2001 Ruling 2001-0069213 - limited partnership; call option

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:

1. whether LP Units are tax shelters
2. whether existence of call option causes no REOP
3. whether existence of call option is 96(2.2)(d) benefit
4. whether gaar applies
5. whether, where a trust receives mixed income (split and nonsplit), trust may designate payments to beneficiaries

Position:

1. no
2. not in and of itself
3. not in and of itself
4. maybe, if call option is exercised and 24 month period in 110.6(2.1) avoided
5. yes, as long as nonsplit income allocated to beneficiaries does not exceed non-split income of trust

Reasons:

1. limited partners cannot receive cumulative losses that are greater than XXXXXXXXXX % of their capital contribution
2. must consider all facts re REOP
3. call option is at discretion of general partner, not limited partners/ option price is fmv
4. 110.6
5. law does not prohibit streaming or require equal payouts of split and nonsplit income

XXXXXXXXXX 2001-006921

XXXXXXXXXX, 2001

Dear XXXXXXXXXX:

Re: Advance Income Tax Ruling
XXXXXXXXXX

We are writing in response to your letter of XXXXXXXXXX, wherein you requested an advance income tax ruling, and your subsequent correspondence and our (XXXXXXXXXX) telephone discussions concerning this ruling request.

To the best of your knowledge and that of the taxpayers involved in this ruling request, none of the issues contained herein is:

(i) dealt with in an earlier return of the taxpayers or a related person;

(ii) being considered by a tax services office or taxation centre in connection with a previously filed tax return of one or any of the taxpayers or a related person;

(iii) under objection by one or any of the taxpayers or a related person;

(iv) subject to a ruling previously issued by the Income Tax Rulings Directorate;

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

(vi) with respect to the exercise of the Offer described in paragraph 17 below, dealt with in any documents or any agreements (either verbal or written), other than the documents and agreements that have been submitted to the Income Tax Rulings Directorate in draft form. Further, both you and the taxpayers involved have made enquiries with respect to whether any such additional documents or agreements exist or will exist.

In this letter, the following terms have the meanings specified:

(a) "Act" means the Income Tax Act, R.S.C 1985 (5th Supp.) c.1, as amended to the date hereof, and, unless otherwise stated, every reference herein to a Part, section, subsection, paragraph or subparagraph is a reference to the relevant provision of the Act;

(b) "Adjusted Cost Base ("ACB") of a Partnership Interest" has the meaning assigned in section 54, as modified by paragraphs 53(1)(e) and 53(2)(c) of the Act;

(c) "Canadian-controlled private corporation" ("CCPC") has the meaning assigned by subsection 125(7) of the Act;

(d) "Capital Property" has the meaning assigned by section 54 of the Act;

(e) "CBCA" means the Canada Business Corporations Act, and where applicable, its predecessor statutes;

(f) "CCRA" means the Canada Customs and Revenue Agency;

(g) "Company Act" means the Business Corporations Act of XXXXXXXXXX, and, where applicable, its predecessor statutes;

(h) "Fiscal Period" of Limited Partnership has the meaning assigned by section 249.1 of the Act;

(i) "General Partner" of the Limited Partnership means ParentCo;

(j) "General Partnership Unit" means the interest of General Partner in the Limited Partnership;

(k) "Individual" means XXXXXXXXXX;

(l) "Initial Limited Partner" means the Principal;

(m) "Limited Partners" mean persons, other than Initial Limited Partner, with a limited partnership interest in Limited Partnership;

(n) "Limited Partnership" means XXXXXXXXXX, a limited partnership to be registered pursuant to the laws of the Province XXXXXXXXXX prior to closing of the syndication of Limited Partnership Units;

(o) "Limited Partnership Agreement" means the agreement to be entered into between General Partner and Initial Limited Partner, and subsequently Limited Partners;

(p) "Limited Partnership Unit" means an interest of a Limited Partner in the Limited Partnership;

(q) "Management Services Fee" means the fees that Limited Partnership will be entitled to receive, as described below in paragraph 15;

(r) "Matchable Expenditures" has the meaning assigned by subsection 18.1(1) of the Act;

