2002 Ruling 2000-0054763 - DISTRESS PREFERRED SHARES

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 ISSUE:Whether the proposed issuance of distress preferred shares meets the requirements under the exception in (e)(iii) of the definition of term preferred shares in subsection 248(1).

Position:Favorable ruling given.

REASON:

XXXXXXXXXX 		2000-005476

XXXXXXXXXX, 2002

Dear Sirs/Mesdames:

Re: Advance Income Tax Ruling
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX

This is in response to your letter of XXXXXXXXXX, wherein you request an advance income tax ruling on behalf of the above-noted taxpayers. We also acknowledge the information provided in subsequent correspondence and during various telephone conversations and meetings in connection with your request.

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

(i) is in an earlier return of a taxpayer identified in this document or of a related person,

(ii) is being considered by any Tax Services Office or Taxation Centre of the Agency in connection with a tax return already filed,

(iii) is under objection by a taxpayer identified in this document or by a related person, or

(iv) is the subject of a ruling previously considered 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 and proposed transactions is as follows:

Facts

1. XXXXXXXXXX (hereinafter the "Debtor") was incorporated under the Business Corporations Act (XXXXXXXXXX) (the "XXXXXXXXXX"), on XXXXXXXXXX, as XXXXXXXXXX. Its name was subsequently changed to XXXXXXXXXX. The Debtor is a private corporation, a taxable Canadian corporation and a Canadian-controlled private corporation. The Debtor has authorized share capital consisting of an unlimited number of voting and participating common shares. XXXXXXXXXX (hereinafter "Development Co") owns all XXXXXXXXXX issued and outstanding common shares of the Debtor. The Debtor's head office is located at XXXXXXXXXX. Debtor is served by the XXXXXXXXXX Tax Services Office (TSO) and the XXXXXXXXXX Taxation Centre.

The Debtor was, at the time of its incorporation, a wholly-owned subsidiary of XXXXXXXXXX (hereinafter "Investco").

XXXXXXXXXX

2. The Debtor currently operates XXXXXXXXXX (hereinafter the "Asset"), which consists of XXXXXXXXXX.

XXXXXXXXXX.

3. Development Co was incorporated on XXXXXXXXXX as a corporation without share capital by Letters Patent issued under Part II of the Canada Business Corporations Act (the "CBCA"). Development Co is a non-profit organization within the meaning of paragraph 149(1)(l). Development Co's head office is located at XXXXXXXXXX Development Co is served by the XXXXXXXXXX TSO and the XXXXXXXXXX Taxation Centre.

Development Co is governed by a Board of Directors which is elected by the members of Development Co. The Board of Directors governs Development Co on behalf of the members, in the same fashion that a board of directors of a for-profit corporation would govern on behalf of shareholders of such a corporation. The Board of Directors consists of XXXXXXXXXX At present, Development Co's only members are its Directors. Directors are appointed by the other members of the Board. That is, XXXXXXXXXX Directors constitute a quorum of the Board and as such can approve the appointment of the other XXXXXXXXXX directors. In the case of a tie vote by the Board of Directors when voting on management issues, no one has been provided with the right to cast a tie-breaking vote.

4. XXXXXXXXXX (hereinafter the "Bank") is a Canadian chartered bank to which the Bank Act (Canada) applies. It is a taxable Canadian corporation and a specified financial institution. The Bank deals at arm's length with each of the Debtor, Development Co and Organization within the meaning of section 251. The Bank's head office is located at XXXXXXXXXX. The Bank is served by the XXXXXXXXXX TSO and the XXXXXXXXXX Taxation Centre.

5. Development Co was incorporated by XXXXXXXXXX officers of Organization who became its original members and Board of Directors. Development Co's Letters Patent set out its objects as follows:

(a) XXXXXXXXXX.

b) XXXXXXXXXX.

(c) XXXXXXXXXX.

(d) To receive and maintain a fund or funds and other property and to apply from time to time all or part thereof or the income therefrom for the attainment of the objects of the corporation.

In accordance with its objects, Development Co developed and now operates a XXXXXXXXXX (the "DC Asset").

6. Development Co does not own any of its lands. Instead, Organization has leased XXXXXXXXXX of its land to Development Co, until XXXXXXXXXX, for a total rent of $XXXXXXXXXX . Organization also acts as a fiscal agent for Development Co by providing accounting and bill payment services for which Development Co pays a fee to Organization of XXXXXXXXXX% of net expenses (excluding interest).

XXXXXXXXXX.

7. XXXXXXXXXX Development Co expected that the Debtor's operations would be profitable and thereby generate dividend income.

8. On XXXXXXXXXX, Development Co acquired the remaining XXXXXXXXXX% of the common shares of the Debtor from Investco for nominal consideration when Investco, due to financial difficulties, failed to fulfill its obligations to the development and abandoned its interest in the Debtor. In order to maintain the operation, Development Co was forced to assume full financial responsibility and operation of the Asset.

9. XXXXXXXXXX provided the initial construction financing (the XXXXXXXXXX was the bank with which Investco dealt). In XXXXXXXXXX, the Bank advanced the Debtor $XXXXXXXXXX in order to refinance the original advances provided by the XXXXXXXXXX as well as to provide the Debtor with additional funds to complete construction of the Asset . The Bank provided an additional advance of $XXXXXXXXXX as further financing for the Debtor's construction costs. The Bank also provided further advances to the Debtor in XXXXXXXXXX to provide the Debtor with working capital which resulted in an aggregate principal amount of indebtedness to the Bank equal to the current outstanding principal amount of $XXXXXXXXXX.

10. At present, the tenants of Development Co are comprised of XXXXXXXXXX corporations and XXXXXXXXXX. These entities employ approximately XXXXXXXXXX full- and part-time staff and occupy XXXXXXXXXX buildings totaling XXXXXXXXXX square feet of rental space. However, Development Co itself has no employees.

