2005 Ruling 2005-0133281R3 - License Amortization and Financing Fees

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: License Agreement for 30 years for completing project

Position: Acceptable

Reasons: Given before in 2004-0105611

XXXXXXXXXX
2005-013328

XXXXXXXXXX, 2005

Dear XXXXXXXXXX:

Re: Advance Income Tax Ruling
XXXXXXXXXX
XXXXXXXXXX

This is in response to your letter of XXXXXXXXXX and further to your revision of XXXXXXXXXX, wherein you requested an advance income tax ruling in respect of the above named taxpayers.

To the best of your knowledge and that of the Partnership and its members none of the issues involved in the requested Ruling:

(i) is in an earlier return of the Partnership, its members or a related person;

(ii) is being considered by a tax services office or taxation centre in connection with a previously filed tax return of the Partnership, its members or a related person;

(iii) is under objection by the Partnership, its members or a related person;

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

(v) is the subject of a ruling previously issued by the Directorate.

DEFINITIONS

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

(a) "Act" means the Income Tax Act, R.S.C. 1985 (5th Suppl.) c.1, as amended to the date thereof. All statutory references in this letter are to the Act unless otherwise stated;

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

(c) "Concession Agreement" is the agreement referred to in paragraph 6 to be entered into by the Partnership and the Province and the Entity;

(d) "Construction Period" is the period that will begin when the Concession Agreement is entered into and will end when the Substantial Completion of the Facility is achieved. The construction of the Facility is expected to last for a period of approximately XXXXXXXXXX years;

(e) "Contract Period" is the period that includes the Construction Period and the Operating Period and is expected to last for a period of XXXXXXXXXX years;

(f) "Contractor" means the joint venture between XXXXXXXXXX (a wholly-owned subsidiary of Z Co) and XXXXXXXXXX that will design and build the Project under an EPC Contract with the Partnership;

(g) "CRA" means Canada Revenue Agency;

(h) "Entity " is the XXXXXXXXXX;

(i) "EPC Contract" means the engineering, procurement and construction contract between the Partnership and the Contractor;

(j) "Facility" is the proposed XXXXXXXXXX;

(k) "GP" is XXXXXXXXXX;

(l) "Licence" is the non-exclusive licence that the Province will grant to the Partnership, pursuant to the Concession Agreement, to provide the Partnership with rights of use and access to the Site and the Facility, for the purposes of constructing the Facility and providing services during the Operating Period;

(m) "Loan Agreement" is the agreement between XXXXXXXXXX and XXXXXXXXXX (collectively the "Lenders"), the Partnership, and GP pursuant to which the Lenders will make a loan to the Partnership;

(n) "Operating Period" is the part of the Contract Period that begins immediately after the Construction Period and ends at the end of the Contract Period;

(o) "Partnership" is a limited partnership formed under the laws of XXXXXXXXXX called the XXXXXXXXXX, with Z Co as the limited partner and XXXXXXXXXX as the general partner;

(p) "Project" is the XXXXXXXXXX;

(q) "Province" is the Province of XXXXXXXXXX;

(r) "Site" is the land on which the Facility will be constructed;

(s) "Substantial Completion" means the substantial completion of the construction of the Facility as outlined in the Concession Agreement;

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

(u) "TSO" means Tax Services Office; and

(v) "Z Co" is XXXXXXXXXX.

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

FACTS

1. The Project is a public-private partnership, which involves XXXXXXXXXX. The aggregate cost of the project will be approximately $XXXXXXXXXX to $XXXXXXXXXX.

2. The Partnership was formed on XXXXXXXXXX under the XXXXXXXXXX Partnership Act as a limited partnership pursuant to a limited partnership agreement. The limited partner of the Partnership is Z Co and the general partner of the Partnership is GP (from time to time, the "Partners" or a "Partner"). It is contemplated that additional Canadian corporations may be admitted as limited partners before the closing date of the transaction.

3. Z Co is a taxable Canadian corporation that files its tax returns in the XXXXXXXXXX Tax Services Office and its business number is XXXXXXXXXX.

4. GP is a taxable Canadian corporation that was incorporated under the XXXXXXXXXX Business Corporations Act on XXXXXXXXXX . The shares of GP are legally and beneficially owned by XXXXXXXXXX, a corporation incorporated under the Canada Business Corporations Act on XXXXXXXXXX . Z Co owns all of the shares of XXXXXXXXXX.

PROPOSED TRANSACTIONS

5. The total Contract Period is expected to last for XXXXXXXXXX years. There will be two separate periods in the Contract Period. The first period is the Construction Period that includes the XXXXXXXXXX. The Construction Period ends once a certificate is issued that Substantial Completion has occurred. The second period is the Operating Period and this period starts immediately after Substantial Completion and runs to the end of the Contract Period. During the Operating Period the Partnership will be responsible for maintaining the Facility.

6. The Partnership will enter into the Concession Agreement with the Province and the Entity. The Concession Agreement will set out the obligations of the Province, the Entity and the Partnership during the Construction Period and the Operating Period.

7. The Partnership will not acquire an interest in the Site or the Facility. The Concession Agreement specifically provides that the Licence will not be construed as granting any legal estate or other interest in land to the Partnership. XXXXXXXXXX.

8. The Province will be the owner of the Facility at the end of the Construction Period.

9. The Partnership will be responsible for XXXXXXXXXX, and maintaining the Facility throughout the Operating Period, all in accordance with the requirements set out in the Concession Agreement. The Partnership will be required to finance all of the above activities at its own cost and risk. The Partnership will agree to be liable for any defects that may be found during the Operating Period.

