2002 Ruling 2002-0167263 - CHANGES TO TERMS OF DEBT & CONSEQUENCES

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 ISSUE:

(a) Will the amendment of the terms of the Trust Indenture and the Debentures constitute a disposition of the Debentures by their holders and the issuance of a new obligation for the purposes of subparagraph 212(1)(b)(vii)?

(b) Whether the cash amount paid in satisfaction of the XXXXXXXXXX % Interest is deductible under paragraph 20(1)(f)?

Position:

(a) Amendments to the terms of the Indenture and the Debentures do not result in a new obligation.

(b) Yes, deductible under 20(1)(f)(ii).

REASON:

(a) The changes are not sufficiently fundamental as to bring into existence a new obligation.

(b) Yes. For purposes of paragraph 20(1)(f) the principal amount under the terms of the Debenture Agreements is the total amount paid by the issuer at the time of the repayment such that that portion of the said amount paid by the issuer that is in respect of the fair market value of the XXXXXXXXXX % Interest will constitute an amount paid in the year in satisfaction of the principal amount.

However, the amount for which the Debentures were issued is substantially less than 97% of the principal amount and the "effective yield" is substantially more than 4/3 or the interest rate payable. As such, subparagraph 20(1)(f)(i) will not apply, rather 20(1)(f)(ii) will apply.

XXXXXXXXXX 			2002-016726

XXXXXXXXXX, 2002

Dear XXXXXXXXXX:

Re: Advance Income Tax Ruling
XXXXXXXXXX

This is in response to your letter dated XXXXXXXXXX, wherein you request an advance income tax ruling on behalf of the above-noted taxpayers. We also acknowledge the information provided in subsequent correspondence and during various telephone conversations in connection with your request (XXXXXXXXXX).

We understand that to the best of your knowledge and that of the taxpayers involved none of the issues involved in this ruling:

(i) is in an earlier return of a taxpayer identified in this document or of a related person,

(ii) is being considered by any Tax Services Office or Taxation Centre of the Agency in connection with a tax return already filed,

(iii) is under objection by a taxpayer identified in this document or by a related person,

(iv) is before the courts or, if a judgment has been issues, the time limit for appeal to a higher court has not expired, and

Unless otherwise stated, all references to a statute are to the Income Tax Act R.S.C. 1985 (5th Supp.), c.1, as amended, (hereinafter the "Act") and all terms and conditions used herein that are defined in the Act have the meaning given in such definition unless otherwise indicated.

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

Facts

1. XXXXXXXXXX, (hereinafter "Parentco") was incorporated under the Canada Business Corporations Act (hereinafter the "CBCA") on XXXXXXXXXX. Parentco is a Canadian controlled private corporation and a taxable Canadian corporation. Parentco's authorized share capital is comprised of class A common shares. Parentco's issued and outstanding shares are comprised of XXXXXXXXXX class A common shares. Parentco's offices are located at XXXXXXXXXX. Parentco is served by the XXXXXXXXXX TSO and the XXXXXXXXXX Taxation Centre.

Parentco is a holding company. Following its incorporation, Parentco was the parent company of XXXXXXXXXX (hereinafter "Old Parentco").

Old Parentco's businesses included XXXXXXXXXX.

Old Parentco was also the sole shareholder of Predecessor A Co and Predecessor B Co (see paragraph 2 below). On XXXXXXXXXX Old Parentco was wound-up into Parentco such that the assets held by Old Parentco at that time (i.e. including the shares of Holdco) became assets of Parentco. At the time of the wind-up Parentco changed its name XXXXXXXXXX, by way of articles of amendment. Parentco transferred/ sold its remaining businesses, with the last sale occurring in XXXXXXXXXX.