11. XXXXXXXXXX.

12. XXXXXXXXXX.

13. Organization has had an association with Development Co since Development Co's incorporation. Prior to XXXXXXXXXX, Development Co and the Debtor had financed themselves entirely through externally borrowed capital (other than Organization). In XXXXXXXXXX, the level of the external debt burden that had accumulated for each of the Debtor and Development Co was examined. It was determined that the debt burden was unsustainable and that an infusion of capital would be needed by the Debtor and Development Co. Based on a financial plan forecasting positive cash flow for Development Co, Organization agreed to advance $XXXXXXXXXX in the form of a debenture to Development Co. The proceeds of this loan were used to pay down debts owing to other creditors. Organization has not provided any direct funding to the Debtor.

14. The terms of the XXXXXXXXXX debenture called for payments of interest to be deferred for the first XXXXXXXXXX years to provide Development Co with time to recover its losses without further impairing its working capital position. No interest has yet been paid to Organization under the terms of the debenture. A key component of the decision by Organization to advance funds was the financial model presented by Development Co which suggested that the investment in the debenture would yield an overall annualized return of XXXXXXXXXX% to Organization over the term of the debenture and that the resulting financial structure would permit the success of Development Co. This has proven not to be the case and it has become evident that the assumptions in the original financial model are not consistent with Development Co's current circumstances.

Financial difficulty of the Debtor

15. The Asset is generating a mature revenue stream and has reached its sustainable market share. As a practical matter, the Debtor's business is currently operating as well as can be expected given the XXXXXXXXXX Consequently, the Debtor is not expected to be able to significantly increase its revenues. Even though it is generating acceptable revenues given its business and the market, the Debtor is insolvent and is forecasted to remain insolvent under the existing financial structure. The problem is not one of operations, but of financial structure. That is, the realizable parameters of the market will not support an attainable level of operations which could support the Debtor's existing financial burden. In other words, there is no reasonable action that could be taken by the Debtor with respect to its operations that would enable it to increase its revenues sufficiently to meet its current financial obligations as they become due.

16. The total amount of outstanding debt obligations of the Debtor as at XXXXXXXXXX was $XXXXXXXXXX consisting of the following:

(a) a loan payable to the Bank with an outstanding principal amount of $XXXXXXXXXX (the "Bank Loan");

(b) a line of credit for operating purposes extended by the Bank with an outstanding balance of $XXXXXXXXXX which was in excess of the credit limit of $XXXXXXXXXX (the "Bank LOC"); and

(c) an intercompany loan payable to Development Co with an aggregate outstanding principal amount of $XXXXXXXXXX (the "Intercompany Debt").

17. The Bank Loan is payable on demand and bears interest at the Bank's rate for XXXXXXXXXX plus XXXXXXXXXX basis points, interest being payable monthly. Proceeds of the Bank Loan advances were used by the Debtor to refinance existing XXXXXXXXXX financing, fund completion of XXXXXXXXXX of the Asset and to provide it with working capital. The Bank Loan is collateralized by a mortgage of $XXXXXXXXXX on the real property owned by the Debtor (i.e., the Asset property). Although not yet in default, the Debtor will be unable to satisfy its interest obligations in respect of the Bank Loan in the near future unless its current outstanding indebtedness is refinanced through the issuance of distress preferred shares. The Debtor's financial difficulties are discussed more fully below.

18. Organization provided the Bank with a form of comfort letter dated XXXXXXXXXX in respect of the Bank Loan (the "Comfort Letter"). However, there is currently a difference of opinion between Organization and the Bank regarding the extent of Organization's liability, if any, for the repayment of the Bank Loan under the Comfort Letter.

In the Comfort Letter, Organization agreed to take all requisite actions, steps and to do all things necessary to cause the Debtor to operate in such a manner as to be able to meet all of its financial obligations. Organization also agreed that it would "not reduce its effective control in" Development Co or its level of ownership in the Debtor.

19. The Bank takes the position that the Comfort Letter permits the Bank to look to Organization to provide financial assistance and funding to Development Co and the Debtor, with respect to interest payments, to ensure all payments are current and it further expects Organization to fully fund Development Co and the Debtor to retire the principal amount outstanding in these two entities if called upon.

Organization takes the position that the Comfort Letter is not a guarantee and should not be construed as a guarantee. Rather, Organization considers the Comfort Letter to be a representation that it will take action so as to cause the Debtor and Development Co to operate in such manner as to meet their financial obligations and, therefore, any onus on Organization is only with respect to the operations of the entities.

20. The Bank LOC is payable on demand by the Bank and bears interest at the Bank's prime rate which was XXXXXXXXXX% at XXXXXXXXXX. The Debtor's outstanding balance regarding the Bank LOC is constantly near or over the credit limit relating to the Bank LOC. The Debtor has been periodically exceeding the credit limit on the Bank LOC and the Bank has, in turn, been required to demand payment of the overage. Such overages have been occurring with increasing frequency.

21. The Intercompany Debt is an unsecured demand loan bearing interest at a rate equal to the rate charged under the Bank Loan. The proceeds of the Intercompany Debt are used to provide the Debtor with working capital.

22. Except for the XXXXXXXXXX fiscal year, the Debtor has experienced increasing net cash losses (over the prior fiscal year) in each of its last XXXXXXXXXX fiscal years. For the fiscal year ended XXXXXXXXXX, the net cash loss from the Debtor's operations was $XXXXXXXXXX. In XXXXXXXXXX, the Debtor experienced net cash losses of $XXXXXXXXXX, respectively. The Debtor's cash flow from operations for the XXXXXXXXXX fiscal years is summarized in the following table:

The Debtor
Cash Flow from Operations
XXXXXXXXXX Fiscal Years

FISCAL YEAR

XXXXX
XXXXX
XXXXX
XXXXX
REVENUE

XXXXXXXXXX
XXXXX
XXXXX
XXXXX
XXXXX
XXXXXXXXXX
XXXXX
XXXXX
XXXXX
XXXXX
Other
XXXXX
XXXXX
XXXXX
XXXXX
Total Revenue
XXXXX
XXXXX
XXXXX
XXXXX

OPERATING EXPENDITURES

Product Costs
XXXXX
XXXXX
XXXXX
XXXXX
Labour
XXXXX
XXXXX
XXXXX
XXXXX
Operating Expenses
XXXXX
XXXXX
XXXXX
XXXXX
Interest - Bank Loan and Bank LOC
XXXXX
XXXXX
XXXXX
XXXXX
Interest - Intercompany Debt

