2004 Ruling 2003-0047281R3 - Interest and an amalgamation

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.

Principal Issues: 1) Is interest deductible on a loan used to purchase shares of a Targetco? 2) Is interest deductible by Amalco after sub and target have been amalgamated? 3) Are there any thin cap issues? 4) Is the bump available to Amalco under 88(1)(d)?

Position: 1) Yes 2) YES 3) No 4) YES

Reasons: 1) loan used to acquire property - the shares of the outgoing shareholders 2) See par. 21 IT-533. 3) not a back to back loan 4) property is capital and reading of section 87 and 88.

XXXXXXXXXX 								2003-004728

XXXXXXXXXX, 2004

Dear XXXXXXXXXX:

Re: Advance Income Tax Ruling
XXXXXXXXXX
XXXXXXXXXX

This is in reply to your letters of XXXXXXXXXX and E-mails of XXXXXXXXXX and is further to telephone conversations of XXXXXXXXXX wherein you request an advance income tax ruling on behalf of the above named corporations.

We understand that to the best of your knowledge and that of the taxpayers involved, none of the issues contained in the ruling requested herein is:

(a) in an earlier tax return of the taxpayers or a related persons,

(b) being considered by a Tax Services Office or a Taxation Centre in connection with a tax return already filed by the taxpayers or a related person,

(c) under objection by the taxpayers or a related person,

(d) before the Courts, or if a judgement has been issued, the time limit for appeal to a higher Court has expired, or

(e) the subject of a previous ruling considered by the Income Tax Rulings Directorate.

Unless otherwise stated, all references to a statute are to the Income Tax Act, R.S.C. 1985, c.1 (5th Supp.), as amended to the date of this letter, (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.

Definitions

In this letter, unless otherwise expressly stated, the following terms have the meanings specified:

XXXXXXXXXX;

"Offer" means the offer made by Offeror as described in paragraph 8 below and is further described in the definition of "Support Agreement" below;

"Offeror" means XXXXXXXXXX and is described in paragraph 3 below;

"OfferorSub" means XXXXXXXXXX, a corporation incorporated on XXXXXXXXXX and further described in paragraph 10 below;

"capital property" has the meaning assigned by section 54 of the Act;

"cost amount" has the meaning assigned by subsection 248(1) of the Act;

"depreciable property" has the meaning assigned by subsection 13(21) of the Act;

"Holdco" means XXXXXXXXXX and is described in paragraph 2 below;

"Lock-up Agreements" means the agreements dated XXXXXXXXXX by Parent, Offeror and XXXXXXXXXX as described in paragraph 6 below;

"paid-up capital" has the meaning assigned by subsection 89(1) of the Act;

"Parent" means XXXXXXXXXX and is described in paragraph 1 below;

"private corporation" has the meaning assigned by subsection 89(1) of the Act;

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

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

"Support Agreement" means the agreement entered into on XXXXXXXXXX by Parent, Offeror and Target, which provides, among other things, that Parent will, through Offeror, make an offer to acquire all the of the shares of Target at a price of $XXXXXXXXXX per share;

"Target" means XXXXXXXXXX and is described in paragraph 4 below;

"Target Foreign Subsidiary" means XXXXXXXXXX and is described in paragraph 5 below;

"taxable Canadian corporation" has the meaning assigned by subsection 89(1) of the Act;

"XXXXXXXXXX Treaty" means the Canada-XXXXXXXXXX Tax Convention, as amended.

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

Facts

1. Parent is a publicly held corporation that is listed on the XXXXXXXXXX Stock Exchange and its XXXXXXXXXX are listed on the XXXXXXXXXX Stock Exchange.

The head office of Parent is located at XXXXXXXXXX. Parent is the holding company of a group of companies located in numerous jurisdictions (the "Parent Group")

XXXXXXXXXX.

Parent is not resident in Canada and does not carry on business in Canada for purposes of the Act. Parent is incorporated under the laws of XXXXXXXXXX, and does not have a permanent establishment in Canada as defined under XXXXXXXXXX.

2. Holdco was incorporated under the laws of XXXXXXXXXX. The registered office of Holdco is located at XXXXXXXXXX. Holdco is not a resident of Canada and does not carry on business in Canada for purposes of the Act and does not have a permanent establishment in Canada as defined under XXXXXXXXXX.

Companies in the Parent Group own all the outstanding common shares in Holdco. Prior to the transactions described below, Holdco had no other assets and no other outstanding shares except for those noted in paragraph 3 below.

3. Offeror was incorporated under the XXXXXXXXXX and is an indirect subsidiary wholly-owned corporation of Parent. Subsequent to the transactions described below, Offeror provides certain advisory services to members of the Parent Group. The registered office of Offeror is located at XXXXXXXXXX. Offeror is a private corporation and a taxable Canadian corporation. Offeror has authorized capital of unlimited common shares. Holdco owns all the XXXXXXXXXX outstanding common shares in Offeror. Holdco acquired one share for nominal value from incorporator, Parent. Its remaining shareholdings were acquired on subscription in exchange for $XXXXXXXXXX of cash consideration. Prior to the transactions described below, Offeror had no other assets and no other outstanding shares.