2. XXXXXXXXXX, (hereinafter "Holdco") was created under the CBCA on XXXXXXXXXX as a result of the amalgamation of XXXXXXXXXX (hereinafter "Predecessor A Co"), and XXXXXXXXXX (hereinafter "Predecessor B Co"). Holdco is a Canadian controlled private corporation and a taxable Canadian corporation. Holdco's authorized share capital is comprised of; an unlimited number of common shares; an unlimited number of non-voting restricted common shares (hereinafter the "Restricted Common Shares") which are, subject to restrictions relating to the number of voting shares held by non-residents, convertible into common shares on the basis of one for one; and an unlimited number of preferred shares. Holdco's issued and outstanding share capital is comprised of XXXXXXXXXX common shares. Holdco's taxation year-end XXXXXXXXXX Holdco's offices are located at XXXXXXXXXX Holdco is served by the XXXXXXXXXX TSO and the XXXXXXXXXX Taxation Centre.

Holdco is a holding company.

Prior to its amalgamation with Predecessor B Co, Predecessor A Co issued convertible subordinate Series A debentures and Series B debentures (hereinafter the "Debentures") for an aggregate amount of $XXXXXXXXXX.

3. Pursuant to the amalgamation of Predecessor A Co and Predecessor B Co, Holdco assumed all of the obligations under the Debentures.

4. XXXXXXXXXX (hereinafter "Lender 1") is a XXXXXXXXXX limited partnership. Lender 1 is an investment fund which makes portfolio investments in XXXXXXXXXX businesses. These investments generally take the form of equity debt and/ or convertible debt, warrants and other types of instruments.

5. XXXXXXXXXX (hereinafter "Lender 2") is a non-resident investment vehicle created to allow the principals behind Lender 1 and some employees to invest in parallel with Lender 1.

6. On XXXXXXXXXX Lender 1 purchased Series A Debentures for an aggregate amount of $XXXXXXXXXX and Series B Debentures for an aggregate amount of $XXXXXXXXXX. Lender 2 purchased Series A Debentures for an aggregate amount of $XXXXXXXXXX and Series B Debentures for an aggregate amount of $XXXXXXXXXX. XXXXXXXXXX, a resident of the U.S. (hereinafter "Lender 3"), purchased Series A Debentures for an aggregate amount of $XXXXXXXXXX and Series B Debentures for an aggregate amount of $XXXXXXXXXX.

Lender 1, Lender 2 and Lender 3 are hereinafter collectively referred to as the "Holders". The purpose of this investment by the Holders was to provide Holdco with capital and with a potential equity investor (through the XXXXXXXXXX% Interest (see below)) XXXXXXXXXX.

7. The Debentures were issued under the terms of Debenture Agreements made between Predecessor A Co and the Holders. The principal terms of the Debentures and the Debenture Agreements are as follows:

(a) The Debentures were issued on XXXXXXXXXX and mature on XXXXXXXXXX.

(b) The Debentures were issued in two different series, the Series A Debenture and the Series B Debenture. The Series A Debentures were issued for the aggregate amount of $XXXXXXXXXX and the Series B Debentures were issued for the aggregate amount of $XXXXXXXXXX. The combined total amount for which the Series A and Series B Debentures were issued is $XXXXXXXXXX.

(c) The Debentures are unsecured and at the time of issuance bore interest at the rate of XXXXXXXXXX% per annum payable on or before XXXXXXXXXX of each year. As explained in paragraph 13 below, the interest rate was recently reduced to a rate equivalent to the XXXXXXXXXX-day rate on Canadian dollar banker's acceptances as posted on the "CDOR Page" of the Reuter Monitor Money Rates Services (hereinafter the "CDOR Rate"). For reference, the CDOR Rate on XXXXXXXXXX was XXXXXXXXXX%.

(d) In certain circumstances the Debentures are convertible into Restricted Common Stock at the option of the Holders or Holdco. In the event of a conversion Holdco is required to pay the outstanding principal amount together with the accrued and unpaid interest thereon and in addition the XXXXXXXXXX% Interest (described below).

The payment of the XXXXXXXXXX% Interest may be made through the issuance of XXXXXXXXXX Restricted Common Shares out of a total of XXXXXXXXXX common shares (including the XXXXXXXXXX Restricted Common Shares) [which represented the issued shares of Predecessor A Co at the time of the issuance] outstanding after such issuance. The number of Restricted Common Shares is adjusted from time to time by virtue of paragraph XXXXXXXXXX of the Debenture Agreements to protect against dilution. Accordingly, by operation of paragraph XXXXXXXXXX of the Debenture Agreement, the number of Restricted Common Shares to be issued on a conversion, adjusted to take into account the current number of common shares (XXXXXXXXXX) would amount to XXXXXXXXXX.