XXXXX
XXXXX
XXXXX
Total Operating Expenditures
XXXXX
XXXXX
XXXXX
XXXXX
NET CASH FLOW (LOSS) FROM OPERATIONS
XXXXX
XXXXX
XXXXX
XXXXX
Less: Capital Expenditures
XXXXX
XXXXX
XXXXX
XXXXX
NET CASH FLOW (LOSS)
XXXXX
XXXXX
XXXXX
XXXXX

23. As can be seen from the above table, the Debtor has experienced increasing cash deficits over the prior year in the period spanning the XXXXXXXXXX fiscal years and a significant cash shortfall again in the XXXXXXXXXX fiscal year. These shortfalls were funded through advances from Development Co of $XXXXXXXXXX respectively, which advances were added to the outstanding principal amount of the Intercompany Debt. However, Development Co is no longer able to provide the Debtor with sufficient advances to meet the Debtor's cash losses.

24. The Debtor's operations have been reviewed both internally and by various external third-party consultants. As a result of these reviews, it was determined that changes to the management structure should be implemented as a means of reducing the Debtor's labour costs. More specifically, any savings realized will come from reduced labour costs in the XXXXXXXXXX operations of the Asset. The Debtor has implemented the recommended changes but has not as yet realized any savings. In any event, only relatively modest savings are expected from these changes. The potential savings are estimated to be in the range of only $XXXXXXXXXX.

25. Development Co, on behalf of itself and the Debtor, has engaged in discussions with its financial partners (i.e., Organization and the Bank). However, these discussions have been unsuccessful in producing any additional sources of funding for the Debtor.

26. As indicated above, Organization loaned funds to Development Co in XXXXXXXXXX with the expectation of yielding an annualized return of approximately XXXXXXXXXX% over the term of the debenture. Organization now faces the potential of losing its investment rather than obtaining a positive return on capital.

Organization, itself, has recently suffered financially, incurring a deficit of $XXXXXXXXXX for the year ended XXXXXXXXXX and a deficit of $XXXXXXXXXX for the year ended XXXXXXXXXX (per Organization audited combined financial statements).

XXXXXXXXXX

27. The Bank is unwilling to provide any further financing to the Debtor. The Debtor's line of credit is frequently overdrawn and the Debtor is having increased difficulty meeting its existing obligations with the Bank with respect to interest payments. These facts combined with the lack of any source from which principal payments on its existing indebtedness could be made results in a level of credit risk which is unacceptable to the Bank.

28. The current financial position of the Debtor precludes any opportunity for third party intervention in the form of a debt infusion or equity investment. The Debtor has a debt burden in excess of $XXXXXXXXXX on an asset base that has an estimated current market value significantly below that amount. Under these circumstances, there is no economic basis for refinancing and no return for potential equity participants.

Cash Flow Projections for the Debtor -Non-DPS Scenario (Best Case)

29. The projected cash flow of the Debtor for the fiscal years XXXXXXXXXX on the basis that a distress preferred share ("DPS") refinancing does not take place is set out below. The projected cash flow statement was prepared on the assumption that interest is not payable on the Intercompany Debt and that Development Co was not required to make interest payments on the Organization Debenture (as described in paragraphs 33 and 34 below). The assumptions made result in projections that are, in effect, a best case scenario in the absence of a DPS refinancing. As is clear from this "best case" projection, the Debtor would still continue to experience significant cash flow deficits in the XXXXXXXXXX fiscal years in the absence of a DPS refinancing and Development Co would be unable to provide it with sufficient advances to fully compensate for the cash shortages.

The Debtor
Projected Cash Flows for XXXXXXXXXX Fiscal Years
Best Case, Non-DPS Scenario

FISCAL YEAR

XXXXXX
XXXXX
XXXXXX
XXXXX
XXXXX
REVENUE (1)

XXXXXXXXXX
XXXXXX
XXXXX
XXXXXX
XXXXX
XXXXX

XXXXXXXXXX
XXXXXX
XXXXX
XXXXXX
XXXXX
XXXXX

Other
XXXXXX
XXXXX
XXXXXX
XXXXX
XXXXX
Total Revenue
XXXXXX
XXXXX
XXXXXX
XXXXX
XXXXX

OPERATING EXPENDITURES (1)

Product Costs
XXXXXX
XXXXX
XXXXXX
XXXXX
XXXXX

Labour
XXXXXX
XXXXX
XXXXXX
XXXXX
XXXXX

Operating Expenses
XXXXXX
XXXXX
XXXXXX
XXXXX
XXXXX

Interest - Bank Loan/LOC (2)
XXXXXX
XXXXX
XXXXXX
XXXXX
XXXXX
Total Operating Expenditures (3)
XXXXXX
XXXXX
XXXXXX
XXXXX
XXXXX
NET CASH FLOW (LOSS) FROM OPERATIONS
XXXXXX
XXXXX
XXXXXX
XXXXX
XXXXX
Less: Capital Expenditures
XXXXXX
XXXXX
XXXXXX
XXXXX
XXXXX
DEBTOR'S NET CASH FLOW (LOSS)
XXXXXX
XXXXX
XXXXXX
XXXXX
XXXXX
Plus: Advances from Development Co(4)
XXXXXX
XXXXX
XXXXXX
XXXXX
XXXXX
NET CASH FLOW (LOSS) AFTER ASSISTANCE
XXXXXX
XXXXX
XXXXXX
XXXXX
XXXXX

NOTES:

(1) All costs and revenues increase by XXXXXXXXXX% per year.

(2) Interest rate on Bank Loan and Intercompany Debt is assumed to be XXXXXXXXXX% and on Bank LOC is assumed to be XXXXXXXXXX%.

(3) Assumes no interest paid by Debtor to Development Co on the Intercompany Debt.

(4) Assumes that all Development Co surplus cash flow from operations advanced to the Debtor.

