2020-0874851R3 Post-mortem Hybrid Pipeline

Principal Issues: 1. Does paragraph 84.1(1)(b) deem a dividend on the transfer of the shares of the "original corporation" to the "pipeline corporation"? 2. Does subsection 84(2) apply to deem a dividend in the Proposed Transactions? 3. Does the GAAR apply to re-characterize the Proposed Transactions?

Position: 1. No. 2. No. 3. No. Favourable Rulings given.

Reasons: In accordance with the Act and relevant jurisprudence, as well as our previous positions.

Author: XXXXXXXXXX
Section: Ss. 40(3.6); 40(3.61); 70(5); 83(2) 84(2); 89(14); 85(1); 84.1)(1); 87(3); 112(3.2); 164(6); 186(4); 251(1); 251(2); 245(2)

XXXXXXXXXX

XXXXXXXXXX, 2021

                                                                                                                                  2020-087485

Object:     Income Tax Ruling – Post-Mortem Planning
                XXXXXXXXXX

Dear XXXXXXXXXX,

We are writing in response to your request for an advance income tax ruling (“Ruling Request”) dated XXXXXXXXXX on behalf of the above-noted Taxpayers. We also acknowledge the additional information provided in various email correspondence, as well as the information provided during telephone conversations.

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

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

(i)   being considered by the CRA in connection with any such tax return;

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

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

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

The addresses, tax account numbers, Tax Services Offices and the Tax Centres of the Taxpayers involved are as follows:

XXXXXXXXXX

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

Unless otherwise stated:

1.    all statutory references are to provisions of the Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.), as amended (the “Act”) and all references to regulations are to the Income Tax Regulations, C.R.C., c. 945, as amended (the “Regulations”);

2.    each term or expression mentioned in this letter and for which the Act (or the Regulations) provide a definition has the meaning given to it by that definition;

3.    all amounts are in Canadian dollars;

4.    Words importing the singular number only include the plural and vice versa.

I.    DEFINITIONS

The following abbreviations, terms and expressions have the meanings specified, and the relevant parties to the Proposed Transactions (as defined below) will be referred to as follows:

“A” means the late XXXXXXXXXX, the parent of Beneficiary1 and Beneficiary2;

“Act1” means the XXXXXXXXXX;

“adjusted cost base” has the meaning assigned in section 54;

“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 the new corporation formed on the amalgamation between the Corporation and Newco under Act1, as described in Paragraph 32;

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

“Beneficiary1” means XXXXXXXXXX, a resident of Canada, a child of A, and sibling of Beneficiary2;

“Beneficiary2” means XXXXXXXXXX, a resident of Canada, a child of A, and sibling of Beneficiary1;

“Beneficiary3” means XXXXXXXXXX, a resident of Canada, a grandchild of A, a child of Beneficiary1, and sibling of Beneficiary 4;  

“Beneficiary4” means XXXXXXXXXX, a resident of Canada, a grandchild of A, a child of Beneficiary1, and sibling of Beneficiary 3;

“Beneficiary5” means XXXXXXXXXX, a resident of Canada, a grandchild of A, a child of Beneficiary2, and sibling of Beneficiary6, Beneficiary7, and Beneficiary8;

“Beneficiary6” means XXXXXXXXXX, a resident of Canada, a grandchild of A, a child of Beneficiary2, and sibling of Beneficiary5, Beneficiary7, and Beneficiary8;

“Beneficiary7” means XXXXXXXXXX, a resident of Canada, a grandchild of A, a child of Beneficiary2, and sibling of Beneficiary5, Beneficiary6, and Beneficiary8;

“Beneficiary8” means XXXXXXXXXX, a resident of Canada, a grandchild of A, a child of Beneficiary2, and sibling of Beneficiary5, Beneficiary6, and Beneficiary7;

“Canadian-controlled private corporation” has the meaning assigned in subsection 125(7);

“capital dividend” means a dividend to which subsection 83(2) applies;

“capital property” has the meaning assigned in subsection 54(1);

