2003 Ruling 2003-0051283 - XXXXXXXXXX ATR

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: (i) Whether the value of the shares of Financeco is derived principally from real property situated in Canada? (ii) Whether Article XIII of the Canada-United States Income Tax Convention is applicable where the gain arose as a result of the application of subsection 40(3) of the Income Tax Act (the "Act")? XXXXXXXXXX

Position: (i) No. (ii) Yes. XXXXXXXXXX

Reasons: (i) XXXXXXXXXX ; The gain that arose as a consequence of the application of subsection 40(3) of the Act does not have anything to do with the value of these shares. (ii) The gain is deemed to be a gain from disposition of property under paragraph 40(3)(c). XXXXXXXXXX

XXXXXXXXXX 2003-005128

XXXXXXXXXX, 2003

Dear XXXXXXXXXX:

Re: XXXXXXXXXX
XXXXXXXXXX
Advance Income Tax Ruling

We are writing in reply to your letter of XXXXXXXXXX in which you requested an advance income tax ruling on behalf of the above-referenced taxpayers. We also acknowledge the additional information provided in subsequent correspondence and during our telephone conversations (XXXXXXXXXX).

XXXXXXXXXX tax affairs are administered by the XXXXXXXXXX Tax Services Office and it files its tax returns at the XXXXXXXXXX Taxation Centre under Business Number XXXXXXXXXX.

To the best of your knowledge and that of the taxpayers involved, none of the issues involved with this request:

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

(ii) is being considered by a tax services office or a taxation centre in connection with a tax return already filed by the taxpayer or a related person;

(iii) is under objection; or

(iv) is before the courts or, if a judgement has been issued, the time limit for appeal has not expired.

Definitions

In this letter the following terms have the meanings specified:

(a) "Act" means the Income Tax Act R.S.C. 1985 c.1 (5th Supp.), as amended to the date hereof, and unless otherwise stated, every reference herein to a Part, section, subsection, paragraph or subparagraph is a reference to the relevant provisions of the Act;

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

(c) "Cansub#1'' means XXXXXXXXXX;

(d) "Cansub#2'' means XXXXXXXXXX;

(e) "Cansub#3'' means XXXXXXXXXX;

(f) "Financeco'' means XXXXXXXXXX;

(g) "Gco'' means XXXXXXXXXX;

(h) "OP'' means XXXXXXXXXX;

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

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

(k) "Regulations" means Income Tax Regulations, Consolidated as of December 31, 1977;

(l) "Rco" means XXXXXXXXXX;

(m) "subsidiary wholly-owned corporation'' has the meaning assigned by subsection 248(1);

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

(o) "Treaty'' means the Canada-United States Income Tax Convention (1980), as amended by subsequent protocols;

(p) "USD'' means U.S. dollars;

(q) "USHoldco'' means XXXXXXXXXX;

(r) "USParentco'' means XXXXXXXXXX, a corporation incorporated in the U.S.

(s) "Xco'' means XXXXXXXXXX, a corporation incorporated in the U.S.; and

(t) "Yco'' means XXXXXXXXXX, a corporation incorporated in the U.S.

Facts

Our understanding of the facts, proposed transactions and purpose of the proposed transactions is as follows:

1. Cansub#2 is a taxable Canadian corporation, incorporated under the laws of Canada, and continued under the laws of XXXXXXXXXX. Cansub#2's business is the XXXXXXXXXX. Cansub#2 was formerly Rco which was formed as a result of the XXXXXXXXXX amalgamation of Rco, XXXXXXXXXX. Rco was formerly Gco, which was acquired by Xco on XXXXXXXXXX. The registered head office of Cansub#2 is located at XXXXXXXXXX. Cansub#2 is a subsidiary wholly-owned corporation of Cansub#1.

2. Cansub#1 is a taxable Canadian corporation, incorporated under the laws of XXXXXXXXXX, and continued under the laws of XXXXXXXXXX. Cansub#1 primarily carries on the XXXXXXXXXX.The registered head office of Cansub#1 is located at XXXXXXXXXX. Cansub#1 is a subsidiary wholly-owned corporation of USHoldco.

3. USHoldco is a C corporation for the purposes of the Internal Revenue Code and was incorporated under the laws of the State of XXXXXXXXXX. It is a resident of the U.S. for purposes of the Treaty. USHoldco does not carry on business in Canada. Its registered head office is located at XXXXXXXXXX. All of the shares of USHoldco are owned by USParentco, a widely held U.S. corporation, the common shares of which are listed for trading XXXXXXXXXX.