(e) The Debenture may under certain circumstances that include an Event of Default be redeemed at the option of the Holders ("Mandatory Redemption"). Upon receipt of a notice of the intention by the Holder to exercise his right of redemption, Holdco shall redeem each Debenture by wire transfer of immediately available funds in cash in aggregate amount equal to the Redemption Amount, consisting of the then principal amount of such Debenture, together with accrued and unpaid interest and the Fair Market Value (as defined under the Debenture Agreements) of the XXXXXXXXXX% Interest;

(f) Holdco may, pursuant to XXXXXXXXXX the Debenture Agreements, also redeem in full, but not in part, the Debenture ("Voluntary Redemption"). The voluntary redemption payment is equivalent to the Redemption Amount except that the payment of the XXXXXXXXXX% Interest is satisfied through the issuance of Restricted Common Stock in lieu of cash. Thus, upon such redemption, Holdco must deliver to the Holder:

(i) by wire transfer of immediately available funds an amount equal to the outstanding principal amount of this Debenture, together with accrued and unpaid interest thereon; and

(ii) a certificate or certificates registered in the name of the Holder representing a number of shares equal to the XXXXXXXXXX % Interest, which shares shall be duly and validly issued and fully paid and non-assessable, free of all liens and not subject to any pre-emptive rights.

(g) In addition to the ability to issue shares in payment of the XXXXXXXXXX% Interest on a Voluntary Redemption, in the manner set out above, XXXXXXXXXX of the Debenture Agreement also provides that solely with respect to the Series A Debentures:

At any time on or prior to the XXXXXXXXXX anniversary of the Amalgamation Closing Date but prior to a Conversion, this Debenture shall be subject to voluntary redemption in full, but not in part, by the Company at any time, provided that the Company shall have given at least XXXXXXXXXX days prior written notice to the holder. This Debenture shall not be redeemed by the Company pursuant to this XXXXXXXXXX except pursuant to the redemption of all of the Series A Debentures. Upon such redemption in full, the Company shall pay to the Holder by wire transfer of immediately available funds an amount equal to:

(a) the outstanding principal amount of this Debenture, together with accrued and unpaid interest thereon; and

(b) such Holder's pro rata share of $XXXXXXXXXX, such pro rata share being based upon the principal amount of this Series A Debentures relative to the then outstanding principal amount of all Series A Debentures.

Holdco has stated that it is the understanding of all parties to the Series A Debenture Agreement that the Voluntary Redemption rights described in paragraphs (f) and (g) above are alternative rights granted to Holdco such that in the event of a Voluntary Redemption prior to the XXXXXXXXXX anniversary of the Amalgamation Closing Date, Holdco may, at its sole discretion chose to complete the Voluntary Redemption under either paragraph XXXXXXXXXX [paragraph (f) above] or paragraph XXXXXXXXXX [paragraph (g) above]of the Debenture Agreement.

(h) The Debenture Agreement contains detailed covenants including covenants restricting the ability of Holdco to declare or pay any dividends; purchase, redeem or retire any of Holdco's capital stock or other equity securities, directly or indirectly; make any other distribution to any holder of Holdco's equity securities. The Debenture Agreement contains further provisions in the event of a change of control of Holdco or in an event of default by Holdco as set out in the Debenture Agreement.

(i) The Debentures and the Debenture Agreement are governed by the laws of the Province of XXXXXXXXXX and the laws of Canada applicable therein.

(j) Relevant definitions in XXXXXXXXXX the Debenture Agreement include the following:

? "XXXXXXXXXX% Interest" means the Restricted Common Shares issuable upon conversion of the debenture assuming the debentures were convertible in full at the option of the Holder as of such date.

