2017-0709331E5 Vertical absorptive foreign merger

Principal Issues: Whether paragraph (n) of the definition “disposition” in subsection 248(1) applies to a cancellation of the shares of a foreign affiliate held directly by the survivor corporation in a vertical absorptive foreign merger involving three affiliates.

Position: No.

Reasons: Wording of subparagraph (n)(iii) of the definition “disposition” in subsection 248(1) of the Act.

Author: Eroff, Ina
Section: 248(1) “disposition” (n), 87(8.1), 87(8.2)

XXXXXXXXXX                                                                                                     2017-070933
                                                                                                                             Ina Eroff, B.C.L./LL.B.
September 15, 2017

Dear XXXXXXXXXX:

Re: Vertical absorptive foreign merger involving three foreign affiliates

We are writing in reply to your letter of May 30, 2017 in which you requested our comments on whether paragraph (n) of the definition “disposition” in subsection 248(1) of the Income Tax Act (the “Act”), would apply to a cancellation of the shares of a foreign affiliate held directly by the survivor corporation in a vertical absorptive foreign merger involving three foreign affiliates.

Unless otherwise stated, all statutory references herein are to the Act.

Hypothetical facts:

1. Canco is a corporation resident in Canada that owns all of the shares of a non-resident corporation (“FA1”). 

2. FA1 owns all of the shares of another non-resident corporation (“FA2”), which itself owns all of the shares of a third non-resident corporation (“FA3”).

3. FA1, FA2 and FA3 are residents of the same foreign country, a country with which Canada has concluded a comprehensive income tax treaty.

4. Under a single merger agreement governed by the corporate law of the foreign country, FA2 and FA3 will simultaneously merge with and into FA1, with FA1 being the survivor corporation (the “Merger”). Under the merger agreement, all of the property of FA2 and FA3 (other than the shares of FA3) will become the property of FA1 and all of the liabilities of FA2 and FA3 will become the liabilities of FA1. 

5. FA2 and FA3 will simultaneously cease to exist on the Merger resulting in the shares of FA2 and FA3 being cancelled. 

6. The shares of FA1 held by Canco will remain outstanding, and FA1 will continue as the same legal entity under the foreign law.

7. It is assumed that the Merger will be a merger described in the preamble of subsection 87(8.2) and that it will qualify as a “foreign merger” within the meaning of subsection 87(8.1).

Our comments:

This technical interpretation provides general comments about the provisions of the Act.  It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination. The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R7, Advance Income Tax Rulings and Technical Interpretations.

The definition “disposition” in subsection 248(1) provides for certain inclusions and exclusions. Among other things, paragraph (n) of that definition (“Paragraph N”) excludes a cancellation of a share of the capital stock of a corporation (referred to in that paragraph as the “issuing corporation”) held by another corporation (referred to in that paragraph as the “disposing corporation”) if the cancellation occurs as part of a “foreign merger” (within the meaning assigned by subsection 87(8.1)) of two or more corporations (including the issuing corporation and the disposing corporation) to form one corporate entity (referred to in that paragraph as the “new corporation”), provided the disposing corporation receives no consideration for the share other than property that was, immediately before the merger, owned by the issuing corporation and that, on the merger, becomes property of the new corporation. (The latter condition is contained in clause (iii)(B) of Paragraph N.)

In our view, while Paragraph N would apply to the cancellation of the shares of FA3 held by FA2, because FA2 would receive no consideration for the shares of FA3, Paragraph N would not apply to the cancellation of the shares of FA2. This is so because the shares of FA2 and FA3 would be cancelled simultaneously and, thus, FA1 would simultaneously receive property of both FA2 and FA3 on the Merger. In these circumstances, it is our view that the property of FA3 would be received by FA1 as consideration for the shares of FA2. Since the property of FA3 would not be owned by FA2 immediately before the Merger, Paragraph N would not apply.

We hope this information is of assistance to you and thank you for your enquiry.

Yours truly,

Dave Beaulne, CPA, CA
Director
International Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

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