(s) "ParentCo" means XXXXXXXXXX. ParentCo was incorporated pursuant to the Company Act of the Province on XXXXXXXXXX. ParentCo's Business Identification Number is XXXXXXXXXX and its address is XXXXXXXXXX. ParentCo files its income tax returns with the XXXXXXXXXX Tax Services Office;

(t) "Partner(s)" means one or more Limited Partners or the General Partner or a combination of the two;

(u) "Principal" means XXXXXXXXXX, the CEO and principal shareholder of ParentCo. Principal is a resident of the Province. Principal's SIN number is

XXXXXXXXXX;

(v) "Private Corporation" has the meaning assigned by subsection 89(1) of the Act;

(w) "Production" means the a television series to be entitled, "XXXXXXXXXX", and to be produced by SubCo;

(x) "Province" means the Province of XXXXXXXXXX;

(y) "Related Persons" has the meaning assigned by subsection 251(2) of the Act;

(z) "Small Business Corporation" has the meaning assigned by subsection 248(1) of the Act;

(aa) "Split Income" has the meaning assigned by subsection 120.4(1) of the Act;

(bb) "SubCo" means a corporation to be incorporated pursuant to the Company Act of the Province, all the issued and outstanding shares of which will initially be owned by General Partner;

(cc) "Taxable Canadian Corporation" ("TCC") has the meaning assigned by subsection 89(1) of the Act;

(dd) "Tax Shelter" has the meaning assigned by section 237.1 of the Act;

(ee) "Tax Shelter Investment" has the meaning assigned by subsection 143.2(1) of the Act;

(ff) "Wholly-Owned Subsidiary Corporation" has the meaning assigned by subsection 248(1) of the Act.

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

FACTS

1. ParentCo is a TCC and a CCPC. Principal owns approximately XXXXXXXXXX of the XXXXXXXXXX common shares issued and outstanding of the capital stock of ParentCo. The remaining shares of the capital stock of ParentCo are owned by Canadian residents who deal at arm's length with Principal. Principal has a verbal agreement with the Individual, who will be a working partner and who may be able to obtain up to XXXXXXXXXX% of the common shares of ParentCo. In that event, Principal would then own less than the XXXXXXXXXX common shares of ParentCo. The Individual will not be an investor in the Limited Partnership and his involvement will be that of a shareholder-employee, providing services to the Limited Partnership or its subsidiary corporations for a salary.

2. ParentCo has entered into working and contractual relationships with a number of respected television producers relating to various stages of development of the production of episodes or shows for TV broadcasting or the production of content for webcasting. Working with another writer/broadcaster, ParentCo has created the idea for the Production, packaged the idea, and on XXXXXXXXXX, presented this idea to XXXXXXXXXX and negotiated the terms of a broadcast contract for the Production.

PROPOSED TRANSACTIONS

3. Limited Partnership will be formed by ParentCo as General Partner and Initial Limited Partner to acquire and carry on the business currently carried on by ParentCo. Limited Partnership will operate as a management and administrative vehicle. Limited Partnership will provide management services to and receive management fees from new corporations (NewCos) that will produce films and initially will be wholly-owned subsidiary corporations of Limited Partnership and to third parties who are not Related Persons with respect to Limited Partnership. Limited Partnership will also incorporate a corporation ("DistributionCo") which will distribute film and video productions. Limited Partnership will own XXXXXXXXXX% of the shares of DistributionCo. Limited Partnership will, inter alia, provide the following services:

• evaluate potential ideas that could be developed into TV productions;
• negotiate for the rights to these television productions;
• act as a co-ordinator between financing corporations, including banks, broadcasters, insurance companies and completion bonders, and film production corporations;
• assemble all grants and applications for financing;
• provide management services, including negotiating all contracts relating to broadcast sales and the licensing of intellectual property related to any productions;
• receive investment income from a new wholly-owned subsidiary corporation of Limited Partnership that will distribute films.

4. Limited Partnership will not use proceeds from the issuance of Limited Partnership Units to fund specific productions. It is anticipated that all funds raised on the issuance of Limited Partnership Units will be expended on financing expenses and operating costs of Limited Partnership. Limited Partnership does not intend to make any expenditures that would be Matchable Expenditures.

