3 February 1995 GST/HST Ruling 1995-02-03 - Joint Venture Operations

XXXXX  XXXXX

February 3, 1995

Dear XXXXX

This is in reply to your correspondence of May 11, 1994, in which you advised Revenue Canada of certain facts and proposed transactions relevant to the subject matter of the GST ruling issued on September 28, 1993. You have requested certain rulings regarding those transactions, as well as confirmation of the various rulings contained in the September 1993 ruling upon the occurrence of the proposed transactions. This request is prompted as a result of the admission of another corporate entity, XXXXX into the Project.

In your letter of January 12, 1995 you have requested a status report on both the above noted ruling as well as one requested in your letter of October 15, 1993. With respect to the latter we currently anticipate being able to provide you with a response by mid to late February 1995.

Please note that unless defined within this ruling, capitalized words are those defined in a relevant Project Agreement or in Schedule A, which is appended to all agreements dealing with the Project.

Background

The federal government (the Government), through the Minister of Government Services, entered into agreements with XXXXX for the development of a fixed crossing of the XXXXX . Financial Closing for the Project took place on XXXXX The various agreements relating to the Project were entered into and the Subsidy Bonds were issued on that date. Work has commenced in connection with various matters pertaining to the Project, including the construction of the Yard Facility.

Statement of Facts

Based on correspondence provided by XXXXX and on verbal conversations between representatives of that company and our officials, our understanding of the material changes to the facts included in the application ruling (copy attached) dated September 28, 1993 is as follows:

1. XXXXX is a Canadian corporation as defined in paragraph 89(1)(a) of the Income Tax Act and a private corporation as defined in paragraph 89(1)(f) of that Act. XXXXX was incorporated on August 23, 1993 under the XXXXX

2. XXXXX is a wholly owned, indirect subsidiary of XXXXX a corporation incorporated under the laws of the XXXXX

3. XXXXX GST registration number is XXXXX

4. During the months preceding Financial Closing, the members of the Construction Consortium had detailed discussions with XXXXX concerning their potential involvement in a number of aspects of the Project, including becoming a member of the Construction Consortium and a shareholder of XXXXX . Although discussions were substantially advanced at Financial Closing, XXXXX 's involvement in the Project was not finalized at that time to ensure that Financial Closing was not delayed.

5. Before the entry of XXXXX into the Project, XXXXX held all of the issued and outstanding shares of XXXXX as follows:

XXXXX

Total 1000 shares (100%)

6. XXXXX also held corresponding proportionate interests in the Construction Consortium, a joint venture.

7. The Joint Venture Agreement was amended effective XXXXX XXXXX , the date of Financial Closing, to add XXXXX as a Joint Venturer with XXXXX rights and obligations to be the same as those of XXXXX and XXXXX (except as to proportionate shares).

8. It is the intention of XXXXX that the agreements and amendments to agreements related to the admission of XXXXX as a Joint Venturer in the Construction Consortium take effect in their application to the Construction Consortium from Financial Closing and that XXXXX be treated as if it had been a member of the Construction Consortium from Financial Closing.

9. Prior to the closing of the transactions (Closing) provided for in the XXXXX common shares of XXXXX, constituting 11% of the issued and outstanding common shares will have been transferred by XXXXX to XXXXX, a wholly owned indirect subsidiary of XXXXX the corporation which owns all of the outstanding shares of XXXXX[.]

10. Pursuant to the Admission Agreement, at XXXXX will acquire 200 shares of XXXXX , constituting 20% of the 1000 issued and outstanding common shares.

11. XXXXX will acquire a 20% proportionate share of the XXXXX assets, including a 20% interest in the funds in the XXXXX and will assume a 20% proportionate share of the obligations of the XXXXX under the Construction Contract and other Principal Project Agreements referred to in paragraph 19 below.

12. The 200 issued and outstanding common shares of XXXXX to be acquired by XXXXX will be obtained as follows:

•   At Closing, 110 shares from XXXXX (which XXXXX acquired from XXXXX) at a price of XXXXX per share for a total purchase price of XXXXX. This amount was payable by a cash payment on closing of XXXXX with the balance due and payable on the earlier of May 31, 1998 and the Date of Final Completion.

•   On September 30, 1994, a further 90 shares from XXXXX at a price of XXXXX per share for a total purchase price of XXXXX[.] This amount was payable by a cash payment on closing of XXXXX with the balance due and payable on the earlier of May 31, 1998 and the Date of Final Completion.

