2015-0604451R3 95(2)(a)(i)

Principal Issues: Does subparagraph 95(2)(a)(i) apply to recharacterize the income from property earned by the single-purpose controlled foreign affiliates from a commercial real estate investment that comprises part of the investments required to be held by another foreign affiliate to XXXXXXXXXX of its XXXXXXXXXX business?

Position: Yes

Reasons: Subparagraph 95(2)(a)(i) will apply to include a certain proportion of the income earned by each foreign affiliate from its real estate investment in its income from an active business to the extent that the shares of that foreign affiliate are directly or indirectly held by foreign affiliates engaged in an active regulated XXXXXXXXXX business and those shares are XXXXXXXXXX in that business within the quantum and in the manner required by the relevant local regulatory authority.

Author: XXXXXXXXXX
Section: 95(2)(a)(i)

XXXXXXXXXX
                                                                                                                                      2015-060445

XXXXXXXXXX, 2016

Dear XXXXXXXXXX:

Re:  Advance Income Tax Ruling
        XXXXXXXXXX

This is in reply to your letter of XXXXXXXXXX wherein you requested an advance income tax ruling on behalf of the above-noted taxpayer. We also acknowledge the additional information provided to us in your emails, the last of which was dated XXXXXXXXXX.

To the best of your knowledge, and that of the above-noted taxpayer, none of the issues involved in this advance income tax ruling are:

(i)   in an earlier tax return of the above-noted taxpayer or of a related person;

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

(iii) under objection by the above-noted taxpayer or by 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)   the subject of a ruling previously considered by the Income Tax Rulings Directorate in connection with the above-noted taxpayer or a related person.

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”) or the Income Tax Regulations (the “Regulations”).

Our understanding of the Facts, Proposed Transactions, Purpose of the Proposed Transactions and Additional Information is as follows:

Definitions

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

a.    “active business” has the meaning assigned to that term in subsection 95(1) of the Act;

b.    “ACB” means adjusted cost base and has the meaning assigned to that term in section 54 of the Act;

c.    “Canco” means: XXXXXXXXXX;

d.    “common shares” has the meaning assigned to that term in subsection 248(1) of the Act;

e.    “controlled foreign affiliate” has the meaning assigned to that term in subsection 95(1) of the Act; 

f.    “CRA” means Canada Revenue Agency;

g.    “FMV” means fair market value;

h.    “foreign affiliate” has the meaning assigned to that term in subsection 95(1) of the Act;

i.    “FA1” means: XXXXXXXXXX;

j.    “FA2” means: XXXXXXXXXX;

k.    “FA3” means: XXXXXXXXXX;

l.    “FA4” means: XXXXXXXXXX;

m.    “FA5” means: XXXXXXXXXX;

n.    “FA6” means: XXXXXXXXXX;

o.    “FA7” means: XXXXXXXXXX;

p.    “FA8” means: XXXXXXXXXX;

q.    “FA9” means: XXXXXXXXXX;

r.    “FA Holdco” means: a corporation to be formed under the laws of XXXXXXXXXX;

s.    “investment business” has the meaning assigned to that term by subsection 95(1) of the Act;

t.    “Property Co” means a corporation that holds one or more real estate properties in XXXXXXXXXX that will be newly formed for that single purpose;

u.    “public corporation” has the meaning assigned to that term by subsection 89(1) of the Act;

v.    “qualifying interest” has the meaning assigned to that term by paragraph 95(2)(m) of the Act;

w.    “Regional FAs” means, collectively, FA1, FA2, FA3, FA4, FA5, FA7, FA8 and FA9; and

x.    “taxable Canadian corporation” has the meaning assigned to that term in subsection 89(1) of the Act.

FACTS

1.    Canco is a XXXXXXXXXX that is resident in Canada for purposes of the Act.  Canco carries on XXXXXXXXXX business in Canada and elsewhere. Canco is a taxable Canadian corporation.

