2003 Ruling 2003-0034663 - COMMUNITY SMALL BUSINESS

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: Whether provincial credits earned under the Ontario Community Small Business Investments Program would be subject to paragraph 12(1)(x) of the Act?

Position: No, to the extent the provincial credits are used to reduce provincial capital tax that would have otherwise been deductible in computing income for federal income tax purposes.

Reasons: Our reading of paragraph 12(1)(x).

XXXXXXXXXX 2003-003466

XXXXXXXXXX, 2003

Dear XXXXXXXXXX:

Re: XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
Advance Income Tax Ruling Request

We are writing in response to your letter of XXXXXXXXXX (the "Ruling Request"), wherein you requested an advance income tax ruling on behalf of the parties named above. We also acknowledge the numerous amendments to the Ruling Request and our several telephone conversations and electronic mail messages (XXXXXXXXXX).

Definitions

In this letter the following definitions are used:

"Act" means the Income Tax Act, R.S.C 1985 (5th Supp.) c.1, as amended to the date hereof;

"ACo" means XXXXXXXXXX, as described in Paragraph 4;

"BCo" means the XXXXXXXXXX;

"CCo" means XXXXXXXXXX, as described in Paragraph 18;

"CRA" means the Canada Revenue Agency;

"DCo" means XXXXXXXXXX, as described in Paragraph 17;

"ET" means XXXXXXXXXX, as described in Paragraph 17;

"Foreign Producer" means XXXXXXXXXX, as described in Paragraph 5;

"Fund" means XXXXXXXXXX, as described in Paragraph 1;

"Manager" means XXXXXXXXXX, as described in Paragraph 16;

"Paragraph" refers to a numbered paragraph in this letter; and

"Production Services Provider" means XXXXXXXXXX, as described in Paragraph 3.

Facts

1. The Fund was incorporated under the Business Corporations Act (Ontario) (the "OBCA") on XXXXXXXXXX, and is a taxable Canadian corporation (as defined in subsection 89(1) of the Act). No shares in the capital stock of the Fund have been issued. The address of its head office is XXXXXXXXXX.

2. The Fund will be registered as a "Community Small Business Investment Fund Corporation" ("CSBIF") pursuant the Community Small Business Investment Funds Act (Ontario) (the "CSBIF Act"). The Community Small Business Investment Fund Program was designed to provide Ontario small businesses (total assets of $1 million or less at the time of a CSBIF's initial investment) with greater access to investment capital. The program does this by encouraging the formation of community sponsored venture capital pools and by providing eligible investors with incentives for purchasing Class A shares of registered CSBIFs. In particular, "qualifying financial institutions" as defined in the CSBIF Act are entitled to receive "Small Business Investment Tax Credits" under the Corporations Tax Act (Ontario) (the "CTA") in respect of an investment by the qualifying financial institution, or certain related corporations, in Class A shares of a CSBIF. Those Small Business Investment Tax Credits may be deducted from the qualifying financial institution's capital tax otherwise payable under the CTA. Once registered and capitalized, a CSBIF is required to make investments in eligible businesses located within the community of its sponsor. You have provided us with a copy of an advance ruling on these proposed transactions, which you obtained from the Ontario Ministry of Finance, dated September 9, 2003, as amended dated November 25, 2003 (together referred to herein as the "Provincial Ruling"). The Provincial Ruling was given with respect to the application of Part III.1 of the CSBIF Act and section 66.1 of the CTA.

3. The Production Services Provider is a taxable Canadian corporation incorporated on XXXXXXXXXX, under the OBCA. The first director of the Production Services Provider is XXXXXXXXXX, a resident of Ontario. No shares in the capital stock of the Production Services Provider have been issued and it does not yet have a business number. The Production Services Provider does not currently have any assets or liabilities. The business that the Production Services Provider intends to undertake is the provision of film and television production services.

4. ACo is a trust company operating pursuant to the XXXXXXXXXX. Its head office is located at XXXXXXXXXX ACo carries on trust and lending activities. For example, it acts as trustee for a number of XXXXXXXXXX investment funds. It maintains in excess of $XXXXXXXXXX of capital reserves.