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

“Class A Common Shares” means the XXXXXXXXXX Class A common shares of the Corporation as described in Paragraph 17;

“Class A Preferred Shares” means the XXXXXXXXXX Class A preferred shares of the Corporation as described in Paragraph 17;

“Corporation” means XXXXXXXXXX, a body corporate formed on a vertical amalgamation on XXXXXXXXXX under Act1 of XXXXXXXXXX and its wholly owned subsidiary, XXXXXXXXXX;  

“CRA” means the Canada Revenue Agency;

“ERDTOH” has the meaning assigned to the term “eligible refundable dividend tax on hand” in subsection 129(4);

“Estate” means the estate of A whose beneficiaries are Beneficiary1, Beneficiary2, Beneficiary3, Beneficiary4, Beneficiary5, Beneficiary6, Beneficiary7, Beneficiary8;

“Executors” means XXXXXXXXXX and XXXXXXXXXX, the executors of the Estate, who were appointed as executors of the Estate pursuant to the terms of the Will;

“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;

“graduated rate estate” has the meaning assigned in subsection 248(1);

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

“Marketable Securities” means the diversified portfolio of investment property held by the Corporation that includes cash and cash equivalents, bonds, and equity;

“NERDTOH” has the meaning assigned to the term “non-eligible refundable dividend tax on hand” in subsection 129(4);

“Newco” refers to a corporation to be incorporated pursuant to Act1;

“Newco Common Shares” means the XXXXXXXXXX common shares of Newco issued in consideration for the transfer of the Class A Common Shares of the Corporation to Newco, as described in Paragraph 29;

“Newco Loan” means the loan of $XXXXXXXXXX made by the Corporation to Newco as described in Paragraph 30;

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

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

“PN1” means the non-interesting bearing demand promissory note issued by the Corporation to the Estate in full payment and satisfaction of the redemption  price of the Class A Preferred Shares, having a principal amount of $XXXXXXXXXX and as described in Paragraph 23;

“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;

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

“Shareholder Loan” means the $XXXXXXXXXX debt owing by A to the Corporation immediately before her death which then became owing by the Estate to the Corporation as a result of A’s death;

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

“Will” means A’s last will and testament with respect to the shares of the Corporation.

II.   FACTS

A complete description of all the relevant facts is as follows:

1.    A passed away on XXXXXXXXXX.

2.    The Corporation was at all relevant times and is a Canadian-controlled private corporation and a taxable Canadian corporation. The Corporation has a taxation year end of XXXXXXXXXX. 

3.    The authorized share capital of the Corporation consists of an unlimited number of common shares. The common shares are voting, entitle the holder to discretionary dividends and to participate in the property and assets of the Corporation on dissolution. 

4.    The Corporation is a holding corporation whose main assets are Marketable Securities; the other assets of the Corporation consist of shares in related entities. Immediately before the time of A’s death, the aggregate fair market value of the Marketable Securities was approximately $XXXXXXXXXX.

5.    The Marketable Securities are comprised of approximately XXXXXXXXXX% equity investments and XXXXXXXXXX% bond investments which were held with the overall goal of generating long-term capital gains. The portfolio is managed by a number of investment advisors who are affiliated with XXXXXXXXXX.

6.    The mix and value of the Marketable Securities remain substantially the same as before A’s death. There will not be any material change with regard to the investment policies observed by the investment advisors. There will not be any material change to the investment and management activities carried on by the Corporation from the date of the Ruling Request until the date the Proposed Transactions are completed and thereafter, except as described herein.

7.    Immediately before A’s time of death, the Corporation had the following tax accounts in the following approximate amounts:

a.    ERDTOH – $XXXXXXXXXX;

b.    NERDTOH – $XXXXXXXXXX;

c.    GRIP – $XXXXXXXXXX;

d.    CDA – the current balance is nil; however, the Corporation would have to realize net taxable capital gains in excess of approximately $XXXXXXXXXX in order for the CDA balance to be positive; and

e.    Net capital losses – $XXXXXXXXXX.

8.    Immediately before A’s time of death, the total accrued net capital gains on the Marketable Securities was approximately $XXXXXXXXXX.

