2002 Ruling 2001-0093903 - German Organschaft

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 income transferred to the parent affiliate of a German organschaft would be recharacterized as income from an active business of the parent pursuant to clause 95(2)(a)(ii)(B).

Position: Yes, within the limits provided in the ruling and based on the facts of this case.

Reasons: See detailed issue sheet

XXXXXXXXXX 2001-009390

Attention: XXXXXXXXXX

XXXXXXXXXX, 2002

Dear Sirs:

Re: XXXXXXXXXX ("Canco")
Advance Income Tax Ruling

This is in reply to your letter dated XXXXXXXXXX as revised by your letter dated XXXXXXXXXX requesting an advance income tax ruling on behalf of the above-referenced taxpayer. In your letters dated XXXXXXXXXX additional information was provided regarding the facts and proposed transactions described in your original letter. We also acknowledge the information provided during our various telephone conversations (XXXXXXXXXX).

Canco files its T2 Return with the XXXXXXXXXX Tax Centre.

Definitions

In this letter unless otherwise expressly stated:

(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, subparagraph, clause or subclause, is a reference to the relevant provision of the Act unless otherwise specified;

(b) "active business" has the meaning assigned by subsection 95(1);

(c) "adjusted cost base" has the meaning assigned by section 54;

(d) "arm's length" has the meaning assigned by subsection 251(1);

(e) "CBCA" means the Canada Business Corporations Act, R.S.C. 1985, c. C-44, as amended to the date hereof;

(f) "controlled foreign affiliate" has the meaning assigned by subsection 95(1);

(g) "earnings" has the meaning assigned by subsection 5907(1) of the Income Tax Regulations (the "Regulations");

(h) "exempt earnings" has the meaning assigned by subsection 5907(1) of the Regulations;

(i) "exempt surplus" has the meaning assigned by subsection 5907(1) of the Regulations;

(j) "foreign affiliate" has the meaning assigned by subsection 95(1);

(k) "public corporation" has the meaning assigned by subsection 89(1);

(l) "related persons" has the meaning assigned by subsection 251(2); and

(m) "taxable Canadian corporation" has the meaning assigned by subsection 89(1).

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

Facts

1. Canco was incorporated on XXXXXXXXXX and is subsisting under the CBCA.

2. The authorized capital of Canco consists of an unlimited number of common shares without par value and an unlimited number of preferred non-voting shares without par value.

3. The common shares of Canco are listed on the XXXXXXXXXX Stock Exchange.

4. The common shares of Canco are widely held and no person or group of persons has control of Canco.

5. Canco is a public corporation and a taxable Canadian corporation.

6. The taxation year of Canco ends on XXXXXXXXXX.

7. Canco is the parent holding company of several operating companies (located in Canada, the United States and Germany) the principal business activity of which is the XXXXXXXXXX.

8. As at XXXXXXXXXX Canco owned XXXXXXXXXX% of the shares in XXXXXXXXXX ("FA Opco1"), a Gesellschaft mit beschränkter Haftung formed under the laws of Germany. As at XXXXXXXXXX, the remaining XXXXXXXXXX% of the shares in FA Opco1 were owned as to XXXXXXXXXX% by XXXXXXXXXX a Gesellschaft mit beschränkter Haftung formed under the laws of Germany, and as to XXXXXXXXXX% by XXXXXXXXXX another Gesellschaft mit beschränkter Haftung formed under the laws of Germany. Canco is unrelated to, and deals at arm's length with, both XXXXXXXXXX at all relevant times.

9. FA Opco1 is, and will be, a foreign affiliate and a controlled foreign affiliate of Canco at all relevant times. FA Opco1 is, and will be, at all relevant times resident in Germany for purposes of the Act and the Canada-Germany Income Tax Convention (the "Convention"). As at XXXXXXXXXX, the adjusted cost base to Canco of its shares in FA Opco1 was C$XXXXXXXXXX.

