2014-0537161R3 Reduction of stated capital

Principal Issues: Whether subsection 84(2) applies to a reduction of capital.

Position: Yes

Reasons: Complies with law and CRA administrative positions.

Author: XXXXXXXXXX
Section: 84(4.1), 84(2), 53(2), 40(3)

XXXXXXXXXX
                                                                                                                                            2014-053716

XXXXXXXXXX, 2014

Dear XXXXXXXXXX:

Re:   XXXXXXXXXX
         Advance Income Tax Ruling Request
This is in reply to your letter of XXXXXXXXXX in which you requested an advance income tax ruling on behalf of the taxpayers referred to above.  The documents submitted with your request are part of this document only to the extent described herein.
We understand that to the best of your knowledge and that of the taxpayers on whose behalf this ruling was requested, none of the issues involved in this ruling are:
(a)   in an earlier return of the taxpayers referred to above or a related person;
(b)   being considered by a tax services office or taxation centre in connection with a previously filed tax return of the taxpayers referred to above or a related person;
(c)   under objection by the taxpayers referred to above or a related person;
(d)   in relation to the taxpayers referred to above or a related person, before the courts or the subject of a judgment the time limit for appeal from which has not expired; or
(e)   the subject of a ruling previously considered by the Directorate in relation to the taxpayers referred to above or a related person.
DEFINITIONS
In this letter, unless otherwise indicated, all monetary amounts are expressed in Canadian dollars, and unless otherwise indicated or the context otherwise requires, the following terms have the meanings specified:
“Act” means the Income Tax Act, R.C.S. 1985, c.1 (5th Supp.), as amended to the date hereof and, unless otherwise stated, all references to a section, subsection, paragraph, subparagraph and clause contained herein are to the Act;
“Act 1” means the XXXXXXXXXX;
“Act 2” means the XXXXXXXXXX;
“adjusted cost base” has the meaning assigned by section 54;
“Business” means resource projects in Canada and XXXXXXXXXX focussing on XXXXXXXXXX;
“capital gain” has the meaning assigned by paragraph 39(1)(a);
“capital property” has the meaning assigned by section 54;
“Company” means XXXXXXXXXX;
“designated stock exchange” has the meaning assigned by subsection 248(1);
“disposition” has the meaning assigned by subsection 248(1);
“Exchange” means the XXXXXXXXXX;
“Facts” means the information described in Paragraphs 1 through 25 of this letter;
“fiscal period” has the meaning assigned by subsection 249.1(1);
“paid-up capital” has the meaning assigned by subsection 89(1);
“Paragraph” means a numbered paragraph in this letter;
“principal-business corporation” has the meaning assigned by subsection 66(15);
“Proposed Transactions” means the transactions described in Paragraphs 26 through 29 of this letter;
“public corporation” has the meaning assigned by subsection 89(1);
“Subco1” means XXXXXXXXXX;
“Subco1 Distribution Shares” means the common shares of Subco1 acquired by the Company as described in Paragraph 26;
“Subco1 Loan” means the aggregate of the amounts advanced by the Company to Subco1 as described in Paragraph 19;
“Subco1 Warrants” means the warrants of Subco1 as described in Paragraph 26;
“Subco2” means XXXXXXXXXX;
“Subco3” means XXXXXXXXXX;
“Subco4” means XXXXXXXXXX;
“Subco5” means XXXXXXXXXX;
“taxable Canadian corporation” has the meaning assigned by subsection 89(1);
“taxable dividend” has the meaning assigned by subsection 89(1); and
XXXXXXXXXX.
FACTS
1.    The Company is a corporation incorporated under Act 2 and subsequently continued under Act 1.
2.    The Company is a public corporation, a taxable Canadian corporation and a principal-business corporation.
3.    The Company carries on the Business both directly and through subsidiary corporations.
4.    The fiscal period of the Company ends on XXXXXXXXXX of each year.
5.    The authorized share capital of the Company consists of an unlimited number of common shares, an unlimited number of first preferred shares and an unlimited number of second preferred shares.
6.    There are XXXXXXXXXX common shares in the capital of the Company issued and outstanding.  There are no first preferred shares and no second preferred shares in the capital of the Company issued and outstanding.
7.    The common shares of the Company are listed on the Exchange.
8.    One individual, a non-resident of Canada, owns XXXXXXXXXX common shares of the Company.  The remaining XXXXXXXXXX common shares of the Company are widely held. 
9.    The paid-up capital of the common shares of the Company as a class is $XXXXXXXXXX or $XXXXXXXXXX per common share.
10.   Subco2, a wholly owned subsidiary of the Company, is a corporation incorporated under Act 1.
11.   Subco2 is a taxable Canadian corporation.
11.1. The only asset of Subco2 is a share and warrant investment in XXXXXXXXXX, a public corporation that is listed on the Exchange.
12.   The fiscal period of Subco2 ends on XXXXXXXXXX of each year.
13.   Subco1, a wholly owned subsidiary of the Company, is a corporation incorporated under Act 1.
13.1. Subco1 currently serves as the Canadian holding company for the investments of the Company in XXXXXXXXXX.  The only assets of Subco1 are investments in, and advances to, Subco3.
