The Canada Revenue Agency (the "CRA") released an advance tax ruling (the 'Ruling") recently dealing with the consequences under the Income Tax Act (Canada) (the "Act") of the conversion of a Dutch BV into a Dutch Co-Op under the Dutch Civil Code. The purpose of the proposed transactions was for a Dutch cooperative to be wholly owned by its Canadian parent in order to avoid Dutch withholding tax on dividends. This article reviews the Ruling and past ruling practices of the CRA in respect of the characterization of foreign entities for purposes of the Act.
Based on the expurgated ruling, the following was the existing ownership structure before the proposed transactions.
The proposed transactions were as follows:
- Holdco would cause Newco to be incorporated under the Canada Business Corporations Act (the "CBCA") and would subscribe for one common share in the capital of Newco.
- L Co. would be liquidated and dissolved pursuant to the laws of the relevant foreign country, and, on that liquidation and dissolution, all of the liabilities of L Co. would be assumed by Holdco and all of the property of L Co., including the shares of BV held by L Co., would be distributed to Holdco.
- Holdco would transfer a percentage of the shares in the capital of BV to Newco in exchange for the issuance by Newco to Holdco of one additional common share in the capital of Newco. Holdco and Newco would file an election in accordance with subsection 85(6) of the Act to have the provisions of subsection 85(1) apply to such transfer.
- BV would convert into a Dutch Co-Op ("DC") pursuant to the Dutch Civil Code (the "Conversion"). The execution of the notarial deed effecting the Conversion would result in DC being regarded as a legal entity under the Dutch Civil Code that continues to exist separate and apart from Holdco and Newco.
- Pursuant to the Dutch Civil Code, DC would be the same corporation as, and a continuation of, BV, and BV would not be considered to have disposed of any of its property to any person on the conversion of BV into DC.
- On the conversion of BV into DC, the issued share capital of BV would be cancelled and Holdco and Newco would automatically become members of DC, holding membership interests proportionate to their respective shareholdings in BV immediately before such conversion.
- Pursuant to the Dutch Civil Code:
- DC would have a separate legal existence, and would be considered to be equivalent to a natural person with respect to the law of property, rights and interests;
- subject to the restrictions under its Articles, the board of directors of DC would be charged with the management of DC; and
- where the Articles so provide, the board of directors of DC would have the authority to generally commit or otherwise bind DC to agreements and/or undertakings.
- The Articles would provide that:
- the members of DC may enter into membership agreements with DC;
- DC would carry on its business in its own name and at its own expense and risk;
- admission of new members requires unanimous consent of all existing members of DC;
- each member must make capital contributions to DC as unanimously agreed upon by all members;
- the management of DC has the authority to represent DC;
- all members, if not suspended, are entitled to attend any general meeting of members and to vote thereat. The number of votes that a member may cast at a general meeting of members is equal to the percentage of ownership in DC held by such member. Each member entitled to vote at any general meeting of members would at all times be entitled to at least one vote;
- the retained profits of DC are available to DC for its use unless the members vote to distribute all, or a portion of, such retained profits. A distribution of retained profits would only be made with the unanimous agreement of all members of DC. The distribution of any retained profits would be proportional to the ownership percentage of each member of DC at the time of such distribution; and
- the members and former members of DC are not liable for any debts or losses incurred by DC that are in excess of their required contributions to the capitalization of DC.
- In one or more separate transfer(s), Canco would transfer all of the issued and outstanding shares in the capital of its foreign affiliates to Holdco in exchange for the issuance by Holdco to Canco of additional common shares in the capital of Holdco. Canco and Holdco would elect in accordance with subsection 85(6) to have the provisions of subsection 85(1) apply to such transfer(s).
- In one or more separate transfer(s), Holdco would transfer a percentage of the shares in the capital of each of the foreign affiliates to Newco in exchange for the issuance by Newco to Holdco of additional common shares in the capital of Newco. Holdco and Newco would elect in accordance with subsection 85(6) of the Act to have the provisions of subsection 85(1) apply to such transfer(s).
