2001 Ruling 2001-0097223 - REWARD POINTS

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:Whether 12(1)(a) and 20(1)(m) apply re amounts paid:

(a) to Partnership by ParentCo for future services to be provided by Partnership
(b) to ParentCo by Partnership for future services to be provided by ParentCo

Position: yes. yes.

Reasons: payments are for services to be provided in future/ - obligations are present obligations to perform services when requested/ are not contingent

XXXXXXXXXX 2001-009722

XXXXXXXXXX, 2001

Dear XXXXXXXXXX:

Re: XXXXXXXXXX
XXXXXXXXXX
Advance Income Tax Ruling

We are writing in response to your letter of XXXXXXXXXX wherein you requested an advance income tax ruling on behalf of the above taxpayers and your subsequent correspondence.

To the best of your knowledge, and that of the taxpayers involved, 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; or

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

DEFINITIONS

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

(a) "ACB" means Adjusted Cost Base, within the meaning assigned by section 54 of the Act;

(b) "Act" means the Income Tax Act, R.S.C. 1985, c.1 (5th Supp.), as amended, and all references to a statute are to the Act, unless otherwise indicated;

(c) "Ancillary Agreements" shall mean the Participation and Services Agreement, the Corporate Real Estate Agreement, the Management Services Agreement and any other agreements executed by ParentCo and the Partnership as part of the Asset Purchase Agreement;

(d) "Asset Purchase Agreement" shall mean the agreement between ParentCo and the Partnership which sets out the terms and conditions for, inter alia, the transfer of the Current Reward Program Business (and liabilities), certain ParentCo Current Reward Program trademarks and other branding activities by ParentCo to the Partnership;

(e) "Brand Name" means XXXXXXXXXX;

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

(g) "Canadian Partnership" has the meaning assigned by subsection 102(1) of the Act;

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

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

(j) "Corporate Real Estate Agreement" shall mean the agreement to be executed by ParentCo and the Partnership which sets out the terms and conditions for, inter alia, the leased premises to the Partnership at XXXXXXXXXX;

(k) "Current Reward Points" shall mean the Brand Name XXXXXXXXXX issued by ParentCo which will be outstanding prior to the creation of the Partnership and which constitute a liability for ParentCo;

(l) "Current Reward Program" shall mean the program and benefits established by ParentCo for its frequent customers, and subsequently expanded to include Participant's customers, as described in paragraphs 2 to 5 below;

(m) "Current Reward Program Assets" means certain tangible and intangible properties of ParentCo, consisting of Current Reward Program Business software acquired in XXXXXXXXXX, leasehold improvements, computer equipment (mostly acquired in XXXXXXXXXX), furniture, and including commercial contracts with ParentCo and other parties, Retained Employees, and any rights conferred to the Partnership under the Ancillary Agreements, which includes restrictions imposed on ParentCo;

(n) "Current Reward Program Business" means ParentCo's Current Reward Program business, the XXXXXXXXXX Reward Business and associated goodwill and including the Current Reward Program Assets;

(o) "General Partner" means NewCo;

(p) "Institution" means the XXXXXXXXXX;

(q) "Institution Customers" means XXXXXXXXXX;

(r) "IPO" means initial public offering of NewCo which is scheduled to occur on or prior to XXXXXXXXXX;

(s) "Main Services" means XXXXXXXXXX;

(t) "Management Services Agreement" between ParentCo and the Partnership means the services that ParentCo will provide to the Partnership on a cost plus basis including, accounting, corporate real estate, secretarial, legal, labour relations and information technology services;

(u) "NewCo" means a corporation to be formed under the Canada Business Corporation Act to act as general partner of the Partnership whose mission is to acquire and operate the Current Reward Program Business, operate the New Reward Program Business, and eventually to become a Public Corporation;

(v) "New Participants" shall mean goods and/or services corporations which have entered into New Reward Program agreements with Partnership in order to have New Reward Points issued to their own clients in consideration for a "XXXXXXXXXX" based fee by such New Participants to Partnership and to also offer the New Participants' own goods and/or services upon redemption of New Reward Points in consideration for a fee payable by Partnership to such New Participants;

(w) "New Reward Points" shall mean XXXXXXXXXX granted to Users under Partnership's New Reward Program which can be redeemed for XXXXXXXXXX, goods or services;

(x) "New Reward Program" shall mean the new customer loyalty program pursuant to which New Reward Points will be issued by Partnership to Users as rewards which can be redeemed for Main Services, goods or other services;