30. Therefore, it is clear that, unless the Debtor receives assistance in the form of a refinancing of the Bank Loan and the Bank LOC into DPS, the Debtor will be unable to meet its obligations as they become due in the very near future. Furthermore, this situation is not expected to change in the absence of a DPS refinancing.

Cash Flow Projections for the Debtor - DPS Scenario

31. The projected cash flow of the Debtor for the fiscal years XXXXXXXXXX on the assumption that a DPS refinancing occurs, effective XXXXXXXXXX, is set out below. The projections assume that interest payable by the Debtor to Development Co on the Intercompany Debt would be deferred. Whether interest is paid or not by the Debtor on the Intercompany Debt does not affect the Debtor's cash flow projections since any such interest paid would be advanced back to the Debtor by Development Co. The projections also assume that interest payable by Development Co in respect of the Organization Debenture, as described in paragraphs 33 and 34 below, would be deferred. A DPS issuance is the only realistic method for the Debtor to continue to meet its obligations as they become due.

The Debtor
Projected Cash Flows for XXXXXXXXXX Fiscal Years
DPS Scenario
REVENUE (1)
FISCAL YEAR

XXXXXXXX
XXXXX
XXXXX
XXXXX
XXXXX

XXXXXXXXXX
XXXXXX
XXXXX
XXXXX
XXXXX
XXXXX

XXXXXXXXXX
XXXXXX
XXXXX
XXXXX
XXXXX
XXXXX

Other
XXXXXX
XXXXX
XXXXX
XXXXX
XXXXX
Total Revenue
XXXXXX
XXXXX
XXXXX
XXXXX
XXXXX

EXPENDITURES (1)

Product Costs
XXXXXX
XXXXX
XXXXX
XXXXX
XXXXX

Labour
XXXXXX
XXXXX
XXXXX
XXXXX
XXXXX

Operating Expenses
XXXXXX
XXXXX
XXXXX
XXXXX
XXXXX

Interest - Bank Loan/LOC (2)
XXXXXX
XXXXX
XXXXX
XXXXX
XXXXX
Total Expenses (3)
XXXXXX
XXXXX
XXXXX
XXXXX
XXXXX
NET CASH FLOW (LOSS) FROM OPERATIONS
XXXXXX
XXXXX
XXXXX
XXXXX
XXXXX

Less:

Capital Expenditures
XXXXXX
XXXXX
XXXXX
XXXXX
XXXXX

DPS Dividends Payable (5)
XXXXXX
XXXXX
XXXXX
XXXXX
XXXXX

Plus:

Advances from Development Co (4)
XXXXXX
XXXXX
XXXXX
XXXXX
XXXXX
NET CASH FLOW (LOSS)
XXXXXX
XXXXX
XXXXX
XXXXX
XXXXX

NOTES:

(1) All costs and revenues increase by XXXXXXXXXX% per year.

(2) Interest rate on Bank Loan and Intercompany Debt is assumed to be XXXXXXXXXX% and on Bank LOC is assumed to be XXXXXXXXXX%.

(3) Assumes no interest paid by the Debtor to Development Co on the Intercompany Debt.

(4) Assumes that all Development Co cash flow from operations advanced to the Debtor. See Development Co cash flow projections below.

(5) DPS dividend rate equal to XXXXXXXXXX% multiplied byXXXXXXXXXX.

(6) A net cash loss may arise in XXXXXXXXXX as the benefit of the DPS issuance would not be fully realized in the XXXXXXXXXX fiscal year since the XXXXXXXXXX fiscal year began XXXXXXXXXX. The projections assume that the DPS share issuance occurred at the start of the XXXXXXXXXX fiscal year, but the issuance is now not likely to occur before XXXXXXXXXX. That is, a significant portion of the Debtor's XXXXXXXXXX fiscal year has already occurred in the absence of a distress preferred share refinancing. To the extent a net cash loss results in the XXXXXXXXXX fiscal year, such shortfall is expected to be met through additional advances from Development Co. Development Co, in turn, will fund the additional advances through a combination of its remaining cash reserves (if any), its net cash flow from operations and additional debt (Development Co's borrowing capacity is expected to increase a minimal amount only in the event that the Debtor refinances its indebtedness to the Bank through a distress preferred share issuance).

32. As indicated in paragraph 22 above, the Debtor has produced insufficient cash flow in each of its last XXXXXXXXXX fiscal years to support its obligations to the Bank and has relied on Development Co to meet the shortfalls. Development Co in turn has relied on its own cash flow and advances from Organization and arm's length financial institutions to provide the Debtor with sufficient cash to cover its shortfalls. However, Development Co is no longer able to provide sufficient support to meet the Debtor's cash shortfalls. Development Co is suffering under its own significant debt burden and it is forecasting significantly decreased cash flow over the next XXXXXXXXXX fiscal years. Furthermore, it is unable to obtain any further financing from Organization, the Bank or other external sources.

33. The total amount of outstanding debt obligations of Development Co as at XXXXXXXXXX was $XXXXXXXXXX which consisted of the following:

(a) a debenture due to Organization with a principal amount of $XXXXXXXXXX (the "Organization Debenture");

(b) a loan payable to the Bank with an outstanding principal amount of $XXXXXXXXXX (the "Development Co Bank Loan");

(c) an operating line of credit from the Bank with an outstanding balance of $XXXXXXXXXX (the "Development LOC"); and

(d) short-term advances from Organization in the amount of $XXXXXXXXXX (the "Organization Debt").

34. The Organization Debenture is due on XXXXXXXXXX and bears interest at a rate which is expected to yield an annualized rate of return to Organization of XXXXXXXXXX% over its term. The rate at which interest accrues and becomes payable varies from year to year, but generally increases each year throughout the term of the Organization Debenture. The total interest that will accrue over the term of the Organization Debenture will result in an annualized interest rate of XXXXXXXXXX%. For example, no interest was payable under the terms of the Organization Debenture until XXXXXXXXXX. Interest is then payable each year thereafter at annual rates which increase each year. The interest obligation each year is, however, contingent upon Development Co and the Debtor generating a consolidated positive cash flow. Development Co has the option to repay principal on any anniversary date without penalty. Organization representatives have indicated that Organization will defer Development Co's obligation to pay any interest under the Organization Debenture throughout the XXXXXXXXXX fiscal years in the event a DPS refinancing of the Debtor takes place. Consequently, all DPS scenario cash flow projections herein assume that no such interest would be payable by Development Co.