2.    FA1, FA2, FA3, FA4, FA5, FA6, FA7, FA8 and FA9 are each corporations that are not resident in Canada for purposes of the Act, and are each controlled foreign affiliates of Canco in which Canco has a qualifying interest.  Each of FA1, FA2, FA3, FA4, FA5, FA6, FA7, FA8 and FA9 is resident in a designated treaty country as defined in subsection 5907(11) of the Regulations.

3.    FA6 is an indirect wholly-owned subsidiary of Canco.  FA6 is the principal holding company for the group’s XXXXXXXXXX businesses and carries on all activities relevant to its function as a holding company, including making loans and other similar transactions with related parties.

4.    FA1, FA2, FA3, FA4, FA5, FA7, FA8 and FA9 are each direct or indirect wholly-owned subsidiaries of FA6, except that (i) Canco holds approximately XXXXXXXXXX% of the outstanding shares of FA7 directly, and (ii) an arm’s-length third party holds less than XXXXXXXXXX% of the outstanding shares of FA8.

5.    FA1, FA3, FA4, FA5, FA7, FA8 and FA9 each carry on active regulated XXXXXXXXXX businesses in XXXXXXXXXX.  The business of each of FA1, FA3, FA4, FA5, FA7, FA8 and FA9 includes XXXXXXXXXX to arm’s length XXXXXXXXXX who are resident in countries that have a tax treaty with Canada.  Each of these corporations earns income from an active business.

6.    FA2 earns income from XXXXXXXXXX of FA5.  FA2’s XXXXXXXXXX income is included in computing its income from an active business pursuant to clause 95(2)(a)(ii)(B) and subparagraph 95(2)(a)(i).

7.    FA1 and FA9 own real estate, used as offices in the operation of their respective active regulated XXXXXXXXXX businesses in XXXXXXXXXX, while FA5 owns commercial real estate in XXXXXXXXXX for investment purposes.  Although FA3, FA4, FA7 and FA8 do not own any commercial real estate, each may acquire commercial real estate prior to the proposed transactions discussed below.

8.    The commercial real estate held by FA5 for investment purposes comprises part of the investments held by FA5 to XXXXXXXXXX.  Income from this commercial real estate investment is included by FA5 in computing its income from an active business.

9.    The amount of investments XXXXXXXXXX of FA5 (XXXXXXXXXX of FA2) does not exceed the size of its XXXXXXXXXX as determined by the higher of the applicable local GAAP and IFRS.

PROPOSED TRANSACTIONS

10.   FA6 will establish a new corporation (“FA Holdco”). FA Holdco will not be resident in Canada for purposes of the Act, and will be a controlled foreign affiliate of Canco.  FA Holdco will be resident in a designated treaty country as defined in subsection 5907(11) of the Regulations.

11.   FA Holdco will establish one or more Property Cos that will be held by FA Holdco, either directly or indirectly.

12.   The Property Cos will make real estate investments including the acquisition of the real estate currently owned by FA1, FA5 and FA9 and other commercial real estate, as discussed further below, in order to facilitate the creation of a combined XXXXXXXXXX division pool of real estate investments.

13.   Each real estate investment will be held by a Property Co.  The Property Cos will not be resident in Canada for purposes of the Act and will be controlled foreign affiliates of Canco in which Canco has a qualifying interest.  The Property Cos will each be resident in a designated treaty country as defined in subsection 5907(11) of the Regulations.

The number of Property Cos at any time will be determined by commercial considerations (including the particular country in XXXXXXXXXX in which a particular real estate investment is located, and the desire to limit liability through use of holding certain investments in separate legal entities).

14.   The property owned by FA1 will be transferred to a Property Co in exchange for cash or shares of that Property Co.  If the property is transferred in exchange for shares, FA1 would then transfer the shares of the Property Co to FA Holdco in exchange for shares of FA Holdco. To the extent that FA2, FA3 or FA4 acquires commercial real estate prior to the proposed transactions, they would transfer the property to a Property Co in the manner described in respect of FA1.

15.   The properties owned by FA5 and FA9 will each be transferred to a Property Co in exchange for cash or shares of the Property Co. To the extent that FA7 and FA8 acquire commercial real estate prior to the proposed transactions, they would transfer the property as described in respect of FA5 and FA9.