13. At XXXXX and XXXXX will hold all of the issued and outstanding shares of XXXXX as follows:

 XXXXX
Total 1000 shares (100%)

14. XXXXX obligation to pay the balance of the purchase price to XXXXX and XXXXX is secured by promissory notes (the Notes) issued by XXXXX in the amounts o XXXXX to XXXXX and XXXXX respectively. Each of the Notes is on the same terms and bears interest at the rate of 7% per annum, compounded annually. Interest and principal are payable on the earlier of May 31, 1998 and the Date of Final Completion.

15. Pursuant to paragraph 2 of the Admission Agreement, XXXXX will be entitled, but not obliged, to purchase 55 common shares in the capital of XXXXX from XXXXX and XXXXX will be entitled, but not obliged, to purchase 45 common shares in the capital of XXXXX from XXXXX at a price of XXXXX per share in each case once distributions of dividends on the shares held by XXXXX have reached prescribed levels.

16. The Admission Agreement provides that XXXXX will acquire a 20% interest in the Construction Consortium. Upon such acquisition, the interest of each of XXXXX and XXXXX in the Project will be correspondingly reduced and the proportionate interests in the Construction Consortium of each member will be as follows:

 XXXXX

17. XXXXX and XXXXX have concluded that the value of the rights and entitlements with respect to the Construction Contract and the burden of the obligations thereunder are equal, with the result that the right of XXXXX to participate in the Construction Consortium has no net value.

18. As a consequence of the arrangements set out in paragraphs 1 to 17 above, the following amendments will be made to the agreements and related documents referred to in the ruling of September 28, 1993.

(a) The Principal Project Agreements will be amended, in the case of agreements to which the Construction Consortium is a party, to amend the definition of a member of the Construction Consortium to include XXXXX as a member having joint and several liability with the original members for the obligations of the Construction Consortium.

The Principal Project Agreements are as follows:

Development Agreement
Developer Security Agreement
Construction Contract
Contractor Security Agreement
Regional Benefit Agreement
Project Trust Agreement
Insurance Trust Agreement
Maintenance Trust Agreement

(b) The Parent Companies' Development Guarantee and the Parent Companies' Construction Guarantee will be amended to provide for XXXXX to be jointly and severally liable for Developer and Contractor Obligations with the original Parent Companies, XXXXX

(c) XXXXX as the holder of XXXXX shares, will guarantee the Developer's obligations and pledge its XXXXX shares to secure the guarantee on a limited recourse basis, as did the other shareholders of XXXXX at Financial Closing.

(d) XXXXX will enter into a supplementary debenture with the other members of the Construction Consortium and the Security Trustee to include XXXXX as a joint and several obligor under the debenture granted by the original members, and amended security registrations will be recorded to register the security interests against XXXXX assets.

(e) XXXXX and XXXXX will enter into indemnification agreements with XXXXX and XXXXX to arrange for a pro rata sharing of losses in the event any demand is made on any of them by the surety companies or by the Bank which issued the Letter of Credit.

(f) The shareholder agreement among the shareholders of XXXXX will be amended to include XXXXX on a pro rata basis.

The joint venture agreement among the members of the Construction Consortium also will be amended to include XXXXX on a pro rata basis in the undertaking, assets and liabilities of the Construction Consortium.

19. Paragraph 8 of the Admission Agreement provides that XXXXX shall be obliged to provide its proportionate share of any working capital contributed by the joint venturers before the closing date.

20. It is an assumed fact that the activity of the Construction Consortium is the construction of real property for the purposes of section 273 of the Excise Tax Act and paragraph 3(1)(a) of the Joint Venture (GST) Regulations.

Rulings Requested

You asked that we confirm the following.

1. The original rulings dated September 28, 1993 with respect to the Project remain in place notwithstanding the addition of a fourth participant in the Construction Consortium and a fourth shareholder in XXXXX

2. XXXXX, by virtue of subsection 273(2) of the Excise Tax Act, is deemed to have entered into the joint venture election between the original participants in the Construction Consortium and all GST accounting with respect to the joint venture operations may continue to be the responsibility of the "operator" of the joint venture.

3. The acquisition by XXXXX of 20% of the issued and outstanding shares of XXXXX from XXXXX and XXXXX (as applicable), is a financial transaction and exempt from GST pursuant to Section 1 of Part VII of Schedule V to the Excise Tax Act.

4. The reacquisition by XXXXX of 20% of the shares of XXXXX pursuant to paragraph 2 of the Agreement is a financial transaction and exempt from GST pursuant to Section 1 of Part VII of Schedule V to the Excise Tax Act.

