2005 Ruling 2005-0130541R3 - Participating Interest

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: Can the Additional Interest paid or payable be deducted under paragraph 20(1)(c) provided it does not exceed a reasonable amount?

Position: YES

Reasons: IT-533, par 2 - not an equity investment.

XXXXXXXXXX
							2005-013054

XXXXXXXXXX, 2005

Dear XXXXXXXXXX:

Re: Advance Income Tax Ruling
XXXXXXXXXX
XXXXXXXXXX

This is in reply to your letter of XXXXXXXXXX and further to our electronic messages of XXXXXXXXXX wherein you request an advance income tax ruling on behalf of the above named taxpayers.

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

(i) in a return of the taxpayer or related persons;

(ii) being considered by a tax services office or taxation centre in connection with a previously filed tax return of the taxpayer or related persons;

(iii) under objection by the taxpayer or a related person;

(iv) before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has expired; or

(v) the subject of a ruling previously issued by the Income Tax Rulings and Interpretation Directorate of the CRA.

To the best of the knowledge of the taxpayer, the Proposed Transactions will not have any impact on outstanding tax liabilities, if any, of the taxpayer.

Unless otherwise stated, all statutory references are to the Income Tax Act (Canada), R.S.C. 1985 (5th Supp.), c.l, as amended to the date of this letter (the "Act"). Throughout this letter, the singular should be read as plural and vice versa where the circumstances so require.

DEFINITIONS

In this letter, the following terms are defined as follows:

(a) "A Co" means XXXXXXXXXX;

(b) "A Co Shareholder" means a beneficial owner of one or more A Co common shares but does not include a XXXXXXXXXX;

(c) XXXXXXXXXX;

(d) "ACB" means adjusted cost base and has the meaning assigned by section 54 of the Act;

(e) "AcquisitionCo" means XXXXXXXXXX, a Taxable Canadian Corporation incorporated under the XXXXXXXXXX , all of the shares of which are held by LP;

(f) "Additional Interest" will be payable annually by the Debtor and will be equal to the lesser of a specific percentage amount of the outstanding principal amount of the Debt, currently estimated to be XXXXXXXXXX% per annum (being an amount intended to increase the effective interest rate on the Debt to the prevailing market rate of interest for comparable debt), and an amount equal to the taxable income of the Debtor minus $XXXXXXXXXX calculated without regard to the Additional Interest component;

(g) XXXXXXXXXX;

(h) "Base Interest" means interest at a fixed rate, currently estimated to be XXXXXXXXXX% per annum, of the outstanding principal amount of the Debt that will be payable annually by the Debtor;

(i) "Combination" means the proposed combination into one corporation, (XXXXXXXXXX) of all assets and liabilities of AcquisitionCo, A Co, the XXXXXXXXXX and the subsidiaries by way of the amalgamation of such corporations under subsection 87(1) of the Act;

(j) "CombinationCo" means the corporation that will be created as a result of the amalgamation of AcquisitionCo, A Co, the XXXXXXXXXX and the subsidiaries;

(k) "CRA" means the Canada Revenue Agency;

(l) "Debt" means the debt to be issued by AcquisitionCo to LP as outlined in the Proposed Transactions, the terms and conditions of which will include interest at a maximum rate, currently estimated to be XXXXXXXXXX% per annum, payable annually and comprised of (i) Base Interest, and (ii) Additional Interest; with any Interest that has become payable but has not been paid within a specified period of time being added to the principal amount of the Debt then outstanding;

(m) "Debtor" means the debtor under the Debt, which initially will be AcquisitionCo and as more fully outlined under the Proposed Transactions, will be CombinationCo when certain corporations are amalgamated with AcquisitionCo;

(n) "FMV" means fair market value;

(o) "GAAR" means the general anti-avoidance rule under section 245 of the Act;

(p) "GPCo" means a Taxable Canadian Corporation incorporated under the XXXXXXXXXX to function as administrator of the MFT and the Trust, the general partner of LP, and whose share capital is wholly-owned by the MFT;

(q) "XXXXXXXXXX" means a Taxable Canadian Corporation incorporated under the XXXXXXXXXX, all or substantially all of the assets of which will be common shares of XXXXXXXXXX;

