2020-0854091R3 Safe Income and Section 47

Principal Issues: Whether safe income can be averaged across common shares of the same class that are acquired in two separate transactions and whether following a subsection 85(1) transfer where common shares are exchanged for preferred shares and new common shares will the redemption of the preferred shares for their ACB result in a reduction of the safe income associated with the common shares?

Position: The safe income on hand should be averaged across shares of the same class acquired in separate transactions and if there is no inherent gain associated with the preferred shares the redemption of the preferred shares will not result in a reduction of the safe income associated with the common shares.

Reasons: The allocation of safe income on a pro rata basis is consistent with the CRA's existing administrative positions. The safe income on hand associated with common shares that are exchanged for new preferred shares and new common shares should be allocated based on the inherent gain of the shares received if the exchange is made on a rollover basis and the ACB of the shares received equals the ACB of the shares exchanged.

Author: XXXXXXXXXX
Section: 47, 55(2.1)(c), 85(1)(g) and 88(1)(b)

XXXXXXXXXX                                                                                        2020-085409

Dear XXXXXXXXXX:

Re: Advance Income Tax Ruling
      XXXXXXXXXX (collectively referred to as the “Taxpayers”)

This is in reply to your letter dated XXXXXXXXXX (the “Request”) in which you requested an advance income tax ruling on behalf of the Taxpayers.

We understand that to the best of your knowledge and that of the Taxpayers, none of the proposed transactions or issues involved in this Ruling are the same as or substantially similar to transactions or issues that are:

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

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

(d) the subject of a current or completed court process involving the Taxpayers or a related person; or

(e) the subject of a ruling previously considered by the Income Tax Rulings Directorate in relation to the Taxpayers or a related person.

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

This document is based solely on the facts and Proposed Transactions described below. The documentation submitted with the Request does not form part of the facts and Proposed Transactions and any references thereto are provided solely for the convenience of the reader.

DEFINITIONS

In this letter, unless otherwise noted, the following terms have the meanings specified herein. All references in the singular include the plural.

“adjusted cost base” or “ACB” has the meaning assigned by section 54;

“agreed amount” in respect of a property means the amount that a transferor and transferee have agreed upon in a joint election under subsection 85(1) in respect of a transfer of an eligible property;

“CA” means the XXXXXXXXXX;

“Class A Common Shares” has the meaning specified in Paragraph 10;

“Common Shares” means the common shares in the capital of Subsidiary;

“CRA” means the Canada Revenue Agency;

XXXXXXXXXX;

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

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

“fair market value” or “FMV” means the highest price expressed in terms of money or money's worth, available in an open and unrestricted market between knowledgeable, informed, and prudent parties acting at arm's length, neither party being under any compulsion to transact;

“Historical Portion” has the meaning specified in Paragraph 4;

XXXXXXXXXX;

“Holdco” means XXXXXXXXXX;

“New Pref” has the meaning specified in Paragraph 10;

“paid-up capital” or “PUC” has the meaning assigned by subsection 89(1);

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

“Parent” means XXXXXXXXXX;

XXXXXXXXXX;

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

“Proposed Transactions” means the transactions described in Paragraphs 10 to 20;

“public corporation” has the meaning assigned by subsection 89(1);

“Recently Acquired Portion” has the meaning specified in Paragraph 7;

XXXXXXXXXX;

“safe-income determination time” has the meaning assigned by subsection 55(1);

“safe income on hand” in respect of a particular dividend received (as part of a transaction or event or a series of transactions or events) on a particular share means the income earned or realized (as determined for purposes of section 55) by any corporation after 1971 and before the safe-income determination time for the transaction, event or series that could reasonably be considered to contribute to the capital gain that could be realized on a disposition at fair market value of the particular share immediately before the dividend;

“Subsidiary” means XXXXXXXXXX;

XXXXXXXXXX;

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

“XXXXXXXXXX” means the XXXXXXXXXX.

FACTS

1. Parent is a taxable Canadian corporation and a XXXXXXXXXX. Parent’s taxation year-end is XXXXXXXXXX.

2. Holdco is a taxable Canadian corporation, and a wholly owned subsidiary of Parent. It files its Canadian federal income tax returns with the XXXXXXXXXX and is served by the XXXXXXXXXX. Its business number is XXXXXXXXXX. Holdco’s taxation year-end is XXXXXXXXXX.

3. Subsidiary is a taxable Canadian corporation XXXXXXXXXX. It files its Canadian federal income tax returns with the XXXXXXXXXX and is served by the XXXXXXXXXX. Its business number is XXXXXXXXXX. Subsidiary’s taxation year-end is XXXXXXXXXX. Subsidiary’s issued and outstanding preferred shares are listed on the XXXXXXXXXX.

4. Immediately before XXXXXXXXXX, Holdco held a controlling interest in Subsidiary consisting of approximately XXXXXXXXXX% of the issued and outstanding Common Shares (such portion of the Common Shares is referred to as the “Historical Portion”). The remaining interest in Subsidiary’s Common Shares was held by XXXXXXXXXX.

5. Parent’s (direct or indirect) controlling interest in Subsidiary had been held for XXXXXXXXXX. Holdco’s direct controlling interest in Subsidiary was transferred by Parent to Holdco in XXXXXXXXXX and has been held by Holdco since that time.

6. The ACB of the Historical Portion is XXXXXXXXXX per share. There is XXXXXXXXXX safe income on hand associated with the Historical Portion.

7. On XXXXXXXXXX. Parent thereby acquired all issued and outstanding Common Shares not already held by Holdco (such portion of the Common Shares is referred to as the “Recently Acquired Portion”).

8. As a result, Parent and Holdco are now the only holders of Common Shares. In the XXXXXXXXXX a joint election under section 85 (and any corresponding provision of provincial income tax law) with XXXXXXXXXX. The ACB of the recently acquired portion will depend in part on the agreed amounts specified in the applicable joint elections; such ACB is anticipated to be XXXXXXXXXX per share. In view of XXXXXXXXXX, the safe income on hand associated with the recently acquired portion (including any safe income on hand inherited from XXXXXXXXXX with whom Parent makes a joint election under section 85) is expected to be XXXXXXXXXX.

9. XXXXXXXXXX.

PROPOSED TRANSACTIONS

10. Articles of Amendment will be filed for Subsidiary to create (i) a new class of redeemable, retractable preferred shares (“New Pref”), and (ii) a new class of common shares, to be designated as “Class A Common Shares”.

11. The New Pref will be non-voting, and redeemable and retractable at $XXXXXXXXXX per share. The New Pref will rank junior to all of the currently outstanding preferred shares of Subsidiary XXXXXXXXXX. The terms of the New Pref will include a provision for a non-cumulative annual fixed dividend of $XXXXXXXXXX per share, payable if, but only if, declared by the board of directors of Subsidiary in its discretion. It is not currently expected that such dividends will be declared. The terms of the New Pref will provide that, on a liquidation, dissolution or winding-up of Subsidiary, or any reduction of capital or redemption, the sole entitlement of the holder of each New Pref will be to receive the redemption amount of such then outstanding New Pref. The New Pref will be “preferred shares” for purposes of the Act in accordance with subsection 248(1).

12. The holders of the Class A Common Shares, like the holders of the existing Common Shares, will be entitled to dividends at the discretion of the board of directors of Subsidiary, as and when declared in the board’s discretion, and will not carry a defined rate of dividend. Subsidiary’s articles will prohibit the board from declaring a dividend on the Class A Common Shares or the Common Shares if, following payment of such a dividend, Subsidiary would not have sufficient assets to satisfy the aggregate redemption price of the New Pref then outstanding. It is not currently anticipated that this limitation will in fact limit Subsidiary’s ability to pay dividends on the Class A Common Shares or the Common Shares at any time in the foreseeable future.

13. The Class A Common Shares will be identical in all material respects to the Common Shares, except that (i) the stipulated notice period for meetings of shareholders will differ between the Class A Common Shares and the Common Shares, and (ii) the Class A Common Shares will be convertible at the holder’s option into Common Shares on a one-for-one basis (but the Common Shares will not themselves be convertible into Class A Common Shares). Both the issued and outstanding Common Shares and the Class A Common Shares (as and when issued) will be entitled to receive upon liquidation the remaining property of Subsidiary, after satisfaction of the entitlements of all holders of existing preferred shares and New Pref. Neither the issued and outstanding Common Shares nor the Class A Common Shares (as and when issued) will be precluded on any reduction of capital, redemption or purchase for cancellation from participating in the assets of the corporation beyond the amount paid up on the applicable share plus a fixed premium. The Common Shares and the Class A Common Shares will be “common shares” for purposes of the Act in accordance with subsection 248(1).

14. Parent, as the sole shareholder of Holdco, will pass a resolution authorizing and requiring Holdco to be wound up and dissolved into Parent. On the winding-up, Holdco’s assets, including the Historical Portion, will be distributed to Parent and Parent will assume Holdco’s liabilities. As a result of the winding-up, Parent will own all of the Common Shares, consisting of both the recently acquired portion that it has owned since XXXXXXXXXX and the historical portion distributed by Holdco on the winding-up. The filing of articles of dissolution in order to complete Holdco’s dissolution will occur within a reasonable period thereafter.

15. Parent will transfer all of the Common Shares to Subsidiary in exchange for the issuance by Subsidiary of New Pref and Class A Common Shares having an aggregate fair market value equal to the fair market value of the Common Shares so transferred. Such transferred shares will be cancelled upon their acquisition by Subsidiary. Subsidiary will issue New Pref having an aggregate redemption amount no greater than $XXXXXXXXXX, which is estimated to represent no greater than approximately XXXXXXXXXX% of the total fair market value of the transferred Common Shares. The aggregate redemption amount of the New Pref so issued will not exceed the ACB of the transferred Common Shares immediately before the transfer.

