2002 Ruling 2002-0178983 - REFINANCING

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 corporation that owns the key asset within the corporate group is in financial difficulty. The two major creditors have directed that the corporation reorganize its finances to insure the long term stability of the key asset.

Position:

Favorable ruling given.

REASON:

XXXXXXXXXX  			2002-017898

XXXXXXXXXX, 2002

Dear XXXXXXXXXX:

Re: Advance Income Tax Ruling
XXXXXXXXXX
XXXXXXXXXX
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 telephone conversations in connection with your request (XXXXXXXXXX), as well as additional 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; or

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

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

(a) "Act" means the Income Tax Act, R.S.C 1985 (5th Supp.) c.1, as amended to the date hereof, and, unless otherwise stated, every reference herein to a Part, section, subsection, paragraph or subparagraph is a reference to the relevant provision of the Act;

(b) "arm's length" has the meaning assigned by section 251;

(c) "Assets" means the primary assets owned by Operating Partnership which are the Operating Assets (trade and other accounts receivable, deposits and rights arising from the prepayment of certain amounts) and principally "Asset #1", which means XXXXXXXXXX;

(d) "Bank" means the XXXXXXXXXX;

(e) "Canadian-controlled private corporation" has the meaning assigned by subsection 125(7);

(f) "Canco #1" means XXXXXXXXXX;

(g) "Canco #2" means XXXXXXXXXX;

(h) "Canco #3" means XXXXXXXXXX;

(i) "Canco # 4" means XXXXXXXXXX;

(j) "Canco # 5" means XXXXXXXXXX;

(k) "Canco # 6" means XXXXXXXXXX;

(l) "Canco # 7" means XXXXXXXXXX;

(m) "Canco # 8" means XXXXXXXXXX;

(n) "Canco # 9" means XXXXXXXXXX;

(o) "Canco # 10" means XXXXXXXXXX;

(p) "Canco # 11" means XXXXXXXXXX;

(q) "Canco # 12" means XXXXXXXXXX;

(r) "Company A" means XXXXXXXXXX and its partners and persons related thereto;

(s) "Creditor #1" means XXXXXXXXXX;

(t) "Creditor #2" means XXXXXXXXXX;

(u) XXXXXXXXXX;

(v) XXXXXXXXXX;

(w) XXXXXXXXXX;

(x) XXXXXXXXXX;

(y) XXXXXXXXXX;

(z) XXXXXXXXXX;

(aa) XXXXXXXXXX;

(bb) XXXXXXXXXX;

(cc) XXXXXXXXXX;

(dd) XXXXXXXXXX;

(ee) XXXXXXXXXX;

(ff) XXXXXXXXXX;

(gg) "Incentive Fee" means the fee described in paragraph 28 below;

(hh) "Lender #2" means XXXXXXXXXX corporation which deals at arm's length with all parties referred to in this Ruling;

(ii) "Liabilities" and "Liabilities of Canco # 3" means the primary liabilities of Canco # 3 and are estimated XXXXXXXXXX to consist of:

i) XXXXXXXXXX;

ii) XXXXXXXXXX;

iii) XXXXXXXXXX;

iv) XXXXXXXXXX;

v) XXXXXXXXXX;

vi) XXXXXXXXXX;

vii) XXXXXXXXXX;

viii) XXXXXXXXXX;

ix) XXXXXXXXXX;

x) XXXXXXXXXX;

xi) XXXXXXXXXX;

(jj) "Main Activity" means the XXXXXXXXXX of the Operating Partnership's, XXXXXXXXXX;

(kk) "matchable expenditure" has the meaning assigned by subsection 18.1(1);

(ll) XXXXXXXXXX;

(mm) "Offering Partnership" means XXXXXXXXXX, as described in paragraph 11 below;

(nn) "Offering General Partner" means, XXXXXXXXXX the general partner of the Offering Partnership as described in paragraph 12 below;

(oo) "Operating Assets" means XXXXXXXXXX;