(r) "XXXXXXXXXX" means a person that beneficially owns one or more XXXXXXXXXX;

(s) "XXXXXXXXXX" means shares in the capital of XXXXXXXXXX;

(t) "Indenture" means the declaration of trust to be made by the trustee of the Trust to, among other things, hold in trust any and all property of the Trust and any income and gains therefrom for the benefit of the beneficiary of the Trust;

(u) "Interest" means the interest payable in respect of the principal amount owing under the Debt from time to time, comprised of the Base Interest plus the Additional Interest;

(v) "LP" means a limited partnership formed under the XXXXXXXXXX pursuant to the LP Agreement;

(w) "LP Agreement" means the written partnership agreement entered into between GPCo, as general partner, and the Trust as limited partner of the LP;

(x) "LP Unit" means an interest in the LP's capital issued pursuant to the terms of the LP Agreement;

(y) "mutual fund trust" has the meaning assigned by subsection 132(6);

(z) "MFT" means a mutual fund trust created and governed under the laws of the Province of XXXXXXXXXX and formed pursuant to the MFT Indenture;

(aa) "MFT Indenture" means the declaration of trust made by the trustee of MFT to, among others, hold in trust any and all property of the MFT and any income and gains therefrom, for the benefit of the MFT Unitholders;

(bb) "MFT Unitholder" means a holder of a MFT Unit;

(cc) "MFT Unit" means a trust unit of MFT, each such unit representing an equal fractional undivided beneficial interest in any distributions from the MFT and in any net assets of the MFT in the event of termination of the MFT;

(dd) "XXXXXXXXXX Partnership" means a partnership formed under the XXXXXXXXXX pursuant to a written partnership agreement having a PartnerCo and one or more subsidiaries as its only partners;

(ee) "Option" means an option to acquire an A Co common share pursuant to an agreement as contemplated under subsection 7(1) of the Act;

(ff) "PartnerCos" means those Taxable Canadian Corporations, each of which is wholly-owned indirectly by MFT, that hold an interest in one or more of the XXXXXXXXXX Partnerships and that will remain as separate corporations holding such direct interest in one or more of the XXXXXXXXXX Partnerships after the Combination;

(gg) "Proposed Transactions" means those transactions and events described in paragraphs 13 to 17;

(hh) "Public Corporation" has the meaning assigned by subsection 89(1) of the Act;

(ii) "XXXXXXXXXX " means those Taxable Canadian Corporations formed under the XXXXXXXXXX that are either wholly-owned by A Co or another subsidiary;

(jj) "Taxable Canadian Corporation" has the meaning assigned by subsection 89(1) of the Act;

(kk) "Trust" means an inter vivos trust for purposes of the Act, to be created and governed under the laws of the Province of XXXXXXXXXX, the sole beneficiary of which will be the MFT;

(ll) "Trust Note" means a promissory note evidencing a debt obligation issued by the trustee of Trust in accordance with the Trust Indenture; and

(mm) XXXXXXXXXX.

FACTS

1. A Co is an XXXXXXXXXX incorporated company, is a Taxable Canadian Corporation and a Public Corporation.

2. A Co common shares are listed on the XXXXXXXXXX.

3. A Co had XXXXXXXXXX Options to acquire A Co common shares outstanding as of XXXXXXXXXX.

4. A Co had approximately XXXXXXXXXX common shares outstanding as at XXXXXXXXXX. A Co does not anticipate issuing any more common shares prior to the Proposed Transactions herein, other than pursuant to Options which may be exercised.

5. A Co, the subsidiaries and the XXXXXXXXXX Partnerships, together carry on a XXXXXXXXXX services business, primarily in Canada. Substantially all of the assets used to carry on such businesses will be held by the XXXXXXXXXX Partnerships.

6. No new equity capital will be raised as part of the Proposed Transactions.

7. The amount of the Interest will be reasonable in the circumstances and an investment banker has provided such an opinion.

8. For financial statement purposes, any Interest that is paid or becomes payable in a year pursuant to the terms of the Debt will be recorded as an expense and any amount of Interest that has become payable but has not been paid in a fiscal period will be accrued as a liability of the Debtor.

9. MFT was established in accordance with the terms of the Indenture and will qualify as a mutual fund trust under subsection 132(6) of the Act.

