2002 Ruling 2001-0114583 - unwinding 243

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: Will certain transactions undertaken to unwind two NROs permit debts owed to the NRO's to be transferred to a limited partnership and interest on those debts to continue to be deductible by Canco?

Position: Yes. The transactions have the effect of winding up the NRO into the limited partnership and the interest on the debts involved will continue to be deductible to Canco.

Reasons:				See Issue Sheet.

XXXXXXXXXX 2001-011458

XXXXXXXXXX, 2002

Dear XXXXXXXXXX:

Re: XXXXXXXXXX ("Canco")
XXXXXXXXXX ("NRO One")
XXXXXXXXXX . ("NRO Two")
XXXXXXXXXX ("US Parent")
XXXXXXXXXX ("USco")
a limited partnership governed by the laws of XXXXXXXXXX ("Partnership")
XXXXXXXXXX unlimited liability companies to be formed ("ULC1" and "ULC2")

This is in reply to your letter dated XXXXXXXXXX, with revisions received by facsimile and by electronic mail on XXXXXXXXXX, and further revisions received by electronic mail XXXXXXXXXX, wherein you request an advance income tax ruling on behalf of the above-mentioned taxpayers, with respect to the refinancing of the debt presently owing from Canco to NRO One and NRO Two.

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

i) is in an earlier income tax return of Canco, NRO One, NRO Two or a related person;

ii) is being considered by a Tax Services Office or Taxation Centre in connection with a previously filed income tax return of Canco, NRO One, NRO Two or a related person;

iii) is under objection by Canco, NRO One, NRO Two or a related person;

iv) is before the Courts or, if a judgement has been issued, the time limit for appeal to a higher Court has not expired; or

v) is the subject of a Ruling previously considered by the Directorate.

Income Tax Act and Other Definitions

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

(a) "Act" means the Income Tax Act, R.S.C. 1985 c.1 (5th Supp.), as amended to the date hereof. Unless otherwise stated, statutory references in this letter are to the Act;

(b) "ACB" means adjusted cost base as defined in section 54 of the Act;

(c) "ARTOH" means allowable refundable tax on hand as defined in subsection 133(9) of the Act;

(d) "business" has the meaning stated in subsection 248(1) of the Act;

(e) "Canadian corporation" has the meaning stated in subsection 248(1) of the Act;

(f) "Canco Debt A" means the indebtedness owing by Canco to NRO One in the amount of $XXXXXXXXXX pursuant to an agreement entered into between XXXXXXXXXX and Canco on XXXXXXXXXX, and subsequently assigned to NRO One on XXXXXXXXXX, and maturing on XXXXXXXXXX;

(g) "Canco Debt B" means the indebtedness owing by Canco to NRO Two in the amount of $XXXXXXXXXX pursuant to an agreement entered into between XXXXXXXXXX and Canco on XXXXXXXXXX and subsequently assigned to NRO Two on XXXXXXXXXX, and maturing on XXXXXXXXXX;

(h) "carrying on business" has its extended meaning as stated in subsection 253(1) of the Act;

(i) "Corporation" has the meaning stated in subsection 248(1);

(j) "FMV" means fair market value;

(k) "NRO" means a corporation that has elected to be treated as a non-resident owned investment corporation as defined in subsection 133(8) of the Act;

(l) XXXXXXXXXX;

(m) "PUC" means paid up capital as defined in subsection 248(1) of the Act;

(n) "Taxable Canadian corporation" has the meaning stated in subsection 248(1) of the Act; and

(o) "US Treaty" means the Canada-United States Income Tax Convention.

Facts

1. Canco is a Taxable Canadian corporation incorporated pursuant to the XXXXXXXXXX with a fiscal year-end of XXXXXXXXXX and is in the XXXXXXXXXX business.

2. The capital of Canco consists of common share capital of $XXXXXXXXXX (common shares owned by US Parent), contributed surplus of $XXXXXXXXXX (contributed by a $XXXXXXXXXX cash contribution in Canco's taxation year ended XXXXXXXXXX and the balance contributed by cash prior thereto), preferred share capital of $XXXXXXXXXX (preferred shares owned by NRO One and subscribed for by way of cash subscriptions totalling $XXXXXXXXXX) and a second class of preferred exchangeable shares, most of which are held by arm's length parties.

3. Canco used and continues to use the $XXXXXXXXXX (related to the preferred shares) to earn income from a business or property (other than to acquire property the income of which would be exempt or to acquire a life insurance policy).

4. NRO One is a NRO formed pursuant to the XXXXXXXXXX with a fiscal year-end of XXXXXXXXXX.

NRO One is wholly owned by US Parent and it elected within the prescribed time and in the prescribed manner to be taxed as a NRO under Section 133 of the Act and has not rescinded that election.

5. NRO One has common share capital of $XXXXXXXXXX and XXXXXXXXXX common shares issued. $XXXXXXXXXX of the share capital relates to XXXXXXXXXX shares issued for cash and the balance relates to the payment of stock dividends for which XXXXXXXXXX common shares were issued.

The PUC and ACB of the NRO One common shares is $XXXXXXXXXX.

6. NRO Two is a NRO formed pursuant to the XXXXXXXXXX with a fiscal year-end of XXXXXXXXXX.

NRO Two is wholly owned by NRO One and it elected within the prescribed time and in the prescribed manner to be taxed as a NRO under Section 133 of the Act and has not rescinded that election.

7. NRO Two's issued and outstanding share capital consists of XXXXXXXXXX common shares issued for cash of $XXXXXXXXXX.

The PUC and ACB of the NRO Two common shares is $XXXXXXXXXX in aggregate.

8. NRO One's only assets consist of its investment in NRO Two common shares of $XXXXXXXXXX, Canco Debt A (in the amount of $XXXXXXXXXX), preferred shares of Canco in the amount of $XXXXXXXXXX (nominal non-cumulative dividend rate) and cash held on deposit with a Canadian financial institution of approximately $XXXXXXXXXX .

9. NRO Two's only assets consist of Canco Debt B (in the amount of $XXXXXXXXXX) and cash held on deposit with a Canadian financial institution of approximately $XXXXXXXXXX.

10. USco is a corporation formed pursuant to the laws of the state of XXXXXXXXXX. US Parent is a corporation formed under the laws of the state of XXXXXXXXXX. USco and US Parent each qualify as residents of the United States for purposes of the US Treaty. US Parent is wholly owned by USco. Neither USco nor US Parent carry on any business in Canada nor do they have a permanent establishment in Canada for purposes of the US Treaty.

11. The FMV of Canco Debt A on or about XXXXXXXXXX is estimated to be its face amount of $XXXXXXXXXX.

12. The FMV of Canco Debt B on or about XXXXXXXXXX is estimated to be $XXXXXXXXXX greater than its face amount of $XXXXXXXXXX.

13. NRO One had a ARTOH balance of approximately $XXXXXXXXXX at its XXXXXXXXXX taxation year end.

14. Through the period of XXXXXXXXXX to on or about XXXXXXXXXX, NRO One is expected to earn approximately $XXXXXXXXXX of interest income on Canco Debt A and receive approximately $XXXXXXXXXX of dividend income from NRO Two.

15. NRO Two had ARTOH of approximately $XXXXXXXXXX at its XXXXXXXXXX taxation year end.

16. For the period of XXXXXXXXXX to on or about XXXXXXXXXX, NRO Two is expected to earn approximately $XXXXXXXXXX of interest income on Canco Debt B, as well as receive prepaid interest of approximately $XXXXXXXXXX from Canco in respect of Canco Debt B.

Proposed Transactions

17. Before XXXXXXXXXX, NRO Two will request from the CCRA a year-end change to a day that is before XXXXXXXXXX ("New Year End A"), effective XXXXXXXXXX.

18. Before XXXXXXXXXX, NRO One will request from the CCRA a year-end change to a day that is before XXXXXXXXXX ("New Year End B"), effective XXXXXXXXXX. New Year End B will be one day after New Year End A.

19. By late XXXXXXXXXX, US Parent will form ULC1 with capital of approximately $XXXXXXXXXX and US Parent will also form ULC2 with capital of approximately $XXXXXXXXXX.

20. By early XXXXXXXXXX, US Parent and ULC2 will form a limited Partnership governed by the laws of XXXXXXXXXX ("Partnership"). US Parent will have a XXXXXXXXXX% interest in Partnership and will be a limited member. ULC2 will have a XXXXXXXXXX% interest in Partnership and will be the general partner. The initial contributions to the Partnership will be cash of $XXXXXXXXXX by ULC2 and cash of $XXXXXXXXXX by US Parent.

21. By early XXXXXXXXXX, Canco will add the $XXXXXXXXXX of contributed surplus to the stated capital of its existing common shares. As a result, the common shares of Canco will have a stated capital and PUC of $XXXXXXXXXX.

22. Sometime after the transaction in paragraph 21 and by early XXXXXXXXXX, Canco will undergo a reorganization of its capital whereby its existing common shares (all owned by US Parent) will be reorganized into XXXXXXXXXX Class A preferred shares (same class as the preferred shares held by NRO One, and redeemable/retractable for $XXXXXXXXXX per share) or into a new class of preferred shares which will have $XXXXXXXXXX of stated capital and PUC and new common shares with $XXXXXXXXXX of stated capital and PUC. After the capital reorganization, US Parent will own XXXXXXXXXX preferred shares and XXXXXXXXXX % of the common shares of Canco. A request for a tax clearance certificate will be made, with respect to this reorganization, as required in section 116 of the Act.

23. US Parent will contribute XXXXXXXXXX preferred shares of Canco to ULC1 in exchange for common shares of ULC1 with a stated capital and PUC of $XXXXXXXXXX. A request for a tax clearance certificate will be made, with respect to this transaction, as required in section 116 of the Act.

24. US Parent will elect, in accordance with the applicable provisions of the United States Internal Revenue Code of 1986 (the "Code") and associated regulations, that the Partnership be treated as a Canadian corporation for the purposes of the Code.

25. On New Year End A, Canco will pay the interest due to NRO Two on the Canco Debt B (approximately $XXXXXXXXXX). At the same time, Canco will prepay a sufficient amount of interest on Canco Debt B ("Canco Debt B Prepaid Interest") such that the interest remaining to be paid on Canco Debt B after New Year End A through to maturity of Canco Debt B in XXXXXXXXXX will cause the FMV of Canco Debt B on the day after New Year End A not to exceed its face amount of $XXXXXXXXXX. The Canco Debt B Prepaid Interest may approximate $XXXXXXXXXX.

26. Pursuant to paragraphs 18(9)(a) and (b) of the Act, Canco will not deduct any amount of the Canco Debt B Prepaid Interest from its income until the taxation year to which the prepaid interest can reasonably be considered to relate.

27. On New Year End A, NRO Two will pay a stock dividend of approximately $XXXXXXXXXX to NRO One on NRO Two common stock. As a result of this stock dividend, the stated capital of NRO Two's common shares will increase by the amount of the stock dividend.

28. Interest on Canco Debt A accruing from XXXXXXXXXX to New Year End B will amount to approximately $XXXXXXXXXX. Canco will pay to NRO One on New Year End B the interest accrued to New Year End B on Canco Debt A.

29. On the day after New Year End A, effective XXXXXXXXXX, NRO Two will pay a stock dividend to NRO One by issuing further common shares. The amount of the stock dividend will approximate the income of NRO Two for the taxation year ended on New Year End A. The amount of the stock dividend will approximate $XXXXXXXXXX. As a result of this stock dividend, the stated capital of NRO Two's common shares will increase by $XXXXXXXXXX.

30. On the day after New Year End A, effective XXXXXXXXXX, NRO One, as sole shareholder of NRO Two, will resolve to wind-up (but not dissolve) NRO Two. As part of the liquidation, NRO Two will execute a general conveyance agreement effective XXXXXXXXXX. on the day after New Year End A, to distribute all of its property and liabilities to its sole shareholder as a result thereof.

31. On New Year End B, NRO One will pay a stock dividend to US Parent of approximately $XXXXXXXXXX. The dividend will be in the form of common shares of NRO One. The stated capital of NRO One's common shares will increase by the amount of the stock dividend.

32. On the day after New Year End B, effective XXXXXXXXXX, NRO One will pay a stock dividend to US Parent of approximately $XXXXXXXXXX. The amount of the stock dividend will be approximately equal to the income of NRO One for the year on New Year End B. The stated capital of NRO One's common shares will increase by the amount of the stock dividend.

33. With respect to the stock dividends paid in paragraphs 31 and 32, US Parent will either remit applicable withholding tax of 10% under Part XIII of the Act directly to the CCRA or provide NRO One with the cash required to satisfy the withholding tax that will apply to the dividends. That tax will be remitted to the CCRA by or on behalf of US Parent on or before the XXXXXXXXXX of the calendar month following the dividend payments in paragraphs 31 and 32.

34. On the day after New Year End B, effective XXXXXXXXXX, US Parent will contribute XXXXXXXXXX% of its shares of NRO One to ULC2 for at least one share of ULC2. A request for a tax clearance certificate will be made, with respect to this transfer, as required in section 116 of the Act.

35. On the day after New Year End B, effective at XXXXXXXXXX, US Parent will contribute its shares of NRO One to Partnership in exchange for XXXXXXXXXX units of Partnership. At the same time, ULC2 will contribute its shares of NRO One to Partnership for 1 unit of Partnership. A request for a tax clearance certificate will be made, with respect to this transfer, as required in section 116 of the Act.

36. On the day after New Year End B, effective at XXXXXXXXXX, Partnership, as sole shareholder of NRO One, will resolve to wind-up (but not dissolve) NRO One. As part of the wind-up, NRO One will execute a general conveyance agreement effective XXXXXXXXXX on the day after New Year End B, to distribute all of its property and liabilities to its sole shareholder as a result thereof.

Prior to completion of the transactions in paragraphs 30 and 36, NRO One and NRO Two will undertake to:

(a) make all required remittances and filings with CCRA in respect of their taxation years ending on New Year End A, New Year End B, and the day after New Year End B (as the case may be), and at the time of dissolution and an application for a refund of NRO One's and NRO Two's allowable refund for each such year, in the manner and within the time referred to in subsection 133(6);

(b) make all required remittances to the CCRA in connection with the stock dividends paid as set out above;

(c) make all filings and take all other actions necessary to obtain any tax refunds to which NRO One and NRO Two are entitled;

(d) receive any tax refunds to which NRO One and NRO Two are entitled and forthwith remit these amounts to the Partnership, and

(e) retain sufficient funds to permit NRO One and NRO Two to make any such payments and perform these activities.

Pursuant to general conveyance agreements, all of the property of NRO One will become the property of Partnership as at XXXXXXXXXX on the day after New Year End B and all of the liabilities of NRO One will become liabilities of Partnership as of that time.

NRO One and NRO Two will, in a timely manner, make all required remittances to the CCRA in connection with interest accruing on the tax refunds in respect of which US Parent and ULC2 have become the beneficial owners pursuant to the winding-up agreement between NRO One and Partnership and between NRO Two and NRO One.

37. On the day after New Year End B, effective at XXXXXXXXXX, US Parent will sell its interest in Partnership to ULC1 in exchange for an interest bearing note with a principal amount owing of approximately $XXXXXXXXXX (the "ULC1 Debt") and at least one common share of ULC1. A request for a tax clearance certificate will be made, with respect to this transfer, if required in section 116 of the Act.

It is expected that the assets of Partnership at the time of the transfer to ULC1 will consist principally of the following:

Canco Debt A $ XXXXXXXXX
Canco Debt B $ XXXXXXXXX
Canco preferred shares $ XXXXXXXXX
Cash re accrued interest on Canco Debt A (para. 26) $ XXXXXXXXX
Cash re accrued interest on Canco Debt B (para. 24) $ XXXXXXXXX
Cash re Canco Debt B Prepaid Interest (para. 24) $ XXXXXXXXX
Other Cash $ XXXXXXXXX
Total $ XXXXXXXXX

The cash balances on hand in Partnership, as noted above, will be loaned to Canco on commercial terms.

38. XXXXXXXXXX days or more after New Year End B, NRO One and NRO Two will revoke their elections to be taxed as an NRO under Section 133 of the Act.

NRO One and NRO Two will also elect to have Section 134.2 of the Act apply and will specify an elected time that is XXXXXXXXXX on the day after New Year End B.

As a result, NRO One and NRO Two will each have a taxation year that ends immediately before XXXXXXXXXX on the day after New Year End B (a several minute taxation year and one-day and several minute taxation year respectively) and each will have a new taxation year that commences at XXXXXXXXXX on the day after New Year End B. NRO One and NRO Two will elect under Section 134.1 of the Act with respect to the tax year commencing at XXXXXXXXXX on the day after New Year End B.

39. Tax refunds received by NRO One and by NRO Two with respect to taxation years ending on the day after New Year End B and prior thereto, will be loaned by Partnership to Canco ("Canco Debt C"). Canco Debt C will have commercial terms.

40. After the tax refunds have been obtained for taxation years ending on the day after New Year End B and prior thereto, NRO One and NRO Two will be dissolved and will each file a terminal tax return for the period commencing at XXXXXXXXXX on the day after New Year End B to the date of dissolution.

41. ULC1 may issue further shares for cash and/or borrow further amounts. ULC1 would use any such cash proceeds for various purposes including subscribing for further preferred shares of Canco or to further capitalize Partnership.

42. ULC1 will pay interest on the ULC1 Debt in accordance with the terms of that debt. ULC1 will have a variety of sources of cash to provide it with cash to pay the interest. The sources include distributions from Partnership, borrowings by ULC1 and issuance of shares by ULC1 for cash.

43. If Partnership makes further loans to Canco ("Canco New Debt"), Canco, in accordance with the provisions of Canco New Debt, will pay interest on that indebtedness to Partnership.

44. Partnership will maintain a bank account in Canada with a Canadian financial institution in which interest payments will be deposited. If required to do so, Partnership will appoint a Canadian resident agent strictly for service of process.

Purpose of the Proposed Transactions

45. The purpose of the proposed series of transactions is to unwind the NRO One and the NRO Two financing structures without creating adverse Canadian or United States income tax consequences.

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, we rule as follows.

A. Provided that US Parent does not become resident in Canada and does not become a foreign affiliate of a taxpayer resident in Canada:

(i) NRO One and NRO Two will continue to qualify as NRO's through their taxation years ended on the day after New Year End B and prior thereto (and for greater certainty none of the proposed transactions will cause NRO One and/or NRO Two to cease to qualify as NRO's prior to their taxation year commencing at XXXXXXXXXX on the day after New Year End B);

(ii) Provided that NRO One and NRO Two file returns of income for taxation years ending on New Year End A, New Year End B, and the day after New Year End B, as the case may be, and at the time of their dissolution, and an application for a refund of their allowable refund for such taxation years is made by NRO One and NRO Two, in the manner and within the time referred to in subsection 133(6), subsection 133(6) will be applicable.

B. Subsections 69(5) and 84(2) will apply in respect of the winding-up/dissolution of NRO Two described in paragraph 30 above such that:

(i) NRO Two will be deemed to have disposed of all of its property for an amount equal to the fair market value of such property at the time it is distributed to NRO One;

(ii) NRO One will be deemed to have acquired the property referred to in (i) above, for the amount referred to in (i) above; and

(iii) NRO Two will be deemed to have paid a dividend to NRO One and NRO One will be deemed to have received a dividend from NRO Two, in the amount, if any, by which the amount referred to in (i) above, less the NRO Two liabilities assumed by NRO One, exceeds the amount by which the PUC in respect of its common shares is reduced on the distribution.

C. Subsections 69(5) and 84(2) will apply in respect of the winding-up/dissolution of NRO One described in paragraph 36 above such that:

(i) NRO One will be deemed to have disposed of all of its property for an amount equal to the fair market value of such property at the time it is distributed to Partnership;

(ii) Partnership will be deemed to have acquired the property referred to in (i) above, for the amount referred to in (i) above; and

(iii) NRO One will be deemed to have paid a dividend to Partnership and Partnership will be deemed to have received a dividend from NRO One, in the amount, if any, by which the amount referred to in (i) above, less the NRO One liabilities assumed by Partnership, exceeds the amount by which the PUC in respect of NRO One's common shares is reduced on the distribution.

D. Pursuant to paragraph 12(1)(c) and subsection 12(3) of the Act: (i) NRO Two will include the amount of Canco Debt B Prepaid Interest in its income for the taxation year ending on New Year End A; and (ii) any Canco Debt B Prepaid Interest included in the income of NRO Two for the taxation year ending on New Year End A will not be includable in the income of NRO Two in any subsequent taxation year.

E. The prepayment of interest by Canco that results in Canco Debt B Prepaid Interest will not result in a disposition or settlement of Canco Debt B by NRO Two.

F. Provided that Canco has a legal obligation to pay interest on Canco Debt A and Canco Debt B and that Canco continues to use the proceeds of this debt to earn income from a business or property (other than to acquire property the income from which would be exempt or to acquire a life insurance policy), the interest paid or payable pursuant to Canco Debt A and Canco Debt B in respect of each of Canco's taxation years (depending on the method regularly followed by Canco in computing its income) will be deductible by Canco to the extent that it is reasonable.

G. The $XXXXXXXXXX increase by Canco in its stated capital with respect to its common shares will not be deemed to be a dividend under subsection 84(1) of the Act pursuant to subparagraph 84(1)(c.3)(ii) of the Act.

H. As a result of the proposed transactions, in and by themselves, subsection 245(2) will not be applied to re-determine the tax consequences described in the rulings given above to any of the Parties.

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 Canada Customs and Revenue Agency 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:

(i) the determination of the fair market value or adjusted cost base of any property, or the PUC of any shares, referred to herein;

(ii) the tax treatment of any interest owing from the government of Canada in respect of the tax refunds;

(iii) the application of section 212.1 of the Act to the transaction described in paragraphs 34;

(iv) the application of subsection 18(4) of the Act regarding any debt owing to US Parent; and

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

Yours truly,

For Director
International Section I
International & Trusts Division
Income Tax Rulings Directorate