14.   Subco1 is a taxable Canadian corporation.
15.   The fiscal period of Subco1 ends on XXXXXXXXXX of each year.
16.   The authorized share capital of Subco1 consists of an unlimited number of common shares, an unlimited number of first preferred shares and an unlimited number of second preferred shares.
17.   One common share of Subco1 is issued and outstanding, and is legally and beneficially owned by the Company.  No first preferred shares and no second preferred shares of Subco1 are issued and outstanding.
18.   The Company has engaged a qualified valuator to establish the fair market value of Subco1.  At the time of the Proposed Transactions described in Paragraphs 26 to 28 below, the fair market value of all of the assets of Subco1 will be equal to or will exceed all of the liabilities of Subco1, including the Subco1 Loan.   
19.   The Company has funded Subco1’s acquisition and XXXXXXXXXX activities conducted in XXXXXXXXXX by making non–interest bearing loans to Subco1.  The amount of the Subco1 Loan is approximately $XXXXXXXXXX.
20.   Subco3, a wholly owned subsidiary of Subco1, is a corporation incorporated under the laws of XXXXXXXXXX.
20.1. Subco3 currently serves as the XXXXXXXXXX holding company for the investments of the Company in XXXXXXXXXX.  The only assets of Subco3 are investments in, and advances to, Subco4 and Subco5.
21.   Subco4, a wholly owned subsidiary of Subco3, is a corporation incorporated under the laws of XXXXXXXXXX.
21.1. Subco4 owns and XXXXXXXXXX properties in XXXXXXXXXX.
22.   Subco5, a wholly owned subsidiary of Subco3, is a corporation incorporated under the laws of XXXXXXXXXX.
23.   Subco5 owns and XXXXXXXXXX in XXXXXXXXXX.
24.   Subco3, Subco4, and Subco5 are all resident in XXXXXXXXXX for purposes of the Act.
25.   Since the acquisition of certain XXXXXXXXXX properties by Subco4 and Subco5, in XXXXXXXXXX and XXXXXXXXXX, the only significant XXXXXXXXXX activity undertaken by either of these corporations has been XXXXXXXXXX conducted by or on behalf of Subco5 on property owned by Subco5.  XXXXXXXXXX. 
PROPOSED TRANSACTIONS
The Company proposes to reorganize its Business as follows:
26.   The Company will exchange $XXXXXXXXXX of the Subco1 Loan for XXXXXXXXXX Subco1 common shares (the “Subco1 Distribution Shares”) from treasury and XXXXXXXXXX Subco1 Warrants (the “Subco1 Warrants”).  The Subco1 Warrants, outstanding for up to one year from date of issue, will entitle the holder thereof to purchase one common share of Subco1 at $XXXXXXXXXX per share for the first XXXXXXXXXX months increasing to $XXXXXXXXXX per share for the second XXXXXXXXXX month period.  The amount by which the Subco1 Loan exceeds $XXXXXXXXXX will remain an obligation of Subco1 to the Company.
27.   The Company will reduce the paid-up capital of its common shares in accordance with Act 1 by an amount equal to the aggregate of the fair market value of the Subco1 Distribution Shares and the fair market value of the Subco1 Warrants.  The fair market value of the Subco1 Distribution Shares will be approximately $XXXXXXXXXX per share, and the fair market value of the Subco1 Warrants will be approximately $XXXXXXXXXX per warrant.  For greater certainty, the amount by which the paid-up capital of the Company will be reduced will not exceed the aggregate paid-up capital of the common shares of the Company outstanding at such time.
28.   Concurrent with the reduction of the paid-up capital of its common shares, the Company will distribute, on a pro rata basis, all the Subco1 Distribution Shares, the one common share of Subco1 previously outstanding as described in Paragraph 17 above, and the Subco1 Warrants to the Company’s common shareholders. 
28.1. All or part of the Proposed Transactions will be implemented pursuant to a Plan of Arrangement under Act 1.
29.   At a particular subsequent time, the common shares in the capital of Subco1 will be listed for trading on the Exchange or on another designated stock exchange.
PURPOSE OF THE PROPOSED TRANSACTIONS
30.   After completion of the Proposed Transactions all of the XXXXXXXXXX projects situated in Canada will be owned, directly or indirectly, by the Company and all of the XXXXXXXXXX projects situated in XXXXXXXXXX will be owned, directly or indirectly, by Subco1.  As a result, the value in the properties situated in Canada will be reflected in the value of the common shares of the Company and the value in the properties situated in XXXXXXXXXX will be reflected entirely in the value of the common shares in the capital of Subco1.
The Company believes that it is in the best interests of its shareholders to proceed with the Proposed Transactions as it expects that providing the common shareholders of the Company with separate and direct holdings of Canadian and XXXXXXXXXX opportunities will result in a value enhancement for the common shareholders, and will allow the Company and Subco1 to pursue funding and access capital markets independently based on their different needs and XXXXXXXXXX.
31.   Following the distribution described at Paragraph 28, Subco1 will be an independent entity which will require funding for XXXXXXXXXX activities as well as corporate overhead.  The issuance of the Subco1 Warrants described at Paragraph 26 is intended to partially meet this funding requirement.
ADDITIONAL INFORMATION
