2003 Ruling 2003-0020553 - XXXXXXXXXX

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CCRA.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.

Principal Issues: Deductibility of Interest in an affiliated group.

Position: Deductible.

Reasons: The law.

XXXXXXXXXX 2003-002055

XXXXXXXXXX, 2003

Dear XXXXXXXXXX:

Re: XXXXXXXXXX
Advance Income Tax Ruling Request

This is in reply to your letter of XXXXXXXXXX, and your subsequent correspondence, wherein you requested an advance income tax ruling on behalf of the above-noted taxpayers. You have advised us that to the best of your knowledge and that of the taxpayers involved none of the issues involved in this ruling is:

(i) in an earlier return of any of the taxpayers or a related person;

(ii) being considered by a tax services office ("TSO") or taxation centre ("TC") in connection with a previously filed tax return of any of the taxpayers or a related person;

(iii) under objection by any of the taxpayers or a related person;

(iv) before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has not expired; or

(v) the subject of a ruling previously issued by the Income Tax Rulings Directorate.

The taxpayers have also represented that the proposed transactions described herein will not result in any taxpayer described herein as being unable to pay their outstanding tax liabilities.

DEFINITIONS

In this letter, unless otherwise specified, all monetary amounts are expressed in Canadian dollars and the following terms have the meanings specified:

(a) "Act" means the Income Tax Act, R.S.C. 1985 (5th Supp.) c.1, as amended from time to time and consolidated to the date of this letter and, unless otherwise expressly stated, every reference herein to a part, section or subsection, paragraph or subparagraph and clause or subclause is a reference to the relevant provision of the Act and the Income Tax Regulations thereunder are referred to as the "Regulations";

(b) "adjusted cost base" ("ACB") has the meaning assigned by section 54;

(c) "affiliated persons" has the meaning assigned by subsection 251.1(1);

(d) "agreed amount" has the meaning assigned by subsection 85(1);

(e) "arm's length" has the meaning assigned by subsection 251(1);

(f) "Bank Loan" has the meaning assigned by Paragraph 9;

(g) "CBCA" means the Canada Business Corporations Act, R.S.C. 1985, c.44, as amended;

(h) "Company" means XXXXXXXXXX as described more fully in Paragraph 2;

(i) "Company Debenture" has the meaning assigned by Paragraph 11;

(j) "cost amount" has the meaning assigned by subsection 248(1);

(k) "Demand Loan" has the meaning assigned by Paragraph 12;

(l) "dividend rental arrangement" has the meaning assigned by 248(1);

(m) "fair market value" ("FMV") means the highest price available in an open an unrestricted market between informed, prudent parties acting at arm's length and under no compulsion to act;

(n) "financial intermediary corporation" has the meaning assigned by subsection 191(1);

(o) "guarantee agreement" has the meaning assigned by subsection 112(2.2);

(p) XXXXXXXXXX;

(q) XXXXXXXXXX;

(r) "Issued Newco Preferred Shares" has the meaning assigned by Paragraph 10;

(s) XXXXXXXXXX;

(t) "Newco" means the new corporation described in Paragraph 7;

(u) "Newco Common Shares" has the meaning assigned by Paragraph 7;

(v) "Newco Preferred Shares" has the meaning assigned by Paragraph 7;

(w) "paid-up capital" ("PUC") has the meaning assigned by subsection 89(1);

(x) "Paragraph" refers to a numbered paragraph in this advance income tax ruling;

(y) "Parent" means XXXXXXXXXX as described more fully in Paragraph 1;

(z) XXXXXXXXXX;

(aa) "principal amount" has the meaning assigned by subsection 248(1);

(bb) "Proposed Transactions" means the proposed transactions described in Paragraphs 7 to 16;

(cc) "public corporation" has the meaning assigned by subsection 89(1);

(dd) "related persons" has the meaning assigned by subsection 251(2);

(ee) "specified financial institution" has the meaning assigned by subsection 248(1);

(ff) "Target" means XXXXXXXXXX and is more fully described in Paragraph 4;

(gg) "taxable Canadian corporation" has the meaning assigned by subsection 89(1);

(hh) "taxable dividend" has the meaning assigned by subsection 89(1); and

(ii) XXXXXXXXXX.