10. MFT incorporated GPCo and subscribed for XXXXXXXXXX common shares in the capital of GPCo for $XXXXXXXXXX.

11. The Trust was established in accordance with the terms of the Indenture.

12. LP was formed by way of execution of the LP Agreement and contribution of $XXXXXXXXXX by each of GPCo and the Trust in consideration of LP Units.

PROPOSED TRANSACTIONS

13. Pursuant to a plan of arrangement, the following transactions will be undertaken:

(a) holders of Options that have given appropriate notice will exercise their Options and will be issued A Co common shares from treasury;

(b) MFT will issue MFT Units to the Trust in exchange for the Trust Note with a principal amount equal to the FMV of the MFT Units issued to the Trust;

(c) The Trust will sell the MFT Units acquired in paragraph 13(b) to LP in exchange for additional LP Units; and

(d) A Co Shareholders and XXXXXXXXXX will transfer to LP their A Co common shares and XXXXXXXXXX, respectively, in exchange for MFT Units, or if appropriate notification is made, a combination of MFT Units and LP Units. As a result, LP will become the sole shareholder of each XXXXXXXXXX and LP together with the XXXXXXXXXX will own all of the issued and outstanding A Co common shares. An election will be filed under subsection 97(2) and 96(4) of the Act by those transferors who provide appropriate notice of their desire to receive LP Units with the result that their particular transfer will occur on a tax-deferred basis to the extent permitted under those provisions.

14. LP will sell it's A Co common shares and XXXXXXXXXX to AcquisitionCo in exchange for the Debt and additional AcquisitionCo common shares. An election will be filed as contemplated under subsections 85(1), (2) and (6) of the Act with the result that this transfer will occur on a tax-deferred basis. It is currently estimated that the principal amount of the Debt will be in the range of $XXXXXXXXXX to $XXXXXXXXXX.

15. In order to properly align business assets, the subsidiaries will transfer all or substantially all of their directly held business assets to the XXXXXXXXXX Partnerships.

16. The Combination will occur and the Debt will become the Debt of CombinationCo.

17. To manage certain XXXXXXXXXX issues, certain of the subsidiaries will not transfer certain of their assets to the XXXXXXXXXX Partnerships on XXXXXXXXXX as part of the plan of arrangement but will transfer such assets to the XXXXXXXXXX Partnerships after XXXXXXXXXX and before XXXXXXXXXX once all the desired XXXXXXXXXX are established in the particular XXXXXXXXXX Partnership. After such transfer, the subsidiaries that are not amalgamated pursuant to the plan of arrangement will be wound-up or amalgamated into or with CombinationCo on or before XXXXXXXXXX.

PURPOSE OF PROPOSED TRANSACTIONS

The purpose of the Proposed Transactions is to convert A Co into a mutual fund trust.

RULINGS GIVEN

Provided that the preceding statements constitute complete and accurate disclosure of all the relevant facts, proposed transactions and purpose of the proposed transactions, and provided that the proposed transactions are completed in the manner described above, we rule as follows:

A. Provided that the Debtor continues to have a legal obligation to pay the Debt and the Debt continues to be held for the purpose of gaining or producing income from the property or for the purpose of gaining or producing income from a business, the Base Interest paid or payable annually by the Debtor will be deductible by the Debtor as interest under paragraph 20(1)(c) of the Act to the extent such amount does not exceed a reasonable amount.

B. Provided the Debt continues to be held for the purpose of gaining or producing income from the property or for the purpose of gaining or producing income from a business, the Additional Interest paid or payable by the Debtor in respect of a particular taxation year will be deductible by the Debtor under subparagraph 20(1)(c)(ii) of the Act to the extent such amount does not exceed a reasonable amount.

C. Subsection 245(2) of the Act will not be applied to the Proposed Transactions, in and by themselves, to re-determine the tax consequences confirmed in the rulings given.

These rulings are given subject to the general limitations and qualifications set forth in Information Circular 70-6R5 dated May 17, 2002 issued by the CRA, and are binding 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.

Nothing in this letter should be construed as implying that the CRA has agreed to or accepted:

(i) the GST implications of any of the proposed transactions;

(ii) 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 Sector and Exempt Entities Division
Income Tax Rulings Directorate
Policy and Planning Branch