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: Whether interest is deductible where a loan is transferred from Holdco to Amalco.
Position: Yes
Reasons: Paragraph 21 of IT-533.
XXXXXXXXXX 2004-006195
XXXXXXXXXX, 2004
Re: Advance Income Tax Ruling
XXXXXXXXXX
This is in reply to your letters from XXXXXXXXXX to XXXXXXXXXX, requesting an advance income tax ruling on behalf of the above noted-taxpayer. We also acknowledge the information provided during our various telephone conversations (XXXXXXXXXX).
Unless otherwise stated, all references to a statute are to the Income Tax Act (Canada), R.S.C. 1985, c.1 (5th Supp.), as amended to the date of this letter, (the "Act"). All terms and conditions used herein that are defined in the Act have the meaning given in such definition unless otherwise indicated. More specifically, the expression "adjusted cost base" has the meaning under section 54 and the expressions "taxable Canadian corporation" and "public corporation" have the meaning under subsection 89(1).
Our understanding of the facts, proposed transactions and purpose of the proposed transactions is as follows:
Definitions
Unless otherwise stated, in this letter the following terms and expressions have the meanings specified below:
CRA The Canada Revenue Agency
Aco XXXXXXXXXX
Bco XXXXXXXXXX
Cco XXXXXXXXXX
Dco XXXXXXXXXX
Eco XXXXXXXXXX
Fco XXXXXXXXXX
Gco XXXXXXXXXX
Hco XXXXXXXXXX
Ico XXXXXXXXXX
Jco XXXXXXXXXX
Kco XXXXXXXXXX
Lco XXXXXXXXXX
Mco XXXXXXXXXX
Nco XXXXXXXXXX
Oco XXXXXXXXXX
Amalco XXXXXXXXXX
Facts
History
1. Aco was a taxable Canadian corporation and a public corporation whose shares were traded on the XXXXXXXXXX Stock Exchange.
2. Bco was a taxable Canadian corporation and a wholly owned subsidiary of Aco. Bco was a XXXXXXXXXX which was operated through XXXXXXXXXX separate divisions.
3. Cco was a U.S. corporation and a wholly owned subsidiary of Bco. Cco was a U.S. XXXXXXXXXX essentially the same products as Bco.
4. Dco, a XXXXXXXXXX company, is a world leader in the XXXXXXXXXX with operations throughout the world.
5. In XXXXXXXXXX, Dco offered to purchase all the issued and outstanding shares of Aco from the public for approximately $XXXXXXXXXX.
6. Dco incorporated a wholly owned Canadian corporation, Eco, to purchase the shares of Aco which was capitalized with approximately $XXXXXXXXXX of interest bearing advances from Dco and $XXXXXXXXXX of share capital.
7. On XXXXXXXXXX, Aco and Bco amalgamated and continued under the name of Fco.
8. On XXXXXXXXXX, Fco transferred its XXXXXXXXXX divisions to the following newly incorporated subsidiaries: Gco (XXXXXXXXXX), Hco (XXXXXXXXXX), Ico (XXXXXXXXXX) and Jco (XXXXXXXXXX).
9. On XXXXXXXXXX, under a plan of arrangement, Eco acquired all the issued and outstanding shares of Fco and Eco and Fco were amalgamated and continued on the name of Kco.
10. The permissible assets acquired by Kco on the amalgamation of Fco and Eco were bumped in accordance with paragraph 88(1)(d) by virtue of paragraph 87(11)(b). Accordingly, the adjusted cost base of Gco shares was bumped to their fair market value.
11. On XXXXXXXXXX, Kco sold Hco, Ico, Jco and Cco to Lco, a non-related party, for proceeds of $XXXXXXXXXX.
12. Subsequent to the XXXXXXXXXX sale, Kco performed head office activities and owned all the issued and outstanding shares of Gco. Gco operates an XXXXXXXXXX business across Canada.
13. Subsequent to the XXXXXXXXXX sale, Kco changed its name to Mco and Gco changed its name to Nco.
14. During XXXXXXXXXX, the operations of Mco and Nco were restructured whereby the head office and other functions of Mco were transferred to Nco in an effort to reduce duplication. As a result, for XXXXXXXXXX onward, Mco will not have sufficient income to absorb the interest expense on its long-term debt and advances.
Current situation
15. Mco has a permanent establishment XXXXXXXXXX. Nco has permanent establishments in XXXXXXXXXX. They are both taxable Canadian corporations.
16. Dco owns all XXXXXXXXXX issued and outstanding preferred shares and XXXXXXXXXX issued and outstanding common shares of Mco with a total stated capital of $XXXXXXXXXX.
17. Mco has interest bearing advances from Dco in the amount of approximately $XXXXXXXXXX (as of XXXXXXXXXX) bearing interest at XXXXXXXXXX%, which is presently equal to the current bankers acceptance rate (2.25%) plus XXXXXXXXXX%.
18. Mco owns all XXXXXXXXXX issued and outstanding common shares of Nco having a fair market value of approximately $XXXXXXXXXX , an adjusted cost base of approximately $XXXXXXXXXX (as a result of the bump under 10 above) and nominal paid-up capital.
19. As presented in Mco's financial statements as of XXXXXXXXXX, Mco has:
? assets of approximately $XXXXXXXXXX;
? liabilities of approximately $XXXXXXXXXX; and
? shareholder's equity of approximately $XXXXXXXXXX.