9.    Immediately before her death, A held XXXXXXXXXX common shares of the capital stock of the Corporation with an estimated fair market value of approximately $XXXXXXXXXX and paid-up capital of $XXXXXXXXXX. The adjusted cost base of the common shares to A was $XXXXXXXXXX.

10.   The XXXXXXXXXX common shares of the Corporation are not, and have never been, qualified small business corporation shares. As a result, A was not eligible to claim the deduction under section 110.6 on the shares nor did A, or any person not dealing at arm’s length with A, previously claim the deduction under that provision in respect of the shares or shares for which the shares were substituted within the meaning of subsection 248(5).

11.   Pursuant to paragraph 70(5)(a), immediately before her death, A was deemed to have disposed of the XXXXXXXXXX common shares of the Corporation and to have received proceeds of disposition equal to the fair market value of those shares immediately before her death.

12.   A capital gain of approximately $XXXXXXXXXX will be reported on A’s final tax return. Approximately $XXXXXXXXXX of income taxes will be payable in respect of A’s final taxation year on or before XXXXXXXXXX.

13.   Pursuant to the Will, Beneficiary1 and Beneficiary2 will each acquire XXXXXXXXXX% of the residue of the Estate and Beneficiary3, Beneficiary4, Beneficiary5, Beneficiary6, Beneficiary7, and Beneficiary8 will each acquire XXXXXXXXXX% of the residue of the Estate. Separate testamentary trusts are to be created by the Will for each of Beneficiary3 and Beneficiary4 such that each of their shares of the Estate will be invested until each attains the age of XXXXXXXXXX when XXXXXXXXXX of the capital and accumulated income of such trust shall be distributed to them. The remainder of the trust property will be distributed when each attains the age of XXXXXXXXXX. A separate testamentary trust is to be created for each of Beneficiary5, Beneficiary6, Beneficiary7, and Beneficiary8 such that each of their shares of the Estate will be invested until each attains the age of XXXXXXXXXX when the property of each trust will be distributed. The distribution of the income earned by the above noted trusts is subject to the discretion of the trustees.

14.   The Estate is a Canadian resident for tax purposes.

III.  PROPOSED TRANSACTIONS

The following proposed transactions will be implemented in the order presented unless otherwise noted.

15.   The Estate will repay $XXXXXXXXXX of the Shareholder Loan. The repayment will be funded by assets of the Estate other than its interest in the Corporation.

16.   Prior to XXXXXXXXXX, the Corporation will dispose of Marketable Securities with an estimated accrued capital gain of $XXXXXXXXXX. Approximately $XXXXXXXXXX will be added to the Corporation’s CDA.

17.   The share capital of the Corporation will be reorganized, and two new classes of shares will be created as follows:

a.    an unlimited number of voting, fully participating Class A Common Shares; and

b.    an unlimited number of non-voting fixed value, redeemable, retractable, Class A Preferred Shares which will have a redemption amount and dividend rate to be fixed by the directors of the Corporation before the first issuance of the Class A Preferred Shares.

18.   Pursuant to subsection 85(1), the Estate will exchange all XXXXXXXXXX issued common shares of the Corporation for XXXXXXXXXX newly authorized Class A Common Shares and XXXXXXXXXX Class A Preferred Shares. The Class A Preferred Shares are expected to have a redemption amount of $XXXXXXXXXX.

19.   The Estate and the Corporation 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 in respect of the transfer described in Paragraph 18. The aggregate agreed amount for purposes of such joint election will be equal to the adjusted cost base to the Estate of the XXXXXXXXXX common shares of the Corporation.

20.   The amount added by the Corporation to the stated capital of the Class A Common Shares and the stated capital of the Class A Preferred Shares will not exceed the maximum that could be added without giving rise to a deemed dividend under subsection 84(1). For greater certainty, the amount added to the stated capital of Class A Common Shares and the stated capital of the Class A Preferred Shares will not exceed the paid-up capital of the XXXXXXXXXX common shares of the Corporation immediately before the time of transfer described in Paragraph 18.