10. The Province will grant the Licence to the Partnership. The period for the Licence will start when the Concession Agreement is entered into and will terminate at the end of the Contract Period. The Licence will be a non-exclusive licence that will grant the Partnership access to the Site and adjacent areas for the purposes of constructing the Facility and providing services during the Operating Period. In return for the grant of the Licence the Partnership will agree to construct the Facility and provide the services during the Operating Period.

11. It is anticipated that the costs incurred by the Partnership in respect of the Licence during the Construction Period will be approximately $XXXXXXXXXX to $XXXXXXXXXX. The costs will include the costs of constructing the Facility (including construction costs of materials, labour and equipment as required under the Concession Agreement) XXXXXXXXXX. The cost of the Licence will also include the Partnership's costs incurred during the Operating Period to the extent that the costs relate to any variations to the construction of the Facility previously agreed to by the Partnership and the Province and any costs incurred to repair any defects in the construction of the Facility that are capital expenditures.

12. For the purposes of apportioning the capital cost of the Licence over the remaining period of the Licence in accordance with paragraph 1100(1)(c) of the Regulations, the Partnership will aggregate its total costs incurred on the Licence on a quarterly basis and amortize that quarterly amount over the remaining period of the Licence.

13. The Province and/or the Entity owns or has rights to the real property interests on which the Project will be constructed. The Province and/or the Entity will license the use of the real property interests to the Partnership for the purpose of building and operating the Project. Ownership of the fixed assets and improvements will remain with the Province. The Partnership will enter into an EPC Contract with the Contractor.

14. During the Contract Period the Partnership will construct and operate the Project and the Province will pay the Partnership performance based payments during the Operating Period, which will be based on a formula contained in the Concession Agreement.

15. Pursuant to the Loan Agreement, the Partnership will borrow the funds it needs to finance the Project from the Lenders on normal commercial terms.

16. The loan will be drawn down over the Availability Period defined in the Loan Agreement and will be repaid on the terms set out in the Loan Agreement.

PURPOSE OF THE PROPOSED TRANSACTIONS

17. The purpose of the proposed transactions is to enable the Partnership to XXXXXXXXXX during the Construction Period and to XXXXXXXXXX during the Operating Period.

18. The Partnership will acquire the Licence, which will enable it to complete the Project, in accordance with the terms of the Concession Agreement, and to receive the performance based payments during the Operating Period.

19. The Proposed Transactions will enable the Province to acquire the Facility at the end of the Construction Period and have the Facility maintained during the Operating Period by the Partnership. XXXXXXXXXX.

RULINGS GIVEN

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

A. The Licence granted to the Partnership will be included in Class 14 of Schedule II of the Regulations.

B. For the purposes of the definition of undepreciated capital cost in subsection 13(21) of the Act, paragraph 20(1)(a) of the Act and paragraph 1100(1)(c) of the Regulations, the capital cost of the Licence will include the total of the costs incurred by the Partnership in respect of the Licence, as described in paragraph 10, 11 and 12 above.

C. For the purposes of paragraph 20(1)(a) of the Act, the capital cost of the Licence, as determined in the manner described in paragraph 11 and 12 above, will be deductible by the Partnership in accordance with the provisions of paragraph 1100(1)(c) of the Regulations.

D. Paragraphs 18(1)(a) and 18(1)(b) of the Act will not apply to deny the Partnership a deduction for all outlays and expenses incurred by the Partnership for the maintenance and repairs to the Facility, provided such outlays and expenses are incurred to satisfy the requirements of the Concession Agreement and are not capital expenditures described in Ruling B above.

E. By virtue of subsection 13(26) of the Act, and in applying the definition of undepreciated capital cost in subsection 13(21) for the purposes of paragraph 20(1)(a) and any of the Regulations made for the purposes of paragraph 20(1)(a) of the Act, in computing the Partnership's income for a taxation year, no amount shall be included in calculating the undepreciated capital cost of the Licence before the time the Licence is considered to have become available for use by the Partnership.

F. For the purposes of subsection 13(26) of the Act, the Licence will be considered to have become available for use, pursuant to subsection 13(27) of the Act at the earlier of:

i. the beginning of the Operating Period, and

ii. the time that is immediately after the beginning of the first taxation year of the Partnership that begins more than XXXXXXXXXX days after the end of the taxation year of the Partnership in which the costs in respect of the Licence are incurred.

G. Since the Partnership will not be entitled to, and provided the Partnership does not actually receive, any portion of the performance based payments, as described in paragraph 14 above, no amount will be included in determining the profit of the Partnership under section 9 or paragraph 12(1)(b) of the Act during or at the end of the Construction Period. During the Operating Period, the Partnership will include the performance-based payments in income in a taxation year in accordance with section 9 and paragraph 12(1)(b) of the Act.

H. Provided that the Partnership has a legal obligation to pay interest on the Loan, the Partnership will, to the extent that the interest is reasonable, be entitled to deduct, in a taxation year, the interest paid or payable (depending on the method regularly followed by the Partnership in computing its income) on the Loan in the taxation year, pursuant to paragraph 20(1)(c) of the Act.

I. The financing costs incurred by the Partnership in the course of borrowing the Loan will, to the extent such financing costs are reasonable in the circumstances, be deductible by the Partnership in accordance with paragraph 20(1)(e) of the Act.

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 Loan Agreement is entered into 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.

COMMENTS

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