35. The XXXXXXXXXX Bank Loan is a demand loan bearing interest at the Bank's rate for XXXXXXXXXX plus XXXXXXXXXX basis points. The proceeds of the XXXXXXXXXX Bank Loan advances were used to provide Development Co with working capital for operating purposes.

36. The XXXXXXXXXX LOC is due on demand by the Bank and bears interest at the Bank's prime rate which was XXXXXXXXXX% at XXXXXXXXXX. The XXXXXXXXXX LOC has a credit limit of $XXXXXXXXXX but Development Co does not usually carry an outstanding balance near its credit limit.

37. The Organization Debt results from Organization paying certain amounts on behalf of Development Co as its fiscal agent. The amount due to Organization, as of XXXXXXXXXX, represents the aggregate of amounts paid (or deposited) by Organization on behalf of Development Co.

38. Development Co's cash flow from operations for its XXXXXXXXXX fiscal years was relatively constant and is summarized below. Development Co's excess cash flow was used in each year to make advances to the Debtor to support the Debtor's cash deficiency.

Development Co
Cash Flow from Operations

XXXXXXXXXX Fiscal Years

FISCAL YEAR

XXXXXX
XXXXX
XXXXX
XXXX
REVENUE

XXXXXXXXXX
XXXXXX
XXXXX
XXXXX
XXXX
Other
XXXXXX
XXXXX
XXXXX
XXXX
Interest Received - Intercompany Debt
XXXXXX
XXXXX
XXXXX
XXXX
Total Revenue
XXXXXX
XXXXX
XXXXX
XXXX
EXPENDITURES

Operating Expenses
XXXXXX
XXXXX
XXXXX
XXXX
Net Common Costs
XXXXXX
XXXXX
XXXXX
XXXX
Interest - Development Co Loan/LOC
XXXXXX
XXXXX
XXXXX
XXXX
Total Operating Expenditures
XXXXXX
XXXXX
XXXXX
XXXX
NET CASH FLOW (LOSS) FROM OPERATIONS
XXXXXX
XXXXX
XXXXX
XXXX
Less: Capital Expenditures
XXXXXX
XXXXX
XXXXX
XXXX
NET CASH FLOW (LOSS)
XXXXXX
XXXXX
XXXXX
XXXX

Cash Flow Projections for Development Co -Non-DPS Scenario

39. Despite being relatively constant over the XXXXXXXXXX fiscal years, Development Co's cash flow declined in XXXXXXXXXX and is expected to decrease further in the next XXXXXXXXXX fiscal periods. Development Co's forecasted cash flow without a DPS refinancing of the Debtor is summarized below. The projections were prepared on the assumption that no interest would be payable by Development Co on the Organization Debenture and that interest would not be received from the Debtor in respect of the Intercompany Debt. These assumptions provide a "best case" non-DPS projection from the Debtor's perspective. Development Co's total projected revenues are less than in the XXXXXXXXXX years as a result, in part, of the assumption that no interest will be received on the Intercompany Debt. However, since any surplus cash would be used by Development Co to make advances to the Debtor, the consolidated cash flow results of Development Co and the Debtor are unchanged by this assumption.

Development Co
Projected Cash Flows for XXXXXXXXXX Fiscal Years

"Best Case" Non-DPS Scenario

FISCAL YEAR

XXXXXX
XXXXXX
XXXXXX
XXXXXX
XXXXXX
REVENUE(1)

XXXXXXXXXX
XXXXXX
XXXXXX
XXXXXX
XXXXXX
XXXXXX

Other
XXXXXX
XXXXXX
XXXXXX
XXXXXX
XXXXXX

Total Revenue(5)
XXXXXX
XXXXXX
XXXXXX
XXXXXX
XXXXXX
OPERATING EXPENDITURES(1)(3)

Operating Expenses
XXXXXX
XXXXXX
XXXXXX
XXXXXX
XXXXXX

Net Common Costs
XXXXXX
XXXXXX
XXXXXX
XXXXXX
XXXXXX

Interest - Development Co Loan/LOC(2)
XXXXXX
XXXXXX
XXXXXX
XXXXXX
XXXXXX

Total Operating Expenditures(3)
XXXXXX
XXXXXX
XXXXXX
XXXXXX
XXXXXX
NET CASH FLOW (LOSS) FROM OPERATIONS
XXXXXX
XXXXXX
XXXXXX
XXXXXX
XXXXXX
Less: Capital Expenditures
XXXXXX
XXXXXX
XXXXXX
XXXXXX
XXXXXX
NET CASH FLOW (LOSS)(4)
XXXXXX
XXXXXX
XXXXXX
XXXXXX
XXXXXX

NOTES:

(1) All costs and revenues increase by XXXXXXXXXX% per year.

(2) Interest rate on Bank Loan and Intercompany Debt is assumed to be XXXXXXXXXX% and on Bank LOC is assumed to be XXXXXXXXXX%.

(3) Assumes that interest on Organization Debenture is not payable by Development Co.

(4) Cash available to be advanced to the Debtor.

(5) Assumes no interest income is received from the Debtor on the outstanding balance of the Intercompany Debt.

40. Development Co experienced reduced cash flow in XXXXXXXXXX and based on the above cash flow projections, Development Co is expected to experience a decreased cash flow for the fiscal years XXXXXXXXXX relative to the XXXXXXXXXX fiscal years. For greater certainty, this would be the case even if the Intercompany Debt interest component of Development Co's revenues is excluded for the XXXXXXXXXX fiscal years as it has been in XXXXXXXXXX and in the projections for the XXXXXXXXXX fiscal years. As noted above, even if all of Development Co's excess cash flow that could be generated in this "best case" scenario was used to support the Debtor, such assistance would still be insufficient to offset the full amount of the Debtor's expected cash shortage in the absence of a DPS refinancing of the Debtor.

41.XXXXXXXXXX Development Co's business is currently operating as well as can be expected in the marketplace, yet Development Co is unable to produce sufficient cash flow to satisfy its operating expenses and debt service obligations while also supporting the Debtor's cash shortfalls. Furthermore, neither Organization, the Bank, nor other external lenders are willing to provide additional financing to Development Co that could be used to provide support to the Debtor. Consequently, Development Co is not in a position to provide any further financial assistance to the Debtor.

Cash Flow Projections for Development Co - DPS Scenario

42. If the same assumptions are used as were used to prepare the Development Co non-DPS cash flow projections, Development Co's projected cash flow in the DPS Scenario is the same as the non-DPS projections.

43. The Bank has confirmed that, if the Loan of the Debtor is not converted to DPS, the Debtor will not have sufficient cash to satisfy all of its obligations and, in the event of such default, the Bank would be forced to consider pursuing its various options, one of which would be to accelerate the Debtor's outstanding indebtedness and enforce its security.

44. The XXXXXXXXXX undertook to amend the Letters Patent of Development Co to provide that Organization will no longer be the beneficiary of the remaining assets of Development Co in the event that Development Co dissolves or winds-up. In this regard, the XXXXXXXXXX passed the following resolution (the "Letters Patent Amendment") by unanimous approval at its XXXXXXXXXX meeting.

The XXXXXXXXXX recommend to the XXXXXXXXXX that the Board undertake amendment of Article XXXXXXXXXX of the letters patent of Development Co to provide that, in the event of a dissolution or winding up of Development Co, all its remaining assets after payment of its liabilities shall be distributed to a person that is exempt from tax under section 149 of the Income Tax Act of Canada and that, at the time of such distribution, deals at arm's length with the Organization for purposes of the Income Tax Act.

Moreover, Development Co has undertaken that it will never make a distribution of property or income to Organization or any party dealing at non-arm's length with Organization.

Proposed Transactions

The following proposed transactions will occur sequentially.

45. Development Co will amend its Letters Patent in accordance with the Letters Patent Amendment as described in paragraph 44 above such that in the event of a dissolution or winding up of the Development Co, all its remaining assets after payment of its liabilities shall be distributed to a person that is exempt from tax under section 149 and that, at the time of such distribution, deals at arm's length with Organization for purposes of section 251.

46. The Debtor will cause a new company ("Newco") to be incorporated under the CBCA. The authorized share capital of Newco will consist of a class of common shares and a single class of preferred shares ("Distress Preferred Shares"). The terms and conditions of the Distressed Preferred Shares will be as follows:

(a) non-voting except after a "Retraction Event" as described in paragraph 47 below;

(b) entitlement to preferential cumulative dividends payable monthly to be paid at a dividend rate based on XXXXXXXXXX% of the interest rate applied by the Bank to debts of XXXXXXXXXX;

(c) redeemable by Newco at any time at their stated capital amount plus accrued and unpaid dividends (the "Redemption Amount");

(d) mandatory redemption from "Excess Cash Flow" (described in paragraph 56 below);

(e) retractable by the holder at an amount equal to the Redemption Amount at any time after a Retraction Event and, in any event, after five years from their date of issue;

(f) in the event of a liquidation, dissolution or winding-up of Newco, the holders of the Distress Preferred Shares will be entitled to receive in priority to the holders of the Common Shares an amount equal to the Redemption Amount; and

(g) disposable or otherwise transferable by the Bank.

Newco will be a taxable Canadian corporation and will have the same fiscal year as the Debtor. The articles of incorporation of Newco will restrict it from carrying on any business, incurring any liabilities or acquiring any assets except as contemplated in these proposed transactions. On incorporation the Debtor will acquire common shares of Newco for nominal consideration.

47. "Retraction Event" for the Distress Preferred Shares will parallel the events of default contained in the agreement relating to the Bank Loan (the "Loan Agreement") and will include the occurrence of any one or more of the following events or circumstances.

(a) Newco fails to pay the regular dividend payable on the Distress Preferred Shares as and when the same is payable in accordance with the terms and conditions of the Distress Preferred Shares;

(b) Newco fails to redeem all or any part of the Distress Preferred Shares at the time and in the manner required by the terms and conditions of the Distress Preferred Shares;

(c) The Debtor fails to make a contribution of capital, or principal repayment, necessary to fund a dividend payment on, or on redemption of, the Distress Preferred Shares;

(d) an order is made or an effective resolution is passed for the winding-up, liquidation or dissolution of Newco;

(e) the Debtor or Newco makes a general assignment for the benefit of its creditors pursuant to a proposal under the Bankruptcy Act (Canada), or is declared bankrupt, or if a custodian, sequestrator, receiver and manager or any other officer with similar powers is appointed of Newco, the Debtor, the property of Newco or the Debtor, or any part thereof that is, in the opinion of the Bank, a substantial part thereof;

(f) an encumbrancer takes possession of the property of Newco or the Debtor, or any part thereof, that is, in the opinion of the Bank, a substantial part thereof, or if a distress, execution or any similar process is levied or enforced there against, and remains unsatisfied for such period as would permit such property, or such part thereof, to be sold thereunder;

(g) the Debtor defaults pursuant to the terms of the Loan Agreement, as amended, including a default on any financial covenant or the Debtor or Newco fails to comply with any of the covenants contained in any of the agreements entered into to implement these proposed transactions;

(h) subsequent to the issue of the Distress Preferred Shares, the Act or Income Tax Regulations (the "Regulations") is changed in a manner which creates a significant adverse impact to the Bank or any notice is given that this ruling is no longer applicable;

(i) the Debtor ceases to beneficially own the common shares of Newco;

(j) the Debtor ceases to carry on business in any material respect;

(k) the Bank commences any enforcement proceedings in respect of its security from the Debtor; or

(l) the Debtor or Newco fails to comply with or otherwise breaches any term or provision of the advance income tax ruling.

48. Newco will borrow approximately $XXXXXXXXXX from the Bank on a demand loan basis and will use all of the demand loan proceeds to purchase the Bank Loan and the Bank LOC (collectively, the "Purchased Debt") from the Bank. The demand loan will be guaranteed by the Debtor.

Newco will enter into an agreement with the Bank under which it will agree with the Bank that the Purchased Debt will continue to be administered on Newco's behalf by the Bank.

49. The Bank will subscribe for and Newco will issue the Distress Preferred Shares to the Bank for an aggregate subscription price of approximately $XXXXXXXXXX. The full amount of the subscription proceeds received by Newco from the issuance of its Distress Preferred Shares will be added to the stated capital account maintained by it in respect of the Distress Preferred Shares.

50. Newco will immediately apply the proceeds from the issuance of the Distress Preferred Shares to repay the demand loan received by it from the Bank as described in paragraph 48 above.

51. The Debtor, Newco and the Bank will enter into a purchase agreement (the "Put Agreement"). Under the terms of the Put Agreement, upon the occurrence of a Retraction Event (see paragraph 47 above) and, in any event, no later than the XXXXXXXXXX anniversary of the issuance of the Distress Preferred Shares, the Bank shall have the right to cause the Debtor to purchase the Distress Preferred Shares for an amount equal to the Redemption Amount plus any accrued but unpaid dividends. The rights of the Bank under the Put Agreement will be secured by security interests over the Debtor, which will be, in effect, the same in all material respects as its security interests in respect of the amounts owing to it by the Debtor under the Bank Loan and the Bank LOC immediately before the transactions herein described.

52. Upon the occurrence of a Retraction Event and, in any event, on the XXXXXXXXXX anniversary of the issuance of the Distress Preferred Shares, the Bank shall have the right to retract the Distress Preferred Shares. Newco will have the right after the Bank has exercised its retraction rights to require the Bank to purchase the Purchased Debt for an amount equal to its then outstanding principal amount in which event Newco will use the proceeds to redeem the Distress Preferred Shares. In such event, the purchase price for the Purchased Debt will be paid by certified cheque or bank draft and Newco will endorse such cheque or bank draft in favour of the Bank in satisfaction of the redemption of Distress Preferred Shares.

53. The Debtor, Newco and the Bank will enter into an agreement under which the Debtor will agree to provide, from time to time, Newco with funds sufficient to pay dividends on the Distress Preferred Shares, pay all operating expenses and pay all fees and expenses required to keep Newco in good standing under the laws of Canada (the "Support Agreement"). Such funds will be advanced by the Debtor as contributions of capital to Newco.

54. Effective on the date of purchase of the Purchased Debt, the Debtor will agree with Newco that no interest will be payable on the Purchased Debt so long as it is held by Newco. However, if the Purchased Debt is subsequently assigned (including reacquisition by the Bank), interest will again become payable at that time in accordance with the original terms of the Bank Loan and the Bank LOC, as applicable.

55. The Debtor will make periodic payments of principal to Newco in respect of the Purchased Debt in order to provide Newco with sufficient funds to meet its obligations relating to the redemption of the Distress Preferred Shares.

56. Notwithstanding the terms and conditions of the Distress Preferred Shares or any mandatory redemption of the Distress Preferred Shares that may be required by the Bank, all Excess Cash Flow arising in each fiscal period shall be applied to redeem the Distress Preferred Shares within XXXXXXXXXX days after the end of that fiscal period.

"Excess Cash Flow" in respect of a particular fiscal period shall be the cash flow for such period of the Debtor from all sources as would be reported on a Consolidated Statement of Changes in Financial Position prepared in accordance with generally accepted accounting principles ("GAAP"), if only directly and indirectly wholly-owned subsidiaries of the Debtor were so included, but before outlays for:

(a) the payment of dividends other than dividends paid on the Distress Preferred Shares;

(b) capital expenditures or any payment on capital account, other than in respect of:

(i) the purchase or redemption of the Distress Preferred Shares, other than purchases or redemptions made in the fiscal period in respect of the Excess Cash Flow of the prior fiscal period;

(ii) repayments of indebtedness incurred in the normal and ordinary course of business and in existence at the date the Distress Preferred Shares are issued;

(iii) repayments of additional debt incurred for the specific purpose of funding current operating requirements;

(iv) reasonable capital expenditures or payments on capital account incurred in the normal and ordinary course of the existing business and repayments of additional debt for the specific purpose of making such capital expenditures or payments on capital account; and

(v) repayments of additional debt incurred for the specific purpose of enabling Newco to redeem the Distress Preferred Shares or to pay dividends on the Distress Preferred Shares;

(c) subject to subparagraphs (b)(ii) and (b)(iii) in this definition of Excess Cash Flow, repayments of loans to shareholders of the Debtor or redemptions of any of the shares of the Debtor; and

(d) loans to directors, officers and shareholders of the Debtor or to other persons, firms or corporations.

For the purposes of this definition of Excess Cash Flow, additional debt shall not include a debt which arose as the result of the use of cash or funds for a purpose that is not envisaged herein.

57. Subject to the operation of any applicable law, Newco will be wound up as soon as reasonably possible after the earlier of:

(a) the date on which the last of the Distress Preferred Shares is redeemed, cancelled or otherwise acquired by Newco; and

(b) the date that is five years after the date the Distress Preferred Shares are issued.

Purpose of the Proposed Transactions

58. The purpose of the proposed transactions is to refinance the long-term debt of the Debtor with Distress Preferred Shares and increase cash flow by reducing debt service requirements and thereby to allow a continuation of operations. In the absence of this financing, there is a substantial likelihood that the Debtor will be unable to meet regular payments of debt and that the Bank will enforce its security for non-payment of interest and principal.

