2000 Ruling 1999-0014393 - INTEREST DEDUCTIBILITY XXXXXXXXXX

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 Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues: The company is proposing to settle a trust, the units of which will be issued to the public and listed on a prescribed Canadian stock exchange. If XXXXXXXXXX , it is necessary that the company control the trust. For this reason only, the company will hold all the voting units in the trust. But for the voting feature, all the units of the trust are identical in all respects. The company is then proposing to issue debt which will be held by the trust. The company has the option to redeem the debentures after 10 years from their issuance by paying the outstanding principal amount and any unpaid income entitlement. The trust has the option to redeem its units after 10 years from their issuance by paying the XXXXXXXXXX amount of the units XXXXXXXXXX . If there is a XXXXXXXXXX or XXXXXXXXXX event at any time, the trust may redeem its units, and the company may redeem its debentures by paying cash equal to the XXXXXXXXXX . If there is a XXXXXXXXXX event, the trust preference shares of the company having a stated capital equal to the outstanding principal and the trust unit holders are deemed to have exchanged their trust units for shares having stated capital equal to the XXXXXXXXXX of their trust units. We are asked to confirm that the interest paid by the company on the debentures will be deductible under paragraph 20(1)(c) and that subsection 104(7.1) will not apply in respect of distributions made by the trust to its unitholders.

Position: The interest is deductible. Subsection 104(7.1) will not apply in respect of distributions made by the trust.

Reasons: Deductibility under this provision is dependent upon there being a borrower and lender relationship between the parties to the debentures. There is a good argument that a loan exists until such time as a XXXXXXXXXX event occurs. The existence of the voting rights attached to the company's shares is not intended to give the company a percentage interest in the trust's property in excess of the company's income interest in the trust.

XXXXXXXXXX 1999-001439

Attention: XXXXXXXXXX

June 29, 2000

Dear Sirs:

Re: Advance income tax ruling request
XXXXXXXXXX ("X Co.")
XXXXXXXXXX ("Y Co.")

This is in reply to your letter of XXXXXXXXXX in which you request an advance income tax ruling on behalf of the above named taxpayers. We also acknowledge the information provided in subsequent correspondence and during our various telephone conversations in connection with your request (XXXXXXXXXX).

We understand that, to the best of your knowledge and that of the taxpayers involved, none of the issues involved in the ruling request

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

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

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

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

(v) is the subject of a ruling previously issued by the Directorate.

Unless otherwise stated, all references to a statute are to the Income Tax Act R.S.C. 1985 (5th Supp.), c.1, as amended ("the Act") and all terms and conditions used herein that are defined in the Act have the meaning given in such definition unless otherwise indicated.

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

Definitions

"XXXXXXXXXX Event" means XXXXXXXXXX.

XXXXXXXXXX

"XXXXXXXXXX Event" means the receipt by Y Co. of an opinion of independent counsel to the effect that the tax treatment of Y Co. or any distribution by Y Co. to holders of Securities or voting units of Y Co. on or after their issue date has been changed in any material way from the treatment provided in sections 104 to 108 of the Act as it read at the time of the closing of the offering of Debentures.

Facts

1. X Co. is a XXXXXXXXXX. The head office of X Co. is located at XXXXXXXXXX. X Co. is a public corporation within the meaning of subsection 89(1) of the Act.

2. XXXXXXXXXX

3. X Co. has structured and proposes to implement the Proposed Transactions XXXXXXXXXX X Co. anticipates that the Proposed Transactions will qualify XXXXXXXXXX.

Proposed transactions

4. X Co. proposes to undertake the transactions and implement the structure described herein (the "Proposed Transactions") through Y Co., a new unit trust which X Co. will establish in Canada. Y Co. proposes to issue Securities to members of the public in Canada. The proceeds of issuance of the Securities will be used by Y Co. to acquire an ownership interest in Debentures which will be XXXXXXXXXX indebtedness issued by X Co. The Debentures will be convertible into Shares of X Co. on the terms and under the circumstances described below.

5. While the XXXXXXXXXX, interest rates and dividend rates set out herein as payable in respect of the Securities, the Debentures and the Shares are expected to be representative, actual rates will be established on the basis of applicable market rates at the time of issue of the instruments.

The Securities

6. X Co. will cause Y Co. to be established for the purposes of this offering. Y Co. will be established with features which will permit it to qualify at all material times as a "unit trust" as defined in subsection 108(2) of the Act.

