2014-0534751R3 Deemed dividends from ULC holdco and Art IV(7)(b)

Principal Issues: Application of Article IV(7)(b) to deemed dividend payments by Canadian-resident entity that is fiscally transparent for United States income tax purposes.

Position: Article IV(7)(b) does not apply to the payments in question.

Reasons: For the purposes of Article IV(7)(b), the dividends will receive the same United States income tax treatment if the Canadian-resident entity were not fiscally transparent for United States income tax purposes.

Author: XXXXXXXXXX
Section: 84(1), 212(2)(a), 245(2), Canada-US Convention Art. IV(7)(b), Art. X(2)(a)

XXXXXXXXXX
                                                                                                                                                          2014-053475

XXXXXXXXXX, 2014

Dear XXXXXXXXXX,

Re:   XXXXXXXXXX
        Advance Income Tax Ruling Request  

We are writing in reply to your letter of XXXXXXXXXX, in which you requested an Advance Income Tax Ruling on behalf of the above named taxpayer.

The rulings given herein are based solely on the facts, proposed transactions, purpose of the proposed transactions and additional information described below. Any documentation submitted in respect of your request that is not set out below does not form part of the facts and proposed transactions on which these rulings are based and any reference to those documents is provided solely for the convenience of the reader.

To the best of your knowledge and that of the taxpayer involved, none of the issues involved with this request is:

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

(ii)  being considered by a tax services office or a tax centre in connection with a previously filed tax return of  the taxpayer or a related person;

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

(iv)  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 considered by the Income Tax Rulings Directorate. Unless otherwise stated, all references to a statute are to the Income Tax Act (Canada), R.S.C. 1985, c.1 (5th Supp.), as amended to the date of this letter, (the “Act”).

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)   “Convention” means the Convention Between Canada and The United States of America With Respect to Taxes on Income and on Capital;

(b)   “E&P pool” means earnings and profits pool as that concept is understood for U.S. tax purposes;

(c)   “Holdco” means XXXXXXXXXX, a corporation formed under the laws of XXXXXXXXXX and resident in Canada for the purposes of the Act and the Convention;

(d)   “Holdco Loan” means the loan from Opco to Holdco as described in 15 below;

(e)   “Investco” means XXXXXXXXXX, a corporation formed under the laws of XXXXXXXXXX and resident in Canada for the purposes of the Act and the Convention;

(f)   “Opco” means XXXXXXXXXX, a corporation formed under the laws of XXXXXXXXXX and resident in Canada for purposes of the Act and the Convention;

(g)   “ULC” means XXXXXXXXXX, an unlimited liability corporation formed under the laws of XXXXXXXXXX and resident in Canada for purposes of the Act;

(h)   “U.S. Parent” means XXXXXXXXXX, a corporation formed under the laws of XXXXXXXXXX, resident in the United States of America and not resident in Canada for the purposes of the Act and the Convention; and

(i)   “U.S.” means the United States of America.

Facts

1.    The authorized capital stock of U.S. Parent consists of common stock, special voting stock, and preferred stock, although no preferred stock has been issued to date.

2.    The special voting stock of U.S. Parent carries one vote per share but is not entitled to receive dividends or distributions or to receive any consideration in the event of a liquidation, dissolution or wind-up.

3.    The common stock of U.S. Parent is regularly and primarily traded on the XXXXXXXXXX, a recognized stock exchange for the purposes of the Convention, and U.S. Parent is a qualifying person per paragraph 2 of Article XXIX-A of the Convention.

4.    As of XXXXXXXXXX, U.S. Parent’s issued and outstanding shares of special voting stock numbered approximately XXXXXXXXXX and its issued and its outstanding shares of common stock numbered approximately XXXXXXXXXX.

5.    U.S. Parent owns all the issued and outstanding shares of ULC.  For U.S. tax purposes ULC is disregarded as an entity separate from U.S. Parent. ULC’s business number is XXXXXXXXXX.  ULC is serviced by the XXXXXXXXXX tax service office and the XXXXXXXXXX tax centre.

6.    U.S. Parent would be the beneficial owner of any dividend declared and paid by ULC for the purposes of the Convention.

7.    ULC’s legal stated capital is approximately $XXXXXXXXXX.  ULC’s paid up capital is approximately $XXXXXXXXXX and U.S. Parent’s adjusted cost base in respect of the ULC shares is approximately $XXXXXXXXXX.