4. Target is a public corporation and a taxable Canadian corporation. Prior to the transactions outlined below, Target had authorized capital consisting of an unlimited number of common shares, first preference shares and second preference shares. The issued and outstanding capital of XXXXXXXXXX common shares is referred to collectively as the "Target Shares". Target represented to Offeror that there were options outstanding issued by Target to purchase XXXXXXXXXX common shares prior to the Offer (as defined below). The Target Shares were traded on the XXXXXXXXXX Stock Exchange ("XXXXXXXXXX"). Subsequent to completion of the offer, Offeror applied to delist the common shares from the XXXXXXXXXX. Target's offices are located at XXXXXXXXXX. Target files its return with XXXXXXXXXX Tax Centre, and is serviced by the XXXXXXXXXX Tax Services Office.

Target is a corporation governed by the XXXXXXXXXX. Target, together with its subsidiaries, are engaged in the XXXXXXXXXX.

5. Target owns all the outstanding shares of Target Foreign Subsidiary. Target Foreign Subsidiary's principal activity is the XXXXXXXXXX. The shares of Target Foreign Subsidiary are capital property of Target.

Target Foreign Subsidiary is not resident in Canada and does not carry on business in Canada for purposes of the Act. Target Foreign Subsidiary is incorporated under the laws of XXXXXXXXXX and does not have a permanent establishment in Canada as defined XXXXXXXXXX.

The XXXXXXXXXX ("XCo"), which owned approximately XXXXXXXXXX % of the outstanding Target Shares (approximately XXXXXXXXXX% on a fully diluted basis) irrevocably agreed to deposit all of the Target Shares it owned to Offeror. XXXXXXXXXX.

6. On XXXXXXXXXX, the Boards of Directors of Parent and Target announced that they had reached agreement whereby Parent would make an offer through Offeror to purchase all of the issued and outstanding common shares of Target at a price of $XXXXXXXXXX per share in cash for an aggregate consideration of $XXXXXXXXXX. The acquisition would be financed out of Parent's existing cash resources.

The offer represented a XXXXXXXXXX per cent premium over Target's closing share price of $XXXXXXXXXX on the XXXXXXXXXX on XXXXXXXXXX and a XXXXXXXXXX per cent premium over Target's XXXXXXXXXX-day volume weighted average share price of $XXXXXXXXXX.

7. On XXXXXXXXXX, Offeror made the Offer. The Offer expired at XXXXXXXXXX on XXXXXXXXXX, at which time approximately XXXXXXXXXX% of the outstanding Target Shares had been tendered to the Offer and not withdrawn. In accordance with the Offer, the tendered shares would be taken up and paid by Offeror not later than XXXXXXXXXX days after the expiry time.

XXXXXXXXXX

9. Holdco made two separate loans (Loan A and Loan B), for an aggregate amount of approximately $XXXXXXXXXX to Offeror. Loan A and Loan B bear interest at rates at Canadian Prime Rates plus XXXXXXXXXX% which is equal to commercial market rate applicable for such loans. Parent has provided a guarantee to Offeror in respect of Loan B. Offeror will pay Parent a guarantee fee of XXXXXXXXXX%. Offeror used the funds provided by the share subscription from Holdco and the proceeds of Loan A and Loan B to acquire the Target Shares under the Offer. Target loaned its excess cash to Parent on a short-term basis.

10. Offeror has incorporated a new Canadian corporation ("OfferorSub") under the XXXXXXXXXX. OfferorSub is a private corporation. OfferorSub was incorporated for a nominal amount. Its taxation year will be XXXXXXXXXX.

Proposed Transactions

11. Target will elect in a prescribed manner not to be a public corporation.

12. OfferorSub will purchase the common shares of Target, held by Offeror in exchange for promissory notes Loan A1, Loan B1 and Loan C and the issuance of a common share of OfferorSub. Offeror and OfferorSub will jointly elect in prescribed form within the time limits referred to in subsection 85(6) of the Act to have the provisions of subsection 85(1) of the Act apply to the purchase of the Target Common Shares. The total consideration paid to Offeror will be equal to the fair market value of the Target shares at that time. Loan A1 and Loan B1 will have the same principal as Loan A and Loan B respectively and will bear interest at rates equal to the commercial market rate applicable for such a loan and sufficient to equal Offeror's cost of borrowing in respect of Loan A and Loan B, i.e., the Canadian Prime Rate plus XXXXXXXXXX% and Canadian Prime Rate plus XXXXXXXXXX% respectively. The principal amount of Loan C will be equal to the fair market value of the Target Shares less Loan A1 and Loan B1. Loan C will bear interest at the Canadian Prime Rate plus XXXXXXXXXX% and be convertible into common shares of OfferorSub at the discretion of Offeror.