7. XXXXXXXXXX, the XXXXXXXXXX require that X Co. control Y Co.. For this reason, all of the voting units of Y Co., representing approximately XXXXXXXXXX% of its total capital, will be subscribed for and owned at all material times by X Co.

8. The Securities, which are to be publicly issued in Canada, will be non-voting trust units which may be listed for trading on a prescribed Canadian stock exchange. The Securities are expected to be widely held and will account for approximately XXXXXXXXXX% of the capital of Y Co.. Apart from the difference in voting rights, the Securities held by the public and the voting units of Y Co. held by X Co. will be identical as to all legal and economic rights.

9. The Securities will carry a fixed XXXXXXXXXX of XXXXXXXXXX% per annum payable semi-annually on the last day of XXXXXXXXXX and XXXXXXXXXX in each year until the XXXXXXXXXX, and thereafter will carry a floating XXXXXXXXXX equal to the XXXXXXXXXX Bankers' Acceptance rate plus XXXXXXXXXX basis points payable quarterly. The XXXXXXXXXX is non-cumulative and will be paid only to the extent that Y Co. receives sufficient funds from its investment in Debentures to permit distributions to be made to holders of Securities.

10. Y Co. will cause all of its net income and net realized gains, if any, to be payable annually, proportionate to their interests in Y Co., to X Co. as holder of its voting units and to the holders of Securities, and will distribute to such holders all of its net income and net realized gains at each XXXXXXXXXX Date. Accordingly, Y Co. does not expect to be subject to payment of any income taxes.

11. The assets of Y Co. will, subject to paragraph 30 below, be limited to XXXXXXXXXX in Debentures issued by X Co. (or any Securities into which the Debentures are converted or for which they are exchanged), cash and amounts receivable from third parties, NHA mortgages and Government of Canada debt obligations.

12. The ownership interest of Y Co. in the Debentures will be held through a custodial arrangement under which the registered holder of the Debentures will be a Trust company (the "Custodian"). At present, it is anticipated that the Custodian will be Z Co., XXXXXXXXXX. As registered holder, the Custodian will hold the Debentures beneficially for the persons having ownership interests in the Debentures from time to time.

13. Ownership interests in the Debentures will be described in a Custodian Agreement which will be concluded between the Custodian, Y Co., X Co. and XXXXXXXXXX (the "XXXXXXXXXX") coincident with the issuance of the Debentures.

14. Under the terms of the Custodian Agreement, both Y Co. and XXXXXXXXXX will acquire ownership interests in the Debentures. Y Co. will acquire the "XXXXXXXXXX Ownership Interest" as described in paragraph 15 below, which it will hold beneficially for holders of XXXXXXXXXX and X Co. as holder of the voting Y Co. units, proportionate to their respective interests in Y Co.. XXXXXXXXXX will acquire the "XXXXXXXXXX Ownership Interest" as described in paragraph 15 below.

15. Under the terms of the XXXXXXXXXX Ownership Interest held by Y Co., the Custodian will be obliged to pay to Y Co. all principal and interest due and payable on the Debentures on the date such payments are made by X Co. unless X Co. has failed to pay XXXXXXXXXX. In circumstances in which X Co. is not paying XXXXXXXXXX, no interest will be paid on the XXXXXXXXXX Ownership Interest in the Debentures held by Y Co.. In such event, the XXXXXXXXXX Ownership Interest will entitle XXXXXXXXXX to receive the interest on the Debentures. Under the terms of the XXXXXXXXXX Ownership Interest, XXXXXXXXXX will continue to be so entitled until such time as X Co. once again commences to pay XXXXXXXXXX.

16. The XXXXXXXXXX Ownership Interest and the XXXXXXXXXX Ownership Interest have been designed to ensure, XXXXXXXXXX, that Y Co. does not receive interest on the Debentures, and consequently that unitholders of Y Co. will not receive any XXXXXXXXXX, during any period when X Co. is not paying XXXXXXXXXX. The price to be paid by both Y Co. and XXXXXXXXXX to acquire their respective ownership interests in the Debentures will be set at the fair market value of such interests. The cost to XXXXXXXXXX of the XXXXXXXXXX Ownership Interest is expected to be nominal.

