2002 Ruling 2002-0160913 - INTEREST

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 interest is deductible where acquisition debt is moved from Holdco to Opco

Position: yes

Reasons: ITA

XXXXXXXXXX 							2002-016091

XXXXXXXXXX, 2002

Dear XXXXXXXXXX:

Re: XXXXXXXXXX

XXXXXXXXXX
XXXXXXXXXX
Advance Income Tax Ruling

We are writing in response to your letter of XXXXXXXXXX wherein you requested an advance income tax ruling on behalf of the above taxpayers.

To the best of your knowledge, and that of the taxpayers involved, none of the issues contained herein is:

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

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

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

(iv) subject to a ruling previously issued by the Income Tax Rulings Directorate; or

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

In this letter, the following terms have the meanings specified:

(a) "Act" means the Income Tax Act, R.S.C 1985 (5th Supp.) c.1, 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 provision of the Act;

(b) "Adjusted cost base" has the meaning assigned by section 54 of the Act;

(c) "Amalco" means the corporation that will result from the short-form vertical amalgamation of Newco 2 and Opco under the Company Act as described in paragraph 23 below;

(d) "Area #1" means XXXXXXXXXX;

(e) "Area #2" means XXXXXXXXXX;

(f) "Canadian corporation" has the meaning assigned by subsection 89(1) of the Act;

(g) "Company Act" means the Business Corporations Act of XXXXXXXXXX;

(h) "Foreign Bank" means XXXXXXXXXX, a limited liability company formed under the laws of Foreign Country, and resident therein under central management and control tests XXXXXXXXXX;

(i) "ForeignCo" means XXXXXXXXXX a limited liability company incorporated under the laws of Foreign Country, with its head office at XXXXXXXXXX. ForeignCo is owned by Foreign Parent #1 (XXXXXXXXXX%), Foreign Holdco (XXXXXXXXXX%) , Foreign Parent #2 (XXXXXXXXXX%) and Foreign Bank (XXXXXXXXXX%);

(j) "Foreign Country" means XXXXXXXXXX;

(k) "Foreign Holdco" means XXXXXXXXXX, a limited liability company formed under the laws of Foreign Country, and resident therein under central management and control tests XXXXXXXXXX. This company acts as a holding company for the family of Principal;

(l) "Foreign Parent #1" means XXXXXXXXXX, a limited liability company incorporated under the laws of Foreign Country, and managed and controlled out of Foreign Country (XXXXXXXXXX). Foreign Parent #1 is owned by Foreign Holdco (XXXXXXXXXX%) and directly by the family of Principal (XXXXXXXXXX%);

(m) "Foreign Parent #2" means XXXXXXXXXX, a limited liability company formed under the laws of Foreign Country, and resident therein under central management and control tests (XXXXXXXXXX). Foreign Parent #2 is a subsidiary of Foreign Holdco (i.e., XXXXXXXXXX% directly and XXXXXXXXXX % indirectly);

(n) "Holdco" means XXXXXXXXXX, a wholly-owned subsidiary of ForeignCo incorporated on XXXXXXXXXX under the laws of the province of XXXXXXXXXX as XXXXXXXXXX through which ForeignCo purchased Canada;

(o) "Legal stated capital" means the amount included in the capital account of a corporation under applicable corporate law;

(p) "Newco 1" means the wholly-owned subsidiary of ForeignCo that will be incorporated under the Company Act as part of the Proposed Transactions described herein;

(q) "Newco 2" means the wholly-owned subsidiary of Holdco that will be incorporated under the Company Act as part of the Proposed Transactions described herein;

(r) "Opco" means XXXXXXXXXX a corporation formed under the laws of the Province on the amalgamation of XXXXXXXXXX;

(s) "Opco Acquisition Debt" means XXXXXXXXXX;

(t) "Opco Replacement Debt" means the interest-bearing debt incurred by Holdco and used by Holdco to repay Loan #3. The Opco Replacement Debt is interest-bearing debt. It consists of term indebtedness of XXXXXXXXXX;

(u) "Paid-up capital" has the meaning assigned by subsection 89(1) of the Act;

(v) "Principal" means XXXXXXXXXX;

(w) "Private corporation" has the meaning assigned by subsection 89(1) of the Act;

(x) "Products" means XXXXXXXXXX;

(y) "Promissory Note" means the interest-bearing promissory note issued by Newco 2 in favour of Holdco on the transfer of XXXXXXXXXX common shares of Opco to Newco 2 by Holdco that will take place as described in paragraph 22 below;

(z) "Province" means the Province of XXXXXXXXXX;