5. The Foreign Producer is a corporation incorporated under the laws of the State of XXXXXXXXXX. The Foreign Producer has obtained the rights to produce (or arrange for the production of) various feature films and television programs for the benefit of non-Canadian production entities or studios (the "studios" one of which is the "Studio" referred to in Paragraph 9).

6. Each of ACo, the studios and the Foreign Producer will at all relevant times deal at arm's length with the Fund, the Production Services Provider, DCo, ET, the Manager, BCo and the Class A Subscribers (including CCo - see Paragraph 18). DCo, ET and the Manager will at all relevant times deal at arm's length with the BCo and the Class A Subscribers. ACo will at all relevant times deal at arm's length with the Foreign Producer and the studios. ET will at all relevant times deal at arm's length with the Manager.

7. To the best of your knowledge and that of the taxpayers involved, none of the issues involved in this ruling

(a) is in an earlier return of the taxpayer(s) or a related person,

(b) is being considered by a tax services office or taxation centre in connection with a previously filed tax return of the taxpayer(s) or a related person,

(c) is under objection by the taxpayer(s) or a related person,

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

(e) is the subject of a ruling previously issued by Revenue Canada, the Canada Customs and Revenue Agency or CRA.

Proposed Transactions

8. The Fund will enter into a management services agreement (the "Management Agreement") with the Manager under which the Manager will, inter alia, agree to seek out and identify a film or television program that will be produced by the Production Services Provider as the Film Property (as described in Paragraph 9). After identifying such a project, the Production Services Provider will become party to the Management Agreement (this is contemplated in article XXXXXXXXXX of Management Agreement). The Production Services Provider will then enter into the Production Services Agreement and other proposed transactions as described below in this letter. Pursuant to the terms of the Management Agreement, the Manager will also provide general management services to the Production Services Provider, such as negotiating with the Studio and the Foreign Producer (see Paragraph 9) the terms of the Production Services Agreement to be entered into by the Production Services Provider, reviewing proposed production budgets, insurance arrangements and reporting on the production, etcetera.

The Manager will not receive any compensation from the Fund in respect of its services provided to the Fund and the Fund will not expense any amounts in respect thereof. XXXXXXXXXX.

The Production Services Provider will pay a fee (the "Management Fee") to the Manager solely for the management services provided by the Manager to the Production Services Provider, as described above [i.e., not for any services provided by the Manager to the Fund]. The Production Services Provider will pay for the Management Fee out of the proceeds from the First Installment referred to in Paragraph 13. The Management Fee is not included in the computation of the Production Expenses and the Production Services Budget referred to in Paragraph 10.

9. Once a suitable film or television program has been identified (see Paragraph 8), the Production Services Provider will enter into a production services agreement (the "Production Services Agreement") with the Foreign Producer whereby the Production Services Provider will agree to provide production services in respect of the particular film or television program (the "Film Property") for which the rights to produce have been acquired by the Foreign Producer, and within the restrictions set forth in Part III.1 of the CSBIF Act for "eligible businesses". The Studio, which is the copyright owner of the Film Property and is not an "eligible production corporation" (as defined in subsection 125.5(1) of the Act), will also be a party to the Production Services Agreement and will consent to the engagement of the Production Services Provider. The production services (the "Production Services") to be provided by the Production Services Provider will be in respect of the production of the Film Property, and will include the supply, provision and application of technical knowledge, expertise and financing, services of personnel, appropriate facilities, equipment and supplies.

10. The terms of the Production Services Agreement will provide that the Production Services Provider will be responsible for paying for all expenses pertaining to the provision of the Production Services (the "Production Expenses") up to an agreed maximum amount (the "Production Services Budget"). The Production Services Budget will be approximately $XXXXXXXXXX and will not include the Management Fee referred to in Paragraph 8.

