2020-0863701E5 CEWS - Asset Sale Followed by Amalgamation

Principal Issues: Do the continuity rules in subsections 125.7(4.1) and (4.2) apply in conjunction with the continuity rule in paragraph 87(2)(g.6)?

Position: Yes, unless it is reasonable to consider that one of the main purposes of the amalgamation is to cause the new corporation to qualify or increase a payment for the CEWS.

Reasons: Paragraph 87(2)(g.6) applies for the purposes of all of section 125.7. Therefore, based on the specific facts set out in the particular hypothetical scenario provided, Amalco would be deemed to be the same corporation as, and a continuation of Newco when applying subsections 125.7(4.1) and (4.2).

Author: Wharram, Kimberley
Section: Subsection 125.7(4.2) and paragraph 87(2)(g.6)

April 12, 2021

XXXXXXXXXX,                               Headquarters
                                                        Income Tax Rulings Directorate
                                                        André Payette
                                                        2020-086370
Dear XXXXXXXXXX,

Re: Interaction between subsection 125.7(4.2) and paragraph 87(2)(g.6) of the Income Tax Act (Canada). (footnote 1) 

We are writing to you in response to your enquiry of September 11, 2020, relating to the Canada Emergency Wage Subsidy (“CEWS”) in section 125.7. More specifically, you requested confirmation that the continuity rules provided in subsections 125.7(4.1) and (4.2) relating to an acquisition of business assets can be applied in conjunction with the continuity rule in paragraph 87(2)(g.6) dealing with amalgamations.

Background

Current Reference Period and Prior Reference Period

A taxpayer’s entitlement to claim the CEWS under subsection 125.7(2) for a qualifying period will depend on the amount of its qualifying revenue for its applicable “current reference period” as compared to its qualifying revenue for its applicable “prior reference period”. More specifically:

*    a taxpayer that is seeking to claim the CEWS for a qualifying period described in any of paragraphs (a) to (c.1) of the definition of “qualifying period”, will generally not be a “qualifying entity” (and therefore would not be eligible to claims the CEWS for that qualifying period) unless its qualifying revenues for the current reference period are equal to or less than the specified percentage, for the qualifying period, of its qualifying revenues for the prior reference period (the “revenue reduction test”); (footnote 2)  and

*    a taxpayer that is seeking to claim the CEWS for a qualifying period that is described in any of paragraphs (c.2) to (d) of the definition of “qualifying period” will be required to compute its “revenue reduction percentage”, which also requires a comparison between its qualifying revenue for the current reference period and its qualifying revenue for the prior reference period. (footnote 3)

Asset Sale Provisions – Subsections 125.7(4.1) and (4.2)

Subsections 125.7(4.1) and (4.2) are relieving provisions that determine the qualifying revenue of an eligible entity when the eligible entity acquires assets of a person or partnership (the “seller”) during a qualifying period or at any time before that period.

More specifically, subsection 125.7(4.1) sets out the conditions that must be met in order  to allow, under subsection 125.7(4.2), an eligible entity to include in determining its qualifying revenue for its prior reference period or current reference period, as the case may be, for a qualifying period, the amount of the qualifying revenue of the seller of those assets for that period that is reasonably attributable to the acquired assets (“assigned revenue”). The assigned revenue is then subtracted from the qualifying revenue of the seller for the applicable prior reference period or current reference period, as the case may be, for the qualifying period.

Amalgamation Continuity Rule – Paragraph 87(2)(g.6)

Paragraph 87(2)(a) provides that, where there has been an amalgamation of two or more corporations after 1971, the corporate entity formed as a result of the amalgamation shall be deemed to be a new corporation for purposes of the Act. However, paragraph 87(2)(g.6) states that, for purposes of section 125.7, the new corporation is deemed to be the same corporation as, and a continuation of, each predecessor corporation unless it is reasonable to consider that one of the main purposes of the amalgamation is to cause the new corporation to qualify or increase a payment for the CEWS.

Hypothetical Fact Situation

1.    ParentCo and TargetCo are taxable Canadian corporations and are each an “eligible entity” within the meaning assigned by subsection 125.7(1).

2.    In January 2018, ParentCo acquired all of the issued and outstanding shares of TargetCo.

3.    TargetCo carried on a single business (the “TargetCo Business”) and continued carrying on the same business without interruption from the time of the acquisition by ParentCo until the transfer of the TargetCo Business Assets (defined below). The TargetCo Business is carried on exclusively in Canada.

4.    On December 31, 2019, the following reorganization steps were implemented in the following order (the “TargetCo Reorganization”):

Step 1:    A new corporation was incorporated (“Newco”). The authorized share capital of Newco included a class of common shares and a class of preferred shares redeemable at the option of the holder (“Newco Preferred Shares”). Newco is an “eligible entity” within the meaning assigned by subsection 125.7(1).

Step 2:    ParentCo subscribed for 100 common shares of Newco for cash consideration of $100.