21.   The directors of the Corporation will resolve that the legal stated capital on the Class A Preferred Shares be increased by an amount that will not exceed the lesser of (i) the CDA of the Corporation immediately before such increase in the legal stated capital and (ii) the amount that would have been the CDA of the Corporation at the time which is immediately before the death of A if the Corporation had disposed of all of its Marketable Securities at that time. The increase in legal stated capital will result in a deemed dividend pursuant to subsection 84(1).

22.   The Corporation will elect, in the prescribed manner and form referred to in subsection 83(2), that the full amount of the deemed dividend described in Paragraph 21 be a capital dividend.

23.   Prior to XXXXXXXXXX, the Corporation will redeem the XXXXXXXXXX Class A Preferred Shares and will issue PN1 to the Estate in full satisfaction of the redemption price, resulting in a deemed dividend which is expected to be approximately $XXXXXXXXXX. The Corporation will designate a portion of such deemed dividend, estimated to be approximately $XXXXXXXXXX, to be an eligible dividend pursuant to subsection 89(14). This amount will not be in excess of the Corporation’s GRIP balance at the end of the taxation year of the Corporation in which the deemed dividend arose.

24.   On the disposition of the Class A Preferred Shares described in Paragraph 23, the Estate will report a capital loss equal to the difference between the proceeds of disposition (determined in accordance with paragraph (j) of the definition thereof in section 54) and the adjusted cost base of the Class A Preferred Shares to the Estate. The amount of such capital loss is expected to be approximately $XXXXXXXXXX, less any adjustments under subsection 112(3.2).

25.   The Executors will make an election in prescribed manner and within the prescribed time under subsection 164(6) to carry back the Estate’s capital loss, described in Paragraph 24, to reduce a portion of the capital gain that arose from the deemed disposition of the common shares of the Corporation realized on A’s terminal T1 income tax return as described in Paragraph 12. Such capital loss will not be deemed to be nil pursuant to subsection 40(3.6) because of the application of subsection 40(3.61).

26.   Prior to XXXXXXXXXX, the Corporation will repay approximately $XXXXXXXXXX of PN1 to the Estate. The Estate will use the funds received to repay part of the remaining balance of the Shareholder Loan. The remaining balance of PN1 will be approximately $XXXXXXXXXX.

27.   The Estate will be designated as a GRE when the Executors file the T3 Trust Income Tax and Information Return for the Estate’s first taxation year.

28.   The Estate will incorporate Newco. Newco will be a Canadian-controlled private corporation and a taxable Canadian corporation at all relevant times. The authorized share capital of Newco will consist of an unlimited number of voting, fully-participating Common shares.

29.   The Estate will transfer the Class A Common Shares to Newco in consideration for XXXXXXXXXX common shares of the capital stock of Newco (the “Newco Common Shares”).

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 described in this Paragraph. The agreed amount will be equal to the adjusted cost base of the Class A Common Shares to the Estate immediately before the transfer, provided that the agreed amount in respect of each share so transferred will not be less than the lesser of the two amounts specified in paragraph 85(1)(c.1).

Newco will add to the stated capital of the Newco Common Shares an amount equal to the lesser of the fair market value of the Class A Common Shares as at the date of the transfer and the fair market value of the common shares of the Corporation as at the date of A’s death (the latter estimated to be approximately $XXXXXXXXXX).

For greater certainty, the amount added will not exceed the maximum amount that could be added to the paid-up capital of these shares without resulting in an adjustment in computing the paid-up capital of such shares having regard to paragraph 84.1(1)(a).

30.   The Corporation will make a loan of $XXXXXXXXXX to Newco (the “Newco Loan”). Newco will resolve to reduce the stated capital of its common shares by $XXXXXXXXXX and will pay such amount to the Estate. The Estate will use this amount to pay income taxes owing in respect of A’s terminal T1 income tax return as described in Paragraph 12. 

31.   For a period of one year after the transfer of the Class A Common Shares to Newco, the asset allocation of the Marketable Securities as well as the investment activities carried on by the Corporation in respect of the Marketable Securities will be governed by the same guidelines as before the death of A and the implementation of the Proposed Transactions.