4. Financeco is a taxable Canadian corporation incorporated under the laws of XXXXXXXXXX. Financeco's only activity is financing USParentco's Canadian group activities. Financeco financed the XXXXXXXXXX Xco acquisition of Gco by issuing third party debt (at an average interest rate of XXXXXXXXXX%) and inter-company debt and equity with Xco. Financeco loaned the funds to Cansub#1 in exchange for an interest-bearing demand promissory note (the "Cansub#1 Note") described in paragraph 5 below.

5. At the time of this ruling request, the only asset held by Financeco is the Cansub#1 Note issued on XXXXXXXXXX by Cansub#1 that bears interest at the rate of XXXXXXXXXX% per annum. Interest payments are due on XXXXXXXXXX of each year. The principal amount of the Cansub#1 Note is USD $XXXXXXXXXX and is due on XXXXXXXXXX. Prior to the transactions described in 19 and 20 below, the Cansub#1 Note was unsecured.

6. OP is a general Canadian partnership formed under the laws of XXXXXXXXXX. It held XXXXXXXXXX. Before it was dissolved as described in paragraph 15 below, Cansub#2 owned a XXXXXXXXXX % interest in the partnership and Cansub#3, a subsidiary wholly-owned corporation of Cansub#2, owned a XXXXXXXXXX% interest.

7. A ruling was requested and received by the above-mentioned companies on XXXXXXXXXX. The primary purpose of transactions described in the XXXXXXXXXX ruling was to match the interest expense incurred on the debt used to make the XXXXXXXXXX Gco acquisition with the taxable income earned by Rco (formerly Gco). All of the proposed transactions described in that ruling have been carried out in the manner described in that ruling.

8. XXXXXXXXXX.

9. Immediately after the merger, former Yco stockholders held approximately XXXXXXXXXX% of the outstanding shares of USParentco common stock, while former Xco stockholders held approximately XXXXXXXXXX%. USParentco common stock which was listed on the XXXXXXXXXX Stock Exchange began trading on XXXXXXXXXX.

10. At the time of the XXXXXXXXXX merger, the share structure of the three Canadian companies (Cansub#2, Cansub#1, and Financeco) was as follows:

Cansub#2

? XXXXXXXXXX authorized common shares of which XXXXXXXXXX were issued and outstanding and all owned by Cansub#1.

Cansub#1

? XXXXXXXXXX authorized common shares of which XXXXXXXXXX were issued and outstanding and all owned by Xco.

? XXXXXXXXXX authorized Class A Preferred shares of which XXXXXXXXXX were issued and outstanding and all owned by Xco.

? XXXXXXXXXX authorized Class B Preferred shares of which XXXXXXXXXX were issued and outstanding and all owned by Financeco.

? XXXXXXXXXX authorized Class C Preferred shares of which XXXXXXXXXX were issued and outstanding and all owned by OP.

Financeco

? XXXXXXXXXX authorized common shares of which one was issued and outstanding and owned by Xco.

? XXXXXXXXXX authorized Class A Preferred shares of which XXXXXXXXXX were issued and outstanding and all owned by Xco. Each Class A Preferred share has a stated capital and paid-up capital of $XXXXXXXXXX per share and is redeemable and retractable for the sum of $XXXXXXXXXX per share. The Class A Preferred shares are non-voting, and carry discretionary non-cumulative dividend rights.

11. It was determined, based on an independent appraisal as at XXXXXXXXXX, that the value of Financeco and Cansub#1 had declined since the XXXXXXXXXX Xco acquisition of Gco. Therefore, as a result of the XXXXXXXXXX merger, for Canadian income tax purposes, Xco was required under the provisions of paragraph 111(4)(c) to reduce, to fair market value, the adjusted cost base of the Class A Preferred shares it held in Financeco and the common and Class A Preferred shares it held in Cansub#1. Financeco was also required under the same provision to reduce, to fair market value, the adjusted cost base of the Class B Preferred shares it held in Cansub#1. None of the capital losses that arose as a consequence of the application of paragraph 111(4)(d) were offset or reduced by the gains from the disposition of any property designated under paragraph 111(4)(e).

12. On XXXXXXXXXX, Xco transferred all the common and Class A Preferred shares and debt it held in Financeco and all of the common and Class A Preferred shares it held in Cansub#1 to USHoldco, its subsidiary wholly-owned corporation. In consideration for the transfer, USHoldco issued to USParentco (the parent corporation of Xco) XXXXXXXXXX newly issued shares of its common stock. A section 116 Certificate was requested and received with respect to such transfers.

