2016-0670871R3 Post-mortem pipeline

Principal Issues: 1. Does subsection 84(2) apply to the Proposed Transactions? 2. Does the GAAR apply to the Proposed Transactions?

Position: 1. No. Favourable ruling provided. 2. No. Favourable ruling provided.

Reasons: In accordance with the Act and consistent with our previous positions.

Author: XXXXXXXXXX
Section: 84.1, 84(2), 245(2)

XXXXXXXXXX                                                                                                   2016-067087

XXXXXXXXXX, 2017

Dear Sir,

Re: Advance Income Tax Ruling
      XXXXXXXXXX
      XXXXXXXXXX Tax Service Office and XXXXXXXXXX Taxation Centre

This is in reply to your letter dated XXXXXXXXXX in which you requested an advance income tax ruling on behalf of the Taxpayers. We also acknowledge the information provided in your emails.

We understand that to the best of your knowledge and that of the Taxpayers involved, none of the issues described herein are:

(a) in a previously filed return of the Taxpayers or a related person;

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

(c) under objection by the Taxpayers or a related person;

(d) before the courts or, if a judgement has been issued, the time limit for appeal to a higher court has expired; and

(e) the subject of a ruling previously considered by the Income Tax Rulings Directorate.

Unless otherwise noted, all references herein to sections or components thereof are references to the Income Tax Act, R.S.C. 1985, c.1 (5th Supp.), as amended, or the Income Tax Regulations, C.R.C., c. 945, as appropriate, and all references to monetary amounts are in Canadian dollars. 

DEFINITIONS

“A” means the late XXXXXXXXXX;

“A’s children” means the adult children of A and are XXXXXXXXXX;

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

“Act1” means XXXXXXXXXX;

“agreed amount” means the amount agreed on by the transferor and transferee in respect of a transfer of an eligible property in a joint election filed pursuant to subsection 85(1);

“Amalco” means a corporation to be formed by way of an amalgamation of PCo and Newco, as described in the Proposed Transactions;

“arm’s length” has the meaning assigned by subsection 251(1);

“Beneficiary 1” means a testamentary trust created in the Will for the benefit of XXXXXXXXXX (XXXXXXXXXX of A) and XXXXXXXXXX spouse and children;

“Beneficiary 2” means a testamentary trust created in the Will for the benefit of XXXXXXXXXX (XXXXXXXXXX of A) and XXXXXXXXXX spouse and children;

“Beneficiary 3” means a testamentary trust created in the Will for the benefit of XXXXXXXXXX (XXXXXXXXXX of A) and XXXXXXXXXX spouse and children;

“Beneficiary 4” means a testamentary trust created in the Will for the benefit of XXXXXXXXXX (XXXXXXXXXX of A) and XXXXXXXXXX spouse and children;

“Beneficiary 5” means the XXXXXXXXXX, which is an inter-vivos trust established on XXXXXXXXXX for the benefit of XXXXXXXXXX (XXXXXXXXXX of A), and both the XXXXXXXXXX and XXXXXXXXXX are non-residents of Canada;

“Beneficiary 6” means a testamentary trust created in the Will for the benefit of XXXXXXXXXX (XXXXXXXXXX of A) and XXXXXXXXXX spouse and children;

“beneficiaries” means collectively Beneficiary 1, Beneficiary 2, Beneficiary 3, Beneficiary 4, Beneficiary 5 and Beneficiary 6;

“Board of Directors” means the board of directors of PCo and is comprised of the Executors;

“Business” means the dealing and investing in Marketable Securities as described in Paragraph 31;

“capital gain” has the meaning assigned in paragraph 39(1)(a);

“capital property” has the meaning assigned in section 54;

“CCPC” means “Canadian-controlled private corporation” and has the meaning assigned to that term in subsection 125(7);

“CDA” means “capital dividend account” and has the meaning assigned to that term in subsection 89(1);

“CRA” means the Canada Revenue Agency;

“disposition” has the meaning assigned in subsection 248(1);

“eligible property” has the meaning assigned in subsection 85(1.1);

“Estate” means the estate of A governed by the terms of the Will, which will be designated as a GRE when the Executors file the first tax return for the Estate;

“Executors” means the executors of the Estate as appointed by A in his Will and are XXXXXXXXXX;

“Family Office” means XXXXXXXXXX;

“FMV” or “fair market value” means the highest price expressed in terms of money or money’s worth available in an open and unrestricted market between informed, prudent parties, acting at arm’s length and under no compulsion to act, expressed in terms of cash;

“GRE” means “graduated rate estate” and has the meaning assigned to that term in subsection 248(1);

