2012 Ruling 2011-0429261R3 - Article IV(7)(b) Loan Restructuring

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.

Principal Issues: 1) Whether treaty benefits apply to interest payments on intercompany debt owing by a Canadian-resident corporation that is fiscally transparent for United States tax purposes. 2) Whether principal amount of intercompany debt owed by Canadian-resident subsidiary to its Canadian-resident holding company is deemed to be owed to non-resident under s. 18(6). 3) Interest Deductibility.

Position: 1) Yes. 2) No. 3) Subject to reasonableness and thin capitalization restrictions, interest is deductible.

Reasons: 1) Interest will be considered to receive “same treatment” for the purposes of Article IV(7)(b). 2) Existing position. 3) Meets the requirements of s. 20(1)(c).

XXXXXXXXXX
2011-042926
Attention: XXXXXXXXXX

XXXXXXXXXX, 2012

Dear Sir:

Re: XXXXXXXXXX
Advance Income Tax Ruling Request

This in response to your letter of XXXXXXXXXX, in which you requested an advance income tax ruling on behalf of the above-noted taxpayers (the “Ruling Request”). We also acknowledge the information provided in the course of various telephone conversations (XXXXXXXXXX) and through e-mail correspondence. You have advised us that, to the best of your knowledge and that of the taxpayers involved, none of the issues involved in the Ruling Request are:

(i) in an earlier return of a taxpayer or persons related to a taxpayer;
(ii) being considered by a tax services office or taxation centre in connection with a previously filed tax return of a taxpayer or persons related to a taxpayer;
(iii) under objection by a taxpayer or persons related to a taxpayer;
(iv) before the courts; or
(v) the subject of a ruling previously issued by the Income Tax Rulings Directorate.

Unless otherwise noted, all statutory references herein are to the Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.), as amended (hereinafter referred to as the “Act”) and all references to currency are to Canadian dollars.

DEFINITIONS

(a) “Acquisitionco” means XXXXXXXXXX, a corporation incorporated under the laws of XXXXXXXXXX;

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

(c) “arm’s length” has the meaning assigned by subsection 251(1);

(d) “BCA 1” means XXXXXXXXXX;

(e) “BCA 2” means XXXXXXXXXX;

(f) “Canco” means XXXXXXXXXX, an unlimited liability corporation incorporated under BCA 1;

(g) “Canco Common Shares” means the common shares of Canco described in Paragraph 7;

(h) “Canco Debt” means the debt owed by Canco as described in Paragraph 17;

(i) “Cansub” means XXXXXXXXXX, a corporation incorporated under BCA 2;

(j) “Code” means the Internal Revenue Code of 1986, 26 U.S.C.;

(k) “CRA” means the Canada Revenue Agency;

(l) “disproportionate class of shares” has the meaning assigned by Article XXIX A(5)(b) of the U.S. Treaty;

(m) “Loan Advance Date” means a day that is within XXXXXXXXXX days after the issuance of an advance income tax ruling by the CRA with respect to the Ruling Request;

(n) “New Canco Debt” means the debt obligations to be issued by Canco to Subco as described in Paragraph 20;

(o) “New Opco Debt” means the debt obligation to be issued by Opco to Canco as described in Paragraph 21;

(p) “Note 1” means the debt obligation described in Paragraph 13 after taking into account any amounts of principal that have been repaid since the original issuance of such debt obligation;

(q) “Note 2” means the debt obligation described in Paragraph 15 after taking into account any amounts of principal that have been repaid since the original issuance of such debt obligation;

(r) “Note 2 Property” has the meaning assigned in Paragraph 37;

(s) XXXXXXXXXX;

(t) “Opco” means XXXXXXXXXX, an unlimited liability corporation continued under BCA 1;

(u) “Opco Debt” means the debt owed by Opco as described in Paragraph 17;

(v) “Opco Debt Property” has the meaning assigned by Paragraph 39;

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

(x) “Paragraph” means a numbered paragraph in this letter;

(y) “Parentco” means XXXXXXXXXX, a corporation incorporated under the laws of XXXXXXXXXX;

(z) “Parentco Common Shares” means the common stock of Parentco described in Paragraphs 2 and 3;

(aa) “Parentco Consolidated Group” means the affiliated group of corporations that includes Parentco and Subco, which elected under the Code to file an income tax return on a consolidated basis for United States federal income tax purposes;

(bb) “principal class of shares” has the meaning assigned by Article XXIX A(5)(e) of the U.S. Treaty;

(cc) “Proposed Transactions” means the transactions described in Paragraphs 20 to 26;

(dd) “qualifying person” has the meaning assigned by Article XXIX A(2) of the U.S. Treaty;