13. On XXXXXXXXXX, Financeco sold all the Class B Preferred shares it held in Cansub#1 to USHoldco for $XXXXXXXXXX which was their fair market value at that time. After this sale, Financeco no longer had an equity interest in any company in the corporate group. Its value is completely attributable to the debt obligation that it holds in Cansub#1 (i.e., the Cansub#1 Note). The reason for the sale of the Class B Preferred shares of Cansub#1 was that it was never intended that Financeco be a long-term shareholder of Cansub#1. The shareholding came about because in the latter part of XXXXXXXXXX Financeco needed to issue enough equity to ensure compliance with the thin capitalization rules. As a result, it issued approximately $XXXXXXXXXX of equity to Xco and , in turn, invested a like amount in Class B Preferred shares of Cansub#1. With the decline in value of Cansub#1 Class B Preferred shares and the write- down under paragraph 111(4)(c), it was simply a good time to clean up the structure. This also made it easier to implement the transactions described in paragraphs 19 and 20 below.

14. On XXXXXXXXXX, immediately after the share sale described in paragraph 13 above, USHoldco exchanged all of its XXXXXXXXXX Class A Preferred shares in Cansub#1 and all of its XXXXXXXXXX Class B Preferred shares in Cansub#1 for XXXXXXXXXX common shares of Cansub#1. A section 116 Certificate was requested and received.

15. On XXXXXXXXXX,OP was dissolved. An undivided interest in its assets, including the XXXXXXXXXX Cansub#1 Class C Preferred shares, were distributed upon the winding up to the partners: Cansub#2 (XXXXXXXXXX%) and Cansub#3 (XXXXXXXXXX%).

16. On XXXXXXXXXX, Cansub#3 declared and paid a dividend in kind to Cansub#2 consisting of its undivided XXXXXXXXXX % interest in the Cansub#1 Class C Preferred shares.

17. On XXXXXXXXXX, after the dividend described in paragraph 16 above, Cansub#2 declared and paid a dividend in kind to Cansub#1 consisting of XXXXXXXXXX Cansub#1 Class C Preferred shares.

18. On XXXXXXXXXX, after the receipt of the dividend described in paragraph 17 above, Cansub#1 cancelled all its outstanding Class C shares.

19. On XXXXXXXXXX, Cansub#1 entered into a forward share subscription agreement with USHoldco, its parent company. Under the terms of this agreement, USHoldco has undertaken to subscribe for new common shares in the capital stock of Cansub#1 which will have a fair market value equal to the principal amount of the Cansub#1 Note at that time. Cansub#1 is entitled under the agreement to call upon USHoldco to subscribe in cash for the requisite number of common shares to fund each repayment of the principal made by the Cansub#1 under the Cansub#1 Note.

20. On XXXXXXXXXX, Cansub#1 entered into a limited security agreement with Financeco. Under this agreement, Cansub#1 granted Financeco a security interest in Cansub#1's rights under the forward share subscription agreement. In return Financeco agreed to limit its recourse to its security interest in the forward share subscription agreement in the event of default by Cansub#1 on the repayment of the principal of the Cansub#1 Note. The limited security agreement does not provide security over any real property situated in Canada.

21. The transactions described in paragraphs 19 and 20 above were undertaken solely for U.S. related reasons. XXXXXXXXXX. At the time that the transactions described in paragraphs 19 and 20 above were developed and implemented, there was no intention to repatriate funds in the manner described in this ruling.

22. On XXXXXXXXXX Xco and Yco merged under the laws of the State of XXXXXXXXXX with the surviving company being Yco.

23. Prior to XXXXXXXXXX, because of the decline in value of Cansub#1, Financeco forgave a portion of the Cansub#1 Note the adjusted cost base of which had been written down to fair market value under paragraph 111(4)(c) as a result of the XXXXXXXXXX merger. As Financeco's primary source of income is the spread that it earns on the funds that it borrows and lends, in order to manage the Canadian operation's overall cash and tax exposure, it is important that Financeco's debt be more or less equal to the Cansub#1 Note receivable, it was decided that the transactions described in paragraphs 24 and 25 be carried out.

24. On XXXXXXXXXX, a promissory note in the amount of USD $XXXXXXXXXX issued on XXXXXXXXXX by Financeco to Xco, but transferred to USHoldco on XXXXXXXXXX, was settled by the issuance to USHoldco by Financeco of its XXXXXXXXXX Class A Preferred shares. The stated capital of these issued shares of Financeco was increased by an amount equal to the fair market value of the promissory note at the time of the settlement.

