2005 Ruling 2005-0149491R3 - Shareholder Loan and Deemed Interest Income

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. Does subsection 15(2) of the Act apply to the loan from Canadian Sub to FFC? 2. Does subsection 17(1) of the Act apply to the loan (s) payable to FFC by the European subsidiay(ies) of Foreign Parent?

Position: 1. No. 2. To a portion of the loan.

Reasons: 1. Canadian Sub and FFC are not connected by virtue of paragraph 15(2.1)(a) of the Act. 2. Subsection 17(1) of the Act applies to deem the European subsidiary(ies) to owe Canadian Sub an amount equal to that portion of the loan(s) payable by the European subsidiary(ies) to FFC that became owing to FFC because of Canadian Sub's transfer of property to FFC on the acquisition of the shares of FFC.

XXXXXXXXXX 									2005-014949

XXXXXXXXXX, 2005

Dear XXXXXXXXXX:

Re: XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
Advance Income Tax Ruling

This is in response to your XXXXXXXXXX request for an advance income tax ruling on behalf of the above taxpayers. We acknowledge receipt of the additional information provided to us during our XXXXXXXXXX

Unless otherwise stated, all references to a statute are to the Income Tax Act R.S.C. 1985 (5th Supplement), c.1, as amended, (the "Act") to the date of this advance income tax ruling and all terms and conditions used herein that are defined in the Act have the meaning given in such definitions.

Unless otherwise stated, all references to currency are to Canadian dollars.

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

Definitions

(a) "Foreign Parent" is XXXXXXXXXX;

(b) "Canadian Parent" is XXXXXXXXXX.;

(c) "Canadian Sub" is XXXXXXXXXX.;

(d) "FFC" is XXXXXXXXXX;

(e) "Foreign Stock Exchanges" is the XXXXXXXXXX;

(f) "Foreign Jurisdiction" is the XXXXXXXXXX;

(g) "Foreign Tax Authority" is the XXXXXXXXXX tax authority;

(h) "Acquisition Date" is XXXXXXXXXX;

(i) "Province" is a reference to XXXXXXXXXX;

(j) "depreciable property" and "undepreciated capital cost" have the meaning assigned by subsection 13(21) of the Act;

(k) "financial institution" and "long term debt" have the meaning assigned by subsection 181(1) of the Act;

(l) "foreign affiliate" has the meaning assigned by subsection 95(1) of the Act;

(m) "paid-up capital" and "taxable Canadian corporation" have the meaning assigned by subsection 89(1) of the Act;

(n) "non-capital loss" has the meaning assigned by subsection 111(8) of the Act; and

(o) "taxation year" has the meaning assigned by subsection 249(1) of the Act.

Facts

1. Foreign Parent is a multinational corporation and is XXXXXXXXXX. The shares of Foreign Parent trade on the Foreign Stock Exchanges. Foreign Parent is not resident in Canada for the purposes of the Act.

2. Canadian Parent is a taxable Canadian corporation. The Foreign Parent owns all of the issued and outstanding shares of Canadian Parent, which consists of XXXXXXXXXX common shares. The paid-up capital of these shares is $XXXXXXXXXX ($XXXXXXXXXX per share). Canadian Parent was incorporated by Foreign Parent to acquire all of the issued and outstanding shares of Canadian Sub on the Acquisition date.

3. Canadian Sub is a taxable Canadian corporation. The Canadian Parent owns all XXXXXXXXXX of the issued and outstanding common shares, all XXXXXXXXXX of the issued and outstanding Class C preferred shares and all XXXXXXXXXX of the issued and outstanding Class F preferred shares, being all of the issued and outstanding shares, of Canadian Sub. Canadian Sub operates a XXXXXXXXXX in the Province.

4. Both Canadian Parent and Canadian Sub have incurred significant non-capital losses in the period subsequent to the Acquisition Date. As of XXXXXXXXXX, Canadian Sub has incurred post acquisition losses in the amount of approximately $XXXXXXXXXX and Canadian Parent has reported post-acquisition losses in the amount of $XXXXXXXXXX. The magnitude of these losses is the result of a XXXXXXXXXX.