11. To pay for the Production Expenses to be incurred by the Production Services Provider, the Foreign Producer will provide interim financing to the Production Services Provider by way of (i) the Tax Credit Loan referred to in Paragraph 12, and (ii) a maximum non-interest bearing credit facility (the "Production Facility") equal to the Production Services Budget less the amount of the Tax Credit Loan. The Production Services Provider will be required to fully repay the Production Facility no later than XXXXXXXXXX.

12. The Production Services Provider intends to claim both the federal Film or Video Production Services Tax Credit, pursuant to section 125.5 of the Act, and the Ontario Production Services Tax Credit, pursuant to section 43.10 of the CTA (together referred to as the "Tax Credits"), in respect of its Production Expenses incurred in making the Film Property. The Foreign Producer will lend the Production Services Provider an amount equal to the Tax Credits (the "Tax Credit Loan"), which amount will be used in rendering the Production Services. The Tax Credit Loan shall be interest free and will be repaid upon receipt of the proceeds of the Tax Credits.

13. In consideration for the rendering of the Production Services, the Production Services Provider will be entitled to receive a production fee (the "Production Fee") from the Foreign Producer. XXXXXXXXXX. It is expected that the amount of the Fixed Portion of the Production Fee will exceed the total of the Production Services Provider's Production Expenses (net of the Tax Credits) and all other expenses incurred by the Production Services Provider (including operating costs and the Management Fee). The Fixed Portion of the Production Fee will be payable in installments with a first payment (the "First Installment") expected to be between XXXXXXXXXX% and XXXXXXXXXX% (maximum of XXXXXXXXXX%) of the Fixed Portion, payable on the later of completion of Production Services and XXXXXXXXXX and the balance (the "Balance of the Fixed Portion") payable on XXXXXXXXXX. Any Net Profit Participations will be payable in the year earned by the Foreign Producer. Notwithstanding the deferred receipt of any portion of the Production Fee, as explained above, the Production Services Provider will report its income for income tax purposes on an accrual basis.

14. The Foreign Producer will provide security to the Production Services Provider in respect of the Balance of the Fixed Portion. XXXXXXXXXX.

XXXXXXXXXX

15. As noted in Paragraph 2, the Fund will be registered as a CSBIF under Part III.1 of the CSBIF Act. The registration of the Fund as a CSBIF will be sponsored by the XXXXXXXXXX (the "Sponsor").

16. The Manager, which is an integrated wealth management company, will manage the Fund (see Paragraph 8). The Manager is a private corporation and a taxable Canadian corporation (as defined in subsection 89(1) of the Act) incorporated under the laws of the Province of XXXXXXXXXX with approximately $XXXXXXXXXX currently under management.

17. The Fund will issue Class A shares (the "Class A Shares", as discussed in Paragraph 18) and Class B shares (the "Class B Shares"). Each Class A Share and Class B Share will be entitled to one vote. It is intended that the Fund will issue a maximum of XXXXXXXXXX Class A Shares and XXXXXXXXXX Class B Shares. To the extent that the Fund is not fully subscribed, the Class A Shares and Class B Shares will still be issued on the same ratio (i.e., XXXXXXXXXX).

The Class B Shares will be issued only to DCo, a taxable Canadian corporation incorporated in Ontario. DCo does not yet have a business number. The Class B Shares will be issued for nominal consideration (approximately $XXXXXXXXXX per share) and will not be permitted to receive dividends or participate in the profits of the Fund. In the event of liquidation, dissolution or winding-up, the holders of the Class B Shares will only be entitled to receive a return of paid-up capital in respect of such shares.

DCo will issue XXXXXXXXXX common shares to the Manager and XXXXXXXXXX common shares to ET. No other shares of DCo will be issued.

XXXXXXXXXX

XXXXXXXXXX

18. The Fund will issue the Class A Shares to one or more entities (the "Class A Subscribers") that would each constitute a "financial institution", a "specified corporation" related to the financial institution at the time the investment was made, or an "insurance corporation" related to the financial institution at the time the investment was made (all within the meaning of subparagraphs 66.1(4)(a)(i) to (iii) of the CTA). These shares will be issued to the Class A Subscribers by way of private placement exemptions under the Securities Act (Ontario). You have advised us that the Class A Subscribers will acquire the Class A Shares in the ordinary course of their business operations. Any written materials provided to the Class A Subscribers that describe the rulings requested herein will have the following mention:

"THE RULING OBTAINED FROM CANADA CUSTOMS AND REVENUE AGENCY CONTAINS CAVEATS. THE RULING MAY BE VIEWED ON REQUEST PROVIDED THAT THE REQUESTING PARTY EXECUTES A CONFIDENTIALITY AGREEMENT".