- In one or more separate transfer(s), Holdco would transfer the remaining shares of its foreign affiliates (being all such shares except for the shares transferred to Newco in paragraph 10 above) to DC. As sole consideration for the transfer, DC would increase Holdco's membership interest in DC by an amount that would be equal to the fair market value of the shares of the foreign affiliate transferred by Holdco to DC. In respect of each transfer, Holdco, in its tax return for the taxation year in which the transfer takes place, would file a notice stating that it intends to have the rollover provisions in subsection 85.1(3) apply to the transfer.
- In one or more separate transfer(s), Newco would transfer the shares in the capital of the foreign affiliate transferred to it by Holdco as described in paragraph 10 above to DC. As sole consideration for the transfer, DC would increase Newco's membership interest in DC by an amount that would be equal to the fair market value of the shares of the foreign affiliate transferred by Newco to DC. In respect of each transfer, Newco, in its tax return for the taxation year in which the transfer takes place, would file a notice stating that it intends to have the rollover provisions in subsection 85.1(3), of the Act apply to the transfer.
- Following is the ownership structure after the implementation of the proposed transactions:
PURPOSE OF THE PROPOSED TRANSACTIONS
The purpose of the proposed transactions is to create a holding structure for the shares of Forco and the foreign affiliate that is administratively efficient, while facilitating a tax-efficient repatriation of funds to Newco, Holdco, Canco, and Parent, as DC would not be required to withhold any tax in the Netherlands on any dividends paid to Newco and Holdco. The current holding structure for the shares of Forco and the FAcos facilitates such a tax-efficient repatriation of funds, but is administratively burdensome.
The Ruling stated that the applicants are of the view that DC would be a corporation for the purposes of the Act, since the preponderance of its characteristics, as set out in the Articles and the Dutch Civil Code, would be those of a corporation.'
It also stated that none of the proposed transactions described is part of a series of transactions or events the purpose of which (s to dispose of the shares of the FAcos to a person who, immediately after the series of transactions or events, would be a person with whom Holdco, Newco, Canco, or Parent fs dealing at arm's length.
In summary, the CRA issued the following tax rulings:
- The comments contained in paragraph 3 of Interpretation Bulletin IT-392 regarding the meaning of the term "share" would apply to DC such that each of Holdco and Newco would be considered to own a percentage of the shares of DC.
- On the Conversion, BV would not be considered to have disposed of any of its property for the purposes of the Act.
- The cancellation of the shares in the capital of BV on the Conversion in exchange for the issuance of the membership interests in DC would occur on atax-deferred basis for the purposes of the Act, pursuant to subsection 86(1) of the Act.
- The provisions of subsection 85.1(3) of the Act would apply to the transfers) by Holdco of the shares in the capital of the foreign affiliate to DC described in paragraph it above (the "First Transfer").
- The provisions of subsection 85.1(3) of the Act would apply to the transfers) by Newco of the shares in the capital of the FACOS to DC described in paragraph 12 above (the "Second Transfer", and together with the First Transfer, the "Transfers").
- Subsection 95(6) of the Act would not apply to the Conversion or the Transfers.
The Ruling is of interest as it addresses a conversion of a BV at both the shareholder and corporate level.
The Ruling confirmed that the Conversion would not result in a realization of inherent gains in the shares of the BV or Its assets. As noted above, the applicant's stated premise was that DC would be a corporation for purposes of the Act. There were no rulings made by the CRA in this regard. It was a crucial premise with respect to which the CRA had issued many tax rulings. Continued status as a corporation is very important for many purposes including controlled foreign affiliate status and the treatment of shareholders.
On the basis that there was a disposition of shares of the BV on the Conversion, it was necessary that the disposition occur on a tax-deferred basis. Section 86 requires that there be a disposition "in the course of a reorganization of capital" and that shares of the same corporation be receivable.
Characterization of foreign entities have been the subject of many articles and are highly recommended. Conversions of foreign entities have also been subject to numerous technical interpretations and advance rulings. This ruling is consistent with CRA policy to issue favourable rulings when the characterization of the entity remains as a corporation.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.