17. Except upon the occurrence of a XXXXXXXXXX Event or XXXXXXXXXX Event, the XXXXXXXXXX will not be redeemable by Y Co. for ten years following their issuance. After that time, XXXXXXXXXX, and on not less than XXXXXXXXXX prior notice to holders, Y Co. may redeem on any XXXXXXXXXX Date all of the then outstanding XXXXXXXXXX by the payment of the XXXXXXXXXX. The XXXXXXXXXX is an amount in cash equal to the XXXXXXXXXX of the XXXXXXXXXX, together with any unpaid XXXXXXXXXX, to the extent that income equal to such XXXXXXXXXX has been received by Y Co. on or prior to the date fixed for redemption.

18. Holders of Securities will have the right at any time to surrender their Securities to Y Co. and to receive in exchange therefor an equivalent amount of Shares, that is, an amount of such shares having a liquidation entitlement equal on a dollar for dollar basis to the XXXXXXXXXX of a holder's Securities. Shares will have the same financial attributes as the Securities, except that the dividend rate will XXXXXXXXXX.

19. In the event that circumstances arise which result in XXXXXXXXXX, the Securities will XXXXXXXXXX be exchanged for Shares. XXXXXXXXXX.

20. Upon a XXXXXXXXXX event, holders of Securities will receive Shares having a XXXXXXXXXX equal to the XXXXXXXXXX of Securities. Following a XXXXXXXXXX, Shares will carry an XXXXXXXXXX dividend at a rate of XXXXXXXXXX% per annum.

21. The Securities and the voting units of Y Co. will rank equally in all respects and entitle holders to share equally on a per unit basis in all of the income and capital of XXXXXXXXXX Y Co.. With the prior approval of the Superintendent, Securities may be purchased for cancellation in the market. Further, Securities are redeemable at the option of Y Co. upon the happening of a XXXXXXXXXX or a XXXXXXXXXX at a XXXXXXXXXX payable in cash equal to the XXXXXXXXXX of Securities plus unpaid XXXXXXXXXX to the redemption date.

22. Effective upon the maturity of the Debentures, the permitted investments of Y Co. will be circumscribed to exclude debt obligations of X Co. or any related person, and to include only cash and amounts receivable from third parties, NHA mortgages, Government of Canada debt obligations and, subject to paragraph 30 below, the Securities into which the Debentures are convertible, or for which they may be exchanged.

The Debentures

23. Coincident with the establishment of Y Co. and the issuance of the Securities, X Co. proposes to issue the Debentures. The Debentures will be XXXXXXXXXX debentures issuable only in fully registered form, will have a principal amount (the "Principal Amount") of $XXXXXXXXXX per Debenture and will mature in XXXXXXXXXX. Interest on the Debentures will be payable semi-annually in arrears on the last business day of XXXXXXXXXX in each year at a XXXXXXXXXX rate of XXXXXXXXXX% for XXXXXXXXXX and thereafter at a XXXXXXXXXX, payable quarterly.

24. The Debentures will not be redeemable by X Co. in the ten-year period following issuance except upon the occurrence of XXXXXXXXXX. The Debentures may, however, be redeemed by X Co. after that time XXXXXXXXXX. In the event that XXXXXXXXXX redemption, the Debentures will be redeemable for an amount equal to the Principal Amount of the Debentures together with any accrued and unpaid interest to the date fixed for redemption.

25. The Debentures will be convertible at the option of the holder for an equivalent amount of Shares which will have effectively the same financial attributes as the Debentures as described below, except that XXXXXXXXXX. From and after the occurrence of XXXXXXXXXX, the Shares will carry an XXXXXXXXXX dividend at the rate of XXXXXXXXXX%. For greater certainty, a holder of $XXXXXXXXXX Principal Amount of Debentures who exercises the optional conversion would receive Shares having a liquidation entitlement equal to $XXXXXXXXXX.

26. Upon the occurrence of XXXXXXXXXX within ten years of their issue date, the Debentures will be redeemable at the option of X Co. without the consent of holders by the payment in cash of an amount per Debenture equal to the XXXXXXXXXX of each Debenture plus accrued and unpaid interest to the redemption date. Such a redemption upon the occurrence of such an event XXXXXXXXXX.

27. Upon the occurrence of a XXXXXXXXXX event as described above in paragraph XXXXXXXXXX , and to permit the exchange of Securities for Shares to occur, the Debentures will be XXXXXXXXXX converted into Shares. Immediately after or coincident with such conversion, holders of Securities will be deemed to have XXXXXXXXXX.