(pp) "Operating General Partner" means initially XXXXXXXXXX, the general partner of Operating Partnership. Operating General Partner is a taxable Canadian corporation incorporated under the laws of XXXXXXXXXX. All the issued and outstanding shares in the capital of the Operating General Partner are owned by XXXXXXXXXX, all of whom are individuals who are residents of Canada. Company A and/ or certain directors, officers or affiliates thereof;

(qq) "Operating Partnership" means XXXXXXXXXX, as described in paragraph 13 below;

(rr) "Principal" means XXXXXXXXXX;

(ss) "Regulations" means the regulations to the Act;

(tt) "right to receive production" has the meaning assigned by 18.1(1);

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

Any references to an amount of money are expressed in Canadian dollars, unless otherwise indicated.

FACTS

1. Canco #1 is a taxable Canadian corporation and a Canadian-controlled private corporation. XXXXXXXXXX.

XXXXXXXXXX

2. Canco #2 is a taxable Canadian corporation and a Canadian-controlled private corporation.

XXXXXXXXXX

Canco #2's principal business activity is the operation of the XXXXXXXXXX.

3. XXXXXXXXXX

4. Canco #3 is a taxable Canadian corporation and a Canadian-controlled private corporation. XXXXXXXXXX:

XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX

XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX

Canco # 3 commenced operations on XXXXXXXXXX , Canco # 3's principal business activity was XXXXXXXXXX.

5. XXXXXXXXXX.

6. XXXXXXXXXX.

7. XXXXXXXXXX.

8. XXXXXXXXXX.

9. Pursuant to a number of securities pledge agreements (the "Securities Pledge Agreements") between and among parties, including Creditor # 1, XXXXXXXXXX, Creditor # 2, Canco # 1, and Canco # 3, upon the occurrence of an event of default that has not been waived, Creditor # 1, XXXXXXXXXX , and/or Creditor # 2 will have the right to exercise the rights and powers relating to, in each case, pledged shares that would result in the right to vote over XXXXXXXXXX% of the voting shares of Canco # 3. The Securities Pledge Agreements provide that any security interest created by them will terminate and the pledged shares will be returned to the pledgor when the obligations owed to Creditor # 2, Creditor # 1 and others have been satisfied. Events of default have occurred that have not yet been formally waived.

Creditor # 1, XXXXXXXXXX, and/or Creditor # 2 have not and will not exercise on their security to enable them to vote over XXXXXXXXXX% of the voting shares of Canco # 3.

Creditor # 1, XXXXXXXXXX and Creditor # 2 will be providing consents to the proposed transactions detailed hereunder.

10. Corporations that are controlled directly or indirectly by Principal include the following:

XXXXXXXXXX.

Any companies controlled directly or indirectly by Principal will be referred to collectively in this ruling as the "Principal Group".

The Offering Partnership

11. Offering Partnership is a Limited Partnership formed under the Limited Partnerships Act (XXXXXXXXXX). The partnership interests in the Offering Partnership are divided into Class A Units and Class B Units. The business of the Offering Partnership will include the ownership of a partnership interest in the Operating Partnership, a partnership that will carry on the business of operating the Assets. Additionally, the Offering General Partner will provide consultation, management, administration and financial services to the Offering Partnership for an annual fee. The Offering Partnership has a XXXXXXXXXX year-end.

12. The Offering General Partner is a taxable Canadian corporation. The issued and outstanding common shares of Offering General Partner are held by Company A principals. Company A is in the business, directly or indirectly, of XXXXXXXXXX. Company A and Company A principals deal at arm's length with one another and with the Principal Group of companies, Principal, Creditor # 1 and Creditor #2. The only assets of the Offering General Partner are nominal cash and its general partnership interest in the Offering Partnership.