(ee) “recognized stock exchange” has the meaning assigned by Article XXIX A(5)(f) of the U.S. Treaty;

(ff) “related person” means, in relation to a particular person, another person which is related to the particular person because of subsection 251(2);

(gg) “Subco” means XXXXXXXXXX, a corporation incorporated under the laws of XXXXXXXXXX;

(hh) “Target” means XXXXXXXXXX, a corporation incorporated under BCA 2;

(ii) “taxable Canadian corporation” has the meaning assigned by subsection 89(1);

(jj) “taxation year” has the meaning assigned by subsection 249(1);

(kk) “United States” or “U.S.” means the United States of America; and

(ll) “U.S. Treaty” means the Convention Between the United States of America and Canada with Respect to Taxes on Income and on Capital Signed on 26 September 1980, as Amended by the Protocols Signed on 14 June 1983, 28 March 1984, 17 March 1995, 29 July 1997 and 21 September 2007.

FACTS

1. Parentco and its subsidiaries are in the business of XXXXXXXXXX. Parentco is not resident in Canada for the purposes of the Act. It is a resident of the United States and a qualifying person for the purposes of the U.S. Treaty.

2. The authorized share capital of Parentco consists of one class of common stock (the “Parentco Common Shares”). Approximately XXXXXXXXXX Parentco Common Shares are issued and outstanding. The Parentco Common Shares are listed for trading on the XXXXXXXXXX and are not listed for trading on any other recognized stock exchange. The Parentco Common Shares are the company’s only principal class of shares. Parentco does not have a disproportionate class of shares.

3. The Parentco Common Shares were primarily and regularly traded on the XXXXXXXXXX in XXXXXXXXXX and in previous years. The Parentco Common Shares have traded in more than a de minimis amount for at least XXXXXXXXXX days during the current year. As of XXXXXXXXXX, the aggregate number of Parentco Common Shares traded in XXXXXXXXXX was equal to at least XXXXXXXXXX% of the average number of Parentco Common Shares outstanding during that year.

4. Subco is a wholly-owned subsidiary of Parentco. All of the issued and outstanding shares of Subco are held by Parentco. Subco is XXXXXXXXXX of Parentco and its subsidiaries. Subco is not resident in Canada for the purposes of the Act. It is a resident of the United States and a qualifying person for the purposes of the U.S. Treaty.

5. Parentco and Subco, among others, are members of the Parentco Consolidated Group. Under the Code, the “separate taxable income” of both Parentco and Subco is included in the computation of the “consolidated taxable income” of the Parentco Consolidated Group.

6. Neither Parentco nor Subco has a “permanent establishment” in Canada for the purposes of the Act or the U.S. Treaty.

7. Canco is a taxable Canadian corporation. Its issued and outstanding share capital consists of one class of common shares (the “Canco Common Shares”). All of the issued and outstanding Canco Common Shares are held by Parentco. Canco’s only activity is the holding of shares and debt of Opco. Canco files its Canadian federal income tax return with the XXXXXXXXXX Tax Centre. Its Canadian federal income tax affairs are administered by the XXXXXXXXXX Tax Services Office.

8. Opco is a taxable Canadian corporation. It is in the business of XXXXXXXXXX, as well as providing related services. Opco files its Canadian federal income tax return with the XXXXXXXXXX Tax Centre. Its Canadian federal income tax affairs are administered by the XXXXXXXXXX Tax Services Office. All of the issued and outstanding shares of Opco are held by Canco.

9. Both Canco and Opco are disregarded as entities separate from their respective owners under the Code and are fiscally transparent under the taxation laws of the United States for the purposes of the U.S. Treaty.

10. Parentco indirectly acquired all the issued and outstanding shares of Target in XXXXXXXXXX. In general terms, the acquisition was undertaken as described in Paragraphs 11 to 14.

11. To acquire the issued and outstanding shares of Target, Parentco incorporated Acquisitionco, which, in turn, incorporated Canco. Parentco subscribed for common stock of Acquisitionco in exchange for a cash payment of approximately US$XXXXXXXXXX and the issuance of approximately XXXXXXXXXX Parentco Common Shares.

12. Acquisitionco then subscribed for XXXXXXXXXX Canco Common Shares in exchange for a cash payment of approximately US$XXXXXXXXXX and the transfer to Canco of the Parentco Common Shares acquired by Acquisitionco as described in Paragraph 11. The total of the Canadian dollar equivalent of the cash amount and the fair market value of the transferred Parentco Common Shares was added to the stated capital account maintained in respect of the Canco Common Shares.

13. Concurrent with the subscription for Canco Common Shares described in Paragraph 12, Acquisitionco made a US$XXXXXXXXXX unsecured, interest-bearing loan to Canco evidenced by a promissory note.