“GRIP” means “general rate income pool” and has the meaning assigned to that term in subsection 89(1);

“JCo” means XXXXXXXXXX, a corporation that is directly and indirectly wholly-owned by A’s children. JCo is a holding company. It owns XXXXXXXXXX Class A shares of Pubco, which represent XXXXXXXXXX% of Pubco’s issued and outstanding Class A shares and XXXXXXXXXX Class B shares of Pubco, which represents XXXXXXXXXX% of Pubco’s issued and outstanding Class B shares;

“JCo Note” means the non-interest bearing demand note issued by JCo and payable to PCo as redemption proceeds in the amount of $XXXXXXXXXX resulting from the redemption of all the JCo preferred shares held by PCo, on XXXXXXXXXX;

“Marketable Securities” means a diversified portfolio of investment property that includes cash and cash equivalents, government and corporate bonds, and shares of public corporations;

“Newco” means a corporation to be incorporated under the provisions of Act1 as described in the Proposed Transactions;

“Newco Class A Preferred Shares” means the Class A Preferred Shares in the capital of Newco of which Newco will be authorized to issue an unlimited amount. The terms and conditions of these shares do not entitle the holder to vote, and each share is redeemable and retractable at a price equal to the FMV of any consideration paid to acquire such share on issuance. The terms and conditions also entitle the holder to non-cumulative dividends as and when declared by the board of directors of Newco and, on the winding-up, liquidation or dissolution of Newco, the holder is entitled to the redemption price in priority to any participation by the holders of the Newco Common Shares;

“Newco Common Shares” means the common shares in the capital of Newco of which Newco will be authorized to issue an unlimited amount. The terms and conditions of these shares entitle the holder to one vote per share, non-cumulative dividends as and when declared by the board of directors of Newco, and participation in the remaining assets of Newco in the event of a wind-up, dissolution or liquidation of Newco;

“Newco Note” means a non-interest-bearing promissory note with no set terms of repayment to be issued by Newco to the Estate as described in the Proposed Transactions;

“non-resident” has the meaning assigned by subsection 248(1);

“Paragraph” refers to a numbered paragraph in this letter;

“PCo” means XXXXXXXXXX, incorporated on XXXXXXXXXX under Act1. XXXXXXXXXX;

“PCo Class C Preference Shares” means the Class C Preference shares in the capital of PCo of which PCo is authorized to issue an unlimited amount. The terms and conditions of these shares entitle the holder to one vote per share, and each share is redeemable and retractable at a price equal to the FMV of any consideration paid to acquire such share on issuance. The terms and conditions also entitle the holder to non-cumulative dividends at a rate of XXXXXXXXXX% of a the redemption price, as and when declared by the Board of Directors, and provide that under no circumstance may PCo suspend the redemption, and that on the winding-up, liquidation or dissolution of PCo, the holder is entitled to the redemption price in priority to any participation by the holders of the PCo Common Shares and PCo Class D Preference Shares;

“PCo Class D Preference Shares” means the Class D Preference shares in the capital of PCo of which PCo is authorized to issue an unlimited amount. The terms and conditions of these shares do not entitle the holder to vote, and each share is redeemable and retractable at a price equal to the FMV of any consideration paid to acquire such share on issuance. The terms and conditions also entitle the holder to non-cumulative dividends at a rate of XXXXXXXXXX% of the redemption price, as and when declared by the Board of Directors, and provide that under no circumstance may PCo suspend the redemption, and that, on the winding-up, liquidation or dissolution of PCo, the holder is entitled to the redemption price in priority to any participation by the holders of the PCo Common Shares;

“PCo Common Shares” means the common shares in the capital of PCo of which PCo is authorized to issue an unlimited amount. The terms and conditions of these shares entitle the holder to one vote per share, non-cumulative dividends as and when declared by the Board of Directors, and participation in the remaining assets of PCo in the event of a wind-up, dissolution or liquidation of PCo;

 “PCo Debt” means a non-interest-bearing, demand obligation that PCo has to the Estate (and formerly to A) that was issued in XXXXXXXXXX and that had a principal amount of approximately $XXXXXXXXXX at the time of A’s death;

“PCo Shares” means collectively, all of the PCo Common Shares, PCo Class C Preference Shares and PCo Class D Preference Shares owned by A at the time of his death and then owned by the Estate after A’s death, as the case may be;

“proceeds of disposition” has the meaning assigned in section 54;

“Proposed Transactions” means the proposed transactions which are described herein under the heading Proposed Transactions;

“Pubco” means XXXXXXXXXX, a public company with two classes of shares: Class A non-voting and Class B voting, XXXXXXXXXX traded on the XXXXXXXXXX Stock Exchange, under the symbol XXXXXXXXXX. Pubco is engaged in the XXXXXXXXXX. A’s children control Pubco through JCo and some children are directly involved in the management and operations of Pubco and some occupy positions on Pubco’s board of directors;

“PUC” means “paid-up capital” and has the meaning assigned to that term in subsection 89(1);

“QSBC shares” means “qualified small business corporation shares” and has the meaning assigned to that term in subsection 110.6(1);

“RDTOH” means “refundable dividend tax on hand” and has the meaning assigned to that term in subsection 129(3);

“R Debt” means an amount owed by PCo to the XXXXXXXXXX in the amount of $XXXXXXXXXX plus accrued interest as at the date of A’s death;

“Remaining PCo shares” means the XXXXXXXXXX PCo Common Shares, XXXXXXXXXX PCo Class C Preference Shares, and XXXXXXXXXX PCo Class D Preference Shares that are not purchased for cancellation, as described in Paragraph 15;

“series of transactions or events” means a series of transactions or events as interpreted by the Courts for purposes of the Act and includes the transactions or events referred to in subsection 248(10);

“resident of Canada” means resident of Canada for purposes of the Act;

“taxable Canadian corporation” has the meaning assigned in subsection 89(1);

“taxable Canadian property” has the meaning assigned in subsection 248(1);

“V-Day basis” means the amount, if any, described in paragraph 84.1(2)(a.1) for purposes of “B” of paragraph 84.1(1)(a); and

“Will” means the secondary last will and testament of A executed on XXXXXXXXXX, as amended by codicil.

FACTS

1. A died on XXXXXXXXXX. A was a resident of Canada.

2. At the time of A’s death, he owned the following PCo Shares, which represented all the issued and outstanding shares of PCo:

                                                                                                           Redemption
Class                                 Number        PUC ($)          ACB ($)         Value ($)
Common                           XXXXX         XXXXX           XXXXX          XXXXX
Class C Preference           XXXXX         XXXXX           XXXXX          XXXXX
Class D Preference           XXXXX         XXXXX           XXXXX          XXXXX

3. The Taxpayers represent that the PCo Shares were capital property to A during his lifetime and at the time of his death.

4. According to the Will, the PCo Shares owned by A at the time of his death are to be divided into six equal parts and distributed to the beneficiaries.

5. Pursuant to paragraph 70(5)(a), A was deemed to have disposed of the PCo Shares immediately before his death and to have received proceeds of disposition equal to the FMV of such shares at that time. The following table identifies the proceeds of disposition and capital gain to be reported in A’s terminal income tax return in respect of each PCo share class:

                                                         Proceeds of
Class                             Number      Disposition                 ACB      Capital Gain
                                                         ($)                              ($)          ($)
Common                        XXXXX       XXXXX                      XXXXX   XXXXX
Class C Preference        XXXXX       XXXXX                     XXXXX    XXXXX
Class D Preference        XXXXX       XXXXX                     XXXXX    XXXXX
Total                                XXXXX      XXXXX                      XXXX      XXXXX

6. Pursuant to paragraph 70(5)(b), the Estate was deemed to have acquired the PCo Shares for an amount equal to the proceeds of disposition as stated in Paragraph 5.  The Estate represents that it holds the PCo Shares as capital property.

7. The Estate represents that it is a resident of Canada, and that its first taxation year-end will be XXXXXXXXXX.

PCo

8. The Taxpayers represent that at all relevant times PCo is a taxable Canadian corporation and a CCPC. PCo has a XXXXXXXXXX taxation year-end.

9. PCo operates the Business. At the time of A’s death, PCo’s assets consisted of cash (representing approximately XXXXXXXXXX% of the FMV of the assets of PCo), Marketable Securities, the JCo Note, and a life insurance policy payable on the death of A. The life insurance policy was issued on XXXXXXXXXX.

10. At the time of A’s death, the FMV and ACB of PCo’s Marketable Securities were $XXXXXXXXXX and $XXXXXXXXXX, respectively and the cash balance within the Marketable Securities represented approximately XXXXXXXXXX% of the FMV of the Marketable Securities at that time.

11. The JCo Note is an illiquid asset of PCo. At the time of this letter, JCo does not have the cash to repay it to PCo nor are there any plans in place to settle it. PCo will not demand repayment of the JCo Note until a date that is after the completion of the Proposed Transactions.