(aa) "Unrelated ForeignCo" means XXXXXXXXXX (a company organized under the laws of XXXXXXXXXX), a company that is not related to the companies in the Principal's group of companies, that entered into the Stock and Asset Purchase Agreement described in paragraph 8 below;

(bb) "USCo" means XXXXXXXXXX the wholly-owned subsidiary of ForeignCo that was incorporated on XXXXXXXXXX under the laws of the State of XXXXXXXXXX to acquire certain assets, properties, and rights used in the US business of XXXXXXXXXX a company organized under the laws of the State of XXXXXXXXXX, which was also a wholly-owned indirect subsidiary of XXXXXXXXXX, a public company organized under the laws of XXXXXXXXXX which was to be acquired by Unrelated ForeignCo;

(cc) "Vending Shareholder" means the former shareholder of Canada (i.e., XXXXXXXXXX), a company organized under the laws of XXXXXXXXXX, which was a wholly-owned indirect subsidiary of XXXXXXXXXX a public company organized under the laws of XXXXXXXXXX which was to be acquired by Unrelated ForeignCo at the time.

Any references to an amount of money are expressed in Canadian dollars, unless otherwise indicated.

FACTS

1. ForeignCo is a privately-held corporation, incorporated and resident in Foreign Country, whose common shares are closely held (i.e., XXXXXXXXXX% held by Foreign Parent #1, XXXXXXXXXX% held by Foreign Parent #2, XXXXXXXXXX% held by Foreign Holdco, and XXXXXXXXXX % by Foreign Bank).

2. The Principal's group of companies is the market leader in Area #1 in the Products business. The Principal's group of companies markets its products throughout Area #1 and acquired Opco as part of its business strategy to establish a significant presence in the Area #2 market.

3. Opco is a Canadian corporation and a Private corporation. Opco was formed on XXXXXXXXXX under the laws of the Province as a result of the amalgamation of XXXXXXXXXX under the laws of the Province. XXXXXXXXXX.

4. The authorized share capital of Opco consists of an unlimited number of common shares. On XXXXXXXXXX, all of the issued and outstanding common shares of Opco, which consisted of XXXXXXXXXX common shares, were acquired by Holdco.

5. Opco has a significant share of the Products business in Canada (primarily in the Province).

6. Holdco was incorporated on XXXXXXXXXX under the laws of the Province and is a wholly-owned subsidiary of ForeignCo (i.e., XXXXXXXXXX common shares on incorporation). Holdco's registered head office is located at XXXXXXXXXX.

Holdco was incorporated by ForeignCo for the purpose of acquiring all of the issued and outstanding shares of Opco.

7. USCo was incorporated on XXXXXXXXXX under the laws of the State of XXXXXXXXXX under the name XXXXXXXXXX as a wholly-owned subsidiary of ForeignCo. USCo's registered head office is XXXXXXXXXX.

8. On XXXXXXXXXX (a company organized under the laws of Foreign Country, and a related company in the Principal's group of companies) and Unrelated ForeignCo entered into a Stock and Asset Purchase Agreement pursuant to which Holdco was to acquire the XXXXXXXXXX common shares of Opco and USCo was to acquire certain US business assets and was to assume certain related US business liabilities from XXXXXXXXXX . (a company organized under the laws of the State of XXXXXXXXXX that dealt at arm's length with the Principal's group of companies) for total consideration of US $XXXXXXXXXX in cash plus various adjustments and the assumption of various liabilities on closing.

9. On XXXXXXXXXX, Holdco acquired all (i.e., XXXXXXXXXX) of the issued and outstanding common shares of Opco at an initial purchase price of $XXXXXXXXXX (before various price adjustments, including the adjustment described in paragraph 14 below) and a final purchase price of $XXXXXXXXXX (approximately US$XXXXXXXXXX).

The acquisition by ForeignCo through its wholly-owned subsidiary, Holdco, of all of the issued and outstanding common shares in the share capital of Opco was carried out to gain a strategic foothold in the lucrative Area #2 market.

Holdco loaned $XXXXXXXXXX to Opco on an interest-bearing basis to enable Opco to meet its on-going cash requirements. The purchase of the Opco shares and loan to Opco were funded by the Opco Acquisition Debt and share capital in the amount of $XXXXXXXXXX (i.e., XXXXXXXXXX common shares).

10. On XXXXXXXXXX, subsequent to the acquisition described in paragraph 9 above, for tax planning reasons in Foreign Country, Holdco transferred XXXXXXXXXX% of the issued and outstanding common shares of Opco to ForeignCo (i.e., XXXXXXXXXX common shares) as a repayment of a portion of its indebtedness under Loan #1 to ForeignCo. The purchase price payable by ForeignCo was subject to adjustments that paralleled those affecting the price payable by Opco.