5. Pursuant to elections made, by XXXXX and XXXXX and XXXXX and XXXXX , under section 167 of the Excise Tax Act, the acquisition of a 20% interest in the joint venture by XXXXX will not be subject to GST. (The vendor parties are selling part of their interest in the joint venture to XXXXX who is acquiring sufficient assets from each vendor individually to be able to carry on a business).

Rulings Given

Based on the facts set out above, we rule that:

1. The facts and transactions listed above do not change the eleven rulings, interpretations and opinions provided in the attached GST ruling dated September 28, 1993. Each such ruling, interpretation and opinion shall continue in effect following those transactions.

2. As a result of acquiring the interests in the joint venture from XXXXX and XXXXX is deemed to have made any election that was made by XXXXX and XXXXX appointing an operator pursuant to section 273 of the Act, provided that the other requirements of subsection 273(2) have been met.

3(a). The acquisition by XXXXX of 90 of the issued and outstanding shares of XXXXX from XXXXX is a financial service exempt from GST pursuant to Section 1 of Part VII of Schedule V to the Excise Tax Act.

3(b). The acquisition by XXXXX of 110 of the issued and outstanding shares of XXXXX from XXXXX is a financial service exempt from GST pursuant to Section 1 of Part VII of Schedule V to the Excise Tax Act.

4. The acquisition by XXXXX and XXXXX of shares of XXXXX from XXXXX pursuant to paragraph 2 of the Admission Agreement is exempt from GST pursuant to Section 1 of Part VII of Schedule V to the Excise Tax Act.

5. Elections may be filed by XXXXX and XXXXX and by XXXXX and XXXXX under section 167 of the Excise Tax Act such that GST will not be payable in respect of the acquisition by XXXXX of part of the interests of XXXXX and XXXXX in the Construction Consortium.

This ruling is subject to the general limitations and qualifications outlined in the GST Memorandum 100-3. We are bound by this ruling provided that none of the above issues are presently under audit, objection or appeal, there are no relevant changes in the future to the Excise Tax Act, and provided that you have fully described all necessary facts and transactions for which you requested a ruling.

To the extent that the statements of fact contained in the ruling are not supported or are contradicted by documents to which Revenue Canada has not had access, this ruling will not be considered binding upon the Department.

Should you require additional information, please contact XXXXX

Yours truly,

W. McCloskey
Director General
GST Policy and Legislation
Revenue Canada

 XXXXX Leg. Ref: s. 152, 155, 168, 169, 182, 273, Sch V, Sch VII

 XXXXX

Analysis DOMUS XXXXX

ADDITION OF XXXXX TO CONSORTIUM

1. The facts and transactions listed above do not change the rulings, interpretations and opinions provided in the GST ruling dated September 28, 1993. Each such ruling, interpretation and opinion shall continue in effect following those transactions.

2. As a result of it acquiring the interests in the joint venture from Northern and XXXXX is deemed to have made any election that was made by XXXXX and XXXXX appointing an operator pursuant to section 273 of the Act, provided that the other requirements of subsection 273(2) have been met.

Analysis

It is our view that XXXXX has become a participant in the joint venture by acquiring the interests in the joint venture in the manner described in the documentation. Consequently, subsection 273(2) would be applicable and XXXXX is deemed to have made the joint venture election that was presumably made by the other members of the Construction Consortium.

3(a). The acquisition by XXXXX of 90 of the issued and outstanding shares of XXXXX from XXXXX is a financial service exempt from GST pursuant to Section 1 of Part VII of Schedule V to the Excise Tax Act.

3(b). The acquisition by XXXXX of 110 of the issued and outstanding shares of XXXXX from XXXXX is a financial service exempt from GST pursuant to Section 1 of Part VII of Schedule V to the Excise Tax Act.

4. The reacquisition by XXXXX and XXXXX of shares of XXXXX from XXXXX pursuant to paragraph 2 of the Admission Agreement is exempt from GST pursuant to Section 1 of Part VII of Schedule V to the Excise Tax Act.

Analysis for 3 & 4

There are two issues to be addressed in providing our rulings on these transactions.

First Issue

It appears that the transactions have not been structured as described in the statement of facts in the income tax rulings request which was submitted by XXXXX have requested that we rely on this statement of facts and proposed transactions in providing the GST rulings.