14. Canco used the funds and the Parentco Common Shares received as a result of the transactions described in Paragraphs 12 and 13 to purchase all of the issued and outstanding shares of the Target.

15. After acquiring the shares of Target, Canco incorporated Cansub and transferred all of the shares of Target to Cansub in exchange for common shares of Cansub and a US$XXXXXXXXXX unsecured, interest-bearing promissory note of Cansub.

16. On the same day as the transaction described in Paragraph 15, Cansub and Target amalgamated pursuant to the provisions of BCA 2 to form Opco, which was continued under BCA 1 and converted into an unlimited liability corporation under BCA 1.

17. In XXXXXXXXXX, Acquisitionco exchanged Note 1 for a non-interest-bearing promissory note of Canco that was denominated in Canadian dollars (the “Canco Debt”) and Canco exchanged Note 2 for a non-interest-bearing promissory note of Opco that was denominated in Canadian dollars (the “Opco Debt”). At the time of the exchanges, Acquisitionco and Canco waived entitlement to all accrued and outstanding interest on Note 1 and Note 2, respectively.

18. In XXXXXXXXXX, Acquisitionco was dissolved as part of a process to simplify the structure of Parentco’s corporate group.

19. Parentco controls Opco and Canco for the purposes of the Act.

PROPOSED TRANSACTIONS

20. Subco will loan $XXXXXXXXXX to Canco on the Loan Advance Date (the “New Canco Debt”). The New Canco Debt will bear interest at a rate of XXXXXXXXXX% per year. The term of the Newco Canco Debt will be XXXXXXXXXX years. The New Canco Debt will be unsecured and subordinated to the Canco Debt.

21. Canco will use the proceeds from the issuance of the New Canco Debt to loan $XXXXXXXXXX to Opco on the Loan Advance Date (the “New Opco Debt”). The New Opco Debt will bear interest at a rate of XXXXXXXXXX% per year. The term of the New Opco Debt will be XXXXXXXXXX years. The New Opco Debt will be unsecured and subordinated to the Opco Debt.

22. On the Loan Advance Date, Opco will use the proceeds of the New Opco Debt to repay $XXXXXXXXXX of the principal amount owing on the Opco Debt.

23. On the Loan Advance Date, Canco will use the proceeds received on repayment of the Opco Debt to repay $XXXXXXXXXX of the principal amount owing on the Canco Debt.

24. Parentco will use the funds received on the repayment of the Canco Debt described in Paragraph 23 for general corporate and business purposes to be determined at that time.

25. Opco will pay interest to Canco on the New Opco Debt.

26. Canco will pay interest to Subco on the New Canco Debt.

PURPOSES OF THE PROPOSED TRANSACTIONS

27. The purposes of the Proposed Transactions are to allow:

(i) Canco and Opco to substitute existing non-interest-bearing intercompany debt with interest-bearing indebtedness, so that the interest payable on the new indebtedness can be deductible for Canadian tax purposes, while allowing Parentco to maintain its existing Canadian corporate structure without incurring Part XIII tax on such interest payments,

(ii) Parentco to continue to be considered to directly carry on Opco’s business activities for United States federal income tax purposes, and

(iii) Parentco to maintain access, for United States federal income tax purposes, to foreign tax credits in respect of any Canadian income tax paid by Opco in respect of Opco’s earnings.

ADDITIONAL INFORMATION

28. The interest payable on the New Canco Debt will not be determined with reference to receipts, sales, income, profits or other cash flow of Canco or a related person, to any change in the value of any property of Canco or a related person or to any dividend, distribution or similar payment made by Canco.

29. Canco and Opco were established as unlimited liability corporations that are disregarded as entities separate from their respective owners for United States federal income tax purposes. Consequently, Parentco is considered to be carrying on Opco’s Canadian business operations through a branch in Canada for United States federal income tax purposes, which allows Canadian taxes payable by Canco and Opco to be claimed by the Parentco Consolidated Group as a foreign tax credit for the purposes of computing the group’s United States federal income tax liability.

30. For United States federal income tax purposes, the payment of interest by Canco to Subco on the New Canco Debt will be treated as a payment of interest and will not be disregarded; interest receivable on the New Canco Debt will be included in the calculation of Subco’s separate taxable income for each “taxable year”, as that term is defined under the Code, to the extent that such interest accrues in a particular taxable year.

31. If Canco was not disregarded as an entity separate from its owner for United States federal income tax purposes, interest on the New Canco Debt would be included in the calculation of Subco’s separate taxable income as described Paragraph 30.

32. Opco directly carries on the business activities described in Paragraph 8. For United States federal income tax purposes, the revenues earned by Opco from these business activities are included in the computation of the taxable income of Parentco on a current basis.