16.   For new property acquisitions:

a.    FA1, FA2, FA3 and FA4 will subscribe for shares of FA Holdco for an amount in cash equal to the FMV of the relevant property to be acquired.

b.    FA Holdco in turn will, directly or indirectly, subscribe for shares of the relevant Property Cos for an amount in cash equal to the FMV of the relevant property to be acquired.

c.    Each Property Co would then acquire the relevant property for an amount in cash equal to the FMV of the property.

17.   The decision of FA1, FA3, FA4, FA5, FA7, FA8 and FA9 to transfer any interest in a real estate investment to a Property Co, or to acquire shares in FA Holdco, will be based on local legal, regulatory and other commercial considerations.

18.   Due to local regulatory requirements, FA5, FA7, FA8 and FA9 may directly acquire shares in a Property Co that holds real estate in the jurisdiction in which FA5, FA7, FA8 and FA9, respectively, carries on its business rather than acquiring shares of FA Holdco. However, it is also possible that at some time in the future, FA5, FA7, FA8 and FA9 may invest directly in FA Holdco if permitted by the relevant local regulatory authorities.

19.   At the completion of the Proposed Transactions, all of the outstanding voting shares of FA Holdco (the “Voting Shares”) will be held by FA6, and all of the outstanding non-voting common shares of FA Holdco (the “Non-voting Shares”) will be held by FA1, FA2, FA3 and FA4.

20.   The Voting Shares will be limited-participation shares entitled to one vote per share and will be issued for an aggregate subscription price that does not exceed $XXXXXXXXXX.  The dividend and liquidation entitlements of the Voting Shares will not exceed $XXXXXXXXXX per year and $XXXXXXXXXX, respectively.

21.   The Non-voting Shares will not be entitled to vote, and will be entitled to unlimited dividends after payment of any dividends on the Voting Shares. The Non-voting Shares will be entitled to any remaining assets on liquidation after satisfying any obligations to creditors and paying the liquidation entitlement of the Voting Shares.

22.   The amount of investments in FA Holdco by FA1, FA2, FA3 and FA4, or the amount of investments in a Property Co by FA5, FA7, FA8 and FA9, will be determined based on the needs of their respective active businesses from time to time.  Specifically, each of their investments in FA Holdco or a Property Co will be held XXXXXXXXXX as part of the active regulated XXXXXXXXXX businesses carried on by the Regional FAs and held to support the XXXXXXXXXX associated with such active regulated XXXXXXXXXX business within the quantum and in the manner required by the relevant local regulatory authority.

23.   In the event that FA1, FA2, FA3 or FA4 wish to reduce their exposure to FA Holdco in the future, or if FA5, FA7, FA8 or FA9 wish to reduce their exposure to a Property Co in the future, they may sell shares of FA Holdco or a Property Co to FA Holdco, to each other, or to another controlled foreign affiliate of Canco.  In the event that no controlled foreign affiliate of Canco has a need for the relevant exposure to a FA Holdco or a Property Co then it is possible that Canco may acquire and hold shares of FA Holdco directly for the purpose of providing liquidity to its controlled foreign affiliates, and that FA Holdco may in turn increase its investment in a particular Property Co.

THE PURPOSE OF THE PROPOSED TRANSACTIONS

24.   The purpose of the proposed transactions is to create a combined XXXXXXXXXX division pool of real estate investments that will facilitate XXXXXXXXXX real estate acquisitions and reduce risks to the various regulated XXXXXXXXXX companies in the group.  By diversifying across several markets the risk/return profile for the pool is anticipated to be superior to that of individual real estate exposures.

25.   Under the current business model, each XXXXXXXXXX company in the group that holds a particular real estate investment has its risks concentrated in the specific country and property in which it invests.  Following the proposed transactions, FA1, FA2, FA3 and FA4 will be able to instead hold shares of FA Holdco XXXXXXXXXX – providing each of FA1, FA2, FA3 and FA4 with a broader exposure to a more diverse real estate investment pool.  This allows each of FA1, FA2, FA3 and FA4 exposure to investments in a broader range of investments in multiple XXXXXXXXXX countries.  This broader exposure, in turn, will facilitate acquisitions which in some cases are currently limited by applicable country and property risk concentration limits.

