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 Issues:
Whether the acquisition of a significant interest in a widely held corporation by a person or group of persons, which represents less than de jure control would constitute an acceptable event of a failure or default under the terms or agreement for purposes of clause 212(1)(b)(vii)(C) of the Act
Position TAKEN:
Perhaps. Question of fact.
Reasons FOR POSITION TAKEN:
Consistent with published position.
XXXXXXXXXX 2001-008461
P. Diguer CGA
July 3, 2002
Dear XXXXXXXXXX:
Re: Paragraph 212(1)(b)(vii) of the Income Tax Act (Canada) (the "Act")
This is in reply to your letter dated May 15, 2001 in which you request our views on the application of the exemption in subparagraph 212(1)(b)(vii) of the Act in circumstances where a significant interest, which represents less than de jure control, in a widely held corporation is acquired by a person or group of persons.
Specifically, in your letter you describe a situation where a corporation (the "Borrower") resident in Canada issues a note payable (the "Note") to a non-resident of Canada (the "Lender") with whom the Borrower deals at arm's length. At the time of issuing the Note, a person owns more than 35% of the voting shares of the Borrower, however, no person or group of related persons owns more than 50% of the voting shares of the Borrower.
The terms of the Note will provide that if a "Change of Control Event" (as defined below) takes place, the Lender will have the right to require the Borrower to repurchase the Note.
Under the Note, a "Change of Control Event" is defined to include the consummation of any transaction (including without limitation any merger or consolidation) the result of which is that any person or group or persons becomes beneficial owner directly or indirectly of more than 35% of the voting stock of the Borrower, measured by voting power rather than the number of shares held.
In your view, the Canada Customs and Revenue Agency (CCRA) position, as described in ATR 69, Withholding Tax on Interest Paid to Non-Resident Persons, dated April 20, 1995, is that a change of legal control is an acceptable event of failure or default for purposes of paragraph 212(1)(b)(vii) of the Act.
However, a review of subsequent advance income tax rulings issued by CCRA including document number 9723563 and document number 9629853 suggests that an acceptable change of control event arises in a case where a person or group of persons acquires a sufficient number of voting shares to enable the person or group of persons to elect a new slate of directors even though that person or group of persons does not have legal control of the corporation.
Written confirmation of the tax implications inherent in particular transactions are given by this Directorate only where the transactions are proposed and are the subject matter of an advance ruling request submitted in the manner set out in Information Circular IC 70-6R5 dated May 17, 2002. Nevertheless, we offer the following general comments in connection with your request which we hope are of assistance to you.
CCRA's general views on the provisions of subparagraph 212(1)(b)(vii) of the Act are outlined in Interpretation Bulletin IT-361R3. As stated in paragraph 15 thereof, an "event of failure or default" under the terms of a loan agreement is one that has commercial reality, is beyond the control of the lender and is therefore not contrived. In addition, the paragraph goes on to state that:
... In interpreting the phrase "event of a failure or default under the said terms or agreement," it is recognized that lenders need to protect their loans and, in this regard, would include any event which places one of the parties in breach of the undertaking or guarantees given in the agreement. Usually, if the borrower fails to meet the repayment program or undertakes actions which materially increase the lender's risk, the lender may demand repayment in full.
Some examples that may constitute an event of failure or default, if specified as such in the loan agreement, are:
? a breach or non-compliance with credit covenants in the loan agreement;
? failure to achieve or maintain certain financial ratios as required under the loan agreement; and
? a change of control of the borrower.
(our emphasis added)
As the above highlighted passage from paragraph 15 of IT-361R3 suggests, clause 212(1)(b)(vii)(C) is relieving. In our view, its a recognition of the need for the lender to protect its loan and, in this regard, an "event of failure or default" would, subject to the comments in paragraph 15 of IT-361R3, generally include any event which places one of the parties to the borrowing in breach of the conditions he or she undertook to perform or the guarantees he or she gave in the agreement.
The reference above to "a change of control of the borrower" in paragraph 15 of IT-361R3 is an example of an event which may constitute an event of failure or default for purposes of clause 212(1)(b)(vii)(C) of the Act. It is not intended that changes in de jure control be the only change in equity ownership that would be eligible for the exception in clause 212(1)(b)(vii)(C) of the Act. Rather, the words in clause 212(1)(b)(vii)(C) may include many situations where the lender has included in the terms of the loan or agreement an event that is beyond their control and which in their view would pose a risk to their loan. As such, the three events listed as examples of events of failure or default for purposes of clause 212(1)(b)(vii)(C) in paragraph 15 of IT-341R3 are not intended to be interpreted narrowly or as a finite list of permissible events.
However, the determination of whether the phrase "event of a failure or default under the said terms of agreement" as it appears in clause 212(1)(b)(vii)(C) of the Act will apply to interest paid by a corporation to an arm's length non-resident party in a specific situation is a question of fact and it is not possible to list all acceptable events. Thus, confirmation in this matter can only be given in the context of an advance income tax ruling, based on the particular facts.
Moreover, as stated in Income Tax Technical News No. 9 and at the 1996 Annual Conference of the Canadian Tax Foundation, we will continue to maintain that in order to be acceptable, the events of failure or default and the triggering events must have commercial reality, must be beyond the control of the lender and must not be contrived.
We trust our comments will be of assistance to you.
Yours truly,
Steve Tevlin
for Director
Financial Industries Division
Income Tax Rulings Directorate
Policy and Legislation Branch
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