(y) "New Reward Program Business" shall mean Partnership's new customer loyalty program pursuant to which New Reward Points will be issued by Partnership to Users as rewards which can be redeemed for Main Services, goods or other services;

(z) "OldCo" means XXXXXXXXXX;

(aa) "ParentCo" means XXXXXXXXXX;

(bb) "ParentCo Users" means customers of ParentCo which are members of the Current Reward Program;

(cc) "Participants" shall mean goods and/or services corporations which have entered into Current Reward Program agreements with ParentCo in order to have Current Reward Points issued to their own clients in consideration for a "XXXXXXXXXX" based fee by such Participants to ParentCo and to also offer the Participants' own goods and/or services upon redemption of Current Reward Points in consideration for a fee payable by ParentCo to such Participants. Participants include XXXXXXXXXX;

(dd) "Participation and Services Agreement" shall mean the agreement to be executed by ParentCo and the Partnership as described in paragraphs 14 to 18 below;

(ee) "Partnership" means the partnership to be organized as a limited partnership formed by ParentCo and NewCo and governed by the XXXXXXXXXX;

(ff) "Public Corporation" has the meaning assigned by subsection 89(1) of the Act;

(gg) "Retained Employees" shall mean all of the unionized employees and all of the non-unionized employees of ParentCo's Current Reward Program business, the employment of which shall ultimately be retained by the Partnership;

(hh) "Supplier" means XXXXXXXXXX;

(ii) "Supplier Convertible Debenture" means a $XXXXXXXXXX debt issued by the Partnership as described in paragraphs 22 to 25 below;

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

(kk) "Users" means customers of ParentCo and/or Participants which are members of the Current Reward Program.

FACTS

1. ParentCo is a Canadian Corporation, a Public Corporation and a Taxable Canadian Corporation.

2. In XXXXXXXXXX, ParentCo began a customer loyalty program for ParentCo's Users that is the Current Reward Program. The Current Reward Program, operated under the Brand Name, granted ParentCo's customers Current Reward Points that could be redeemed for Main Services, goods and other services.

3. Through time, Participants entered into Current Reward Program agreements with ParentCo. Although such agreements may vary from one to the other, generally, the agreements allow for the accrual of Current Reward Points to Participants' Users. As such, Current Reward Points can accrue from the purchase of Main Services from say, XXXXXXXXXX or from the purchase of goods and/or services from other Participants. XXXXXXXXXX.

4. On XXXXXXXXXX, ParentCo and Institution entered into one of such commercial agreements described in paragraph 3 above essentially consisting of an XXXXXXXXXX agreement for services to be rendered ("Institution Agreement") whereby ParentCo would grant Current Reward Points to Institution Customers, which Current Reward Points would be redeemed through ParentCo for Main Services, goods, and/or other services. Institution Customers would accumulate Current Reward Points. In consideration for the services for which ParentCo would be obligated (at the time when the Current Reward Points were earned) to provide to Institution Customers in the future, ParentCo received an up-front flat fee and recurrent fees from Institution based on the cost of a Current Reward Point.

5. In addition to the fees set out above, an additional up-front service fee of $XXXXXXXXXX (the "Additional Fee") was paid by Institution to ParentCo pursuant to ParentCo's and Institution's renewal of the Institution Agreement (the "Amended Institution Agreement") dated and effected as of XXXXXXXXXX. Under the Amended Institution Agreement, the services and obligations of ParentCo and the rights of the Institution are expanded in a number of key areas and while the term of the original Institution Agreement was XXXXXXXXXX years, the Institution Agreement has been extended XXXXXXXXXX more years pursuant to the Amended Institution Agreement.

ParentCo represents that the above $XXXXXXXXXX was properly included in computing its income in XXXXXXXXXX pursuant to paragraph 12(1)(a) of the Act.

6. OldCo operated its own loyalty program under the name XXXXXXXXXX until OldCo was acquired by ParentCo during XXXXXXXXXX.

7. As at XXXXXXXXXX, the Current Reward Program Business had approximately XXXXXXXXXX Current Reward Points issued and outstanding. Approximately XXXXXXXXXX Current Reward Points were redeemed during year XXXXXXXXXX. The approximate time span between the accrual of Current Reward Points by a User and their redemption is XXXXXXXXXX.

PROPOSED TRANSACTIONS

8. ParentCo will form a corporation under the CBCA ("NewCo"). NewCo will be a Taxable Canadian Corporation and eventually become a Public Corporation.

The only shares of NewCo that will be issued at this time will be XXXXXXXXXX common shares and XXXXXXXXXX preferred shares which will be issued to ParentCo. The XXXXXXXXXX preferred shares will provide no participation rights in profit distribution or on liquidation of the Partnership, but will allow ParentCo to control NewCo and the Partnership.

9. ParentCo and NewCo will form the Partnership, which will be a Canadian Partnership under the laws of the Province of XXXXXXXXXX. ParentCo will initially have XXXXXXXXXX% of the interests in the Partnership and NewCo will have XXXXXXXXXX% of the interests in the Partnership, until ParentCo determines that there will be an IPO of NewCo.

10. Under the terms of the Partnership agreement, NewCo will, as managing partner, be responsible for the management of the Current Reward Program Business and the management and operation of the New Reward Program Business. The strategic direction of the Partnership will be:

(i) the development and management of ParentCo's Current Reward Program;

(ii) the development and management of the New Reward Program and any future such program; and

(iii) the provision of New Reward Program management services to third parties, XXXXXXXXXX.

In the fiscal period ending in XXXXXXXXXX, ParentCo will adopt segregated accounting in the Current Reward Program Business to reflect that the Current Reward Program Business as a separate division.

11. On or before XXXXXXXXXX, ParentCo will, pursuant to the Asset Purchase Agreement, transfer to the Partnership all of the Current Reward Program Assets and the Current Rewards Program Business. As consideration, Partnership will assume liabilities related to the assets transferred and issue a promissory note in the amount of $XXXXXXXXXX, payable by Partnership to ParentCo in XXXXXXXXXX years with a fixed rate of return, and Partnership will issue additional limited partnership interests in the Partnership to ParentCo. The assets that will be transferred to Partnership will primarily be capital properties and eligible capital properties.

ParentCo and the members of the Partnership will elect jointly in prescribed form and within the time limits referred to in subsection 96(4), to have the rules of subsection 97(2) apply to the transfer of the Current Reward Program Assets that are capital properties and eligible capital properties to Partnership as described immediately above. The amount agreed upon in such election in respect of each property transferred will be equal to the lesser of amounts described in subparagraphs 85(1)(c.1)(i) and (ii).

12. In addition to the transfer described in paragraph 11 above, the Partnership will covenant to assume $XXXXXXXXXX worth of ParentCo's obligations to Institution under the Amended Institution Agreement, for which an equivalent payment in cash will be made by ParentCo to the Partnership as part of the transfer of assets.

Partnership will immediately lend $XXXXXXXXXX to ParentCo and such loan will be repayable by ParentCo in XXXXXXXXXX. The terms of the loan will include the provision that no interest will be payable by ParentCo on the amount loaned.

ParentCo and Partnership will file joint elections, in the form and within the time referred to in subsection 20(25), to have the rules of subsection 20(24) apply to ParentCo as the payer and to Partnership as the recipient in respect of the payment made by ParentCo to Partnership.

13. Concurrently with, and as part of the execution of, the Asset Purchase Agreement, ParentCo will enter into Ancillary Agreements with the Partnership pertaining to, inter alia, New Reward Program services to be rendered by the Partnership, XXXXXXXXXX structure for New Reward Program services to be rendered by ParentCo, leasing of premises and management services for Current Reward Points and management services in general.

14. The Participation and Services Agreement between ParentCo and the Partnership will be executed. The term of the agreement would be set at XXXXXXXXXX years, renewable by the Partnership for another XXXXXXXXXX years. It will set out, inter alia, the terms and conditions pursuant to which the Partnership agrees to perform the New Rewards Program, manage the Current Rewards Program, and provide marketing services for ParentCo's Users. ParentCo will agree to provide services to the Partnership when Users redeem New Reward Points, based on XXXXXXXXXX structure.

15. Following the transfer of the Current Reward Program Business, the Partnership will commence to issue New Reward Points to ParentCo's Users. ParentCo shall pay the Partnership for New Reward Points that will accrue to Users through the purchase of ParentCo products and services at a set rate of $XXXXXXXXXX per New Reward Point. The rate may increase up to the consumer price index for Canada.

Similarly, New Reward Points will be issued by the Partnership to other non-ParentCo Users who purchase specific goods and services from Participants under another loyalty program (e.g., XXXXXXXXXX). The Partnership will charge these Participants a fee according to a similar price per New Reward Point arrangement described immediately above.

The Partnership shall in turn provide ParentCo's Users with goods and/or services. When Users redeem their New Reward Points, the Partnership will purchase either a service from ParentCo and pay ParentCo according to an agreed upon price set under the Participation and Services Agreement or goods and/or services from ParentCo or one of the Participants. It is anticipated that the purchase of services shall constitute one of the Partnership's major expenses.

16. The Partnership shall further agree that no other XXXXXXXXXX will be permitted to participate as a Participant in the Partnership's New Reward Program and ParentCo will agree that for a pre-determined period of time, it shall not enter into an agreement to participate in any way in any loyalty program which is owned, operated or administered by any person other than the Partnership, or create its own loyalty program that gives New Rewards Points as a reward.

17. The Partnership will agree to manage ParentCo's Current Rewards Program for a fee based on the Partnership's cost and an agreed margin. The Partnership will administer ParentCo's Current Reward Points on a first in first out basis. The result is that for a period of XXXXXXXXXX (the approximate time required to redeem a Reward Point) none of the New Reward Points are expected to be redeemed. Other managing services performed by the Partnership to ParentCo would be charged at a cost plus XXXXXXXXXX% mark-up.

18. The Partnership will use most of the available cash generated by the issuance of New Reward Points to purchase, in advance, Main Services from and to be provided in the future by ParentCo. As such, in the initial stages, ParentCo should have a significant service liability towards the Partnership.

19. The Partnership's function will be to enhance the products and services provided to ParentCo's Users, to purchase products and/or services and exchange them for New Reward Points that are issued to Users and provide services related to the sales. As well, it is intended that the Partnership will find New Participants.

20. XXXXXXXXXX.

21. The workforce of the Partnership will be composed of XXXXXXXXXX employees will remain employed by ParentCo, which will provide the services of these employees to the Partnership in return for which the Partnership will reimburse ParentCo.

22. Supplier, as a service provider investor, will enter into a subscription agreement with the Partnership for $XXXXXXXXXX of convertible debentures ("Supplier Convertible Debentures"), which Supplier will receive in payment for services, hardware and software provided by Supplier to the Partnership. Supplier's subscription will be made for a period of XXXXXXXXXX. Tranches of Supplier Convertible Debentures will be issued to Supplier (as work and delivery progress) at the end of each XXXXXXXXXX according to the following schedule:

XXXXXXXXXX.

The debt will bear interest at XXXXXXXXXX% annually and will be for a term of XXXXXXXXXX years.

23. The Partnership shall have the option to purchase the Supplier Convertible Debenture at a premium at any time prior to an IPO at an amount equivalent to the principal amount with a daily compounded annual return of XXXXXXXXXX%.

24. On or prior to XXXXXXXXXX, NewCo will initiate an IPO of XXXXXXXXXX common shares.

25. Upon completion of the IPO, Supplier will exchange the Supplier Convertible Debentures with Partnership in exchange for limited partnership interests to be issued by the Partnership. The exchange ratio of the interest in the Partnership that Supplier will receive will be based on a discount of XXXXXXXXXX% per month from the IPO price for NewCo shares that will accrued each month since the issuance of the Tranche.

Immediately thereafter, Institution will transfer its interest in the Partnership to NewCo in consideration for XXXXXXXXXX common shares which NewCo will issue from treasury. The fair market value of the interest in the Partnership transferred by Institution to NewCo will equal the fair market value of the XXXXXXXXXX common shares in NewCo that it will issue to Institution. Institution will, through its interest in NewCo, have a XXXXXXXXXX% interest in the Partnership.

26. NewCo's net proceeds from the IPO, estimated at approximately $XXXXXXXXXX (net of underwriting commission and legal fees) will be paid to the Partnership in exchange for which the Partnership will issue to NewCo approximately XXXXXXXXXX% interest in the Partnership. The Partnership will use the proceeds to repay the balance of the purchase price of the sale described in paragraph 11 above, if outstanding, and to the extent that the balance of the purchase price of the sale described in paragraph 11 above is not outstanding, Partnership will return that amount of ParentCo's Partnership capital.

27. If for any reason, ParentCo determines that NewCo shall not go public, the Partnership will be required to redeem the Institution Convertible Debenture on the redemption date at no premium.

PURPOSE OF THE PROPOSED TRANSACTIONS

28. The central purpose of the proposed transactions is to enable the Current Reward Program Business to develop into a solid loyalty program management business with an entrepreneurial culture thus allowing it to realise its full potential for profit and to further provide some liquidity to ParentCo and ultimately enhance ParentCo's shareholder value.

In this context, a partnership, as opposed to a corporate entity, was chosen by ParentCo as the most appropriate vehicle to acquire the Current Reward Program Business in order to maintain tax consolidation between ParentCo's XXXXXXXXXX business and ParentCo's indirect ownership interest in the New Reward Program Business.

RULINGS

Provided that the preceding statements constitute a complete and accurate disclosure with respect to all of the relevant warranties in paragraphs (i) to (v) on page 1 of this advance income tax ruling as well as 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 ruling is as set forth below:

A. Provided that paragraph 12(1)(a) of the Act applied to include all or part of the $XXXXXXXXXX described in paragraph 5 above in computing ParentCo's income from its business for the taxation year ending immediately before the time of the distribution of property of ParentCo or any preceding taxation year, the payment from ParentCo to Partnership (as described in paragraph 12 above) for the assumption by Partnership of the undertaking of the ParentCo, may, to the extent that the payment is reasonable and to the extent that an amount was so included in computing the income of ParentCo pursuant to paragraph 12(1)(a) of the Act,:

- pursuant to paragraph 20(24)(a), be deducted in computing the income of ParentCo for its fiscal period in which the payment is made; and

- pursuant to paragraph 20(24)(b), will be deemed to be an amount described in paragraph 12(1)(a) in respect of the Partnership.

B. Provided the requisite election is made and filed within the time permitted by the Act, with respect to the transfer of the Current Reward Program Assets that are capital properties and eligible capital properties by ParentCo to Partnership, as described in paragraph 11 above, the provisions of subsection 97(2) will apply such that:

(i) the agreed amount in respect of each such property will be deemed to be ParentCo's proceeds of disposition thereof and the Partnership's cost thereof; and

(ii) in computing, at any time after the transfers, ParentCo's ACB of its interest in Partnership immediately after the transfers, there shall be added or subtracted the amount, if any, described in paragraph 97(2)(b) in respect of each transfer.

C. Pursuant to subparagraph 12(1)(x)(viii) of the Act, paragraph 12(1)(x) of the Act will not apply to include amounts described in paragraph 11 above in ParentCo's income.

D. Any amount paid by ParentCo to the Partnership under the Participation and Services Agreement for New Reward Points issued by the Partnership to ParentCo's Users will be a current expense deductible by ParentCo under subsection 9(1) of the Act.

E. Any amount received by the Partnership under the Participation and Services Agreement for New Reward Points issued by Partnership to ParentCo's Users will be included in Partnership's income under paragraph 12(1)(a) of the Act and a deduction under paragraph 20(1)(m) of the Act will be available.

F. Any amount received by ParentCo from the Partnership in prepayment of Main Services, as described in paragraph 18 above, will be included in ParentCo's income under 12(1)(a) of the Act and a deduction under 20(1)(m) of the Act will be available;

G. Subsection 245(2) of the Act will not apply to re-determine any of the tax consequences described in the rulings above.

CAVEATS

The above rulings are given subject to the general limitations and qualifications set out in Information Circular 70-6R4 (the "Circular") issued by the CCRA on January 29, 2001, and are binding provided the Asset Purchase Agreement, the Partnership Agreement and the Ancillary Agreements have been entered into on or before XXXXXXXXXX.

These rulings are based on the draft documents provided to us and are based on the Act in its present form and do not take into account the effect of any proposed amendments. Except as expressly stated, our rulings do not imply acceptance, approval or confirmation of any income tax implications of the facts or proposed transactions. In particular, nothing in this letter should be interpreted as confirming, either expressly or implicitly:

(a) whether the Partnership will have a reasonable expectation of profit;

(b) the reasonableness or fair market value of any outlays or expenditures referred to in this letter;

(c) whether Partnership will be acting as a legal agent for ParentCo;

(d) whether paragraph 12(1)(a) of the Act applied in respect of the transaction described in paragraph 5 above;

(e) the GST implications of any of the proposed transactions;

(f) any income tax consequences of the transaction described in paragraph 11 above, other than stated in Ruling B above;

(g) whether or not the Partnership or an interest in the Partnership will be a "tax shelter" within the meaning assigned by section 237.1 of the Act or a "tax shelter investment" within the meaning assigned by subsection 143.2(1) of the Act or any tax consequences if such definitions were to apply; and

(h) any other tax consequences of the proposed transactions or of related transactions or events that are not described herein.

Yours truly,

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