32.   The amount of the distribution described in Paragraph 28 will not exceed the paid-up capital of the Company’s common shares that arose as a result of issuances of its shares for cash only. 
33.   The proposed reduction in the issued and paid-up share capital account of the Company’s common shares has not been preceded by an increase in the paid-up capital of that class that has resulted in a dividend which the Company elected to treat as having been paid out of the Company’s 1971 capital surplus on hand.
34.   The reduction of the Company’s issued and paid-up capital share account on the distribution described in Paragraph 28 is a one-time transaction, and is not being made in lieu of ordinary course dividends.
35.   The Company will realize a capital gain on the disposition of its shares of Subco1.
RULINGS
Provided that the preceding statements constitute a complete and accurate disclosure of all relevant facts, proposed transactions, and the purposes of the Proposed Transactions, and provided that the Proposed Transactions are completed as described above, our rulings are as follows:
A.    Subject to the potential application of subsection 40(3), the reduction of the paid-up capital of the common shares of the Company, as described in Paragraph 27, will not, in and by itself, result in a disposition of the common shares by any shareholder of the Company.
B.    Subsection 84(2) will apply, and subsection 84(4.1) will not apply, to the distribution by the Company of the Subco1 Distribution Shares and the Subco1 Warrants to the shareholders of the Company, as described in Paragraph 28, such that the Company will be deemed to have paid to each holder of the Company’s common shares, and each holder of the Company’s common shares will be deemed to have received from the Company, a taxable dividend on the Company’s common shares in an amount, if any, that is equal to the amount by which the aggregate amount of the fair market value of the Subco1 Distribution Shares, and the fair market value of the Subco1 Warrants, received by the shareholder on the distribution exceeds the aggregate amount by which the paid-up capital of the Company’s common shares that are owned by the shareholder is reduced, as described in Paragraph 27.
C.    Where a holder of common shares of the Company holds such shares as capital property, an amount that is equal to the aggregate of the fair market value of the Subco1 Distribution Shares and the fair market value of the Subco1 Warrants which the holder received on the distribution, as described in Paragraph 28, shall be deducted in computing the particular holder’s adjusted cost base of such shares pursuant to subparagraph 53(2)(a)(ii), and where such amount exceeds the particular holder’s adjusted cost base thereof, the excess will be deemed to be a gain of the particular holder for the year from the disposition of such shares under subsection 40(3).
D.    To the extent that a holder of common shares of the Company realizes a capital gain on his common shares as a result of the application of subsection 40(3), in computing the particular holder’s adjusted cost base of such common shares, as the case may be, the amount of the gain will be added to the adjusted cost base of such shares under paragraph 53(1)(a). 
E.    Provided that the distribution by the Company of the Subco1 Distribution Shares and the Subco1 Warrants to the shareholders of the Company, as described in Paragraph 28, does not result in a deemed dividend under subsection 84(2) to any shareholder, subsection 212(2) will not apply to such distribution.
F.    The cost to a holder of common shares of the Company who receives a Subco1 Distribution Share as a consequence of the distribution described in Paragraph 28 will be equal to the fair market value of the Subco1 Distribution Share at the time.
G.    The cost to a holder of common shares of the Company who receives a Subco1 Warrant as a consequence of the distribution described in Paragraph 28 will be equal to the fair market value of the Subco1 Warrant at the time.
H.    Subsection 15(1) and subsection 246(1) will not apply to require any amount in respect of the Subco1 Distribution Shares and the Subco1 Warrants distributed among the holders of common shares of the Company, as described in Paragraph 28, to be included in computing the income of any such shareholder.
Our rulings are given subject to the limitations set out in Information Circular 70-6R5 dated May 17, 2002, and are binding on the CRA provided the Proposed Transactions are completed within six months of the date of this letter.  Our rulings are based on the law as it currently reads and do not take into account any proposed amendments to the Act or Regulations. 
Our Comments
Nothing in this ruling should be construed as implying that CRA has reviewed any tax consequences relating to the facts or the Proposed Transactions other than those described in the rulings given above, or has agreed:
(a)   to the fair market value or adjusted cost base of any asset or to the paid-up capital of any share; or
(b)   to any tax consequences relating to any transaction described herein other than those specifically described in the rulings given above.
Yours truly,

for Director
Reorganizations and Resources Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

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