12. At the time of A’s death, PCo’s liabilities included the R Debt and the PCo Debt.

Completed post-mortem transactions

13. As a consequence of A’s death, PCo received life insurance proceeds of $XXXXXXXXXX.

14. On XXXXXXXXXX, PCo had the following balances in its tax accounts:

a) RDTOH - $XXXXXXXXXX;

b) GRIP - $XXXXXXXXXX; and

c) CDA - $XXXXXXXXXX.

15. On XXXXXXXXXX, PCo purchased XXXXXXXXXX PCo Common Shares for cancellation for a note. As a result, PCo was deemed to have paid a dividend to the Estate and the Estate was deemed to have received a dividend equal to the amount by which the amount paid by PCo on the purchase for cancellation exceeded the PUC of such shares, and the Taxpayers represent that the excess was equal to the CDA of PCo at that time, which was $XXXXXXXXXX. By XXXXXXXXXX, this note was fully paid in cash using the life insurance proceeds and some of PCo’s existing cash.

PCo elected, in respect of the full amount of the deemed dividend in prescribed manner and prescribed form and within the time referred to in subsection 83(2), to have the provisions of subsection 83(2) apply.

16. The Estate will report a capital loss equal to the difference between the proceeds of disposition of the XXXXXXXXXX PCo Common Shares (determined pursuant to paragraph (j) of the definition thereof) and the ACB of such shares, less the adjustments under subsection 112(3.2).

17. The Executor will make an election in prescribed manner and within the prescribed time for the purposes of subsection 164(6) such that the Estate’s capital loss to be reported from the disposition of the XXXXXXXXXX PCo Common Shares purchased for cancellation in Paragraph 15 will be deemed to be a capital loss of A in A’s terminal year.

18. Since the time of A’s death, PCo has repaid the R Debt, plus accrued interest and approximately $XXXXXXXXXX of the PCo Debt.

19. XXXXXXXXXX

20. [Reserved]

PROPOSED TRANSACTIONS

The Proposed Transactions will be implemented in the order presented, unless otherwise stated.

21. Newco will be incorporated under the provisions of Act1. Newco will be a CCPC and a taxable Canadian corporation.

22. Newco’s authorized share capital will include two classes of shares: Newco Common Shares and Newco Class A Preferred Shares.

23. The Estate will subscribe for 100 Newco Common Shares for $100, and therefore the Estate will control Newco.

24. The Estate will transfer its Remaining PCo Shares to Newco, and in exchange the Estate will receive the following consideration from Newco:

a) The Newco Note, which will have a principal amount and FMV equal to the lesser of:

(i) the aggregate FMV of the Remaining PCo Shares at the date of A’s death, less $100; or

(ii) the aggregate FMV of the Remaining PCo Shares at the date of the transfer, less $100; plus

b) 100 Class A Newco Preferred Shares with a redemption value and a FMV equal to $100 plus the excess, if any, between the FMV of the Remaining PCo Shares at the date of transfer and at the date of A’s death.

The Estate and Newco will jointly elect, in prescribed form and within the time referred to in subsection 85(6), to have the provisions of subsection 85(1) apply to the transfer of the Remaining PCo Shares held by the Estate to Newco. The agreed amount will be equal to the ACB of the Remaining PCo Shares to the Estate immediately before this transfer, subject to paragraph 85(1)(c). For greater certainty, the agreed amount will not be less than the lesser of the two amounts specified paragraph 85(1)(c.1), and will not be less than the amount described in paragraph 85(1)(b).

Newco will add $100 to the legal stated capital account of the Newco Class A Preferred Shares which, for greater certainty will not exceed the maximum amount that could be added to the PUC of these shares without resulting in an adjustment in computing the PUC having regard to paragraph 84.1(1)(a).

The sum of the principal amount of the Newco Note and the PUC of the 100 Newco Class A Preferred Shares will not exceed the FMV of the Remaining PCo shares immediately before the date of A’s death.

25. PCo will continue to carry on the Business for at least thirty months following the transfer of the Remaining PCo Shares to Newco as described in Paragraph 24.

26. After thirty months has elapsed since the transfer of the Remaining PCo Shares described in Paragraph 24, PCo will be amalgamated with Newco to form Amalco.

27. In accordance with subsection 87(1), all of the property and all of the liabilities of Newco and PCo immediately before the amalgamation will become property and liabilities of Amalco. In addition, the Estate will receive shares in Amalco.

28. The authorized share capital of Amalco will be the same as Newco’s authorized share capital. Moreover, the PUC and ACB of each class of shares that the Estate will hold in Amalco after the amalgamation will be equal to the PUC and ACB of the corresponding classes of issued and outstanding shares that the Estate held in Newco immediately prior to the amalgamation.