32.   After at least one year has elapsed since the acquisition of the Class A Common Shares by Newco, the Corporation and Newco will amalgamate pursuant to Act1 to form Amalco in such a manner that;

a.    all of the property (except any amounts receivable from any predecessor corporation) of the predecessor corporations immediately before the amalgamation became property of Amalco by virtue of the amalgamation;

b.    all of the liabilities (except any amounts payable to any predecessor corporation) of the predecessor corporations immediately before the amalgamation, became liabilities of Amalco by virtue of the amalgamation;

c.    the authorized share capital of Amalco will be the same as Newco's authorized share capital (i.e., an unlimited number of voting fully-participating common shares). Moreover, the paid-up capital and the adjusted cost base of the common shares that the Estate will hold in Amalco after the amalgamation will be equal to the paid-up capital and the adjusted cost base of the common shares of Newco that the Estate held immediately prior to the amalgamation.

33.   On the amalgamation, the Class A Common Shares owned by Newco and the Newco Loan will be cancelled.

34.   Over the twelve months following the amalgamation, the directors of Amalco will resolve no more often than quarterly to reduce the stated capital of the common shares of Amalco by an aggregate amount not exceeding the paid-up capital of the common shares, and will make distributions of such amounts to the Estate. The amount of the reductions in stated capital in any given quarter of that year will not exceed 25% of the aggregate paid-up capital of the common shares of Amalco immediately following the amalgamation described in Paragraph 32. While Amalco may sell some of its assets to make such distributions, at all times it will continue to carry on the business formerly carried on by the Corporation.

35.   Once all debts and liabilities of the Estate have been ascertained and settled, the Executors will complete the administration of the Estate and distribute the residue of the Estate to Beneficiary1, Beneficiary2, Beneficiary3, Beneficiary4, Beneficiary5, Beneficiary6, Beneficiary7, and Beneficiary8 in accordance with the terms of the Will.

IV.   PURPOSE OF THE PROPOSED TRANSACTIONS

The purpose of the Proposed Transactions is to return to the Estate an amount equal to the fair market value of the shares of the capital stock of the Corporation immediately before A’s death, while minimizing the inherent double tax that can result from the application of subsections 70(5), 84(2), 84(3), and section 84.1.

V.    RULINGS REQUESTED

Provided that the preceding statements constitute a complete and accurate disclosure of all relevant facts, 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 reduce the paid-up capital of the Newco Common Shares, provided that the paid-up capital of the Newco Common Shares, immediately after the disposition described in Paragraph 29, is equal to or less than the adjusted cost base of the Class A Common Shares to the Estate, immediately before the disposition, as modified by paragraph 84.1(2)(a.1).

B.    Subsection 84(2) will not apply as a result of and by reason of the Proposed Transactions, in and by themselves, to deem the Corporation to have paid a dividend to the Estate and the Estate to have received a dividend on the Class A Common Shares.

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 confirmed in any of the rulings given.

The above rulings are given subject to the limitations and qualifications set forth in Information Circular 70-6R10 dated September 29, 2020. The rulings are binding on the CRA provided, among other things, that the Proposed Transactions are implemented within the time frame specified in the advance ruling letter. For greater certainty, the transactions described in Paragraphs 28 to 30 will be completed not later than 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.

VI.   COMMENTS

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

1.    the fair market value or the adjusted cost base of any property referred to herein, or the paid-up capital in respect of any share referred to herein;

2.    the balance of the ERDTOH, NERDTOH, GRIP, CDA, net capital losses or any other tax account for any corporation described herein;

3.    the Executor’s ability to complete the Proposed Transactions under the terms of the Will;

4.    whether any person described herein deals, or does not deal, with any other person at arm’s length; or

5.    any other tax consequence (including provincial tax consequences) 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, but not limited to the tax consequences associated with the distribution of any assets of the Estate, other than those specifically described in the rulings given above; and, 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 fair market value 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
Reorganizations Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

UNCLASSIFIED

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