11. On XXXXXXXXXX, Holdco borrowed the Opco Replacement Debt and used the proceeds of these borrowings to repay Loan #3.

12. Also on XXXXXXXXXX, Holdco repaid a portion of amounts owing by it under Loan #2 to ForeignCo (i.e., US $XXXXXXXXXX or Cdn $XXXXXXXXXX ) through the issuance by Holdco of additional common shares to ForeignCo (i.e., XXXXXXXXXX additional common shares).

13. On XXXXXXXXXX, Holdco received a cash payment of $XXXXXXXXXX as a working capital adjustment to the purchase price (i.e., $XXXXXXXXXX purchase price reduced to $XXXXXXXXXX) of Opco. ForeignCo used its entitlement to a portion thereof (i.e., XXXXXXXXXX % or $XXXXXXXXXX) to subscribe for an additional XXXXXXXXXX Holdco common shares (i.e., total of XXXXXXXXXX common shares issued and outstanding on XXXXXXXXXX).

14. On XXXXXXXXXX, Unrelated ForeignCo paid $XXXXXXXXXX to the Canadian tax authorities in respect of Opco's Canadian tax liabilities. It is your understanding that this amount represents the final adjustment to the purchase price of Opco. This payment was recorded in the books of Holdco as a loan from Holdco to Opco of $XXXXXXXXXX made for the purpose of Opco satisfying the above tax liability taxes, and as a loan from ForeignCo to Holdco for XXXXXXXXXX% thereof (i.e., $XXXXXXXXXX). This loan from ForeignCo to Holdco was then immediately repaid by the issuance of additional common shares by Holdco (i.e., XXXXXXXXXX shares) to ForeignCo (i.e., legal stated capital and fair market value of $XXXXXXXXXX). Accordingly, the final purchase price of Holdco's purchase of Holdco, as described in paragraph 9 above was $XXXXXXXXXX. Further, the current number of Holdco common shares issued and outstanding is presently XXXXXXXXXX.

US Transactions

15. On XXXXXXXXXX ForeignCo subscribed for XXXXXXXXXX common shares of USCo with a par value of $XXXXXXXXXX per share and paid US $XXXXXXXXXX per share or US $XXXXXXXXXX in the aggregate.

16. On XXXXXXXXXX USCo used the proceeds from the share issuance (i.e., US $XXXXXXXXXX) as well as the proceeds from a loan from XXXXXXXXXX (i.e., US $XXXXXXXXXX) to acquire the USCo business for initial cash consideration of US$XXXXXXXXXX (after closing adjustments, the final purchase price was US$XXXXXXXXXX).

17. On XXXXXXXXXX USCo borrowed US $XXXXXXXXXX or Cdn $XXXXXXXXXX in term debt (from XXXXXXXXXX and other banks). USCo used these funds to repay its bridge loan of US $XXXXXXXXXX and the balance was used to make an interest-bearing loan to Holdco (i.e., US $XXXXXXXXXX or Cdn $XXXXXXXXXX).

PROPOSED TRANSACTIONS

18. ForeignCo will incorporate a new Canadian company ("Newco 1") under the laws of the Province for nominal cash consideration.

19. ForeignCo will then transfer its shares of Opco (i.e., XXXXXXXXXX common shares) to Newco 1 in exchange for additional shares in Newco 1. The amount added to the legal stated capital of Newco 1 will be equal to the fair market value of the transferred shares. No non-share consideration will be issued by Newco 1 as part of the exchange. ForeignCo and Newco 1 will jointly elect, in prescribed form and manner, within the time period prescribed under subsection 85(1) of the Act with respect to the transfer of the common shares of Opco at an amount equal to the adjusted cost base to ForeignCo of the transferred shares. For greater certainty, the elected amount will not exceed the fair market value of the transferred shares.

It is your understanding that the paid-up capital of the Newco 1 shares issued on this transfer by ForeignCo should not exceed the paid-up capital of the XXXXXXXXXX common shares of Opco. Holdco has requested clearance certificates on this proposed transaction under subsection 116(3) of the Act.

20. Newco 1 will then transfer its XXXXXXXXXX common shares of Opco to Holdco in exchange for common shares of Holdco of a separate class. Newco 1 and Holdco will jointly elect, in prescribed form and manner, within the time period prescribed under subsection 85(1) of the Act with respect to the transfer of the common shares of Opco at an amount equal to the adjusted cost base to Newco 1 of the transferred shares. For greater certainty, the elected amount will not exceed the fair market value of the transferred shares. The amount added to the legal stated capital of the common shares in the share capital of Holdco issued to Newco 1 on the transfer of the common shares of Opco will be equal to the fair market value of the transferred shares of Opco.