Step 3: The authorized share capital of TargetCo was amended and a new class of preferred shares was added (the “TargetCo New Preferred Shares”).

Step 4: TargetCo common shares held by ParentCo were exchanged into new common shares and TargetCo New Preferred Shares.

Step 5: TargetCo transferred and assigned all assets and liabilities used in carrying on the TargetCo Business (the “TargetCo Business Assets”) to Newco in consideration for Newco Preferred Shares.

Step 6: ParentCo transferred the TargetCo New Preferred Shares to Newco in consideration for additional common shares of Newco.

Step 7: TargetCo redeemed all of the TargetCo New Preferred Shares held by Newco in consideration for a promissory note (“Note 1”)

Step 8: Newco redeemed all of the Newco Preferred Shares held by TargetCo in consideration for a promissory note (“Note 2”)

Step 9: Note 1 and Note 2 were set-off against one another.

Step 10: On January 1, 2020, ParentCo and Newco amalgamated to form a new corporation (“Amalco”). The amalgamation met all the requirements set out in subsection 87(1).

5.    The fair market value (“FMV”) of the TargetCo Business Assets acquired by Newco constituted all or substantially all of the FMV of the property of TargetCo used in the course of carrying on the TargetCo Business.

6.    Prior to the transfer of the TargetCo Business Assets described above, all “qualifying revenue” of TargetCo was reasonably attributable to the TargetCo Business Assets.

7.    TargetCo remains in existence for commercial and legal reasons following the transfer of the TargetCo Business Assets.

8.    It is reasonable to conclude that none of the main purposes of the acquisition of the TargetCo Business Assets and the TargetCo Reorganization was to cause Amalco or Newco to qualify for the deemed overpayment under subsection 125.7(2) or to increase the amount thereof.

9.    TargetCo and Amalco (as a successor to Newco) will jointly elect in prescribed form and manner pursuant to paragraph 125.7(4.1)(e) to apply the continuity rule in subsection 125.7(4.2) in respect of each “qualifying period” and will file such election with the Minister of National Revenue (the “Minister”).

10.   Amalco will be an eligible entity in all relevant qualifying periods.

Issue

You have asked us whether the continuity rules provided in subsections 125.7(4.1) and (4.2) can be applied in conjunction with the continuity rule in paragraph 87(2)(g.6) such that the “qualifying revenue” of TargetCo for a “prior reference period” that is reasonably attributable to the TargetCo Business Assets can be taken into account in applying the revenue reduction test to Amalco or in computing Amalco’s “revenue reduction percentage”.

Our Comments

This technical interpretation provides general comments about the provisions of the Act and related legislation (where referenced). 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 70-6R10, Advance Income Tax Rulings and Technical Interpretations.

As noted above, paragraph 87(2)(g.6) states that, generally, for the purposes of section 125.7, an amalgamated corporation is deemed to be the same corporation as, and a continuation of, each predecessor corporation. Since this provision applies for the purposes of all of section 125.7, in our view it would apply for the purposes of subsections 125.7(4.1) and (4.2) such that Amalco would be deemed to be the same corporation as, and a continuation of, Newco when applying these provisions.

Therefore, based on the hypothetical facts outlined above, Amalco (as a continuation of Newco) could meet all the requirements of subsection 125.7(4.1) in respect of a particular qualifying period. Specifically:

1.    Amalco (as a continuation of Newco) acquired assets of TargetCo before the qualifying period;

2.    immediately prior to the acquisition of assets, the FMV of the acquired assets constituted all or substantially all of the FMV of the property of TargetCo used in the course of carrying on the TargetCo Business

3.    the acquired assets were used by TargetCo in the course of a business carried on by TargetCo in Canada;

4.    it is reasonable to conclude that none of the main purposes of the acquisition was to increase the amount of the deemed overpayment under subsection 125.7(2); and

5.    Amalco (as a continuation of Newco) and TargetCo will jointly elect in respect of the qualifying period and file such election with the Minister.

As a consequence, for that particular qualifying period, pursuant to subsection 125.7(4.2) Amalco would be able to include in calculating its qualifying revenue for its prior reference period, the amount of the qualifying revenue of TargetCo for the prior reference period that is reasonably attributable to the TargetCo Business Assets.

We trust that these comments will be of assistance.

Yours truly,

Kimberley J. Wharram
Section Manager
for Director
Reorganizations Division
Income tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

FOOTNOTES

Note to reader:  Because of our system requirements, the footnotes contained in the original document are shown below instead:

1  Unless otherwise stated, all references to a statute are to the Income Tax Act R.S.C. 1985 (5th Supp.), c.1, as amended (the “Act”), and all terms and conditions used herein that are defined in the Act have the meaning given in such definition unless otherwise indicated.
2  See paragraph (c) of the definition “qualifying entity” in subsection 125.7(1).
3  See the definition of “revenue reduction percentage” in subsection 125.7(1).

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