10. In its taxation year ended XXXXXXXXXX FA Opco1 earned net income for financial statement purposes of XXXXXXXXXX. As at XXXXXXXXXX FA Opco1 had interest bearing loans payable and accrued interest on such loans payable to Canco (the "FA Opco1 Debt"), to XXXXXXXXXX (the "XXXXXXXXXX Debt") and to XXXXXXXXXX (the "XXXXXXXXXX Debt") of approximately XXXXXXXXXX, respectively.

11. All of FA Opco1's assets are, and will continue to be, used to carry on an active business in Germany at all relevant times.

12. As at XXXXXXXXXX Canco owned XXXXXXXXXX% of the shares in XXXXXXXXXX ("FA Opco2"), a Gesellschaft mit beschränkter Haftung formed under the laws of Germany. FA Opco2 is, and will be, at all relevant times a foreign affiliate and controlled foreign affiliate of Canco and resident in Germany for purposes of the Act and the Convention. As at XXXXXXXXXX FA Opco2 had interest bearing loans payable and accrued interest on such loans payable to Canco (the "FA Opco2 Debt") of approximately XXXXXXXXXX. All of FA Opco2's assets are used to carry on an active business in Germany at all relevant times.

13. During XXXXXXXXXX Canco caused XXXXXXXXXX ("FA Holdco") to be formed as a Gesellschaft mit beschränkter Haftung under the laws of Germany and immediately thereafter acquired all of the shares of FA Holdco for nominal consideration. Canco is the sole shareholder of FA Holdco and FA Holdco is, and will be at all relevant times, a foreign affiliate and a controlled foreign affiliate of Canco. FA Holdco is, and will be at all relevant times, resident in Germany for purposes of the Act and the Convention.

14. During XXXXXXXXXX Canco incorporated XXXXXXXXXX ("Finco") as a limited liability company under the XXXXXXXXXX Canco is the sole member of Finco and Finco is, and will be at all relevant times, a foreign affiliate and a controlled foreign affiliate of Canco. Finco was formed for the purpose of acquiring existing indebtedness from, lending money to, and taking security from, affiliated companies. Finco will at all relevant times be resident in the U.S. for purposes of the Act. Finco will be a flow-through entity for U.S. tax purposes.

Pursuant to the Certificate of Formation of Finco, inter alia:

- the management of Finco is vested in its Board of Managers;

- the Board of Managers may only meet within the boundaries of any State of the United States of America, and no action may be taken by the Board of Managers on behalf of Finco, except by resolution adopted at a duly held meeting at such a location;

- if meetings of the Board of Managers are held by conference call, all members of the Board of Managers shall be physically present in the United States at the time of the conference call, and

- the rules of governance applicable to the Board of Managers are set forth in Finco's Operating Agreement.

Pursuant to the Operating Agreement of Finco, inter alia:

- Canco is the sole member of Finco;

- the Board of Managers shall be agents of Finco with authority to bind Finco in the ordinary course of its business except that the Board of Managers shall have no authority to bind Finco as to the following matters without first obtaining approval by unanimous vote of the members

? amendment of the Certificate of Formation or the Operating Agreement;
? sale, lease, exchange, mortgage, pledge or other transfer or disposition of all or substantially all the assets of Finco;
? the addition of new members;
? the transfer of a Member's interest;
? the entry of Finco into a merger, joint venture or acqusition;
? a transaction involving an actual or potential conflict of interest between a member or manager of Finco, or
? a change in the nature of the business of Finco.

15. During XXXXXXXXXX, Canco transferred all of its shares in FA Opco1 and FA Opco2 to FA Holdco pursuant to subsection 85.1(3). The consideration received in respect of each transfer were shares of FA Holdco and interest bearing debt of FA Holdco with a principal amount and fair market value equal approximately equal to the adjusted cost base of the shares transferred to FA Holdco. Canco also assigned the FA Opco1 Debt and FA Opco2 Debt to FA Holdco, in consideration for additional interest bearing debt of FA Holdco. The debt received in these transactions will collectively be referred to as "the FA Holdco Debt". Canco immediately assigned the FA Holdco Debt to Finco in consideration for additional equity in Finco.

16. Canco invested additional funds in Finco for additional equity in Finco.

17. Finco lent money to FA Holdco at arm's length interest rates (the "FA Holdco Financing Debt") which FA Holdco applied in part to acquire the XXXXXXXXXX% interest in FA Opco1 held by XXXXXXXXXX and the XXXXXXXXXX Debt. All amounts borrowed (or that will be borrowed) by FA Holdco from Finco (other than an immaterial amount that may be used to pay FA Holdco's administrative costs) will be used to acquire additional shares of FA Opco1 or FA Opco2 or to provide additional debt financing to FA Opco1 or FA Opco2. Such debt financing will be made on arm's length terms and conditions, but may be unsecured.

18. To the best of your knowledge, and that of the taxpayer involved, none of the issues contained herein is:

i. dealt with in an earlier return of the taxpayer or a related person;

ii. being considered by a tax services office or taxation centre in connection with a previously filed tax return of the taxpayer or a related person;

iii. under objection by the taxpayer or a related person;

iv. subject to a ruling previously issued by the Income Tax Rulings Directorate; or

v. before the courts or, if a judgement has been issued, the time limit for appeal to a higher court has not expired.

Proposed Transactions

19. In XXXXXXXXXX, but after the date of this ruling, FA Holdco will acquire the XXXXXXXXXX% interest in FA Opco1 held by XXXXXXXXXX and the XXXXXXXXXX Debt in consideration for cash proceeds of approximately XXXXXXXXXX will concurrently subscribe for common shares in Canco worth approximately XXXXXXXXXX and will direct FA Holdco to pay a sufficient amount of the cash proceeds directly to Canco in satisfaction of the subscription price for those shares and to pay the balance of the cash proceeds, if any, to XXXXXXXXXX.

20. Under German corporate law FA Opco1 and FA Opco2 will each enter into a profit transfer agreement (the "Profit Transfer Agreements") with FA Holdco for a minimum term of XXXXXXXXXX years pursuant to which it will be agreed that all income from the operations of FA Opco1 and FA Opco2 will be transferred on an annual basis to FA Holdco and FA Holdco will agree to compensate FA Opco1 and FA Opco2 for any losses which they incur in operating their respective businesses. The Profit Transfer Agreements shall become effective on XXXXXXXXXX. As a result, at each XXXXXXXXXX year end of FA Opco1 and FA Opco2 each company will record a liability to FA Holdco (or a receivable from FA Holdco) in their respective balance sheets equal to the amount of their profit (or loss) computed under German generally accepted accounting principles, less certain statutory reserves that may be claimed under German corporate law. This liability (or receivable) will be settled on an annual basis once the amount of the liability (or receivable) has been finally determined by FA Opco1 and FA Opco2 and accepted by FA Holdco. Furthermore, as a result of being party to the Profit Transfer Agreements, the taxable income of FA Opco1 and FA Opco2 will be reduced to nil on an annual basis under German income tax law and any income generated by FA Opco1 and FA Opco2 and transferred to FA Holdco under the Profit transfer Agreements will be taxable to FA Holdco. Interest paid by FA Opco1 and FA Opco2 to FA Holdco will be deducted in computing the income of FA Opco1 and FA Opco2 both before and after the Profit Transfer Agreements are in effect. Once the Profit Transfer Agreements become effective, the income (or loss) transferred to (or assumed by) FA Holdco under the Profit Transfer Agreements will be the income (or loss) after the deduction of such interest expense. In addition, under German income tax law (subject to Germany's domestic thin capitalization provisions) FA Holdco will be able to deduct the interest expense incurred on the debts payable to Finco in computing the amount of its income which is subject to tax in Germany.

21. In addition to entering into the Profit Transfer Agreements it is anticipated that FA Holdco will enter into agreements with FA Opco1 and FA Opco2 pursuant to which FA Holdco will provide certain services (i.e. book-keeping, payroll tax services, other management services) to FA Opco1 and FA Opco2. FA Opco1 and FA Opco2 will compensate FA Holdco for these services based on arm's length principles. As a result, FA Holdco may also generate profits from its services business.

Purpose of the Proposed Transactions

The purpose of the proposed transactions is to allow Canco to efficiently finance its German operations and to minimize Canco's exposure to German real estate transfer tax on the acquisition of the minority interests in FA Opco1.

Rulings Given

Provided that the preceding statements constitute a complete and accurate disclosure of all of the relevant 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 follows:

A. The amount paid or payable by FA Opco1 or FA Opco2, respectively, to FA Holdco under the Profit Transfer Agreements for a particular taxation year will, to the extent the amount is reflected in FA Opco1's or FA Opco2's respective "earnings" from an active business for the year or a subsequent year (computed before the application of the Profit Transfer Agreements), be considered, for purposes of clause 95(2)(a)(ii)(B), deductible in computing the "earnings" of FA Opco1 or FA Opco2, respectively, from an active business.

B. Provided that FA Holdco carries on an "investment business" within the meaning assigned in subsection 95(1) and provided that the aggregate of any amounts that are paid or payable by FA Opco1 and FA Opco2 to FA Holdco for a particular taxation year under the Profit Transfer Agreements and the amount of the interest paid or payable by FA Opco1 and FA Opco2, respectively, to FA Holdco for that year is greater than the aggregate of the interest payable by FA Holdco to Finco for that year and any other expenses of FA Holdco that are deductible in computing what would otherwise be FA Holdco's income from property for that year, to the extent that such income was derived from amounts that were deductible by FA Opco1 or FA Opco2 in computing their respective "earnings" for the year or a subsequent year from an active business, such income will be included in computing FA Holdco's income from an active business pursuant to clause 95(2)(a)(ii)(B) and, provided the such amounts paid or payable by FA Opco1 and FA Opco2 to FA Holdco were deductible in computing the "exempt earnings" for that year or a subsequent year of FA Opco1 and FA Opco2, respectively, such income will be included in computing the "exempt earnings" of FA Holdco for that year.

C. Where the conditions described in Ruling B, above, have been satisfied, to the extent that the interest paid or payable for that year by FA Holdco to Finco was deductible in computing FA Holdco's "exempt earnings" for the year, the income derived by Finco from such interest will be included in computing its income from an active business for that year pursuant to clause 95(2)(a)(ii)(B) and, provided that Finco is resident in the U.S. for purposes of the Act for that year, such income will be included in computing the "exempt earnings" of Finco for that year.

D. As a result of the proposed transactions, in and by themselves, subsection 245(2) will not be applied to redetermine the tax consequences of rulings given above.

The above rulings are given subject to the general limitations and qualifications set out in Information Circular 70-6R4 dated January 29, 2001 and are binding on the CCRA 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 any proposed amendments to the Act which, if enacted into law, could have an effect on the rulings provided herein.

Comments

Nothing in this ruling should be construed as implying that the CCRA has agreed to or reviewed:

(a) the determination of the fair market value or adjusted cost base of any property referred to herein;

(b) the residence of Finco;

(c) where the business activities of FA Opco1 or FA Opco2, respectively, are carried on and the extent to which the earnings from such activities would be attributable to a permanent establishment that FA Opco1 or FA Opco2, respectively, has in a designated treaty country; or

(d) any tax consequences relating to the facts and proposed transactions described herein other than those specifically described in the rulings given above.

The above rulings are given on the basis that the Profit Transfer Agreements are effective and satisfy all of the conditions and requirements under German law. There may be circumstances where a profit transfer agreement can be cancelled. There may also be circumstances where, if formalities have not been complied with, an agreement would be considered retroactively void for German tax purposes. The above rulings are given on the basis that such circumstances or events do not occur.

Yours truly,

for Director
International and Trusts Division
Income Tax Rulings Directorate
Policy and Legislation Branch