The 200 shares in XXXXX to be acquired by XXXXX will be acquired as follows: 90 from XXXXX as per April 29, 1994 XXXXX submission) 110 from XXXXX

The April 29, 1994 income tax ruling request indicated that these 110 shares would be acquired from XXXXX It appears that as an income tax planning measure, these 110 shares were transferred from XXXXX to XXXXX prior to the closing of the transactions admitting XXXXX into the project. Per discussions with XXXXX is a wholly owned indirect subsidiary of XXXXX which is ultimately the parent of XXXXX

It is XXXXX understanding that the purpose of transferring the shares of XXXXX from XXXXX to XXXXX is to utilize losses of XXXXX against capital gains which would be realized on the disposition of shares of XXXXX to XXXXX . XXXXX transferred the shares to XXXXX and took back preferred shares in XXXXX Subsection 85(1) of the Income Tax Act was used to freeze XXXXX investment in XXXXX and transfer any gains on the ultimate disposition of the shares to XXXXX No income tax or GST rulings have been requested in respect of the transfer of shares from XXXXX to XXXXX In their response, Taxation have simply accepted this transfer as fact.

We have received a copy of the revised income tax ruling request dated August 31, 1994 which makes reference to the transfer from XXXXX to XXXXX For the purposes of the GST ruling, we should also accept this transfer as a fact and rule on the sale of shares from XXXXX to XXXXX and possible subsequent re-acquisition of the shares by XXXXX from XXXXX

Second Issue

This involves the ruling provided by taxation concerning whether or not the share transfer arrangement would constitute a dividend rental arrangement as that term is defined for income tax purposes.

A dividend rental arrangement is defined in subsection 248(1) of the ITA as an arrangement the main purpose of which is to enable a person to receive dividends on shares of capital stock of a corporation but the person receiving the dividends bears no risk with respect to fluctuations in the value of the shares. ITA subsection 112(2.3) denies a corporation the normal subsection 112(1) deduction of taxable dividends received where the dividends are received under a dividend rental arrangement.

Traditionally, dividend rental arrangements had been used to enable taxable and non-taxable entities to earn greater after-tax returns on investment. If a taxable corporation (A) has surplus funds on which it earns a 10% pre-tax return and pays income tax at a rate of 40%, A realizes an after tax return of 6%. If a non-taxable corporation (B) holds shares in another corporation which pays dividends which yield an 8% pre-tax return, there is incentive for the two corporations to form an arrangement whereby A would receive the dividends and B would receive the interest A would have received on its surplus funds.

A would purchase the shares from B and hold them until the dividends are received after which time the shares would be sold back to B for the same amount for which they had been purchased. In this manner, any capital gains accruing on the shares remain with B. In the absence of subsection 112(2.3), the dividends received by A would be deductible for income tax purposes under subsection 112(1) and A would earn an after tax return of 8% rather than the 6% it would have earned investing its surplus funds. B has the surplus funds temporarily available to invest and earns a 10% return which is its after tax return since B is not taxable. Had B simply held the shares, it would have realized a return of 8%.

The denial of the normal 112(1) deduction in these situations removes the possibility that the preferential treatment given to dividend income under the ITA can be used to generate greater after tax returns.

In the XXXXX case, it could appear that the sale of shares to XXXXX and subsequent re-acquisition for the same price after dividends have reached certain levels could be viewed to cause income to be treated as dividends in the hands of XXXXX when in substance the income is not dividends. Since XXXXX initially acquires 20% of XXXXX and this interest may subsequently be reduced to 10%, it may appear that XXXXX is being paid to play a specific role in the project and is being paid to do so with dividends.

Per discussions with XXXXX , this issue was reviewed from a XXXXX and valuations perspective at Taxation with the XXXXX having ultimately been consulted. The question was whether this was really a share purchase or something else (e.g. disposition of goodwill in Joint Venture Interests) which would cause the Department to look through the form of the transaction.

It was determined that their was no basis to take such a position. The income tax rulings requested by XXXXX were confirmed.

Had Taxation taken such a position with respect to the share transfers and dividend payments, this may have impacted on our determination of whether the share transfers could be financial services for GST purposes.

Conclusion:

Based on my discussions with XXXXX and the rulings provided by Taxation in their response dated September 23, 1994, the transfers of shares in XXXXX to XXXXX and the subsequent re-acquisition of the shares by XXXXX and XXXXX are financial services exempt from GST.

The only change to the rulings requested by XXXXX is to substitute XXXXX for XXXXX as the person transferring 110 shares in XXXXX to XXXXX

5. Elections may be filed by XXXXX and XXXXX and by XXXXX and XXXXX under section 167 of the Excise Tax Act such that GST will not be payable in respect of the acquisition by XXXXX of part of the interests of XXXXX and XXXXX in the Construction Consortium.