5. The business model to be used by Limited Partnership is to produce Canadian television production content while minimizing overheads. Limited Partnership will keep overheads down by, inter alia, negotiating with freelance writer/producers rather than keeping them on retainer. Limited Partnership will earn a portion of its profits by arranging for funding for the difference between production costs and the total of payments from clients and government grants.

6. The Limited Partnership Agreement will allow for the issuance of one (1) General Partnership Unit, one Initial Limited Partnership Unit and up to XXXXXXXXXX Limited Partnership Units. Principal will acquire one Initial Limited Partnership Unit for consideration of $XXXXXXXXXX. General Partner will acquire one General Partnership Unit for consideration of $XXXXXXXXXX.

7. The Limited Partnership Agreement will contain the following provisions:

A. The General Partner shall allocate to itself as at XXXXXXXXXX of each Fiscal Period of Limited Partnership, commencing for the Fiscal Period ending XXXXXXXXXX% of Net Income, if any, for such Fiscal Period, and shall allocate the balance pro rata to the Limited Partners at that time as follows:

(a) XXXXXXXXXX% of the balance of the Net Income until the Limited Partners shall have received a cumulative return of XXXXXXXXXX% of the Subscription Price, and thereafter,

(b) XXXXXXXXXX% of the balance of the Net Income until the allocation to each Limited Partner is XXXXXXXXXX% (except in the Fiscal Period next following the Closing in which the allocation shall be XXXXXXXXXX% to reflect advances being made throughout the year XXXXXXXXXX), of the Subscription Price, calculated annually, less XXXXXXXXXX ths of any income allocation in paragraph (a) above. If in any Fiscal Period, no allocation of Net Income is made to the Limited Partners pursuant to this paragraph, the amount of this allocation not distributed shall be added to the allocation obligation of subsequent Fiscal Periods, and thereafter,

(c) XXXXXXXXXX% of the balance of the Net Income until the allocation to each Limited Partner is XXXXXXXXXX% of the Subscription Price, calculated annually. If in any Fiscal Period, no allocation of Net Income is made to the Limited Partners pursuant to this paragraph, the amount of this allocation not distributed shall be added to the allocation obligation of subsequent Fiscal Periods, and thereafter, based on a full subscription of the maximum number of Limited Partnership Units available under this Offering, XXXXXXXXXX% of Net Income after payments made pursuant to paragraphs (a) and (b) above and this paragraph, if any, shall be allocated to the Limited Partners and the balance, if any, shall be allocated to the General Partner.

B. Total losses equal to no more than XXXXXXXXXX% (the "XXXXXXXXXX%") on a cumulative basis from the time of the subscription of Limited Partnership Units by a Limited Partner to the disposition by that Limited Partner of that Limited Partnership Unit will be allocated to each Limited Partner at the end of each Fiscal Year of the Partnership. Any losses in excess of the XXXXXXXXXX% will be allocated to the General Partner. There will be no benefits whatsoever described in subparagraph (b)(ii) of the definition of "tax shelter" in subsection 237.1(1) of the Act.

C. In the event that the General Partner acquires all of the Limited Partnership Units pursuant to an Offer described in paragraph 17 below, the Fiscal Period of Limited Partnership will terminate immediately prior to such acquisition.

D. Limited Partnership will issue a Prospectus and Offering Memorandum pursuant to which Limited Partnership will undertake therein to sell Limited Partnership Units to no more than XXXXXXXXXX investors. Limited Partner will show the Offering Memorandum to no more than XXXXXXXXXX potential investors. Limited Partnership will raise up to $XXXXXXXXXX dollars on the sale of Limited Partnership Units (the "Offering") to individuals and trusts in various provinces of Canada, including XXXXXXXXXX. The anticipated investment amount will be between $XXXXXXXXXX and $XXXXXXXXXX per Limited Partner.

8. The Subscription Document, pursuant to which individuals will acquire their Limited Partnership Units, will include an express agreement whereby Limited Partners contract that they will not incur any debt with respect to the acquisition of the Limited Partnership Units.