As presented in Nco's financial statements as of XXXXXXXXXX, Nco has:
? assets of approximately $XXXXXXXXXX;
? liabilities of approximately $XXXXXXXXXX; and
? shareholder's equity of approximately $XXXXXXXXXX .
Nco had taxable income of approximately $XXXXXXXXXX for its taxation year ending XXXXXXXXXX. It is expected that for its year ending XXXXXXXXXX, Nco's taxable income will be approximately $XXXXXXXXXX and $XXXXXXXXXX respectively.
20. According to the Vice-President-Treasury, Mco and Nco have XXXXXXXXXX available sources of funds. XXXXXXXXXX .
21. Nco's current loans with Mco are demand loans bearing interest at XXXXXXXXXX % per annum.
Proposed Transactions
22. Mco will incorporate a new wholly owned subsidiary, Oco by subscribing for common shares for nominal consideration.
23. Mco will receive permission from its bank to initiate a $XXXXXXXXXX fund transfer to Oco which will result in Mco going into an overdraft position after the making of the loan described in 24 below.
24. Mco will transfer $XXXXXXXXXX by means of a demand loan (the "Loan") to Oco. The terms of the loan will be as follows: annual interest of XXXXXXXXXX%; interest paid XXXXXXXXXX; XXXXXXXXXX year term; renewable on the agreement of the parties and repayable without penalty on XXXXXXXXXX notice. The XXXXXXXXXX% interest rate is based on Mco's historical intercompany, unsecured financing rate and is consistent with a non-investment grade rate (single or double B rating) which averages between XXXXXXXXXX % and XXXXXXXXXX%.
25. Oco will use the $XXXXXXXXXX dollars of cash received from the Loan to subscribe for $XXXXXXXXXX of common shares of Nco.
26. Nco will use the $XXXXXXXXXX of cash proceeds from the share subscription to purchase for cancellation common shares held by Mco having a fair market value of $XXXXXXXXXX.
27. Mco will use the cash proceeds from the share cancellation of $XXXXXXXXXX to settle its bank overdraft position.
28. Mco will dispose of its remaining common shares of Nco (having a fair market value of $XXXXXXXXXX) to Oco and Oco will issue common shares (having a fair market value of $XXXXXXXXXX) to Nco as consideration for the common shares of Nco. Mco will elect under section 85.
29. Oco and Nco will amalgamate and continue under the name of Amalco.
Purpose of the Proposed Transactions
30. As a result of the restructuring in late XXXXXXXXXX, Mco will no longer earn sufficient income to service its long-term debt and advances. Therefore, the proposed transactions will permit Mco to earn interest income to service its debt financing by leveraging Amalco while providing Amalco with an interest deduction against its operating income.
31. Dco wants to retain Mco as a holding company to facilitate future corporate expansion in Canada, creditor protection and repatriation of funds back to XXXXXXXXXX.
32. Due to the XXXXXXXXXX controlled foreign affiliate rules, Mco is precluded from the direct method of leveraging (i.e. transfer its Nco shares to Oco for a $XXXXXXXXXX interest bearing loan and $XXXXXXXXXX in share consideration). Structuring the transactions by the direct method of leveraging could result in the recognition of a $XXXXXXXXXX gain by Dco for XXXXXXXXXX income tax purposes.
33. Mco and Nco file their corporate income tax returns at the XXXXXXXXXX Taxation Centre and their tax affairs are administered by the XXXXXXXXXX Tax Services Office.
34. To the best of your knowledge and that of Mco, none of the issues involved in this request for an advance income tax ruling is or has been:
(a) considered by a tax services office or taxation centre in connection with a previously filed tax return of Mco or a related person;
(b) under objection by Mco or a related person;
(c) before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has expired;
(d) the subject of a ruling previously issued by the Directorate, to Mco or to a person related to Mco; or
(e) in an earlier return of Mco or a related person.
Ruling Given
Provided that the preceding statements constitute a complete and accurate disclosure of all the relevant facts, proposed transactions and purpose of the proposed transactions, that the transactions are legally effective, that Amalco has a legal obligation to pay interest on the Loan described in 24 above and provided that the transactions are completed as proposed, we rule as follows:
A. To the extent that the amount of interest on the Loan described in 24 above is reasonable in the circumstances, interest paid or payable by Amalco on the Loan will be deductible by Amalco pursuant to subparagraph 20(1)(c)(i) in computing its income for a taxation year provided that the Loan is used by Amalco for the purpose of gaining or producing income (other than income which would be exempt).
This ruling is given subject to the general limitations and qualifications set forth in Information Circular 70-6R5 dated May 17, 2002 issued by the CRA, and is binding provided the proposed transactions are completed by XXXXXXXXXX.
This ruling is based on the Act in its present form and does not take into account the effect of any proposed amendments to the Act.
Nothing in this letter should be construed as implying that the CRA has agreed to or accepted:
(i) the cost or fair market value of any property referred to in this letter;
(ii) the income tax consequences of the application of paragraphs 88(1)(d) or 87(11)(b) as described in 10 above;
(iii) the GST implications of any of the proposed transactions; or
(iv) any other tax consequences of the proposed transactions or of related transactions or events that are not described herein.
Yours truly,
Section Manager
for Division Director
Financial Industries Division
Income Tax Rulings Directorate
Policy and Planning Branch
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