. Can Sub1 was a wholly-owned subsidiary of the Partnership and Can Sub2 was a wholly-owned subsidiary of Foreign Sub1. Canco was formed on XXXXXXXXXX pursuant to a horizontal amalgamation of Can Sub1 and Can Sub2. Canco is a taxable Canadian corporation amalgamated under the Corporations Act. The Partnership owns XXXXXXXXXX% of the shares of Canco and Foreign Sub1 owns the remaining XXXXXXXXXX% of the shares of Canco. The shares of Canco were issued to the Partnership and to Foreign Sub1 in proportion to the relative values of Can Sub1 and Can Sub2, respectively, at the time of the amalgamation. The shares of Canco are taxable Canadian property to the Partnership. Canco received its current name on XXXXXXXXXX. However, there was no change in the ownership of Canco's shares at that time.

11. Canco is in the business of XXXXXXXXXX. The shares of Canco do not derive their value principally from real property situated in Canada, within the meaning of that expression in paragraph 3 of Article XIII of the Treaty.

12. The Group has commenced other reorganization steps, including the winding-up and dissolution of an inactive Canadian subsidiary. The Group does not contemplate any other reorganization steps that involve any Canadian entity.

13. We understand that, to the best of your knowledge and that of the above taxpayers, none of the issues involved in this advance income tax ruling request:

(i) is in an earlier return of 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 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 an advance income tax ruling previously issued by this Directorate.

Proposed Transactions

14. Foreign Sub1 will incorporate Holdco as a wholly-owned US "C" corporation. Holdco will be a resident of the US for purposes of the Treaty. Foreign Sub1 will then transfer the shares of Canco held by it to Holdco in exchange for XXXXXXXXXX% of the shares of Holdco. Foreign Sub1 will comply with the provisions of section 116 of the Act in connection with this transfer of the shares of Canco to Holdco. Foreign Sub1 will subsequently be merged with, or converted into, a limited liability company that is not treated as a corporation for US income tax purposes. No advance income tax rulings are being requested with respect to Foreign Sub1's proposed transfer of the Canco shares to Holdco.

15. Simultaneously with Foreign Sub1's transfer of the shares of Canco to Holdco, as described in paragraph 14 above, the Partnership will transfer the shares of Canco held by it to Holdco in exchange for XXXXXXXXXX% of the shares of Holdco. Foreign Sub2 and Foreign LLC, the partners of the Partnership, will comply with the provisions of section 116 of the Act in connection with this transfer of the shares of Canco to Holdco. The Partnership will subsequently elect to be treated as a partnership, i.e. no longer a corporation, for US income tax purposes. This election will not have retroactive effect, so that the Partnership will still be treated as a corporation for US income tax purposes at the time that it transfers the shares of Canco to Holdco.

16. The Group will complete other reorganization steps involving its US and foreign entities. In particular, it is contemplated that XXXXXXXXXX after the proposed transactions described in paragraphs 14 and 15 above have been completed.

Purpose of the Proposed Transactions

17. As confirmed by this ruling, the Partnership is currently a resident of the US for purposes of the Treaty. The Partnership is therefore entitled to the benefits of the Treaty with respect to any capital gain to be realized on the disposition of its shares of Canco to Holdco. In particular, Article XIII of the Treaty will exempt the Partnership from Canadian tax on such gain because the shares of Canco do not derive their value principally from Canadian real property. For US state income tax-related reasons (see paragraph 18 below), Foreign Parent has decided to change the US income tax status of Foreign Sub1, Foreign Sub2 and the Partnership so that, instead of being treated as corporations for US income tax purposes, they will be treated as disregarded or flow-through entities for US income tax purposes. In each case, if the shares of Canco continue to be held directly by Foreign Sub1 and the Partnership after this change, the benefits of the Treaty will no longer be available to Foreign Sub1 or to the Partnership. In order to preserve access to the benefits of the Treaty in connection with any future disposition of the shares of Canco (and any future dividends that Canco may pay on its shares), the shares of Canco held by Foreign Sub1 will be transferred to Holdco and the shares of Canco held by the Partnership will be transferred to Holdco.

18. Changing Foreign Sub1 and the Partnership into disregarded, or flow-through, entities for US state income tax purposes will reduce the number of state income tax returns that the Group will be required to file in the future. Although there are no consolidated group income tax returns permitted for state income tax purposes, the Group will effectively achieve consolidation for most state income tax filing purposes. These changes will also achieve consolidation, for state income tax purposes, of interest expenses incurred at the Foreign Parent level with the operating income that will be generated in the lower tier US operating entities in the Group.

Rulings

Provided that:

(a) the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, proposed transactions and the purpose of the proposed transactions;

(b) the proposed transactions are completed in the manner described above; and

(c) there are no other transactions which may be relevant to the rulings requested,

our rulings are as follows:

A. The Partnership will be considered to be a resident of the United States, within the meaning thereof in Article IV of the Treaty, such that any gain realized by the Partnership on the transfer of the shares of Canco to Holdco will not be subject to Canadian income tax in accordance with the provisions of paragraph 4 of Article XIII of the Treaty.

B. Foreign Sub2 and Foreign LLC will be considered to have disposed of taxable Canadian property on the transfer of the shares of Canco to Holdco by the Partnership. However, any gain realized by Foreign Sub2 and Foreign LLC, from the disposition of the Canco shares by the Partnership, will not be subject to Canadian income tax in accordance with Ruling A above.

These rulings are given subject to the limitations and qualifications set out in Information Circular 70-6R5 issued by the Canada Revenue Agency ("CRA") on May 17, 2002, and are binding on the CRA provided that the proposed transactions are completed before XXXXXXXXXX.

These rulings are based on the Act in its present form and do not take into account any proposed amendments to the Act which, if enacted, could have an effect on the rulings provided herein.

Except as expressly stated, this advance income tax ruling does not imply acceptance, approval or confirmation of any other income tax implications of the facts or proposed transactions.

This letter is based solely on the facts and proposed transactions described above. The CRA has not reviewed whether or not the shares of Canco derive their value principally from real property situated in Canada nor has the CRA reviewed whether or not the Partnership has a permanent establishment in Canada.

Yours truly,

XXXXXXXXXX
for Director
International & Trusts Division
Income Tax Rulings Directorate
Policy and Planning Branch