8.    The authorized capital stock of Holdco consists of common shares and exchangeable shares, which have the following terms and conditions:

a.    any holder of exchangeable shares is entitled at any time to require Holdco to redeem any or all of the exchangeable shares registered in the holder’s name in exchange for an equivalent number of common shares in U.S. Parent, plus a cash payment equal to any amount of accrued and unpaid dividends on the exchangeable shares at the time of redemption;

b.    Holdco has the right to force the exchange of all exchangeable shares for common shares of U.S. Parent (plus a cash payment equal to any amount of accrued and unpaid dividends on the exchangeable shares) at any time after the earlier of XXXXXXXXXX, the date on which fewer than XXXXXXXXXX% of the originally issued exchangeable shares remain outstanding, or the occurrence of certain specified events such as a change of control in U.S. Parent; and

c.    if U.S. Parent declares a dividend on its common stock, the holders of Holdco’s exchangeable shares are entitled to receive from Holdco the same amount as a dividend, or an economically equivalent dividend, on their exchangeable shares.

9.    ULC owns all of the issued and outstanding common shares of Holdco.

10.   The holders of Holdco’s exchangeable shares are the same persons as the holders of U.S. Parent’s special voting stock.  The combination of one Holdco exchangeable share and one share of U.S. Parent’s special voting stock is intended to be the economic equivalent to one share of common stock of U.S. Parent.

11.   The terms and conditions of Holdco’s exchangeable shares are subject to the overriding right of ULC to purchase the exchangeable shares for consideration equal to one share of U.S. Parent’s common stock for each exchangeable share purchased, together with all declared and unpaid dividends on such exchangeable share.  XXXXXXXXXX.

12.   XXXXXXXXXX.  Prior to the initial public offering, Holdco acquired all of the shares of, and then amalgamated with, Investco.  As consideration for the acquisition, Holdco:

a.    issued exchangeable shares to the Canadian shareholders of Investco and provided them with shares of U.S. Parent’s special voting stock, and

b.    provided shares of U.S. Parent’s common stock to the U.S. shareholders of Investco. 

The exchangeable shares issued to the Canadian shareholders of Investco were intended to be a means for the Canadian shareholders to obtain the economic equivalent to shares of U.S. Parent’s common stock on a tax deferred basis as the Act allows for a deferral when property is exchanged for the shares of a Canadian corporation, but not a foreign corporation.

13.   Opco is a XXXXXXXXXX in Canada.  Opco principally XXXXXXXXXX in Canada, as well as through a global network of foreign affiliates and global entities.

14.   In XXXXXXXXXX, Opco declared and paid a dividend to Holdco in the Canadian dollar equivalent of U.S.$XXXXXXXXXX.  Holdco used the proceeds of the dividend to declare and pay a dividend to ULC.  Upon receipt of the proceeds, ULC reduced its stated capital and paid up capital by the Canadian dollar equivalent of U.S.$XXXXXXXXXX and distributed the same amount to U.S. Parent as a return of capital.  U.S. Parent then used these funds to make a contribution to one of its U.S. subsidiaries for the purposes of funding and expanding the corporate group’s U.S. operations.

15.   On XXXXXXXXXX, Opco made a $XXXXXXXXXX unsecured non-revolving demand loan to Holdco.  The purpose of the Holdco Loan was originally to manage the overall cash position of the corporate group.  The principal amount of the funds acquired through the Holdco Loan is held in Holdco’s bank account where it earns interest income.

16.   The Holdco Loan bears interest at the XXXXXXXXXX prime rate and is payable on a XXXXXXXXXX basis.  If Opco does not demand payment beforehand, the Holdco Loan must be paid in full by XXXXXXXXXX.

Proposed Transactions

17.   Opco will declare and pay a dividend out of retained earnings to Holdco.

18.   Holdco will repay the Holdco Loan either before or after the dividend in the above proposed transaction and before the dividend in the following proposed transaction.

19.   Holdco will declare and pay a dividend out of retained earnings to ULC.

20.   ULC will increase, in accordance with the XXXXXXXXXX Business Corporations Act, its stated capital in respect of the shares held by U.S. Parent by an amount equal to the dividend received from Holdco.