? "Cure Period" means, with respect to any Event of Default, a period commencing on the date of the occurrence of such Event of Default and ending on the one hundred and eightieth (180th) day following such occurrence;

? "Event of Default" means, among others, the occurrence of a change of control, or a merger, amalgamation, plan of arrangement, consolidation, reorganization or other business combination which results in a change of control or a sale, transfer or other disposition of all or substantially all of the properties, assets or rights of XXXXXXXXXX;

? "Fair Market Value" means as of any date, with respect to the redemption, at the option of the Holders, (i) prior to the Qualified Public Offering, the fair market value of the XXXXXXXXXX% Interest as determined by an Appraisal, or (ii) on or following the Qualified Public Offering, an amount equal to the Weighted Average Price as of such date multiplied by the number of shares included in the XXXXXXXXXX% Interest;

? Redemption Amount" means, with respect to a debenture as of any date, an amount equal to the sum of

(i) the then outstanding principal amount of such debenture, together with the accrued and unpaid interest thereon, and

(ii) the Fair Market Value of the XXXXXXXXXX% Interest;

? "Redemption Date" means the later of XXXXXXXXXX or the XXXXXXXXXX anniversary of the Amalgamation Closing Date;

? "Restricted Common Stock" means the XXXXXXXXXX restricted common shares which have essentially the same characteristics as the XXXXXXXXXX common shares except that they are redeemable and convertible in common shares at the option of their holders in certain circumstances;

? "Weighted Average Price" means with respect to any security traded on the XXXXXXXXXX, as of any date, the average of the closing prices, last bid or quoted price on such exchange for XXXXXXXXXX trading days preceding such date.

(k) The Fair Market Value of the XXXXXXXXXX% Interest may be determined by an investment banker of a national standing in Canada experienced in XXXXXXXXXX businesses; Note that the XXXXXXXXXX % interest is also payable upon the redemption of the Debentures because of the definition of "Redemption Amount" (see definition above) which refers to the XXXXXXXXXX % interest.

Based upon the current number of issued and outstanding common shares of Holdco (XXXXXXXXXX) the number of Restricted Common Shares to be issued as payment of the XXXXXXXXXX % Interest would equal XXXXXXXXXX shares

[XXXXXXXXXX].

The XXXXXXXXXX% Interest gives the Series A Debenture Holders and Series B Debenture Holders rights to XXXXXXXXXX% and XXXXXXXXXX% (total XXXXXXXXXX%) equity interests, respectively, in Holdco.

(l) Under the terms of the Debentures or any agreement relating thereto, Holdco may not under any circumstances be obliged to pay more than XXXXXXXXXX % of the principal amount of the Debentures within XXXXXXXXXX years from their date of issue except in the circumstances permitted by subparagraph 212(1)(b)(vii) of the Act.

(m) The Debenture Agreements do not contain any specific provisions allowing the parties to amend their terms. Accordingly, any modifications/ amendments may only be made with the consent of all the parties.

8. On XXXXXXXXXX a security holder agreement (hereinafter the "Security Holder Agreement") was concluded between Parentco as sole shareholder of Predecessor A Co and the Holders whereby Parentco agreed to guaranty the payment of the Debentures until the consummation of the amalgamation between Predecessor A Co and Predecessor B Co which, as mentioned above, occurred on XXXXXXXXXX.

9. At the date of the issuance of the Debentures, Parentco, which was carrying on XXXXXXXXXX businesses, directly or through subsidiaries, in XXXXXXXXXX, intended to transfer its assets and properties primarily used in the operation of its XXXXXXXXXX business to Predecessor B Co. The closing of this transaction occurred on XXXXXXXXXX.

10. On XXXXXXXXXX, Holdco entered into a "Convention d'achat d'actions" with XXXXXXXXXX ("Purchaseco") pursuant to which Purchaseco acquired all the assets, properties and rights of Holdco which were, at the time of the offer, used exclusively in connection with the XXXXXXXXXX as well as the shares of XXXXXXXXXX ("R Co") and the shares of XXXXXXXXXX ("M Co"). The closing of this transaction occurred on XXXXXXXXXX.

11. On XXXXXXXXXX, Holdco, certain wholly-owned subsidiaries and partnerships and XXXXXXXXXX ("Acquisitionco") entered into a Purchase Agreement pursuant to which, Acquisitionco acquired the XXXXXXXXXX enterprise carried on directly or indirectly by Holdco in XXXXXXXXXX and by a wholly-owned subsidiary XXXXXXXXXX. The closing of this transaction occurred in XXXXXXXXXX.