The Class A Shares will be voting and, as a class, will represent approximately XXXXXXXXXX% of the overall voting shares of the Fund. The subscription price for Class A Shares will be $XXXXXXXXXX per share. The subscription price may be paid in installments provided that the full subscription price is paid by the Class A Subscriber on or before XXXXXXXXXX. Although reference is made to a number of Class A Subscribers, in this letter we are only ruling with respect to CCo as the identified Class A Subscriber. CCo is an indirectly wholly-owned subsidiary of BCo. XXXXXXXXXX and, with respect to its investment in the Class A Shares, is and will be a specified corporation related to BCo, for the purposes of the CTA. XXXXXXXXXX.

19. The Fund will add the full amount of the subscription price for the Class A Shares to the stated capital account maintained for the Class A Shares. The total amount of funds to be raised by the Fund will be limited to $XXXXXXXXXX. The minimum subscription will be $XXXXXXXXXX per Class A Subscriber and the maximum subscription will be $XXXXXXXXXX per Class A Subscriber. CCo's subscription amount will be $XXXXXXXXXX and its subscription will represent approximately XXXXXXXXXX % of all the issued shares of the Fund. It is currently anticipated that the full $XXXXXXXXXX will be raised by the Fund. The Class A Subscribers will have the right (the "Redemption Right") to require the Fund to repurchase the Class A Shares for cancellation at any time on or after XXXXXXXXXX, at a price per share equal to the fair market value of the net assets of the Fund on the date of redemption divided by the number of Class A Shares then outstanding. CCo will hold its Class A Shares on current account rather than as capital property.

20. CCo will not borrow any amounts in respect of the investment in Class A Shares. There have not been and there will not be any statements or representations that any amounts will be deductible by CCo, or any of the Class A Subscribers, in respect of the Class A Shares within the XXXXXXXXXX-year period following the date that the Class A Shares are acquired.

21. Pursuant to Part III.1 of the CSBIF Act and Part III of the CTA (in particular see subsections 66.1(2) to (4.7) of the CTA), a financial institution (within the meaning of subsection 58(2) of the CTA) may claim a Small Business Investment Tax Credit in respect of investments in a CSBIF made by (i) the financial institution (if it is a deposit-taking institution - see subsection 66.1(1.2) of the CTA), (ii) a "specified corporation" related to the financial institution at the time the investments were made, or (iii) a deposit-taking institution or an insurance corporation related to the financial institution at the time the investments were made. Pursuant to subsection 66.1(2) of the CTA, the Small Business Investment Tax Credit may be deducted by the financial institution claiming the credit (the "Claiming Institution") against its capital taxes otherwise payable under Part III of the CTA. Pursuant to subsection 66.1(4.1) of the CTA, only one Claiming Institution may claim the Small Business Investment Tax Credit in respect of any particular investment. In the case of CCo's investment in the Fund, BCo (which is a financial institution as defined in subsection 58(2) of the CTA) will be the Claiming Institution and, pursuant to subsection 66.1(4.5) of the CTA, BCo will be entitled to claim a tax credit equal to 30% of the equity capital paid by CCo to the Fund on the issuance of Class A Shares (based on the fact that, for the purposes of the CTA, CCo is a specified corporation that is related to BCo). In addition, pursuant to subsection 66.1(4.7) of the CTA, BCo will be entitled to claim an additional tax credit under section 66.1 of the CTA at the time that the Fund invests in the Production Services Provider (as described in Paragraph 22) equal to 30% of the amount of equity capital paid by CCo to the Fund on the issuance of the Class A Shares, to the extent that the Fund reinvests the capital in the Production Services Provider.