Our understanding of the facts, Proposed Transactions and the purpose of the Proposed Transactions is as follows:

FACTS

1. Parent is incorporated pursuant to the laws of Canada. Parent is a taxable Canadian corporation, a public corporation XXXXXXXXXX. Each class of its issued shares is listed for trading on the XXXXXXXXXX Stock Exchange. Parent has a XXXXXXXXXX taxation year-end. Parent's CCRA business number is XXXXXXXXXX and it deals with the XXXXXXXXXX TSO.

2. Company is a XXXXXXXXXX. Company is a taxable Canadian corporation, a public corporation XXXXXXXXXX. All the issued and outstanding common shares of Company are owned by Parent, which controls Company. XXXXXXXXXX. Company has a XXXXXXXXXX taxation year-end. Company carries on the business of XXXXXXXXXX Company's CCRA business number is XXXXXXXXXX and it deals with the XXXXXXXXXX TSO.

3. Parent is a holding corporation that mainly earns income from taxable dividends it receives on the shares it owns of Company and of other subsidiaries. Parent, directly and indirectly through other second-tier subsidiaries, holds all the common shares of XXXXXXXXXX.

4. Target is incorporated under the laws of Canada. Target is a taxable Canadian corporation, a public corporation XXXXXXXXXX. The shares of Target are listed on the XXXXXXXXXX Stock Exchange. Target owns all the common shares of XXXXXXXXXX ("Target Sub"), which is a taxable Canadian corporation, a public corporation XXXXXXXXXX. Target Sub carries on the business of XXXXXXXXXX.

5. Parent intends to acquire all of the outstanding common shares of Target (and thus voting control of Target) in a takeover transaction for their aggregate FMV of approximately $XXXXXXXXXX.

In order to fund the cash component (approximately $XXXXXXXXXX ) of Parent's purchase price for Target's common shares, XXXXXXXXXX. Parent will also borrow funds from Newco under a demand loan as described in Paragraphs 12 and 13.

XXXXXXXXXX

Immediately after Parent acquires all the issued and outstanding Target common shares, Parent will sell such shares to Company for their FMV. Parent and Company will jointly elect under subsection 85(1) in prescribed form and manner and within the time limit specified in subsection 85(6) to set the agreed amount for the purposes of the election equal to the cost amount to Parent of the Target common shares so transferred. As consideration for the Target common shares, Company will pay Parent XXXXXXXXXX.

6. Prior to the proposed takeover of Target by Parent, Parent and Target were arm's-length persons.

PROPOSED TRANSACTIONS

7. Parent will incorporate a new corporation ("Newco") under the CBCA that will be a taxable Canadian corporation XXXXXXXXXX. Newco will have a XXXXXXXXXX taxation year-end. Newco's authorized share capital will consist of one class of an unlimited number of common shares (the "Newco Common Shares") and one class of an unlimited number of preferred shares (the "Newco Preferred Shares"), which will include the following attributes:

(a) the Newco Common Shares will be voting;

(b) the Newco Preferred Shares will be:

(i) non-voting, except where the CBCA otherwise requires a statutory vote, and in circumstances where there is a proposal by Newco to change the restrictions on the limited activity that it may undertake;

(ii) redeemable and retractable at any time for an amount equal to the amount for which they were issued and any unpaid dividends which may accumulate prior to their redemption or retraction;

(iii) entitled to an annual cumulative dividend at a rate of XXXXXXXXXX% per annum calculated on the amount for which they were issued and will have a preference on dissolution over the Newco Common Shares for the return of their redemption amount plus any unpaid dividends.

8. Parent will subscribe for XXXXXXXXXX Newco Common Shares for $XXXXXXXXXX on the incorporation of Newco. Newco will use the subscription proceeds to acquire publicly traded equities.