12. Both transactions with Purchaseco and Acquisitionco constituted an Event of Default under the terms of the Debentures. However, the Holders waived their rights resulting from the Default in each of these transactions.

13. On XXXXXXXXXX, Holdco and the Holders entered into an agreement under which the interest rate of XXXXXXXXXX% per annum stipulated under the Debentures was reduced to a rate equivalent to the XXXXXXXXXX day rate on Canadian dollar banker's acceptance. Holdco and the Holders specifically declared that they did not intend to effect novation of the Debentures in so reducing the interest rate. This Agreement to reduce the interest rate on the Debenture was prompted by the fact that having sold its XXXXXXXXXX Business, Holdco held a substantial amount of cash invested in short term securities. These funds generated and still generate a very low rate of return making it economically very disadvantageous for Holdco to continue to pay XXXXXXXXXX% interest on the Debenture. Holdco was willing to repay the principal of the Debentures but was not prepared, prior to the closing of the Purchaseco transaction, to pay the premium attached thereto. The Holders, on the other hand, demanded that both the principal and the premium be paid simultaneously. In the end, the parties agreed to reduce the rate of interest to a rate approximating the rate of return earned by Holdco on its short-term investments while they awaited the completion of the sale of the XXXXXXXXXX business to Purchaseco.

14. Lender 1, Lender 2 and Lender 3 deal at arm's length with Parentco and Holdco.

15. The current estimated fair market value of the XXXXXXXXXX% Interest (XXXXXXXXXX Restricted Commons Shares of Holdco) is approximately $XXXXXXXXXX.

Proposed Transactions

16. Subject to the receipt of favorable income tax rulings, the terms and conditions of the Debentures will be amended (the "Amendment") as follows on the basis of a written agreement entered into by Holdco and all Holders of the Debentures:

(a) XXXXXXXXXX of both the series A and series B Debenture Agreements, described in paragraph 7(f) above, is replaced by the following:

XXXXXXXXXX: REDEMPTION

(b) Voluntary Redemption

(i) This Debenture shall be subject to voluntary redemption in full, but not in part by the Company at any time, provided that the Company shall have given at least XXXXXXXXXX days prior written notice, or any other prior written notice as agreed by all parties, to the Holder. This Debenture shall not be redeemed by the Company pursuant to this XXXXXXXXXX except pursuant to the redemption of all of the Debentures. Upon such redemption in full, the Company shall deliver to the Holder:

(A) by wire transfer of immediately available funds on aggregate amount equal to the Redemption Amount.

(b) In the definition section, XXXXXXXXXX, the definition of the term "Fair Market Value, of both the series A and series B Debenture Agreements, described in paragraph 7(j) above, is replaced by the following:

XXXXXXXXXX DEFINITIONS; CURRENCY

(a) Certain Defined Terms

"Fair Market Value" means as of any date, with respect to the Mandatory Redemption and the Voluntary Redemption, (i) prior to the Qualified Public Offering, the fair market value of the XXXXXXXXXX% Interest as determined in good faith by the Company and the Holders or, if the Company and the Holders do not reach an agreement on such fair market value within XXXXXXXXXX days after the issuance of a written notice by the Holder or the Company, pursuant to XXXXXXXXXX as the case may be, by an Appraisal, or (ii) on or following the Qualified Public Offering, an amount equal to the Weighted Average Price as of such date multiplied by the number of shares included in the XXXXXXXXXX% Interest;

such that Holdco will, with respect to both the Series A Debentures and Series B Debentures, be permitted to pay the XXXXXXXXXX% Interest in cash in lieu of issuing shares.

As part of the Amendment, Holdco and the Holders will specifically provide in writing that they do not intend to effect novation of the Debentures.

17. Holdco will, with respect to the Debentures currently held by the Holders, exercise its Voluntary Redemption right as described in paragraph 7(f) above, subject to the revisions under the terms of the Amendment.