The Operating Partnership

13. Operating Partnership is a limited partnership formed under the Limited Partnership Act (XXXXXXXXXX). The capital of the Operating Partnership consists of the nominal interest of the Operating General Partner and one class of units (the "OP Units") all of which are owned by the Offering Partnership. The business of the Operating Partnership is to operate the Assets. The Operating Partnership has a XXXXXXXXXX year-end.

14. The Operating General Partner negotiated the terms of acquisition of Asset #1 from Canco #3.

Recently completed preliminary transactions

15. Canco #1 sold its shares in the capital stock of Canco #2 and Canco #3. The sales occurred at fair market value to Principal.

16. On incorporation, Canco # 10 issued XXXXXXXXXX common shares to Principal for aggregate consideration of $XXXXXXXXXX. It is the understanding of the parties to this ruling that XXXXXXXXXX will be a minority shareholder in this company.

17. On incorporation, Canco # 11 issued XXXXXXXXXX common shares to Principal for aggregate consideration of $XXXXXXXXXX. Since that time, Principal sold his XXXXXXXXXX common shares of Canco # 11 to Canco # 10 for consideration of $XXXXXXXXXX. The consideration was paid by Canco # 10 by the issuance of a note payable to Principal.

Amendments to License Agreement between Canco #2 and Canco #3

18. Canco # 2 entered into an agreement (the "Amended License Agreement"), on XXXXXXXXXX to amend the economic terms of the arrangements under which XXXXXXXXXX which provided for the following amendments to the License Agreement:

? XXXXXXXXXX;

? XXXXXXXXXX, as described in paragraph 8 above; and

? a new revenue sharing arrangement (the "Sharing Arrangement") was entered into between Canco # 3 (and subsequently the Operating Partnership) and Canco # 2 for XXXXXXXXXX. The Sharing Arrangement provides that during the term of the Amended License Agreement, Canco # 2 will agree to pay to Operating Partnership amounts intended to increase the economic return to Operating Partnership in respect of revenue generated from XXXXXXXXXX.

Canco # 3 paid consideration of $XXXXXXXXXX (the "License Amendment Fee") to Canco # 2 as consideration for Canco# 2 agreeing to amend the License Agreement by issuance of a note. The License Amendment Fee has been computed as the present value of the expected decrease in the amounts that will now be payable under the Amended Licence Agreement.

The intent of these amendments was to ensure that the amounts payable by Canco # 3 and then subsequently Operating Partnership for the use of XXXXXXXXXX is not less disadvantageous XXXXXXXXXX by adjusting upwards the share of the revenue retained by Canco # 3 and subsequently the Operating Partnership XXXXXXXXXX, thereby having the effect of reducing the occupancy cost payable. XXXXXXXXXX.

Given Canco # 2's economic dependence upon Asset # 1 as mentioned in paragraph 8 above it has entered into the Amended License Agreement in order to encourage completion of the transactions contemplated herein.

19. It was a condition precedent to the purchase of the Assets by the Operating Partnership described below, that the Amended License Agreement be entered into. The Amended License Agreement may be terminated by Canco # 2 after redemption or purchase for cancellation of all of the Class A Units of the Offering Partnership as described below.

20. The Operating Partnership acquired from Canco # 3, on or about XXXXXXXXXX, the assets and undertakings of Canco # 3 which relate to the Main Activity, including the Operating Assets.

The purchase price for the Assets (excluding the Operating Assets) was $XXXXXXXXXX which purchase price was paid by the issuance of a note (the "Purchase Note") by the Operating Partnership. The Purchase Note bears interest, which is anticipated to accumulate to approximately $XXXXXXXXXX (disclosed as $XXXXXXXXXX in the Offering Memorandum) to the date of closing.

21. The Operating Partnership also acquired from Canco # 3 the Operating Assets for a purchase price of approximately $XXXXXXXXXX . The purchase price for the Operating Assets will be paid by the Operating Partnership by its assumption of $XXXXXXXXXX,

Additionally, Canco # 3 issued a note payable to the Operating Partnership (the "Canco # 3/OP Note") in the amount of $XXXXXXXXXX, being the amount by which XXXXXXXXXX exceeds the purchase price for the Operating Assets.

PROPOSED TRANSACTIONS

Offering of Class A Units by the Offering Partnership

22. The Offering Partnership has offered XXXXXXXXXX Class A Units ("Class A Units"), with a unit subscription price of $XXXXXXXXXX (subsequently revised to $XXXXXXXXXX) per Class A Unit for sale to persons (individuals, corporations, partnerships or other entities) resident in Canada (other than the Territories of Canada) pursuant to registration and prospectus exemptions under applicable securities legislation of each province of Canada, by way of a confidential offering memorandum (the "Offering Memorandum").

23. Lender #1 will make an interest-bearing loan (the "Unit Loan") in the amount of $XXXXXXXXXX per Class A Unit to each subscriber for Class A Units (the "Class A Unitholder") of the Offering Partnership who wishes to finance a portion of the purchase price in respect of such Class A Units.

24. Lender #1 has agreed to perform the functions summarized herein, at the request of Canco #2. The Trustee of Lender #1 will deal at arm's length with all parties referred to herein. XXXXXXXXXX.

25. Class A Unitholders who borrow pursuant to a Unit Loan will also contribute $XXXXXXXXXX (subsequently revised to $XXXXXXXXXX) per Class A Unit as interest collateralization which amount will be applied to collaterally secure the obligation of the Class A Unitholder to pay interest on the Unit Loan for the approximate XXXXXXXXXX period following the date of subscription. These proceeds, when received ($XXXXXXXXXX upon subscription, $XXXXXXXXXX on XXXXXXXXXX and $XXXXXXXXXX on XXXXXXXXXX) will be delivered by the Offering Partnership to Lender #1, to effect such collateralization. The collateralized funds will be applied by Lender #1 to pay the interest on the Unit Loan as such interest becomes due and payable.

26. The Offering Partnership will contribute capital to the Operating Partnership in the amount of $XXXXXXXXXX. The Operating Partnership will issue as sole consideration therefore, OP Units representing a XXXXXXXXXX percent limited partnership interest in the Operating Partnership.

27. Principal will cause a new company, XXXXXXXXXX (hereinafter "Newco"), to be incorporated under the laws of Canada or of a Province. The authorized share capital of Newco will consist of an unlimited number of common shares.

On incorporation, Principal will subscribe for and Newco will issue to Principal, XXXXXXXXXX common shares for aggregate consideration of $XXXXXXXXXX.

28. Canco #3 and Newco will enter into an agreement with the Operating Partnership pursuant to which Newco will manage the day-to-day operations of Asset #1 for a fee. Canco #3 previously agreed to release the key senior employees from their employment contracts so that they could be hired by Operating Partnership. The services of these key senior employees of Canco #3 will be essential to the successful operation of the business of the Operating Partnership. As an inducement to allow the services of these employees to be made available to the Operating Partnership, the Operating Partnership agreed to pay to Canco #3 a fee (the "Incentive Fee") in the amount of $XXXXXXXXXX.

29. Canco #2 will enter into an agreement (the "Loan Liability Agreement") with Canco #3 whereby Canco #2 will agree to assume approximately $XXXXXXXXXX of the indebtedness of Canco #3 (that is $XXXXXXXXXX). Although the creditors of the above-noted debts will accept payments on said indebtedness from Canco #2 in satisfaction of the payments required by Canco #3 under said debts, Canco #3 will remain liable at law to the creditors of Debt XXXXXXXXXX.

In consideration for agreeing to pay the indebtedness of Canco # 3 as outlined immediately above, Canco # 3 will issue a note (the "Canco #3 Note") to Canco # 2 in the amount of $XXXXXXXXXX. The Canco # 3 Note will bear interest (at a rate that is equivalent to the average rate of interest on that portion of Debt XXXXXXXXXX assumed by Canco # 3 and Debts XXXXXXXXXX assumed by Canco # 2).