28. Debentures will be subordinate in right of payment to all liabilities of X Co. XXXXXXXXXX other than liabilities that specifically rank pari passu with or junior to the Debentures. Upon any distribution of assets of X Co. on any dissolution, winding-up, liquidation or other similar termination event, all principal, premium, and accrued interest due on all such prior ranking liabilities of X Co. must be paid in full before holders of Debentures will be entitled to receive or retain any payment.

29. Consistent with the rights of holders of Securities to surrender their Securities and to receive Shares in exchange therefor as described above in paragraph XXXXXXXXXX, the Debentures will contain provisions to reflect concurrently any redemption or exchange of the Securities such that the outstanding amount of the Debentures will be adjusted pro rata to reflect any such redemption or exchange of Securities.

30. The Debentures will be XXXXXXXXXX repayable at maturity in cash. Y Co. will thereafter be permitted to invest only in assets consisting of cash or amounts receivable from third parties, or unrelated third party obligations purchased from X Co., and which will be limited to NHA mortgages and/or Government of Canada debt obligations.

The Shares

31. Upon the happening of either a XXXXXXXXXX event, or the exercise at any time by Y Co. of its option to convert Debentures into Shares, respectively, the Debentures are XXXXXXXXXX exchanged for, or become convertible into, Shares. Shares will have an issue price of $XXXXXXXXXX per share and will be exchangeable or convertible at the rate of XXXXXXXXXX Shares for each $XXXXXXXXXX of Debentures. The Shares carry a XXXXXXXXXX dividend at a rate of XXXXXXXXXX% per annum. Following a XXXXXXXXXX event, the Shares carry an XXXXXXXXXX dividend at the rate of XXXXXXXXXX% per annum.

32. The Shares will not be redeemable prior to the XXXXXXXXXX anniversary of the issuance of the Securities and the Debentures. On and after that date, X Co. may, XXXXXXXXXX, redeem all or any part of the outstanding Shares upon notice by the payment of the issue price per share plus all declared and unpaid dividends to the date fixed for redemption. X Co. may at any time XXXXXXXXXX purchase Shares for cancellation in the marketplace at the lowest price or prices at which in the opinion of the board of directors of X Co. such shares are obtainable in the marketplace.

33. The Shares may be converted into a new series of preferred shares of X Co. at the option of the holder in the event that X Co. designates XXXXXXXXXX qua1ifying preferred shares into which the Shares may be converted on a share-for-share basis.

34. Holders of Shares are not entitled to voting rights except in certain extraordinary circumstances. The Shares will rank equally with all other XXXXXXXXXX preferred shares of XXXXXXXXXX X Co. and in priority to X Co.'s common shares and any other shares ranking junior to the Shares.

35. X Co. will elect to pay the 40% tax on dividends on the Shares, as provided for under Part VI. 1 such that no Part IV. 1 tax will be payable by purchasers.

Purpose of the proposed transactions

The net proceeds to be received by X Co. from the sale of the Debentures will be used for income-producing purposes in the ordinary course of X Co.'s XXXXXXXXXX. The purpose of the inclusion in the terms of the Securities and the Debentures of conditions XXXXXXXXXX is XXXXXXXXXX It is intended that the issuance of Securities will qualify XXXXXXXXXX.

Rulings

Provided that the preceding statements constitute a complete and accurate disclosure of all the relevant facts, proposed transactions, and purpose of the proposed transactions and provided further that the proposed transactions are carried out as described above, our rulings are as follows:

We confirm that

A. Provided that the funds borrowed by X Co. under the Debentures are used by X Co. for the purpose of earning income from a business or property (other than to acquire property the income from which would be exempt or to acquire a life insurance policy) in a year, the amount paid in the year or payable in respect of the year (depending upon the method regularly followed by X Co. in computing its income for the purposes of the Act) as interest, to the extent that the amount paid or payable is reasonable and is paid pursuant to a legal obligation to pay interest on the funds, will be deductible pursuant to paragraph 20(1)(c) of the Act by X Co. in computing its income for income tax purposes in respect of the year.

B. The absence of voting rights under the Securities except in extraordinary circumstances will not, in and of itself, cause subsection 104(7.1) to apply to deny a deduction to Y Co. under subsection 104(6) for distributions made payable to its unitholders.

Other comments

The rulings given are subject to the limitations and qualifications set out in Information Circular 70-6R3 dated December 30, 1996 and is binding on the Canada Customs and Revenue Agency provided that the proposed transactions are completed by XXXXXXXXXX.

Yours truly,

XXXXXXXXXX
Manager
Financial Institutions
Financial Industries Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch