2001 Ruling 2000-0060103 - Principal amount of debt obligation

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:

(a) Whether the XXXXXXXXXX % Interest payable in shares is part of the principal amount of the debt for purposes of paragraph 20(1)(f) of the Act.

(b) Whether the amount paid for purposes of paragraph 20(1)(f) of the Act is equivalent to the fair market value of such shares as reflected by a corresponding increase to the shares' stated capital.

Position:

(a) Yes
(b) Yes

Reasons:

(a) The XXXXXXXXXX % Interest payable in shares is part of the principal amount of the debt obligation. The payment of the XXXXXXXXXX % Interest in shares does constitute an amount paid for purposes of paragraph 20(1)(f).

(b) The determination of the amount paid is considered consistent with the Agency's position set out in IT-293R.

XXXXXXXXXX 2000-006010

XXXXXXXXXX, 2001

Dear XXXXXXXXXX:

Re: Advance Income Tax Ruling - XXXXXXXXXX

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

You have advised that, to the best of your knowledge and that of XXXXXXXXXX, none of the matters involved in this advance income tax ruling request are being considered by a tax services office or a taxation centre of the Canada Customs and Revenue Agency in connection with a tax return already filed, nor are any of the matters considered herein under objection or appeal.

Except as otherwise noted, all statutory references in this request for advance income tax rulings are references to the provisions of the Income Tax Act (Canada), R.S.C. 1995 (5th Supp.), as amended (the "Act").

DEFINITIONS

XXXXXXXXXX is referred to as "ACO";

XXXXXXXXXX is referred to as "BCO";

XXXXXXXXXX is referred to as "CCO";

XXXXXXXXXX is referred to as "DCO";

XXXXXXXXXX is referred to as "ECO";

XXXXXXXXXX is referred to as "Mr. X";

Series A Debentures are referred to as "Series A"; and

Series B Debentures are referred to as "Series B".

"XXXXXXXXXX% Interest" means the shares of Restricted Common Stock issuable upon conversion of the Debentures, pursuant to XXXXXXXXXX the Debentures, assuming the Debentures were convertible in full at the option of the holder as of such date. The fair market value of the XXXXXXXXXX% Interest may be determined by an investment banker of a national standing in Canada experienced in XXXXXXXXXX businesses; Note that the XXXXXXXXXX% interest is also payable upon the redemption because of the definition of redemption amount which refers to the XXXXXXXXXX% interest (see definition below).

"Cure Period" means, with respect to any Event of Default, a period commencing on the date of the occurrence of such Event of Default and ending on the one hundred and eightieth (180th) day following such occurrence;

"Event of Default" means, among others, the occurrence of a change of control, or a merger, amalgamation, plan of arrangement, consolidation, reorganisation or other business combination which results in a change of control;

"Fair Market Value" means as of any date, with respect to the redemption, at the option of the Holders, (i) prior to the Qualified Public Offering, the fair market value of the XXXXXXXXXX% Interest, as determined by an investment banker of a national standing in Canada experienced in XXXXXXXXXX businesses, or (ii) on or following the Qualified Public Offering, an amount equal to the Weighted Average Price as of such date multiplied by the number of shares included in the XXXXXXXXXX% Interest;

"Redemption Amount" means, with respect to a debenture as of any date, an amount equal to the sum of

(i) the then outstanding principal amount of such debenture, together with the accrued and unpaid interest thereon, and

(ii) the Fair Market Value of the XXXXXXXXXX% Interest;

"Redemption Date" means the later of XXXXXXXXXX or the XXXXXXXXXX anniversary of the Amalgamation Closing Date;

"Restricted Common Stock" means the ACO restricted common shares which have essentially the same characteristics as the ACO common shares except that they are non-voting and redeemable and convertible into common shares at the option of their holders in certain circumstances;

"Weighted Average Price" means with respect to any security traded on the XXXXXXXXXX, as of any date, the average of the closing prices, last bid or quoted price on such exchange for XXXXXXXXXX trading days preceding such date.

STATEMENT OF FACTS

1. ACO files its T2 Corporation Income Tax Returns with the XXXXXXXXXX Taxation Centre. The business number of ACO is XXXXXXXXXX.

2. ACO is a Canadian controlled private corporation and a taxable Canadian corporation within the meanings assigned by subsection 89(1) of the Income Tax Act (the "Act"). ACO is incorporated under the Canada Business Corporations Act.

3. As of the date hereof, the authorized share capital of ACO consists of an unlimited number of common shares, an unlimited number of restricted common shares and an unlimited number of preferred shares.

4. All of the issued and outstanding shares of ACO are owned by CCO, a Canadian controlled private corporation. At present, there are XXXXXXXXXX common shares issued and outstanding.

5. On XXXXXXXXXX, ACO, formerly BCO, prior to its amalgamation with CCO, issued Series A Debentures and Series B Debentures (collectively referred to as the "Debentures") to DCO, ECO and Mr. X (the "Holders") for an aggregate amount of $XXXXXXXXXX.

6. ECO purchased Series A for an amount of $XXXXXXXXXX and Series B for $XXXXXXXXXX. DCO purchased Series A for an amount of $XXXXXXXXXX and Series B for $XXXXXXXXXX and Mr. X purchased Series A for an amount of $XXXXXXXXXX and Series B for $XXXXXXXXXX.

7. On the same date, a Securityholder Agreement was concluded between CCO, who was at the time the sole shareholder of BCO, and the Holders whereby CCO agreed to guaranty the payment of the Debentures until the consummation of the amalgamation between itself and BCO which occurred on XXXXXXXXXX.

8. Pursuant to the amalgamation of CCO and BCO, ACO assumed all of the obligations under the Debentures.

9. At present, ACO is contemplating effecting a tax free horizontal amalgamation with an unrelated Canadian corporation (hereinafter referred to as "FCO") pursuant to subsection 87(1) of the Income Tax Act.

10. Such an amalgamation of ACO with FCO would, however, constitute an Event of Default under the terms of the Debentures. In order to avoid a default, ACO is considering redeeming the Debentures prior to their maturity.

11. The general terms and conditions of the Debentures provide that they are unsecured with a fixed rate of interest of XXXXXXXXXX% per annum. The Debentures also provide for an "equity kicker" consisting of XXXXXXXXXX% of the share equity of ACO (the "XXXXXXXXXX % Interest") which is payable under any circumstances whether at conversion or redemption of the Debentures and/or before or at maturity. In case of a voluntary redemption by the issuer prior to maturity, the XXXXXXXXXX% Interest is payable in shares of ACO in lieu of cash. The Debentures are convertible either by the holder or ACO following a public offering of ACO. Finally, the Debentures are redeemable at any time by ACO, and their Holders can call such Debentures for redemption after a certain period of time or in case of an uncured event of default.

12. More specifically, the terms and conditions are the following:

Aggregate principal amount upon issuance

The Debentures have been issued in two different series, the XXXXXXXXXX% Series A Debenture and the XXXXXXXXXX% Series B Debenture but are identical in their terms; the aggregate principal amount of the Series B Debenture and of the Series A Debenture is $XXXXXXXXXX;

Interest

The Debentures bear interest at the rate of XXXXXXXXXX% per annum, on the principal amount outstanding from time to time and, to the extent not paid in cash by ACO on or before XXXXXXXXXX of each year (each such date being herein called "Interest Compounding Date"), such interest will be added to principal and compounded annually on such Interest Compounding Date commencing on XXXXXXXXXX and thereafter until payment in full of the principal amount of the Debentures, together with all accrued and unpaid interest; all or any portion of interest, which shall have accrued since the immediately preceding Interest Compounding Date and shall remain unpaid, may be paid and brought current at any time prior to the next Interest Compounding Date; in case of default, the interest rate is increased to XXXXXXXXXX% in a predetermined manner;

Conversion Rights

Following an Initial Public Offering of ACO, the Debentures are convertible into Restricted Common Stock at the option of the Holders, subject to ACO's right to elect to pay the Holders in cash only for the outstanding principal amount together with accrued and unpaid interest. The Debentures are also convertible at the option of ACO where there has been a Qualified Public Offering as defined in the Debentures.

In case of a conversion, the XXXXXXXXXX% Interest payable is satisfied by the delivery of XXXXXXXXXX ACO restricted shares out of a total of XXXXXXXXXX common shares (including the XXXXXXXXXX restricted common shares) outstanding after such issuance. The number of restricted common shares is adjusted from time to time by virtue of XXXXXXXXXX the Debentures to protect against dilution. At present, there are XXXXXXXXXX common shares issued and outstanding of ACO and the XXXXXXXXXX% interest upon conversion would be satisfied by the issuance of XXXXXXXXXX restricted common shares to the Holders of the Debentures.

Mandatory Redemption

The Debentures may be redeemed at the option of the Holders ("Mandatory Redemption") on or after the earlier to occur of (a) the Redemption Date, or (b) the end of a Cure Period relating to an Event of Default, which Event of Default shall remain uncured. Upon receipt of a notice of the intention by the holder to exercise his right of redemption, ACO shall redeem each Debenture by wire transfer of immediately available funds in cash in aggregate amount equal to the Redemption Amount, consisting of the then principal amount of such Debenture, together with accrued and unpaid interest and the Fair Market Value (as defined under the Debentures which in essence is the cash value) of the XXXXXXXXXX% Interest;

Voluntary Redemption

ACO may also redeem in full, but not in part, the Debentures ("Voluntary Redemption"). The Voluntary Redemption payment is equivalent to the Redemption Amount except that the payment of the XXXXXXXXXX% Interest is done through the issuance of restricted common shares in lieu of cash. Thus, upon such redemption, ACO shall deliver to the holder:

(i) by wire transfer of immediately available funds an amount equal to the outstanding principal amount of the Debenture, together with accrued and unpaid interest thereon; and

(ii) a certificate or certificates registered in the name of the holder representing a number of shares equal to the XXXXXXXXXX% Interest, which shares shall be duly and validly issued and fully paid and non-assessable, free of all liens and not subject to any pre-emptive rights (i.e. XXXXXXXXXX shares of the issued XXXXXXXXXX common shares which number includes the XXXXXXXXXX restricted common shares). The number of restricted common shares is adjusted from time to time to protect against dilution.

13. The restricted common shares of ACO carry identical rights as those attached to the common shares with the exception that they do not have any voting rights. In addition, the restricted common shares have certain additional rights and features which were requested in connection with such debenture investment, including specific retraction rights if ACO has not completed a qualified Public Offering, as defined in the Debentures, of its securities with a certain prescribed period of time, as well as the right to convert the restricted common shares into common shares on a one-for-one basis, provided that the maximum number of voting shares held by non-Canadians following such conversion of restricted common shares does not exceed the maximum aggregate holdings of voting shares by non-residents XXXXXXXXXX.

PROPOSED TRANSACTIONS

14. ACO is contemplating an amalgamation with FCO. The amalgamation per se would constitute an Event of Default under XXXXXXXXXX the Debentures. Subject to the receipt of favourable income tax rulings, ACO wishes, prior to the amalgamation with FCO, to exercise its Voluntary Redemption right as described under XXXXXXXXXX the Debentures and in paragraph 12 above.

15. ACO will add to the stated capital of the Restricted Common Stock issued on the Voluntary Redemption an amount equal to the fair market value of the shares so issued.

PURPOSE OF THE TRANSACTION

16. The purpose of the proposed transaction is to avoid being in default under the terms of the Debentures which would result in the payment of the XXXXXXXXXX% Interest in cash in lieu of shares. Also, a default under the Debentures would cause cross-default under ACO's other credit agreements and would result in a breach of representations and warranties under the merger agreement being negotiated between FCO and ACO.

RULINGS GIVEN

Provided the above statements of fact are complete and accurate and the proposed transactions are carried out as described, the following rulings are provided:

A. For purposes of computing the deduction under paragraph 20(1)(f) of the Act, the amount of the XXXXXXXXXX% Interest payable in shares of ACO is considered to be part of the principal amount of the Debentures as defined under subsection 248(1) of the Act.

B. The amount paid for purposes of paragraph 20(1)(f) of the Act will be the fair market value of the shares issued on the Voluntary Redemption of the Debentures in satisfaction of the principal amount of the Debentures

These rulings are provided subject to the limitations and qualifications set out in Information Circular 70-6R3 issued by the Canada Customs & Revenue Agency on December 30, 1996 and are binding upon the Agency provided that the proposed transactions are completed on or before XXXXXXXXXX. The rulings are based on the Income Tax Act and Regulations in their present form and do not take into account the effects of any proposed amendments thereto.

Nothing in this ruling should be construed as confirmation, express or implied, of:

(a) the determination of the fair market value of any shares; or

(b) any tax consequences arising from the facts or proposed transactions described above other than those specifically confirmed in the rulings given.

Yours sincerely,

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