Rulings

Provided that the above description of facts, proposed transactions and purpose of the proposed transactions are accurate and constitute a complete and accurate disclosure of all of the relevant facts, proposed transactions and the purpose thereof, and provided further that the proposed transactions are completed in the manner described above, we confirm that:

A. The Distress Preferred Shares to be issued to the Bank, and where applicable, sold to a subsequent corporate purchaser will be shares described in subparagraph (e)(iii) of the definition of "term preferred share" in subsection 248(1) for a period not exceeding five years from the date of their issuance and, accordingly, subsections 112(2.1), (2.2) and (2.3) will not apply to deny the Bank or where applicable, a subsequent corporate purchaser, a deduction under subsection 112(1) for dividends received or deemed to have been received by it on the Distress Preferred Shares during that five year period;

B. By virtue of the Distress Preferred Shares being shares described in subparagraph (e)(iii) of the definition of "term preferred share" in subsection 248(1), the Distress Preferred Shares to be issued to the Bank will be "exempt shares" pursuant to paragraph (c) of the definition in subsection 112(2.6) for the five year period and, accordingly, subsection 112(2.4) will not apply to deny the Bank a deduction under subsection 112(1) with respect to dividends received or deemed to have been received on the Distress Preferred Shares during the five year period from the date of issue of the Distress Preferred Shares;

C. By virtue of the Distress Preferred Shares being shares described in subparagraph (e)(iii), of the definition of term preferred share in subsection 248(1), the Distress Preferred Shares to be issued to the Bank will not be "short-term preferred shares", by virtue of paragraph (i) of the definition of "short-term preferred share" in subsection 248(1);

D. The Distress Preferred Shares to be issued to the Bank, and where applicable, sold to a subsequent corporate purchaser will not be "taxable preferred shares" or "taxable RFI shares" as those terms are defined in subsection 248(1), for a period of five years from the date of issuance, by virtue of the Distress Preferred Shares being shares described in subparagraph (e)(iii), of the definition of term preferred share in subsection 248(1). The provisions of Part IV.1 and Part VI.1 will not apply with respect to dividends received or paid, as the case may be, on the Distress Preferred Shares for a period of five years from the date of issuance to the Bank;

E. No amount will be included in computing the income of Newco under paragraphs 12(1)(c) or 12(1)(x) or subsections 12(3), 12(9), 16(1) or 246(1) or section 9 in respect of any capital contributions made or required to be made by Debtor to Newco as described in paragraph 53 of the Proposed Transactions nor will such amounts constitute "proceeds of disposition", within the meaning of that term in section 54, to Newco from the disposition by it of any property;

F. No amount will be included in computing the income of the Bank, and where applicable, a subsequent corporate purchaser, under subsections 56(2) or 246(1) in respect of any capital contributions made or required to be made by Debtor as described in paragraph 53 of the Proposed Transactions;

G. Expenses incurred by Newco in the course of issuing the Distress Preferred Shares will, to the extent such expenses are reasonable in the circumstances, be deductible by Newco pursuant to paragraph 20(1)(e);

H. Subject to paragraph 20(1)(e.1), expenses described in subparagraphs 20(1)(e)(ii.2) and 20(1)(e.1)(iii) that are incurred by Debtor in the course of rescheduling or restructuring its indebtedness as set out in the Proposed Transactions described above will, to the extent such expenses are reasonable in the circumstances, be deductible by the Debtor pursuant to paragraph 20(1)(e);

I. No amount will be included in the income of Debtor pursuant to subsections 15(1) and 246(1) solely by virtue of the fact that interest will not be paid or payable by Debtor to Newco on the Purchased Debt as described in paragraph 54 of the Proposed Transactions;

J. Section 80 will not apply in respect of Debtor by virtue of the fact that interest will not be paid or payable by Debtor to Newco on the Purchased Debt;

K. The cost amount, within the meaning of that term in subsection 248(1), to the Bank of the Distress Preferred Shares, immediately after the time that they are issued as described in paragraph 49 of the Proposed Transactions, will be equal to the amount paid by the Bank to Newco in consideration for the Distress Preferred Shares;

L. The cost amount, within the meaning of that term in subsection 248(1), to Newco of the Purchased Debt immediately after it is acquired from the Bank, as described in paragraph 48 of the Proposed Transactions, will be equal to the purchase price paid by Newco to the Bank in consideration for the Purchased Debt;

M. If the Bank reacquires the Purchased Debt from Newco as described in paragraph 52 of the Proposed Transactions, the cost amount, within the meaning of that term in subsection 248(1), of the Purchased Debt to the Bank immediately after it is reacquired will be the purchase price paid by the Bank in consideration for the Purchased Debt;

N. Provided that the Purchased Debt arose from one or more loans made by the Bank in the course of its money lending business, the Purchased Debt reacquired by the Bank will be considered to have been acquired by the Bank in the ordinary course of its business of lending money for the purposes of paragraphs 20(1)(l) and 20(1)(p);

O. Subsection 112(4) will not apply, in respect of any dividends received by the Bank on the Distress Preferred Shares, to any loss realized by the Bank in respect of the Purchased Debt subsequent to it being reacquired by the Bank as described in paragraph 52 of the Proposed Transactions;

P. Subsection 245(2) will not be applicable as a result of the proposed transactions, in and by themselves, to redetermine the tax consequences confirmed in the rulings given.

These rulings are given subject to the general limitations and qualifications set out in Information Circular IC 70-6R4 dated January 29, 2001, and are binding on the Canada Customs and Revenue Agency provided that the proposed transactions are completed by XXXXXXXXXX.

These rulings are based on the Act in its present form and do not take into account amendments to the Act which, if enacted into law, could have an effect on the rulings provided herein.

Comment

Nothing in this letter should be construed as implying that the Agency has agreed to any other tax consequences relating to any facts or proposed transactions referred to herein other than those as specifically described in the rulings given above.

Opinion

Provided that the Bank meets the requirements outlined in paragraph 6209(a) of the Regulations for a particular taxation year and the Distress Preferred Shares are not "prescribed property" to the Bank within the meaning assigned by draft paragraph 6209(b) of the Regulations and provided this draft paragraph is enacted in substantially the same form as proposed in the draft amendments to the Income Tax Regulations which were issued by the Minister of Finance in June 1995, it is our opinion that the Distress Preferred Shares will be "prescribed shares" to the Bank within the meaning assigned by paragraph 6209(a) of the Regulations for purposes of the definition of "lending asset" in subsection 248(1).

Yours truly,

XXXXXXXXXX
for Director
Financial Industries Division
Income Tax Rulings Directorate
Policy and Legislation Branch

..../cont'd

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