5. As of XXXXXXXXXX, Canadian Sub has undepreciated capital cost in its various classes of assets totalling $XXXXXXXXXX and federal investment tax credit carryovers of $XXXXXXXXXX. Subsection 111(5.1) of the Act did not apply to the depreciable property acquired on the Acquisition Date.

6. FFC is a company resident in the Foreign Jurisdiction and not resident in Canada for purposes of the Act. Both of the board of directors and the management personnel of FFC are located outside of Canada. FFC does not carry on business through a permanent establishment in Canada. FFC is not a financial institution. Foreign Parent currently owns all of the issued and outstanding shares of FFC.

7. Canadian Parent's Business Number is XXXXXXXXXX and Canadian Sub's Business Number is XXXXXXXXXX. Canadian Parent and Canadian Sub file their tax returns with the XXXXXXXXXX Tax Centre and deal with the XXXXXXXXXX Tax Services Office.

8. We understand that, to the best of your knowledge and that of the above taxpayers, none of the issues involved in the ruling request:

(i) is in an earlier return of the taxpayers 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 taxpayers or a related person,

(iii) is under objection by the taxpayers 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 not expired, or

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

Proposed Transactions

9. Prior to XXXXXXXXXX, Foreign Parent will subscribe for newly issued Class X preference shares (the "Class X Shares") of Canadian Parent. The total subscription proceeds will equal approximately XXXXXXXXXX The per-share paid up capital of the newly issued Class X Shares will be $XXXXXXXXXX per share such that Canadian Parent will issue XXXXXXXXXX Class X Shares to Foreign Parent.

The Class X Shares will be non-voting, non-participating shares that are redeemable and retractable for $XXXXXXXXXX. The Class X Shares will carry a non-cumulative quarterly dividend of $XXXXXXXXXX per share.

10. Subsequent to Canadian Parent's share issuance to Foreign Parent, Canadian Parent will use the entire proceeds ($XXXXXXXXXX) received from its share issuance to subscribe for XXXXXXXXXX additional newly issued common shares of Canadian Sub at a purchase price of $XXXXXXXXXX per share.

11. Canadian Sub will use a portion of the proceeds received from its share issuance to acquire all of the issued and outstanding share capital of FFC from Foreign Parent for XXXXXXXXXX Canadian Sub will also subscribe for additional, previously unissued, common shares of FFC for XXXXXXXXXX.

12. Canadian Sub will lend the remaining approximately XXXXXXXXXX to FFC. The loan will be a demand loan with interest payable at a rate that is between XXXXXXXXXX% and XXXXXXXXXX% (the final rate is subject to an advance transfer pricing arrangement currently being sought from the Foreign Tax Authority). The loan will be for a term of XXXXXXXXXX years with the full principal amount being repayable on the XXXXXXXXXX anniversary. The loan will be secured by a charge against all of the assets of FFC.

13. FFC will lend the XXXXXXXXXX it received from Canadian Sub to one or more subsidiaries of Foreign Parent. None of these subsidiary(ies) will be a resident of Canada. The Loan(s) will be payable on demand with interest payable at a rate that is between XXXXXXXXXX basis points (XXXXXXXXXX% - XXXXXXXXXX%) higher than the rate charged by Canadian Sub on its loan to FFC. The final rate to be charged by FFC is subject to an advance transfer pricing arrangement currently being sought from the Foreign Tax Authority. The subsidiary(ies) will use the borrowed funds to carry on their active business activities or lend the funds to other operating subsidiaries that will use the borrowed funds to carry on their active business operations.

14. The Canadian Sub will continue to operate the XXXXXXXXXX with an expectation of profit at all times while the proposed transactions described above are being completed. Similarly, Canadian Sub will operate the XXXXXXXXXX with an expectation of profit after the proposed transactions described herein have been completed.

Purpose of the Proposed Transactions

The purpose of the proposed transactions is to permit Foreign Parent to finance its European subsidiary(ies) with interest bearing debt and use the accumulated non-capital losses of Canadian Sub to shelter the interest income on such debt from taxes in any country.