25. On XXXXXXXXXX, USD $XXXXXXXXXX of the promissory note in the amount of $XXXXXXXXXX issued by Financeco to Xco on XXXXXXXXXX, but transferred to USHoldco on XXXXXXXXXX, was converted to XXXXXXXXXX Class A Preferred shares of Financeco. The stated capital of these Class A Preferred shares of Financeco was increased by an amount equal to the fair market value of the promissory note at the time of the conversion.

26. After taking into aXcount all the above transactions, the share structure of the three Canadian companies at the time of this ruling is as follows:

Cansub#2

? XXXXXXXXXX authorized common shares of which XXXXXXXXXX were issued and outstanding and all owned by Cansub#1.

Cansub#1

? XXXXXXXXXX authorized common shares of which XXXXXXXXXX are issued and outstanding and all owned by USHoldco (XXXXXXXXXX of these shares were issued to USHoldco on XXXXXXXXXX)..

? XXXXXXXXXX authorized Class A Preferred shares none of which are issued and outstanding.

? XXXXXXXXXX authorized Class B Preferred shares none of which are issued and outstanding.

? XXXXXXXXXX authorized Class C Preferred shares none of which are outstanding.

Financeco

? XXXXXXXXXX authorized common shares of which one was issued and outstanding and all owned by USHoldco.

? XXXXXXXXXX authorized Class A Preferred shares of which XXXXXXXXXX were issued and outstanding and all owned by USHoldco. Each Class A Preferred share is redeemable and retractable for $XXXXXXXXXX per share. The Class A shares are non-voting, and carry discretionary non-cumulative dividend rights.

Proposed Transactions

27. Cansub#2 is holding a substantial amount of cash XXXXXXXXXX. Cansub#2 wishes to repatriate these funds to the U.S. parent.

28. Cansub#2 will lend the funds to Financeco in exchange for an interest-free promissory note payable on demand.

29. Financeco will use the funds received from Cansub#2 to make a legal reduction of capital in respect of each of its outstanding Class A Preferred shares held by USHoldco. By a special resolution, the article of association of Financeco will be amended to reduce the redemption amount of each Financeco Class A Preferred share by the amount of the reduction of capital.

30. The reduction of capital in respect of the Class A Preferred shares of Financeco will result in the reduction of their ACB to USHoldco under paragraph 53(2)(a).

31. Given USHoldco's low adjusted cost base in the Financeco Class A Preferred shares as a result of the application of paragraph 111(4)(c) described in paragraph 11 above, it is expected that USHoldco will realize a capital gain on the reduction of capital of these Financeco Class A Preferred shares pursuant to subsection 40(3).

Purpose of the Proposed Transactions

XXXXXXXXXX, USParentco has committed to reducing its debt-to-equity ratio from XXXXXXXXXX% to the XXXXXXXXXX% range. It will therefore use the proceeds received from the proposed repatriation to reduce its external debt.

Rulings Given

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

Provided that the return of capital described in paragraph 29 above is permitted XXXXXXXXXX, paragraph 4 of Article XIII of the Treaty will apply such that the capital gain realized by USHoldco on the reduction of capital of the Financeco Class A Preferred shares as described in paragraph 29 above will not be subject to Canadian tax.

The above ruling is given subject to the general limitations and qualifications set out in Information Circular 70-6R4 dated January 29, 2001, and is binding on the Canada Customs and Revenue Agency ("CCRA") provided that the proposed transactions are completed by XXXXXXXXXX.

The ruling is based on the Act in the present form and does not take into aXcount amendments to the Act which, if enacted into law, could have an effect on the ruling provided herein.

Other Comments

Nothing in this ruling should be construed as implying that the CCRA has agreed to or reviewed any tax consequences relating to the facts and proposed transactions described herein other than those specifically described in the ruling given above. In particular, nothing in this ruling should be construed as implying that the CCRA reviewed

(a) the adjusted cost base, the paid-up capital or the fair market value of the shares of any corporation described in this ruling;

(b) the adjusted cost base or the fair market value of any of the debts described in this ruling;

(c) the application of the debt forgiveness provisions of the Act to any of the facts or proposed transactions described in this ruling;

(d) since the transactions described in paragraphs 28 and 29 above would form part of a series of transactions as that phrase is understood in section 247, whether subsection 247(2) would apply to adjust the interest rate on the loan described in paragraph 28 above;

(e) where the fair market value of the loan receivable described in paragraph 28 above held by Cansub#2 is, immediately after the transaction described in paragraph 29 above, less than the principal balance owing on that receivable, the possible application of section 69 or any benefit provisions of the Act (e.g., subsection 56(2) or 246(1)); and

(f) whether the general anti-avoidance rules in section 245 would or would not apply.

Yours truly,

for Director
International and Trusts Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch

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