Analysis

 XXXXX will acquire a 20% interest in the joint venture, with XXXXX and XXXXX reducing their interests by 9% and 11% respectively.

It is submitted by the parties that the joint venture interest has no value - i.e. that the rights and entitlements with respect to the Construction Contract and the burdens and obligations thereunder are equal. No amount would therefore be payable by XXXXX to XXXXX or XXXXX in respect of the joint venture interests.

Basically, they are saying that there is no commercial (or accounting) equity in the joint venture at the time XXXXX is to be admitted. No profit will have been earned on the construction contract although it appears from financial analysis prepared for illustrative purposes x by XXXXX August 25, 1994 memorandum to file) that amounts will have been drawn from the construction price trust to cover costs incurred to that date.

The main benefit acquired by XXXXX on joining the project is to participate in the construction contract and share in the profits earned. No value has been assigned to this right (at least explicitly). It has not been made clear whether the construction contract has been structured to generate an internal profit for the project participants.

Per discussions with XXXXX , Rulings Directorate, Taxation is under the impression that the construction phase does not generate significant profits for the participants except to the extent that they can make money as subcontractors on the project.

It seems that the XXXXX group has a vessel available which is suitable for use in the construction of the bridge and that will require minimal refitting and renovations. This will result in significant cost savings on the project as it had been planned to acquire and substantially renovate a barge specifically for the project.

Per XXXXX the issue of valuation of the joint venture interest was examined in the course of providing the income tax rulings related to the admission of XXXXX to the project. No basis was found to allocate any of the purchase price of shares in XXXXX to the joint venture interest. (see Issue Sheet prepared in Rulings Directorate).

Ruling requested

A ruling is requested confirming that ETA subsection 167(1) will apply to the acquisition of the joint venture interest by XXXXX such that GST will not apply to otherwise taxable supplies of property (i.e. undivided interest in joint venture assets) received by XXXXX .

It is unclear in this case what property might be transferred other than the right to participate in the Construction Contract.

Since XXXXX is assuming a % of the benefits and obligations of the joint venturers on the same terms as the other venturers, and the admission agreement provides that XXXXX will acquire an interest in all property of the joint venture, the transfer of joint venture interests from XXXXX and XXXXX can be viewed as a supply of a business. See enclosed policy position P-103 Transfer of an Undivided Interest in a Joint Venture). The transaction contemplated in this case meets the criteria set out in the policy statement.

In discussions with XXXXX of XXXXX in XXXXX I asked why they were concerned with getting a ruling on section 167 when no money was going to change hands. XXXXX responded that since there might be property held in the joint venture an undivided interest in which would be transferred to XXXXX , a ruling on section 167 was sought.

Consideration

There is a further issue of whether or not there is consideration for the joint venture interest.

The illustrative analysis in the XXXXX memo assumes no property other than accounts receivable and work in progress on the joint venture's balance sheet at the time XXXXX would acquire the joint venture interest.

The admission agreement does, however, require XXXXX to make up its share of working capital contributed by the other venturers prior to the admission of XXXXX

The main adjustments required as a result of the admission of XXXXX seem to arise from the existence of income tax equity in the joint venture. While no income or equity exists from an accounting perspective, the joint venturers will have reported taxable income from the joint venture. This means that there are expenses deferred for income tax purposes which will be deducted against income earned in future years. If XXXXX is to share in the future income of the joint venture, they will need to have access to their share of these deferred expenses to deduct against this future income.

To this end, the income tax reporting will be adjusted so that XXXXX will report as income its share of the income tax based equity in the joint venture at the time of admission. GT and XXXXX who are transferring part of their JV interests to XXXXX will reduce their shares of income reported by their share of the amount to be reported by XXXXX In this manner, the income tax cost associated with there having been taxable income realized in the joint venture is transferred to XXXXX as consideration for XXXXX being able to deduct their share of the deferred expenses from future income(see XXXXX memo at page 5 - these deferred charges are prepaid insurance and UCC of property written off for accounting purposes but capitalized for income tax purposes. WIP has been included in revenue for accounting purposes but is not included in income for tax purposes. Holdbacks payable are deducted for accounting purposes but not for tax purposes).

We are unable to determine at this point whether or not consideration other than assumption of joint venture obligations will be paid for the joint venture interest. A ruling on section 167, however does not require that the amount of consideration be established.

It would be prudent, however, to structure the statement of facts so as not to give the impression that we accept that there is no consideration paid for the joint venture interest.

Conclusion:

The ruling request concerning the application of section 167 to the acquisition of the joint venture interest should be confirmed.