The transfer by Newco 1 of XXXXXXXXXX common shares of Opco to Holdco in exchange for common shares of Holdco will give Newco 1 an equity ownership in Holdco of approximately XXXXXXXXXX% ( Holdco has a current net asset value of approximately $XXXXXXXXXX and therefore the transfer of the XXXXXXXXXX common shares will increase that net asset value by $XXXXXXXXXX, i.e., from $XXXXXXXXXX to $XXXXXXXXXX).

21. Holdco will incorporate a Canadian subsidiary, Newco 2, under the laws of the Province with nominal share capital.

22. Holdco will transfer its XXXXXXXXXX common shares of Opco to Newco 2 in exchange for the Promissory Note of Newco 2 of approximately $XXXXXXXXXX and shares of Newco 2 having nominal legal stated capital. Holdco and Newco 2 will jointly elect, in prescribed form and manner, within the time period prescribed under subsection 85(1) of the Act with respect to the transfer of the common shares of Opco at an amount equal to the adjusted cost base to Holdco of the transferred shares. The Promissory Note will be payable on demand and will bear interest at a rate in excess of the rate of interest payable by Holdco to its lenders on the Opco Acquisition Debt and the Opco Replacement Debt. The interest on the Promissory Note will be calculated and payable monthly.

23. Newco 2 and Opco will then be amalgamated by way of a short-form vertical amalgamation under the Company Act to form Amalco.

24. In the future, ForeignCo may transfer one or more of its investments in Holdco, Newco 1, and USCo within the Foreign Country related party group on a taxable basis and some or all of the shares of ForeignCo may be transferred within that group.

PURPOSE OF THE PROPOSED TRANSACTIONS

The purposes of the Canadian transactions are as follows:

The acquisition of Opco by ForeignCo was the latter's first venture into Canada. However, ForeignCo is continuously evaluating possible acquisition opportunities as part of its overall growth strategy. As a result, other acquisitions in Canada by ForeignCo may occur. To that effect, ForeignCo would like to ensure maximum flexibility with regard to its Canadian holding structure from both a corporate organizational and cash-flow management perspective. Indeed, it may be undesirable to have future acquisitions or other business ventures housed within the existing corporate entity which would otherwise be formed by the amalgamation of Newco 2 and Opco. As a result, ForeignCo would like to maintain Holdco as a Canadian holding company so that future acquisitions or other business ventures could be housed in a separate and distinct subsidiary of Holdco (which would serve as the Canadian parent corporation of ForeignCo's Canadian corporate interests and business operations) thus becoming sister companies of Opco (i.e., Amalco) in ForeignCo's overall Canadian corporate organization.

The purpose for the transfer by Holdco of its XXXXXXXXXX common shares of Opco to Newco 2 in exchange for the Promissory Note of Newco 2 and the subsequent amalgamation of Newco 2 with Opco is solely to shift interest deductions from Holdco to Newco 2 (and ultimately Amalco once Newco 2 is amalgamated with Opco) and it is not to cause any other significant tax consequences to Holdco, Opco, Newco 2, or Amalco.

RULING GIVEN

Provided that the preceding statements constitute a complete and accurate disclosure of all of the relevant warranties in paragraphs (i) to (v) on page 1 of this advance income tax ruling, as well as 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 set forth below:

To the extent that the amount of interest on the Promissory Note assumed by Amalco as a result of the amalgamation of Newco 2 and Opco as described in paragraph 23 above is reasonable in the circumstances, interest paid or payable by Amalco on the Promissory Note will be deductible by Amalco pursuant to subparagraph 20(1)(c)(ii) of the Act.

CAVEAT

The above rulings are given subject to the general limitations and qualifications set out in Information Circular 70-6R5 (the "Circular") issued by the CCRA on May 17, 2002, and are binding provided the Proposed Transactions described in paragraphs 18 to 23 above are completed 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 to the Act.

Nothing in this letter should be construed as implying that the CCRA has agreed to or accepted:

(i) the cost or fair market value of any property referred to in this letter;

(ii) the income tax consequences of any of the proposed elections under subsection 85(1) of the Act described above;

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

(iv) any other tax consequences of the proposed transactions or of related transactions or events that are not described herein.

Yours truly,

XXXXXXXXXX
for Director
Financial Industries Division
Income Tax Rulings Directorate