Canco # 3 will pay a fee (the "Loan Liability Fee") to Canco # 2 in the amount of $XXXXXXXXXX, as consideration for Canco # 2 agreeing to pay the indebtedness described in this paragraph.

30. The Principal Group has obtained independent legal advice to the effect that the entering into the Loan Liability Agreement by Canco # 3 with Canco # 2 under which Canco # 2 will agree to make payments on Canco # 3's behalf, but where the existing loan agreements remain unaltered, will not give rise to a novation in respect of those liabilities.

31. Canco # 2 will enter into the Loan Liability Agreement since it will receive a fee for doing so. Canco # 2 expects the Canco # 3 Note will be paid in full indirectly from the repayment of the Purchase Note issued by the Operating Partnership referred to in paragraph 20 above.

Canco # 3 will enter into the Loan Liability Agreement since, as a result of the combined effects of this agreement and other transactions which will occur as part of the series of transactions described below, Canco # 3 will be able to look to Canco # 2 to repay the $XXXXXXXXXX portion of Debt XXXXXXXXXX, inclusively.

First sources and uses of funds by Canco #3

32. Operating Partnership will use $ XXXXXXXXXX of the funds received from Offering Partnership to repay the Purchase Note ($XXXXXXXXXX), accrued interest on the Purchase Note ($XXXXXXXXXX) and the Incentive Fee ($XXXXXXXXXX) owing to Canco #3. Canco # 3 will use these funds to:

(a) pay the Loan Liability Fee of $XXXXXXXXXX, described in paragraph 29 above, to Canco #2; and

(b) pay the License Amending Fee of $XXXXXXXXXX, described in paragraph 18 above, to Canco #2; and

(c) combine its remaining cash of $XXXXXXXXXX with the $XXXXXXXXXX it will receive from Canco #2 as described in paragraph 36 hereunder to make an interest bearing demand loan, in the amount of $XXXXXXXXXX to Canco #12 (the Canco #3 Loan/ Canco #12 Loan "). Interest on the The Canco # 3/ Canco #12 Loan, will accrue at the prime rate plus XXXXXXXXXX basis points.

The Canco #3/ Canco #12 Loan will be assigned to Canco #2 in exchange for a reduction in Debt XXXXXXXXXX defined in paragraph (ee) above and a reduction in the Canco #3 Note described in paragraph 29 above, resulting in an intercompany amount payable from Canco #2 to Canco #3 (the "Canco #2/Canco #3 IC Amount").

Canco # 3 will agree to pay the above noted fee of $XXXXXXXXXX to Canco # 2 because it expects to earn income on the Canco # 3/ Canco # 12 Loan in excess of such fee.

After the transaction described in this paragraph, Canco #3 will have no funds remaining related to the Proposed Transactions.

Sources and Uses of Funds by Canco #12

33. Canco #12 will now have funds on hand of $XXXXXXXXXX relating to the Proposed Transactions, consisting of the funds received from Canco # 11 and Canco #3, as described in paragraph 32 above.

34. Canco #12 will use a portion of these funds to make a loan (the "Canco #12/Lender #1 Loan") in the amount of $ XXXXXXXXXX to Lender #1. The Canco #12/Lender #1 Loan will have a term of XXXXXXXXXX years and will bear interest, both before and after maturity, from the date of the advance until payment in full is received by Canco #12. The interest rate from the date of the advance until the date that is approximately XXXXXXXXXX months after the date of the advance shall be approximately XXXXXXXXXX% and thereafter will be reset at a rate which is, on such date, equal to the greater of the prime bank rate plus XXXXXXXXXX% and the prescribed rate of interest for the purposes of section 143.2. Interest accruing in any year must be paid by Lender #1 to Canco #12 on or before XXXXXXXXXX of the following year.

Lender # 1 will collateralize interest owing to Canco #12 from the date of closing to XXXXXXXXXX on the Canco #12/Lender # 1 Loan in the amount of $XXXXXXXXXX, which will be included in the income of Canco #12 as it becomes due and payable.