22. The Fund, XXXXXXXXXX, will acquire common shares of the Production Services Provider as described below. XXXXXXXXXX. Prior to the Production Services Provider commencing the Production Services in respect of the Film Property, the Fund XXXXXXXXXX will XXXXXXXXXX initially subscribe for and pay for XXXXXXXXXX common shares of the Production Services Provider (the "Initial Investment") at a fair market value price of $XXXXXXXXXX per share. The Fund XXXXXXXXXX will pay for these shares from the Class A Share and/or Class B Share subscription proceeds described in Paragraphs 18 and 17, as the case may be. At the time of the Initial Investment and as part of the consideration for the Initial Investment, the Fund XXXXXXXXXX will XXXXXXXXXX receive an option (the "Option") to acquire additional common shares of the Production Services Provider at the same fair market value price of $XXXXXXXXXX per share. The Fund XXXXXXXXXX will XXXXXXXXXX have the Option to acquire common shares of the Production Services Provider for consideration XXXXXXXXXX, which when coupled with the Initial Investment, will equal XXXXXXXXXX% of the estimated Production Services Budget net of the Tax Credits (i.e., equal in total to XXXXXXXXXX% of estimated Production Services Budget net of the Tax Credits). The Fund will be entitled to exercise its Option on or before the earlier of (i) the commencement of principal photography in respect of the Film Property and (ii) XXXXXXXXXX.

23. The Production Services Provider will use the subscription proceeds from the issuance of its common shares to the Fund XXXXXXXXXX to (i) repay all amounts owing to the Foreign Producer under the Production Facility and (ii) to pay for the balance, if any, of the Production Expenses that were not incurred with the advances from the Production Facility prior to XXXXXXXXXX.

24. The Fund also intends to invest in other corporations that will render production services in the same manner as the Production Services Provider but in respect of different film or television properties.

25. Once the Production Services Provider has fully repaid the Production Facility, from time to time it may make distributions of available cash (from, for example, the proceeds of the First Installment or the Net Profit Participations) to the Fund XXXXXXXXXX. On XXXXXXXXXX, the Production Services Provider will distribute all available cash to the Fund XXXXXXXXXX. These distributions will be in the form of a return of capital and/or dividends.

26. The Fund will not make any distributions of cash or property to the Class A Subscribers (including CCo) prior to XXXXXXXXXX. It is anticipated that on XXXXXXXXXX, the Fund will distribute all available cash (including any cash received from the Production Services Provider on XXXXXXXXXX) to the Class A Subscribers (including CCo) and such distribution will involve either (i) a purchase for cancellation of Class A Shares, or (ii) a return of capital. If the

Class A Shares have not been redeemed, and if there is any available cash in the Fund for years after XXXXXXXXXX, it will be distributed annually each XXXXXXXXXX.

Purpose of the Proposed Transactions

The combination of the rising Canadian dollar (as against the U.S. dollar), the increasingly competitive global marketplace XXXXXXXXXX have had a significant negative impact on the XXXXXXXXXX film industry. The purpose of the proposed transactions is to raise an alternative source of investment capital in order to attract additional foreign and domestic production into XXXXXXXXXX and to create, maintain and protect jobs for the people of XXXXXXXXXX.

Rulings

Provided that the statement of facts, proposed transactions and the purposes thereof, all as described above, is accurate and constitutes complete disclosure of all of the representations, relevant facts, proposed transactions and the purposes thereof, and provided further that all of the proposed transactions are carried out as described above, and that any written materials provided to the Class A Subscribers that describe the rulings set forth below contain a reference, such as described in Paragraph 18 in respect of the existence of caveats in the rulings given, and provided that the final documents described above are materially as submitted in draft, we confirm the following rulings:

A. Paragraph 12(1)(x) of the Act will not apply so as to add any amount to the income of BCo solely as a result of a particular Small Business Investment Tax Credit of BCo, in respect of CCo's investment in the Class A Shares and the Fund's investment in the Production Services Provider (as described in Paragraphs 19, 21 and 22), to the extent that the particular Small Business Investment Tax Credit deducted by BCo for a taxation year results in both a reduction to BCo's provincial capital tax otherwise payable to the Province of Ontario for the year and a consequential equal reduction in the amount of provincial capital taxes that would otherwise have been deductible in computing BCo's income for the year (within the meaning of subsection 9(1) of the Act) for federal income tax purposes.