Purpose of the Proposed Transactions

Holdco wishes to have the ability to pay the equivalent of the fair market value of the XXXXXXXXXX% Interest in cash while not having to put itself artificially in default under the terms and conditions of the instrument.

It is anticipated that the Fair market value of the portion of the XXXXXXXXXX% Interest attributable to the Series A Debentures will be less than $XXXXXXXXXX. Accordingly, it would not be advantageous for Holdco to avail itself of its Voluntary Redemption rights under the terms of the Debenture Agreement with respect to the Series A Debentures as described in paragraph 7(g) above. Rather, Holdco wishes to redeem the Debentures pursuant to its Voluntary Redemption rights under the terms of the Debenture Agreement with respect to the Series A Debentures as described in paragraph 7(f) above but pay the value of the XXXXXXXXXX% Interest in cash rather than issuing shares.

Given that Holdco has now divested itself of its XXXXXXXXXX assets, it will, pending a decision as to its strategic future, sit mainly with short-term investments. Accordingly, the Holders are no longer viewed as strategic partners in connection with the future direction of the business, both from Holdco and the Holders perspective. However, given that the Holders have agreed to waive their respective right to cause a mandatory Redemption of the Debentures at the time when the sales described in paragraphs 10 and 11 above were concluded (both of which were events of default under the Debenture Agreement) Holdco finds itself in a position where the Debentures need to be amended (with the consent of the Debentures holders) to achieve its goal of paying the Debentures and the value of the XXXXXXXXXX% Interest in cash. This is also in agreement with the views of the Holders who are no longer interested in acquiring an equity investment in Holdco.

Additional information

You have represented to CCRA that

XXXXXXXXXX

XXXXXXXXXX, the Amendment will not result in a disposition of the existing Debentures and in the issuance of new debt obligations since Holdco and the Holders will clearly provide in their agreement giving effect to the Amendment that they do not intend to effect novation.

The Amendment pursuant to which Holdco will be in a position to pay the XXXXXXXXXX% Interest in cash in lieu of shares will not constitute a fundamental change to the basic elements of the Debentures. Indeed, the changes will simply modify the method of payment of the XXXXXXXXXX% Interest without affecting the "very root" of the Debentures, i.e the identity of the debtor, the principle amount of the Debentures, the value and the entitlement to the XXXXXXXXXX% Interest or the maturity date of such Debentures. The modification of the Debentures through the proposed Amendment is fully consistent with the continuing existence of the Debentures since none of its essential features would be affected by the Amendment.

Rulings

Provided that the above description of facts, proposed transactions, purpose of the proposed transactions and additional information 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 that:

(A) Provided that the Amendment, as described in paragraph 16 above, does not result in a novation of the Debentures under the relevant Provincial law, the Amendment to the Debentures would not, in and by itself, result in either the "disposition" thereof by their holders under the definition set out in section 54 or the issuance of a new obligation for the purposes of subparagraph 212(1)(b)(vii).

(B) For purposes of computing the amount that may be deducted for a taxation year by Holdco pursuant to paragraph 20(1)(f)(ii), that portion of the amount paid by Holdco upon the Voluntary Redemption (as revised under the terms of the Amendment) of the Debentures as described in paragraph 17 above that is in respect of the fair market value of the XXXXXXXXXX% Interest will constitute an amount paid in the year in satisfaction of the principal amount.

These ruling 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 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 amendments to the Act which, if enacted into law, could have an effect on the rulings provided herein.

Comment

Nothing in this letter should be construed as implying that the CCRA has reviewed or is making a determination or ruling in respect of:

(a) the laws of the Province of XXXXXXXXXX governing the Debentures, specifically whether the Proposed Transactions result in the novation of the Debentures and their substitution by a new obligations under such laws;

(b) any tax consequences with respect to the Debentures other than those as specifically described in the rulings given above including whether interest paid on the Debentures to a non-resident, prior to the proposed Amendment described in paragraph 14 above, qualifies for the exemption from tax payable pursuant to subparagraph 212(1)(b)(vii); or

(c) any other tax consequences relating to any facts or proposed transactions referred to herein other than those as specifically described in the ruling given above.

Yours truly,

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