9. Parent will borrow an amount not to exceed $XXXXXXXXXX (the "Bank Loan") from an arm's-length financial institution. XXXXXXXXXX, Parent has the capacity to borrow up to $XXXXXXXXXX for the purposes described in the transactions set out below.

10. Parent will use the proceeds from the Bank Loan to subscribe for fully-paid Newco Preferred Shares (the "Issued Newco Preferred Shares"). The amount to be added to the stated capital account maintained for the Issued Newco Preferred Shares under the CBCA will be equal to the amount of the Bank Loan proceeds paid to Newco as payment in full for the subscription price of the Issued Newco Preferred Shares such that these shares will have an aggregate FMV, PUC and redemption amount equal to the Bank Loan proceeds.

11. Parent will immediately transfer all the Issued Newco Preferred Shares to Company at a purchase price equal to their FMV. As sole consideration for such transfer, Company will issue a debenture (the "Company Debenture") to Parent that will have a principal amount and FMV equal to the FMV of the Issued Newco Preferred Shares. The Company Debenture will bear interest at a rate of XXXXXXXXXX% per annum and will be repayable on the XXXXXXXXXX anniversary date of its issue (subject to the right of prepayment without penalty). The Company Debenture will also provide that Parent's right to repayment will be restricted to having recourse to the Issued Newco Preferred Shares only, and not to any other assets of Company. Company will give Parent a secured interest in the Issued Newco Preferred Shares (and in any proceeds from their redemption or sale). The interest charged on the Company Debenture will not create or increase a non-capital loss in Company.

12. Newco will immediately lend the proceeds it received from Parent on the subscription of the Issued Newco Preferred Shares to Parent on an interest-free demand basis (the "Demand Loan").

13. Parent will apply the proceeds from the Demand Loan towards the purchase price of all of the issued and outstanding common shares of Target as described in Paragraph 5.

14. Company will pay interest to Parent on the Company Debenture on an annual basis. Based on Company's financial projections, it will have the financial capacity to honour its obligation to pay such interest on the Company Debenture from its own cash flow. The annual interest payment date on the Company Debenture will be the same as the annual dividend payment date on the Issued Newco Preferred Shares.

15. Parent will agree to, and will make, annual capital contributions on the common share capital of Newco in a total amount equal to the amount of annual dividends to be paid by Newco on the Issued Newco Preferred Shares held by Company for so long as such shares are outstanding. Based on Parent's existing assets and resources, Parent will be able to make the capital contributions to Newco without taking into account the interest income it will receive from Company as described in Paragraph 14. Under generally accepted accounting principles these capital contributions will not be reported as income to Newco in its financial statements. Parent will not be required to make any capital contributions to Newco where Newco is no longer paying dividends to Company on the Issued Newco Preferred Shares.

16. Newco will use the amounts received as capital contributions as described in Paragraph 15 to pay dividends on the Issued Newco Preferred Shares to Company on an annual basis.

ADDITIONAL INFORMATION

17. The Issued Newco Preferred Shares will not be, at any time during the implementation of the Proposed Transactions described herein:

(a) the subject of any undertaking that is a guarantee agreement;

(b) the subject of a dividend rental arrangement;

(c) the subject of any secured undertaking of the type described in paragraph 112(2.4)(a); or

(d) issued for consideration that is or includes:

(i) an obligation of the type described in subparagraph 112(2.4)(b)(i), other than an obligation of a corporation that is related (otherwise than by reason of a right referred to in paragraph 251(5)(b)); or

(ii) any right of the type described in subparagraph 112(2.4)(b)(ii).

18. Each of Parent, Company and Newco will agree that Newco shall be a single purpose company that shall have no liabilities and will carry on no other activity other than as contemplated by the Proposed Transactions.