21.   ULC will reduce the stated capital of the shares held by U.S. Parent, in accordance with the XXXXXXXXXX Business Corporations Act without redeeming or cancelling those shares, by an amount equal to the amount of the increase described in the above proposed transaction.

22.   ULC will distribute an amount in cash as a return of paid up capital to U.S. Parent in the same amount as the reduction of stated capital, above, less the amount of taxes remitted by ULC on U.S. Parent’s behalf under Part XIII of the Act.

23.   U.S. Parent will use the funds received from ULC to buy-back and redeem a portion of its publically traded common stock.

Purpose of the Proposed Transactions

24.   The purpose of the proposed transactions is to distribute earnings from the business operations of Opco to U.S. Parent to facilitate a buy-back and redemption of U.S. Parent’s common stock in a manner that avoids the application of subparagraph 7(b) of Article 4 of the Convention.

Additional Information

25.   XXXXXXXXXX

26.   For U.S. tax purposes the dividend paid by Holdco to ULC will be considered a dividend paid directly to U.S. Parent and will be taxable in the U.S.

27.   The dividends declared and paid by Opco to Holdco and from Holdco to ULC will be from the respective corporations’ E&P pools.

28.   ULC will not have an E&P pool for its U.S. taxation year in which the proposed transactions take place and no creation of, or addition to, an E&P pool of ULC will result from the proposed transactions.

29.   The increase of the stated capital of ULC’s shares as described in 20 above will result in a deemed dividend under subsection 84(1) of the Act.  However, no amount of income, profit or gain will be recognized for U.S. tax purposes as a result of that transaction.  Likewise, no amount of income, profit or gain would be recognized for U.S. tax purposes as a result of that transaction if ULC was not fiscally transparent under the taxation laws of the U.S.A.

30.   The proposed transactions in 17 to 23 above will not affect the U.S. tax treatment of any subsequent distributions on the ULC shares.

31.   Transactions substantially similar or identical to the proposed transactions in 17 to 23 were completed on XXXXXXXXXX, and XXXXXXXXXX, and are not subject to the rulings given below.  Both of these sets of transactions resulting in distributions from ULC to U.S. Parent were in the amount of U.S. $XXXXXXXXXX.

Rulings Given

Provided the preceding statements constitute a complete and accurate disclosure of all the relevant definitions, facts, proposed transactions, purpose of the proposed transactions, and additional information, our rulings are as follows:

A.    To the extent that ULC is deemed to have paid, and U.S. Parent is deemed to have received, a dividend pursuant to subsection 84(1) of the Act as a result of the proposed transaction described in 20 above, that dividend will be a taxable dividend described in paragraph 212(2)(a) of the Act.

B.    For the purpose of applying Article X of the Convention, the amount of the dividend referred to in Ruling A will be considered to be income, as described in the definition “dividends” in paragraph 3 of Article X of the Convention, that is derived by U.S. Parent.

C.    Paragraph (7)(b) of Article IV of the Convention will not apply to treat the dividend referred to in Ruling A as not having been paid to or derived by U.S. Parent.

D.    The dividend referred to in Ruling A will be subject to Part XIII withholding tax at a rate of 5% pursuant to paragraph 2(a) of Article X of the Convention.

E.    Subsection 245(2) of the Act will not be applied as a result of the proposed transactions in 17 to 23, in and by themselves, to re-determine the tax consequences confirmed in the rulings given above.

The above advance income tax rulings, which are based on the Act and the Convention in their present form and do not take into account any proposed amendments thereto, are given subject to the general limitations and qualifications set out in Information Circular 70-6R5 entitled Advance Income Tax Rulings, dated May 17, 2002, and are binding on the Canada Revenue Agency provided the proposed transactions are completed before XXXXXXXXXX.

Comment

Nothing in this letter should be construed as implying that the CRA has agreed to or reviewed:

(a)   the fair market value or adjusted cost base of any property or the paid-up capital of any shares referred to herein;

(b)   whether ULC is fiscally transparent under the taxation laws of the United States of America for the purposes of the Convention; or

(c)   any other tax consequences relating to the facts, proposed transactions, purpose of the proposed transactions, and additional information described herein other than those specifically described in the rulings provided above.

Yours truly,

XXXXXXXXXX
for Director
International Division
Income Tax Rulings Directorate
Legislative and Regulatory Affairs Branch

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