13. OfferorSub will immediately amalgamate with Target to form Amalco (the "Amalgamation").

14. In its tax return for the first taxation year immediately following the Amalgamation, Amalco will designate, pursuant to paragraph 88(1)(d) of the Act, in respect of each of the shares of the Target Foreign Subsidiary and any other capital property (that is not depreciable property) acquired by it on the Amalgamation (and owned by Amalco at the time that Offeror acquired control of Target), an amount not exceeding the amount by which the fair market value of each such property at the time Offeror acquired control of Target exceeds the cost amount of such property to target immediately before the Amalgamation.

Further, the total of the amounts so designated by Amalco will not exceed (i) the total of the adjusted cost base to OfferorSub of the common shares of Target owned by OfferorSub immediately before the Amalgamation, less (ii) the amount by which (A) the total of the costs amounts to Target of all property owned by it immediately before the Amalgamation plus any money of Target on hand immediately before the Amalgamation, exceeds the total of (B) the total of the debts owing by Target, or of any other obligation of Target to pay any amount, that was outstanding immediately before the Amalgamation, and (C) the amount of any reserve (other than those excepted in clause 88(1)(d)(i)(C) of the Act) deducted in computing the income of Target for its taxation year ending immediately before the Amalgamation less (iii) amounts as determined by subparagraph 88(1)(d)(i.1) of the Act.

15. Amalco will immediately transfer the shares of the Target Foreign Subsidiary to a subsidiary wholly-owned corporation of Parent at fair market value for cash consideration.

16. Once Offeror has earned enough interest income to equal the interest expense incurred prior to selling Target to OfferorSub, Offeror will exercise its conversion rights on Loan C and convert Loan C into common shares of Amalco.

17. No property distributed to Amalco on the Amalgamation, or any other property acquired by any person in substitution therefor, will be acquired by a person or persons described in subclauses 88(1)(c)(vi)(B)(I), (II) or (III) of the Act.

Purposes of the Proposed Transactions

The purposes of the proposed transactions are to consolidate profit and losses within a related group by enabling Offeror to earn sufficient interest income on loans received to acquire Target in order to eliminate losses that it would otherwise incur on the acquisition debt. Effectively the proposed transactions permit the application of interest charges with respect to Target debt against income of Target and permits Parent to reorganize its corporate structure in a more efficient manner following the acquisition of Target.

Rulings Given

Provided that the preceding statements constitute a complete and accurate disclosure of all relevant facts, proposed transactions and purposes of the proposed transactions, and provided the transactions are completed as proposed, we rule as follows:

A. Subsection 18(6) of the Act will not be applied to deem the Loan A1, Loan B1, or Loan C (as described in paragraph 12) to be a debt incurred by OfferorSub to Holdco.

B. Provided Offeror has a legal obligation to pay interest on each of Loan A and Loan B, Offeror will be entitled to deduct pursuant to paragraph 20(1)(c) of the Act in computing its income for a taxation year, the lesser of the interest payable in respect of that year, or a reasonable amount in respect thereof.

C. Provided that Amalco has a legal obligation to pay interest on each of Loan A1, Loan B1, and loan C, Amalco will be entitled to deduct pursuant to paragraph 20(1)(c) of the Act, in computing its income for a taxation year, the lesser of the interest payable in respect of that year or a reasonable amount in respect thereof.

D. Provided that no property acquired by Amalco on the Amalgamation as described in paragraph 13 above, or any other property acquired by any person in substitution therefor (within the meaning of that phrase for the purposes of clause 88(1)(c)(vi)(B) of the Act) is acquired by any person described in any of subclauses 88(1)(c)(vi) (B)(I), (II) or (III) of the Act (on the assumption that the "subsidiary" referred to in those subclauses is Target and the "parent" is OfferorSub) as part of the series of transactions or events that includes the acquisition of control of Target by Offeror, the cost to Amalco of each property owned by Target at the time Offeror acquired control of Target and that became property of Amalco by virtue of the Amalgamation will be deemed by paragraph 88(1)(c) of the Act to be the cost amount of such property plus, on the assumption that such property is capital, but not depreciable property, the amount designated by Amalco under paragraph 88(1)(d) of the Act in respect of the property as described in paragraph 14 above.

E. Subsection 245(2) of the Act will not be applied, as a result of the Proposed Transactions, in and of themselves, to redetermine the tax consequences as described in the rulings given.

These rulings are given subject to the general limitations and qualifications set out in Information Circular 70-6R5, dated May 17, 2002, and are binding on the CRA provided the proposed transactions are completed by XXXXXXXXXX.

These rulings are based on the Act as it currently reads and do not take into account any future amendments, whether currently proposed or not, to the Act.

Yours truly,

XXXXXXXXXX
For Director
Financial Industries Division
Income Tax Rulings Directorate
Policy and Planning Branch