33. All of the funds to be advanced by Subco to Canco in respect of the New Canco Debt will come from Subco’s cash on hand generated from customer receipts earned in the ordinary course of Subco’s business activities.

34. The interest rates on the New Canco Debt and the New Opco Debt are comparable to the interest rates on unsecured debt obligations issued by Parentco on XXXXXXXXXX to arm’s-length third parties, which have a similar term to the New Canco Debt and New Opco Debt.

35. Interest on Note 2, which Cansub issued to acquire shares of Target as described in Paragraph 15, would have been deductible to Cansub in computing its income, pursuant to paragraph 20(1)(c).

36. Following the amalgamation described in Paragraph 16, in computing its income for a taxation year, Opco deducted, pursuant to paragraph 20(1)(c), the interest on Note 2, which was previously used by Cansub to acquire the shares of Target.

37. To the extent Opco disposed of the property that had been held by Target for the purpose of gaining or producing income immediately before the amalgamation described in Paragraph 16, Note 2 could be traced to replacement property acquired for the purpose of gaining or producing income. As a result, Note 2 continued to be an amount payable for property acquired for the purpose of gaining or producing income (the “Note 2 Property”).

38. Had the Opco Debt, which was used to repay Note 2 as described in Paragraph 17, been interest-bearing, in computing its income for a taxation year, Opco would have deducted, pursuant to subsection 20(3) and paragraph 20(1)(c) of the Act, the interest payable on the Opco Debt.

39. Following the issuance of the Opco Debt, to the extent that Opco disposed of the Note 2 Property, the Opco Debt could be traced to replacement property acquired for the purpose of gaining or producing income. As a result, the Opco Debt continued to be an amount payable for property acquired for the purpose of gaining or producing income (the “Opco Debt Property”).

40. While all amounts and debts, including the New Canco Debt and New Opco Debt, will be denominated in Canadian dollars, the Proposed Transactions will be undertaken through the advance and transfer of U.S. dollars that are equivalent to the Canadian dollar amounts referred to herein.

RULINGS

Provided that the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, the proposed transactions and the purposes of the proposed transactions, and provided further that the Proposed Transactions are completed in the manner described above, we rule as follows:

A. Provided that Subco is the beneficial owner of the interest paid by Canco to Subco on the New Canco Debt and is a qualifying person under the U.S. Treaty, Subco will not be subject to tax under Part XIII of the Act on the payment of that interest pursuant to Article XI(1) of the U.S. Treaty.

B. Article IV(7)(b) of the U.S. Treaty will not apply to the payment of interest by Canco to Subco on the New Canco Debt.

C. Subsection 18(6) will not apply to deem the New Opco Debt to be owing from Opco to Subco.

D. Provided that Opco has a legal obligation to pay interest on the New Opco Debt and Opco continues to hold the Opco Debt Property for the purpose of gaining or producing income (other than exempt income), in computing its income for a taxation year, Opco will be entitled to deduct, pursuant to paragraph 20(1)(c) and subsection 20(3) of the Act, the lesser of (i) the interest on the New Opco Debt, as described in Paragraph 21, paid in the year or payable in respect of the year (depending on the method regularly followed by Opco in computing its income for the purposes of the Act) or (ii) a reasonable amount in respect thereof.

E. Provided that Canco has a legal obligation to pay interest on the New Canco Debt and the New Opco Debt continues to be held by Canco for the purpose of gaining or producing income from property, in computing its income for a taxation year, Canco will, subject to subsection 18(4) of the Act, be entitled to deduct, pursuant to paragraph 20(1)(c) of the Act, the lesser of (i) the interest on the New Canco Debt, as described in Paragraph 20, paid in the year or payable in respect of the year (depending on the method regularly followed by Canco in computing its income for the purposes of the Act) or (ii) a reasonable amount in respect thereof.

F. Subsection 245(2) will not apply to the Proposed Transactions, in and by themselves, to re-determine the tax consequences confirmed in the rulings given.

The above-noted rulings are based on the Act and the U.S. Treaty in their present form and do not take into account any proposed amendments to the Act or the U.S. Treaty which, if enacted, could have an effect on the rulings provided herein.

CAVEAT

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

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

(b) whether subsection 18(4) of the Act would apply to deny a deduction in respect of any interest that is paid or payable on the New Canco Debt; and

(c) any tax consequences relating to the facts and the Proposed Transactions described herein other than those described in the rulings given above.

This ruling is based solely on the facts, the proposed transactions and additional information described above and is subject to the limitations and qualifications set forth in Information Circular 70-6R5 issued on May 17, 2002. This ruling is binding on the CRA provided that the Proposed Transactions are completed on or before XXXXXXXXXX.

Yours truly,

XXXXXXXXXX
Section Manager
for Director
International Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch