2002 Ruling 2002-0138413 - INTEREST DEDUCTIBILITY FINANCING FEES

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: 1. Deductibility of Interest by Partnership on borrowed money

to:

a) earn income from a business
b) to loan to partners at commercial rate
c) to return partner capital

2. The deductibility of Financing fees related to the borrowing.

Position: 1. a) & b) - interest is deductible

1 c) - Opinion provided based on proposed legislation pursuant to 20.2.

2. The financing fees are deductible pursuant to and in the manner

described in paragraph 20(1)(e) for the expenses incurred in borrowing funds used to earn income from business or property. An opinion is provided on the deductibility of financing fees incurred in borrowing funds to return partner capital as the link to deductibility is through proposed section 20.2.

Reasons: For Issues 1a), 1b), the purpose test is met with respect the borrowed

funds. For Issue 1c) the conditions in IT-80 are not met. However the draft legislation is relevant. The borrowed money is replacing the initial capital and satisfies the adjusted equity test. Therefore opinion provided that the deeming provision of proposed section 20.2 applies. In addition, the financing fees with respect to the borrowing is deductible to the extent that the purpose test is met. Ruling issued with respect to financing costs incurred with respect to positions 1a) and b). Opinion provided with respect to 1c).

XXXXXXXXXX 						2002-013841

XXXXXXXXXX, 2002

Dear XXXXXXXXXX:

Re: Advance Income Tax Ruling
XXXXXXXXXX (the "Partnership")

This is in response to your letter of XXXXXXXXXX, wherein you requested an advance income tax ruling on behalf of the above-noted taxpayer.

To the best of your knowledge, and that of the General Partner of the Partnership, none of the issues contained in this ruling request:

(i) is in an earlier return of any member of the Partnership or a related person;

(ii) is being considered by a tax services office or taxation center in connection with a previously filed tax return of any member of the Partnership or a related person;

(iii) is under objection or appeal by any member of the Partnership 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; and

(v) is the subject of a ruling previously issued by the Income Tax Rulings and Interpretations Directorate of the Canada Customs and Revenue Agency.

In this ruling the following defined terms have the following respective meanings:

(a) XXXXXXXXXX;

(b) "ACo" means XXXXXXXXXX, a public corporation, the shares of which are publicly traded on the XXXXXXXXXX;

(c) "Act" means the Income Tax Act (Canada), R.S.C. 1985 (5th Supp.) c.1, as amended from time to time and consolidated to the date of this letter and, unless otherwise expressly stated, every reference to a part, section or subsection, paragraph or subparagraph and clause or subclause is a reference to the relevant provisions of the Act and the income tax regulations thereunder are referred to as the "Regulations";

(d) "Assignment Agreement" refers to the Assignment Agreement dated XXXXXXXXXX between XXXXXXXXXX and CCo whereby XXXXXXXXXX assigned its interest in the Partnership and its interest in the Partnership Agreement to CCo;

(e) "BCo" means XXXXXXXXXX, a public corporation, XXXXXXXXXX, the issued and outstanding shares of which are publicly traded on the XXXXXXXXXX;

(f) "CCo" means XXXXXXXXXX, a corporation formed pursuant to the XXXXXXXXXX, all of the issued and outstanding shares of which are owned indirectly by BCo;

(g) XXXXXXXXXX;

(h) "DLP" means XXXXXXXXXX, a publicly traded limited partnership, the units of which trade on the XXXXXXXXXX;

(i) "Draft Legislation" means the interest deductibility proposals contained in the draft legislative provisions issued by the Department of Finance on December 20, 1991, which provisions have not yet been formally enacted;

(j) "Existing System" means the XXXXXXXXXX;

(k) "Expansion" means the construction and addition of XXXXXXXXXX systems to the Existing System, which was undertaken by the Partnership during the period commencing on or about the time the Partnership was formed (XXXXXXXXXX) and ending in XXXXXXXXXX;

(l) "GAAP" means Canadian generally accepted accounting principles;

(m) "General Partner" means XXXXXXXXXX, a corporation incorporated pursuant to the XXXXXXXXXX, the share capital of which is owned by the Operator as to XXXXXXXXXX%, DLP as to XXXXXXXXXX% and ACo as to XXXXXXXXXX% and which corporation is the general partner of the Partnership;

(n) "Operator" means XXXXXXXXXX, a corporation incorporated pursuant to the XXXXXXXXXX, all of the issued and outstanding shares of which are indirectly owned by BCo;

(o) "Operating Agreement" means the XXXXXXXXXX Agreement dated XXXXXXXXXX between the Partnership and the Operator XXXXXXXXXX of the XXXXXXXXXX by the Operator;

(p) "Paragraph" refers to a numbered paragraph in this letter;

(q) "Partnership" means the XXXXXXXXXX, initially formed among XXXXXXXXXX, DLP, ACo and the General Partner pursuant to the Partnership Agreement, and subsequently among CCo, DLP, ACo and the General Partner, pursuant to the Assignment Agreement;

(r) "Partner(s)" refers to one or more of the partners to the Partnership;

(s) "Partnership Agreement" means the Limited Partnership Agreement dated XXXXXXXXXX among XXXXXXXXXX (the interest of which was subsequently assigned to CCo pursuant to the Assignment Agreement), DLP, ACo and the General Partner;

(t) "Proposed Transactions" means the transactions proposed herein;

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

(v) "subsidiary wholly-owned corporation" has the meaning assigned by subsection 248(1); and

(w) "TSA" means the XXXXXXXXXX Agreement dated XXXXXXXXXX among the Partnership and XXXXXXXXXX.

FACTS

1. The Partnership is a Canadian partnership as defined under subsection 102(1), and has a fiscal period ending on XXXXXXXXXX of each year. The current members of the Partnership are CCo, as to XXXXXXXXXX%, DLP as to XXXXXXXXXX%, ACo as to XXXXXXXXXX%, and the General Partner as to XXXXXXXXXX%. Pursuant to the Partnership Agreement, the General Partner manages, controls, administers and operates the Partnership and its business and affairs and represents the Partnership in accordance with the Partnership Agreement.

2. The initial capital contributions of the Partners were as follows:

(a) CCo: its entire right, title and interest in the Existing System; other assets which were incorporated into the XXXXXXXXXX; and approximately $XXXXXXXXXX in cash;

(b) each of DLP and ACo: approximately $XXXXXXXXXX in cash; and

(c) General Partner: approximately $XXXXXXXXXX in cash.

3. Generally, the business of the Partnership is to XXXXXXXXXX.

4. The Expansion was undertaken by the Partnership during the period commencing on or about the formation of the Partnership (XXXXXXXXXX), and ending in XXXXXXXXXX. The ownership and use of the Existing System was transferred to the Partnership by CCo on XXXXXXXXXX , at an aggregate cost (for GAAP purposes) of approximately $XXXXXXXXXX. The elections have been made pursuant to the rollover provisions contained in subsection 97(2) of the Act and the aggregate elected amounts were approximately $XXXXXXXXXX. The XXXXXXXXXX assets consists of tangible depreciable properties, primarily consisting of property described in Classes XXXXXXXXXX. The XXXXXXXXXX has an aggregate cost to the Partnership (for GAAP purposes) of approximately $XXXXXXXXXX.

5. Pursuant to the Operating Agreement, the Operator contracted to operate and maintain the XXXXXXXXXX commencing on XXXXXXXXXX and ending XXXXXXXXXX years thereafter, with automatic extension periods of XXXXXXXXXX years. The duties of the Operator mainly consist XXXXXXXXXX.

6. The Partnership entered into long-term XXXXXXXXXX commitments under the TSA with XXXXXXXXXX.

PROPOSED TRANSACTIONS

The following transactions will occur sequentially.

1. The Partnership will issue bonds, debentures or promissory notes (the "Partnership Notes") to one or more arm's length lenders (the "Lenders") in exchange for cash proceeds (the "Borrowed Funds"). Pursuant to the Partnership Notes, interest will be payable to the Lenders on the Borrowed Funds at a reasonable commercial rate, to be determined by negotiation between the Partnership and the Lenders prior to the issuance of the Partnership Notes. The amount of the Borrowed Funds will be determined by negotiation between the Partnership and the Lenders prior to the issuance of the Partnership Notes but is anticipated to be approximately $XXXXXXXXXX to $XXXXXXXXXX. In the course of borrowing the Borrowed Funds, the Partnership will incur expenses (the "Financing Expenses") comprised of legal fees and fees paid to investment advisors for arranging the issue of the Partnership Notes. It is anticipated that the aggregate Financing Expenses will be approximately $XXXXXXXXXX.

2. The Partnership will use approximately $XXXXXXXXXX of the Borrowed Funds directly in the business carried on by the Partnership. The Partnership will distribute approximately $XXXXXXXXXX of the Borrowed Funds to each of CCo, DLP, ACo and the General Partner, by way of a distribution of partnership capital (the "Return of Capital"). Pursuant to the Partnership Agreement, the amount of funds received by each Partner on the Return of Capital will be in proportion to each Partner's respective ownership interest in the Partnership. The aggregate amount of the Return of Capital will not exceed the amount by which the carrying value of the property of the Partnership (as determined pursuant to GAAP), exceeds the total of the Partnership's liabilities (other than liabilities in respect of borrowed money used to acquire properties in paragraph 20.2(3)(d) of the Draft Legislation or in respect of an amount payable to acquire such properties) and any profits or gains from non-arm's length dispositions (to the extent that such profits or gains are reflected in the carrying value of the Partnership's property).

3. The Partnership will loan the portion of the Borrowed Funds remaining after payment of the Financing Expenses and the uses described in 2 above, if any, to each of CCo, DLP, ACo and the General Partner, in exchange for promissory notes (the "Partners' Notes") issued by each Partner. The amounts loaned to each Partner will be in proportion to each Partner's equity interest in the Partnership. Pursuant to each Partner Note, interest will be payable on the principal amounts thereof at a rate that is slightly higher than the interest rate paid by the Partnership on the Borrowed Funds pursuant to the Partnership Notes.

PURPOSE OF THE PROPOSED TRANSACTIONS

The primary purpose of the Proposed Transactions is to effect a borrowing on terms and conditions which are considered advantageous to the Partners. In particular, by borrowing at the level of the Partnership, the recourse of the lenders will be restricted to the assets of the Partnership. XXXXXXXXXX. The purpose for distributing the borrowed funds to the Partners is to enable the borrowed money to be used in the Partners' business operations and to reduce the amount of capital the Partners have at risk in the business of the Partnership.

RULINGS

Provided that the above description of facts, proposed transactions and purpose of the proposed transactions are accurate and constitute a complete and accurate disclosure of all of the relevant facts, proposed transactions and the purpose thereof, and provided further that the proposed transactions are completed in the manner described above, we confirm the following:

A Interest on the portion of the Borrowed Funds used directly to earn income from the business carried on by the Partnership and to lend to each of the Partners in the manner described in paragraph 3 of the proposed transactions will be deductible in computing income of the Partnership, pursuant to paragraph 20(1)(c) for the taxation year in respect of which such expense is paid or payable, depending on the method regularly followed by the Partnership.

B The portion of the Financing Fees that the Partnership will incur in the course of the borrowing as described in paragraph 1 of the proposed transactions and used in the manner described in the preceding paragraph will be deductible pursuant to and in the manner described in paragraph 20(1)(e) of the Act.

OPINION

Provided the provisions of proposed section 20.2 are enacted in substantially the same form as is proposed in the December 20, 1991 Technical Notes (interest deductibility) published by the Department of Finance (the "Draft Legislation"), we are of the opinion that proposed subsection 20.2(1) will apply to the Partnership with respect to the Partnership Notes. Accordingly, the Borrowed Funds the Partnership receives in exchange for the Partnership Notes and utilized for the purpose of making a Return of Capital as described in paragraph 2 of the proposed transactions shall be deemed to be borrowed money used for the purposes of earning income from the business of the Partnership to the extent that the said amount does not exceed the Partnership's "adjusted equity". The expression "adjusted equity" has the meaning assigned by proposed subsection 20.2(2). For the purpose of this definition, "carrying value" is determined in accordance with proposed subsection 20.2(3). Moreover, the future interest deductions on the said borrowing will be based on the adjusted equity at the time of the distribution and the provisions of paragraph 20(1)(c) will determine in each year, the interest deduction available for that particular year. Furthermore, it is our opinion that, the portion of the Financing Fees incurred for arranging the issue of Partnership Notes and used for the Return of Capital as described in paragraph 2 of the proposed transactions will be deductible in computing the income of the partnership pursuant to and in the manner described in paragraph 20(1)(e) of the Act.

COMMENT

The above rulings are given subject to the general limitations and qualifications set out in Information Circular IC 70-6R5 dated May 17, 2002, and are binding on the Agency provided the proposed transactions are completed before XXXXXXXXXX. Also, the above rulings are based on the Act and the Income Tax Regulations in their present form and do not take into account the effects of any proposed amendments thereto other than the opinion with respect to proposed section 20.2 for the purposes of paragraphs 20(1)(c) and 20(1)(e) of the Act.

This ruling letter should not be construed as indicating there has been any modification in the CCRA's administrative practices with regard to interest deductibility.

Yours truly,

XXXXXXXXXX
for Director
Financial Industries Division
Income Tax Rulings Directorate
Policy and Legislation Branch