16. Subsidiary will add to the stated capital accounts maintained for the New Pref and the Class A Common Shares an aggregate amount that does not exceed the total PUC of the Common Shares transferred and cancelled on the exchange. The amount added to the stated capital account in respect of the New Pref and the Class A Common Shares will be determined by Subsidiary’s board of directors based on the relative fair market value of the shares of each class issued on the exchange.

17. Parent and Subsidiary will file a joint election under section 85 in respect of the transfer of the Common Shares described in Paragraph 15. The agreed amount in respect of the section 85 election will be equal to Parent’s aggregate ACB of the Common Shares immediately before the exchange. The ACB of the New Pref will be $XXXXXXXXXX per share by virtue of paragraph 85(1)(g).

18. Parent will convert all of the issued Class A Common Shares of Subsidiary into Common Shares. Subsidiary will add to the stated capital account maintained for the Common Shares an aggregate amount equal to the total PUC of the converted Class A Common Shares.

19. Subsidiary will declare a cash dividend on the Common Shares equal to XXXXXXXXXX.

20. Subsidiary will effect an additional cash distribution by redeeming all or a portion of the then outstanding New Pref in accordance with their terms. The redemption of the New Pref will not affect the fair market value of the Common Shares.

ADDITIONAL INFORMATION

21. XXXXXXXXXX.

22. As a result of the application of the cost base averaging rules in section 47, there will be an unrealized gain on each Common Share following the winding-up of Holdco described in Paragraph 14.

PURPOSE OF THE PROPOSED TRANSACTIONS

23. The purposes of the Proposed Transactions are to simplify the corporate structure and to ensure that Subsidiary can distribute cash to Parent in a tax-efficient manner having regard to the ACB and safe income on hand currently attributable to the Common Shares.

24. The purpose of creating the Class A Common Shares as described in Paragraph 10 is to ensure that there will be a disposition of the Common Shares by Parent when the Common Shares are transferred to Subsidiary in exchange for the Class A Common Shares and New Pref as described in Paragraph 15. The purpose of converting these Class A Common Shares back to Common Shares in Paragraph 18 is to restore the characteristics of the Parent’s common shares in Subsidiary to those of the Common Shares without the distinct characteristics of the Class A Common Shares as described in Paragraph 13.

25. The purpose of Parent transferring the Common Shares to Subsidiary in exchange for Class A Common Shares and New Pref as described in Paragraph 15 is to isolate a portion of the ACB associated with the Common Shares in the New Pref as described in Paragraph 17 and to enable the additional cash distribution through the redemption of the New Pref for an amount equal to their ACB as described in Paragraph 20.

RULINGS

Provided that the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, proposed transactions and the purpose of the Proposed Transactions, and provided that the Proposed Transactions are completed in the manner described above, we rule as follows:

A. As a result of the acquisition of the Historical Portion by Parent on the wind-up of Holdco, the safe income on hand attributable to the Historical Portion will be averaged across all of the Common Shares held by Parent immediately following the winding-up of Holdco described in Paragraph 14.

B. The safe income on hand attributable to the Common Shares will not be reduced as a result of a redemption of the New Pref.

The above rulings are given subject to the limitations and qualifications set forth in Information Circular 70-6R10 issued on September 29, 2020, and are binding on the CRA provided that the Proposed Transactions are completed before XXXXXXXXXX.

The above rulings are based on the Act in its present form and do not take into account any proposed amendments to the Act, which if enacted, could have an effect on the rulings provided herein.

COMMENTS

Unless otherwise expressively confirmed, nothing in this ruling should be construed as implying that the CRA has confirmed, reviewed, made any determination, or accepted any method for the determination in respect of:

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

b) the safe income on hand attributable to any shares of any corporation referred to herein; or

c) any provincial tax consequences of the Proposed Transactions or any other tax consequence relating to the facts, 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, other than those specifically described in the rulings given above, including whether any of the Proposed Transactions would also be included in a series of transactions or events that includes other transactions or events that are not described in this letter.

Nothing in this letter should be construed as confirmation, express or implied, that, for the purpose of any of the rulings given above, any adjustment to the FMV of the properties transferred or the redemption amount of the shares issued as consideration, whether pursuant to a price adjustment clause or otherwise, will be effective retroactively to the time of the transfer or issuance of shares. Furthermore, none of the rulings given in this letter are intended to apply to, or in the event of, the operation of a price adjustment clause, since such adjustment will be due to circumstances that do not constitute proposed transactions that are seriously contemplated. The general position of the CRA with respect to price adjustment clauses is stated in Income Tax Folio S4-F3-C1, Price Adjustment Clauses, updated to November 26, 2015.

Yours truly,

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

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