29. After the amalgamation, Amalco will begin to make payments on the Newco Note to the Estate. For greater certainty, the amount paid in any single quarter of the first year that the Newco Note is outstanding after the amalgamation will not exceed 15% of the principal amount of the Newco Note when it was first issued.

30. Amalco will continue to carry on the Business, however Amalco will sell some of its Marketable Securities in order to make payments to settle the Newco Note.

ADDITIONAL INFORMATION

31. PCo’s Business is operated by the Family Office as authorized by the Board of Directors since XXXXXXXXXX. The Family Office developed the investment strategy for PCo, which is the preservation of capital and reasonable growth within a moderate risk context. This investment strategy was approved by the Board of Directors, and is reviewed by the Board of Directors at quarterly meetings, and also when material economic events occur. The Family Office works with XXXXXXXXXX investment managers and it has full discretion with respect to buying and selling Marketable Securities for PCo. Trading activities occur on a regular basis, based on internal analysis of key metrics and historical market trends and in consultation with the investment managers.  Family Office also prepares quarterly reporting packages on the performance of the Marketable Securities. The Board of Directors have quarterly review meetings with the Family Office and investment managers to review investment performance, which includes reviewing the quarterly reports and making decisions with respect to the investing of the Marketable Securities. Up until approximately XXXXXXXXXX before his death, A attended the quarterly reviews. The Family Office also works with the Board of Directors to assist with cash flow management and corporate governance. There will not be any material change to the Business operations until a date that is after the completion of the Proposed Transactions, if any.

32. A did not claim a deduction under section 110.6 in respect of the PCo shares. There was no person not dealing at arm’s length with A, and with the Estate that previously claimed a deduction under section 110.6 in respect of the PCo Shares or any shares which they were substituted for, within the meaning of subsection 248(5).

33. For greater certainty, there is no V-Day basis included in the ACB of the PCo Shares, or any shares which they were substituted for, within the meaning of subsection 248(5).

34. The Proposed Transaction steps in Paragraphs 21 to 24 will be completed sometime in the first half of XXXXXXXXXX.

PURPOSE OF THE PROPOSED TRANSACTIONS

The purpose of the Proposed Transactions is to return to the Estate, an amount up to the FMV immediately before A’s death of the Remaining PCo Shares, while minimizing the inherent double tax exposure that can result from the application of subsections 70(5), 84(2) and 84(3).

RULINGS GIVEN

Provided that the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, additional information, proposed transactions and purpose of the proposed transactions and provided that the proposed transactions are completed in the manner described above, we confirm the following:

A. Section 84.1 will not apply to deem the Estate to have received a dividend from Newco, on the disposition to Newco of the Remaining PCo Shares, described in Paragraph 24, provided that the FMV of the Newco Note immediately after the disposition, is equal to or less than the ACB of the Remaining PCo Shares to the Estate, immediately before the disposition.

B. Subsection 84(2) will not apply as a result of the Proposed Transactions, in and by themselves, to deem PCo to have paid, and the Estate to have received, a dividend on the Remaining PCo Shares held by the Estate.

C. The provisions of subsection 245(2) will not apply as a result of the Proposed Transactions, in and by themselves, to re-determine the tax consequences stated in the rulings given above.

The above rulings are given subject to the limitations and qualifications set out in Information Circular 706R7 dated April 22, 2016 and are binding on the CRA provided that the Proposed Transactions are completed within the time frame described in this letter, unless otherwise specified.

The above rulings are based on the law as it presently reads and do not take into account any proposed amendments to the Act and the Regulations which, if enacted, could have an effect on the rulings provided herein.

OTHER COMMENTS

Unless otherwise confirmed in the above rulings, nothing in this letter should be construed as implying that the CRA has confirmed, reviewed or has made any determination in respect of:

(a) the PUC of any share or the ACB or FMV of any property referred to herein;

(b) the balance of the CDA, GRIP, or RDTOH of any corporation;

(c) that the Executors are able to complete the Proposed Transactions under the terms of the Will;

(d) that any person or individuals described herein deal, or do not deal, with any other person or individuals at arm’s length;

(e) the application of section 116 to any future disposition of a capital interest in the Estate by Beneficiary 5; or

(f) any other tax consequence relating to the facts, additional information, Proposed Transactions or any transaction or event taking place either prior to the Proposed Transactions or subsequent to the Proposed Transactions, whether described in this letter or not, including, but not limited to the tax consequences associated with the settlement and distribution of the JCo Note and PCo Debt, as well as any other assets of the Estate, other than those specifically described in the rulings given above.

An invoice for our fees in connection with this ruling request will be forwarded to you under separate cover.

Yours truly,

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

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, 2017

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, 2017