26.   The purpose for FA5, FA7, FA8 and FA9 investing directly in Property Cos is to allow FA5, FA7, FA8 and FA9 continued exposure to real estate investments in a manner that complies with local regulatory requirements – together with the flexibility to invest in FA Holdco if permitted by the relevant local regulatory authorities.

RULING

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 completed in the manner described above, we rule as follows:

In respect of the investments described in paragraph 22 above, subparagraph 95(2)(a)(i) will apply to include in computing the income or loss from an active business of a particular Property Co for the taxation year a portion of the income or loss that would otherwise be the income or loss from property of the particular Property Co. Specifically, subparagraph 95(2)(a)(i) will apply to the proportion of the income or loss that the average of all amounts each of which is the FMV of the shares of the particular Property Co that are held (either directly or indirectly) by the Regional FAs at the beginning of each month throughout the relevant taxation year is of the average of all amounts each of which is the FMV of all the outstanding shares of the particular Property Co at the beginning of each month throughout the relevant taxation year.

For the purposes of the above computation, a Regional FA will be considered to hold the number of shares of a Property Co that are held by FA Holdco (either directly or by a wholly owned corporation (as defined in subsection 85(1.3)) that is equal to the proportion of such shares that is the average of all amounts each of which is the FMV of the shares of FA Holdco held by the Regional FA at the beginning of each month throughout the relevant taxation year is of the average of all amounts each of which is the FMV of all the outstanding shares of FA Holdco at the beginning of each month throughout the relevant taxation year.

This Ruling is given subject to the limitations and qualifications set out in Information Circular 70-6R6 and is binding on the Canada Revenue Agency provided that the Proposed Transactions above are completed before XXXXXXXXXX, except that, if one or more of the Regional FAs does not transfer any interest in a real estate investment to a Property Co or acquire shares in FA Holdco (such as due to local legal or regulatory considerations), that in and of itself would not invalidate this Ruling in respect of the other Regional FAs.

Caveats

The Ruling given is based solely on the Facts, Proposed Transactions and Purpose of the Proposed Transactions described above. Any documentation submitted in respect of your request does not form part of the Facts and Proposed Transactions, and any references thereto are provided solely for the convenience of the reader.  Nothing in this letter should be construed as implying that the Canada Revenue Agency has agreed to, reviewed or has made any determination in respect of any tax consequences relating to the Facts and Proposed Transactions described herein other than those specifically described in the ruling given above and, in particular, without limiting the generality of the foregoing, in respect of:

*     any income tax considerations associated with the transfer or issuance of shares or the transfer of property or any of the intermediary transaction steps which give rise to the final proposed structure;

*     any considerations in connection with the XXXXXXXXXX required by regulatory authorities or regulations to XXXXXXXXXX of any particular entity;

*     the FMV or ACB of any property or shares referred to herein; and

*     the reasonableness of any amount.

Yours truly,

XXXXXXXXXX
For Director
International Division
Income Tax Rulings Directorate

All rights reserved. Permission is granted to electronically copy and to print in hard copy for internal use only. No part of this information may be reproduced, modified, transmitted or redistributed in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, or stored in a retrieval system for any purpose other than noted above (including sales), without the prior written permission of Canada Revenue Agency, Ottawa, Ontario K1A 0L5.

© Her Majesty the Queen in Right of Canada, 2016

Tous droits réservés. Il est permis de copier sous forme électronique ou d'imprimer pour un usage interne seulement. Toutefois, il est interdit de reproduire, de modifier, de transmettre ou de redistribuer de l'information, sous quelque forme ou par quelque moyen que ce soit, de façon électronique, mécanique, photocopies ou autre, ou par stockage dans des systèmes d'extraction ou pour tout usage autre que ceux susmentionnés (incluant pour fin commerciale), sans l'autorisation écrite préalable de l'Agence du revenu du Canada, Ottawa, Ontario K1A 0L5.

© Sa Majesté la Reine du Chef du Canada, 2016