19. Company will have the financial capacity to honour the principal amount payable under the Company Debenture.

20. XXXXXXXXXX. You also advise that in your view, neither the acquisition of the Issued Newco Preferred Shares nor the related transactions are in the ordinary course of Company's business.

21. For the past XXXXXXXXXX years Company has been subject to Part I taxes, and expects to continue to be subject to such taxes after the Proposed Transactions are completed.

PURPOSE OF THE PROPOSED TRANSACTIONS

22. The purpose of the Proposed Transactions is to enable Parent to earn sufficient interest income so that in calculating its income under Part I, it will be able to utilize the interest expense that it will incur on the Parent Debentures and Term Loan. In the last XXXXXXXXXX years, neither Parent nor Company has entered into any loss utilization transactions.

23. XXXXXXXXXX.

24. XXXXXXXXXX.

25. XXXXXXXXXX.

RULINGS

Provided that the preceding statements, including the additional information, 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, our rulings are as set forth below.

A. The dividends received by Company on the Issued Newco Preferred Shares, as described in Paragraph 16, will be taxable dividends that will be deductible pursuant to XXXXXXXXXX in computing the taxable income of Company for the year in which such dividends are received; and for greater certainty, such deduction will not be precluded by any of subsections XXXXXXXXXX (2.2), (2.3) or (2.4).

B. Company will not be subject to tax under Part IV.1 under section 187.2 in respect of the dividends described in Ruling A, by virtue of paragraph (b) of the definition of "excepted dividend" in subsection 187.1.

C. Newco will not be subject to tax under Part VI.1 under section 191.1 in respect of the taxable dividends paid to Company by Newco described in Paragraph 16, by virtue of paragraph (a) of the definition of "excluded dividend" in subsection 191(1).

D. Provided that Company has a legal obligation to pay interest on the Company Debenture, as described in Paragraph 11, and Company continues to hold the Issued Preferred Shares, described in Paragraph 16, for the purpose of earning income from a business or property (other than to acquire property the income from which would be exempt or to acquire a life insurance policy), Company will be entitled, pursuant to paragraph 20(1)(c), to deduct the lesser of (i) the interest paid or payable (depending on the method regularly followed by Company in computing its income for the purposes of the Act) in respect of the year on the Company Debenture or (ii) a reasonable in respect thereof.

E. XXXXXXXXXX.

F. No amount will be included in the income of Newco pursuant to section 9, or paragraphs 12(1)(c), or 12(1)(x) in respect of the capital contributions to Newco described in Paragraph 15.

G. The provisions of subsections 15(1), 56(2), 69(1), 69(4), 69(11) or 246(1) will not apply in to the Proposed Transactions, in and by themselves.

H. Subsection 245(2) will not apply to the Proposed Transactions, in and by themselves, to redetermine the tax consequences confirmed in the rulings given.

The above rulings are given subject to the limitations and qualifications set out in IC 70-6R5 and are binding on the CCRA provided that the Proposed Transactions, other than the Proposed Transactions described in Paragraphs 14, 15 and 16 are completed by XXXXXXXXXX. These rulings are based on the law as it presently reads and do not take into account any proposed amendments to the Act which, if enacted into law, could have an effect on the rulings provided herein.

OTHER COMMENTS

Nothing in this letter should be construed as implying that the CCRA has confirmed, reviewed or has made any determination in respect of:

(a) the paid-up capital of any share or the adjusted cost base or fair market value of any share or other property referred to herein;

(b) the application of subsection 55(2) to any dividends that may arise as part of the series of transactions or events that includes the Proposed Transactions whether described in this letter or not; or

(c) any other tax consequence relating to the facts, Proposed Transactions, other information or any transactions or events, taking place either prior to the Proposed Transactions or subsequent to the Proposed Transactions, whether described in this letter or not, including the provincial income tax implications relating to the allocation of income and expenses as a result of the Proposed Transactions, other than those specifically described in the rulings given above.

Yours truly,

for Director
Reorganizations and Resources Division
Income Tax Rulings Directorate
Policy and Legislation Branch