Canadian Sub's purchase of additional common shares of FFC is required to satisfy the minimum capitalization requirements under the Foreign Jurisdiction's corporate law.

Rulings

Provided that:

(a) the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, proposed transactions and the purpose of the proposed transactions;

(b) the proposed transactions are completed in the manner described above; and

(c) there are no other transactions which may be relevant to the rulings requested,

our rulings are as follows:

A. Subsection 15(2) and paragraph 214(3)(a) of the Act will not apply to the loan described in paragraph 12 by virtue of paragraph 15(2.1)(a) of the Act.

B. Subsection 17(2) of the Act will apply, for the purposes of subsection 17(1) of the Act, to deem the European subsidiary(ies) to owe Canadian Sub an amount equal to that portion of the loan payable by the European subsidiary(ies) to FFC, as described in paragraph 13 above, that became owing to FFC because of Canadian Sub's transfer of property to FFC on the acquisition of the previously unissued shares described in paragraph 11 above.

C. Subsection 245(2) of the Act will not apply to the proposed transactions, in and by themselves, to redetermine the tax consequences confirmed in the rulings given.

Comments

These rulings are given subject to the limitations and qualifications set out in Information Circular 70-6R5 issued by the Canada Revenue Agency ("CRA") on May 17, 2002, and are binding on the CRA provided that the proposed transactions are completed before XXXXXXXXXX.

These rulings are based on the Act in its present form and do not take into account any proposed amendments to the Act which, if enacted, could have an effect on the rulings provided herein.

Except as expressly stated, this advance income tax ruling does not imply acceptance, approval or confirmation of any other income tax implications of the facts or proposed transactions described herein.

The rulings given are based solely on the facts, proposed transactions and purposes of the proposed transactions described above. Facts and proposed transactions in the documents submitted with your request and not described above, do not form part of the facts and proposed transactions on which this advance income tax ruling is based.

Nothing in this ruling should be construed as implying that the CRA has agreed to, reviewed or has made any determination in respect of:

(a) the fair market value or adjusted cost base of any property or the paid-up capital of any shares referred to herein;

(b) the undepreciated capital cost of any depreciable property held by Canadian Sub;

(c) the amount of any non-capital loss incurred or available for carryforward of Canadian Parent or Canadian Sub;

(d) the reasonableness of any interest rates payable on any of the loans described in the proposed transactions for the purposes of subsection 17(1) of the Act; or

(e) whether the interest rate charged on the loan from Canadian Sub to FFC, as described in 12 above, "is not less than the interest rate that a lender and borrower would have been willing to agree to if they were dealing at arm's length with each other at the time the loan was made" for the purposes of the definition of "exempt loan or transfer" in subsection 17(15) of the Act.

Opinions

(I) In any taxation year that the loan from Canadian Sub to FFC, as described in paragraph 12 above, has been outstanding for more than a year, and the amount of interest income included in Canadian Sub's income for income tax purposes in that taxation year is less than the amount that would be included in Canadian Sub's income if the interest rate in respect of the loan had been computed at a reasonable rate for the period in the year during which the loan was owing by FFC to Canadian Sub, subsection 17(1) of the Act will apply to include in Canadian Sub's income an amount equal to: the amount of interest that would be included in Canadian Sub's income if the interest on the loan were computed at the prescribed rate, determined pursuant to paragraph 4301(1)(c) of the Income Tax Regulations, less the amount of interest income actually included in Canadian Sub's income, for the period in the year during which the loan was owing from FFC to Canadian Sub.

(II) Subsection 17(2) of the Act will apply, for the purposes of subsection 17(1) of the Act, to deem the European subsidiary(ies) to owe Canadian Sub an amount equal to that portion of the loan payable by the European subsidiary(ies) to FFC, as described in paragraph 13 above, that became owing to FFC because of Canadian Sub's loan to FFC, as described in paragraph 12 above, if the loan from Canadian Sub to FFC is not an "exempt loan or transfer".

Yours truly,

XXXXXXXXXX
for Director
International & Trusts Division
Income Tax Rulings Directorate
Policy and Planning Branch