Canco #12 will prepay approximately XXXXXXXXXX interest on the $XXXXXXXXXX note payable to Canco # 2 which will amount to $XXXXXXXXXX.

After the transactions described above in this paragraph, Canco #12 will have $XXXXXXXXXX of funds remaining related to the Proposed Transactions, which will be retained by Canco #12.

Sources and Uses of Funds by Canco #2

35. Canco # 2 will use the $XXXXXXXXXX received from Canco #3 as described in paragraph 32 above, and the $XXXXXXXXXX received from Canco #12 as described in paragraph 34 above to:

(a) repay Canco #3 an amount owing to it of $XXXXXXXXXX under the Canco #2 Rights Agreement as mentioned in (ii)(x) above;

(b) repay Canco #3 an amount of $XXXXXXXXXX owing to it under the Canco #2/Canco #3 IC Amount described in paragraph 32 above; and

(c) a fee of $XXXXXXXXXX to Canco # 3 related to the assignment of the Canco # 3/ Canco #12 loan described in paragraph 31 above.

Second sources and uses of funds by Canco #3

36. Canco #3 will use the $XXXXXXXXXX received from Canco #2 as described in paragraph 35 above to:

(a) repay $XXXXXXXXXX of Debt XXXXXXXXXX;

(b) collateralize $XXXXXXXXXX of dividends, interest and fees related to Debt XXXXXXXXXX due on or about XXXXXXXXXX;

(c) repay amounts owing to Operating Partnership of $XXXXXXXXXX and make a loan of $XXXXXXXXXX to Operating Partnership on or about XXXXXXXXXX; and

(d) pay professional fees of $XXXXXXXXXX.

XXXXXXXXXX

37. XXXXXXXXXX.

PURPOSE OF THE PROPOSED TRANSACTIONS

38. XXXXXXXXXX.

RULINGS GIVEN

Provided that the above description of facts, proposed transactions, purpose of the proposed transaction and other 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. Any amounts received by Canco # 2 or any amounts paid or collateralized by Canco # 2 as a result of the transactions described in paragraphs 29, 32, 34, 35 and 36 of the proposed transactions will be included and considered allowable expenditures or outlays in determining "Excess Cash Flow" as that term is defined in paragraph 93 of the Canco # 2 Ruling.

B. Any amounts received by Canco # 3 or any amounts paid or collateralized by Canco # 3 as a result of the transactions described in paragraphs 28, 29, 32, 35 and 36 of the proposed transactions will be included and considered allowable expenditures or outlays in determining "Excess Cash Flow" as that term is defined in paragraph 87 of the Canco # 3 Ruling.

C. Provided that Canco # 12 has a legal obligation to pay interest on the Canco # 3/ Canco # 12 Loan as described in paragraph 32 above and provided that the Canco # 12/ Lender #1 Loan as described in paragraph 34 above continues to be held for the purpose of gaining or producing income from property (other than income which would be exempt), Canco # 12 will be entitled to deduct, in computing its income for a taxation year, the lesser of the interest paid or payable in respect of that taxation year or a reasonable amount in respect thereof pursuant to paragraph 20(1)(c).

D. Subsection 245(2) will not be applicable as a result of the proposed transactions, in and by themselves, to redetermine the tax consequences confirmed in the rulings given.

COMMENTS

The above rulings are given subject to the general limitations and qualifications set out in Information Circular 70-6R5 (the "Circular") issued by the CCRA on May 17, 2002, and are binding provided the proposed transactions are completed on or before XXXXXXXXXX.

These rulings are based on the Act in its present form and do not take into account the effect of any proposed amendments to the Act.

Nothing in this letter should be construed as implying that CCRA has agreed to or accepted any other tax consequences of the proposed transactions or of related transactions or events that are not described herein.

Yours truly,

XXXXXXXXXX
for Director
Financial Industries Division
Income Tax Rulings Directorate