9. It is anticipated that all of the Limited Partners will be dealing at arm's length with the General Partner.

10. It is anticipated that a notable percentage of potential investors will be family trusts organized as "personal trusts" in accordance with the definition of personal trusts described in section 248(1) and many beneficiaries, discretionary or otherwise, will be under the age of 18 years.

11. On the closing date of the Offering (the "Closing"), Initial Limited Partner will sell its Limited Partnership Interest to Limited Partnership for $XXXXXXXXXX.

12. ParentCo will transfer its operating assets, other than contracts, to SubCo. The operating assets other than any contracts in place, will have nominal value. The contracts will in themselves have no value until the Limited Partnership has raised the funds necessary to operate the business to fulfill the contracts. ParentCo will make an election under subsection 85(1) in respect of the transfer of assets to SubCo and then again on the transfer of the shares of SubCo to Limited Partnership. The Limited Partnership will then be the only shareholder of SubCo. After this transfer, ParentCo will have no significant assets other than the Contract and its General Partnership Unit. All of the business formerly carried on by ParentCo will be carried on by Limited Partnership. Limited Partnership will be responsible for funding all ongoing business operations of the business of the partnership. Limited Partnership anticipates that during the initial period, estimated to be XXXXXXXXXX, it will operate at a deficit. It is the intention of all the taxpayers involved in this ruling request that Limited Partnership will operate with a reasonable expectation of profit.

13. ParentCo will assign the Contract dated XXXXXXXXXX with the XXXXXXXXXX to SubCo for consideration that is common shares of SubCo. and ParentCo will elect under subsection 85(1) of the Act. A that time, the contract will have nominal value. The Production will be produced by SubCo and any other television or film productions arranged through Limited Partnership will be produced by NewCos, excluding SubCo, that will be incorporated expressly for the purpose of a specific production, or series in the case of episodic productions. Third parties may also acquire equity in such NewCos with any such equity being shares issued from treasury.

14. SubCo will fund the Production using:

a) broadcast license fees,

b) federal and provincial tax credits,

c) industry tax credits, and

d) equity financing either from Telefilm Canada or other debt financing.

15. In consideration of providing management services to SubCo, Limited Partnership will be entitled to receive a fee (the "Management Services Fee") from SubCo equal to the fair market value of those services. These fees are not based on rights related to any productions. The fees will be related to the fair market value of the services provided by Limited Partnership to SubCo.

16. Limited Partnership does not intend to earn any income from the provision of goods or services to or in support of a business carried on by:

(i) a Specified Individual, a person who is related to the Specified Individual at any time in the year,

(ii) a corporation of which a person who is related to the Specified Individual is a specified shareholder at any time in the year, or

(iii) a professional corporation of which a person related to the individual is a specified shareholder at any time in the year.

17. General Partner may at any time after all Limited Partnership Units have been issued and before XXXXXXXXXX, if it, in its absolute discretion, so chooses, offer (the "Offer") to purchase all Limited Partnership Units from the Limited Partners in consideration for the issuance by General Partner of indebtedness of ParentCo and Preferred Shares bearing cumulative stock dividend entitlements and common shares in the capital stock of ParentCo ("General Partner consideration"). The aggregate value of the General Partner consideration provided to a Limited Partner in respect of such a transfer will be equal to the fair market value, including income entitlements from the Limited Partnership Units, of that Limited Partnership Unit at the time of the transfer.

18. If the Offer described in paragraph 17 above is made by General Partner and is accepted by votes representing XXXXXXXXXX% of the Limited Partners Units, all Limited Partners will be required to sell their Limited Partnership Units, the Limited Partnership will terminate, and ParentCo will continue to carry on the business of the Limited Partnership as a sole proprietor.

19. General tax advice has been received from respective tax advisors. However, no representations have been made nor will be made in connection with the Proposed Transactions, including the formation of the Limited Partnership, that the amount of losses (if any) incurred by the Limited Partnership would equal or exceed the cost to persons holding a Limited Partnership Unit or a General Partner of their respective interest in the Limited Partnership, less any benefits described in subparagraph (b)(ii) of the definition Tax Shelter. No representations will be made with respect to the deductibility of any interest if any Limited Partner were to violate their representation and borrow funds to acquire a Limited Partnership Unit.

PURPOSE OF THE PROPOSED TRANSACTIONS

20. ParentCo wishes to attract investment funds in Limited Partnership from passive investors who will have a vested interest in the success and profits of the business of the Limited Partnership. The increased funding will allow ParentCo to develop the potential of its current contracts and projects into an operational producer of Canadian developed content for television and Internet broadcasting.

RULINGS

Provided that the preceding statements constitute a complete and accurate disclosure with respect to all of the relevant warranties in paragraphs (i) to (vi) on page 1 of this advance income tax ruling as well as the facts, proposed transactions and purpose of the proposed transactions, and provided that the proposed transactions are completed in the manner described above, our rulings are as set forth below:

A. Neither the Limited Partnership nor the Limited Partnership Units will be a "Tax Shelter", a Tax Shelter within the meaning assigned by subsection 18.1(1) of the Act, nor a "Tax Shelter Investment".

B. The fact that it is projected that Limited Partnership will have losses in its first Fiscal Period will not, in and of itself, cause the Limited Partnership to be operated without a reasonable expectation of profit.

C. The inclusion of the provision in the Limited Partnership Agreement whereby General Partner may, but is not obliged to, Offer to purchase Limited Partnership Units as described in paragraph 17 above will not, in and of itself, cause the Limited Partnership to be operated without a reasonable expectation of profit.

D. The inclusion of the provision in the Limited Partnership Agreement whereby General Partner may, but is not obliged to, Offer to purchase Limited Partnership Units as described in paragraph 17 above will not be an "amount or benefit" within the meaning of paragraph 96(2.2)(d) of the Act.

E. Subject to the paragraph (iii) of the Caveat below, the general anti-avoidance rule in subsection 245(2) of the Act will not be applied to redetermine the income tax consequences confirmed in the rulings given.

CAVEATS

The above rulings are given subject to the general limitations and qualifications set out in Information Circular 70-6R4 issued by the CCRA on January 29, 2001, and are binding provided the proposed transactions are completed on or before XXXXXXXXXX.

These rulings are based on the Act in its present form and do not take into account the effect of any proposed amendments to the Act.

Nothing in this letter should be construed as implying that CCRA has agreed to or accepted:

(i) the determination of FMV or ACB of any property referred to in this letter;

(ii) whether or not the Limited Partnership will have a reasonable expectation of profit;

(iii) whether or not, if the Option described in paragraph 17 and 18 above is exercised, the general anti-avoidance rule in subsection 245(2) of the Act would apply if a capital gains deduction in subsection 110.6(2.1) of the Act were claimed by a Limited Partner on the disposition of the Preferred Shares described in paragraph 17 and 18 above;

(iv) the applicability or non-applicability of paragraph 96(2.2)(d) of the Act, including whether or not it may apply if the Option is exercised, other than as expressly stated in this ruling;

(v) the GST implications of any of the proposed transactions; and

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

OPINION

Whether a portion of an amount can reasonably be considered to be described in clauses (A), (B), or (C) of subparagraph (c)(i) of the definition of "split income" in subsection 120.4(1) of the Act is a question of fact and we are not able, pursuant to paragraph 15(j) of IC-70-6R4, to rule that this provision will not be applied. However, we are prepared to offer the following general comments. There is no pro-ration rule provided for in section 120.4 of the Act, and as such, all facts must be considered in tracing the nature of the trust's income and payments to beneficiaries.

Where, in a particular year, a trust that received mixed income (that is, both income that is and income that is not Split Income) designates an amount paid to its beneficiaries as income that is not Split Income, and the amount so designated and paid is not in excess of its income that is not Split Income and has not previously been paid to beneficiaries as such, the amount would not reasonably be considered to be a payment to its beneficiaries of Split Income.

The foregoing comments are given in accordance with the practice referred to in paragraph 21 of IC-70-6R4 and are not binding on the CCRA.

Yours truly,

XXXXXXXXXX
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
Policy and Legislation Branch