B. The receipt of the Small Business Investment Tax Credit by BCo, as described in this letter, will not, in and of itself, result in a reduction of the amount of the paid-up capital (as defined in subsection 89(1) of the Act) of each Class A Share held by CCo.

These rulings are given subject to the general limitations and qualifications set forth in Information Circular 70-6R5, issued by CRA (formerly the Canada Customs and Revenue Agency) on May 17, 2002, and are binding provided the proposed transactions are entered into on or before XXXXXXXXXX. These rulings are based on the Act in its present form and do not take into account the effect of any proposed amendments. Except as expressly stated, our rulings do not imply acceptance, approval or confirmation of any income tax implications of the facts or proposed transactions. In particular, unless otherwise stated, nothing in this letter should be interpreted as confirming, either expressly or implicitly that CRA has agreed to or accepted:

i) the reasonableness or deductibility of any expenditures referred to in this letter;

ii) the determination of fair market value or adjusted cost base of any property referred to in this letter;

iii) the GST implications of any of the proposed transactions; and

iv) the computation of any Small Business Investment Tax Credit or provincial capital tax, or the eligibility of any party to claim any Small Business Investment Tax Credit referred to in this letter.

XXXXXXXXXX, our ruling is restricted to the proposed transactions described above under which CCo invests in the Fund that in turn invests in the Production Services Provider. For greater certainty, we are not ruling on

i) the Class A Subscribers referred to in Paragraph 18 (other than CCo),

ii) XXXXXXXXXX,

iii) the other corporations that will render production services referred to in Paragraph 24 (other than the Production Services Provider),

iv) whether CCo is XXXXXXXXXX a specified corporation related to BCo, for the purposes of the CTA (see Paragraph 18),

v) whether CCo, will hold its Class A Shares on current account rather than as capital property (see Paragraph 19), or

vi) the income tax treatment of the distributions described in Paragraphs 25 and 26.

Opinions

1. Provided that draft subsection 18.1(17) of the Act is enacted as proposed in the draft legislation released by the Department of Finance on December 20, 2002, it is our opinion that pursuant to subsection 18.1(17) of the Act, paragraph 18.1(4)(a) of the Act will not apply to restrict the deductibility of the Production Expenses made by the Production Services Provider in a taxation year (net of the Tax Credits for the same year, as described in Paragraphs 10 and 12), or any other matchable expenditures (as defined in subsection 18.1(1) of the Act) made by the Production Services Provider in the year in respect of its obligations to produce the Film Property as noted in this letter (these other matchable expenditures will include the Management Fee in Paragraph 8 and together with the Production Expenses (net of the Tax Credits) are referred to in this letter as the "Matchable Expenditures"), provided that before the end of the taxation year in which the Matchable Expenditures are made, the total of all amounts included in computing the Production Services Provider's income for that year (other than any portion of such an amount that is the subject of a reserve claimed by the Production Services Provider for the year under the Act) in respect of the Film Property, exceeds 80% of such Matchable Expenditures.

2. Provided that draft section 9300 of the Income Tax Regulations is promulgated as proposed and the Film Property qualifies as an "accredited production" under that section, and that the Production Services Provider qualifies as an "eligible production corporation" within the meaning of that term in subsection 125.5(1) of the Act, it is our opinion that the Production Services Provider will be entitled to claim a tax credit to the extent provided in subsection 125.5(3) of the Act, in respect of its qualified Canadian labour expenditures incurred in producing the Film Property.

In accordance with paragraph 22 of Information Circular 70-6R5, the above opinions are only an expression of opinion, and as such should not be construed as an advance income tax ruling, nor are they binding on CRA.

Yours truly,

XXXXXXXXXX
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
Policy and Legislation Branch
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