2005 Ruling 2005-0153641R3 - Withholding - on Loan to a partnership

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. Are interest payments made by Finco to a Non-resident arm's length person exempt under 212(1)(b)(vii)? 2. Does a disposition of a partnership interest affect the withholding tax exemption available to Finco? 3. Is there a new obligation if a Lender assigns its obligation under the Loan agreement that causes the withholding exemption to cease?

Position: 1. YES 2. No 3. No

Reasons: 1. and 2. Finco is responsible for the loan, 3. Terms of the Loan agreement.

XXXXXXXXXX 								2005-015364

XXXXXXXXXX, 2005

Dear XXXXXXXXXX:

Re: Advance Income Tax Ruling
XXXXXXXXXX
XXXXXXXXXX ("Finco")
XXXXXXXXXX ("GP#1)
XXXXXXXXXX ("GP#2)
XXXXXXXXXX ("Partnership")
XXXXXXXXXX (the "Lenders")

We are writing in response to your letter of XXXXXXXXXX, wherein you requested an advance income tax ruling in respect of the above named taxpayers. We acknowledge the additional information we received with your electronic messages of XXXXXXXXXX

To the best of your knowledge and that of the taxpayers involved, none of the issues contained in this ruling request are:

(i) dealt with in an earlier return of the taxpayers or related persons;

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

(iii) under objection by the taxpayers or related persons;

(iv) subject to a ruling previously issued by the Income Tax Rulings Directorate; or

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

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" means the agreement to be entered into by the Partnership, 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 Project is achieved;

(e) "Contract Period" means the period that includes the Construction Period and the Operating Period;

(f) "Contractor" means XXXXXXXXXX. The Contractor will design and build the Project during the Construction Period;

(g) "CRA" means Canada Revenue Agency;

(h) "Design-Build Contract" means the engineering, procurement and construction contract between the Partnership and the Contractor pursuant to which the Contractor will design and build the Project;

(i) "Entity" means XXXXXXXXXX;

(j) "Equity Contribution Agreement" means an agreement amongst GP#1, the Partnership and an indenture trustee under which GP#1 agrees to contribute equity to the Partnership;

(k) "Finco" means XXXXXXXXXX., a Taxable Canadian Corporation, all of whose shares are owned by Holdco;

(l) "GP#1" means XXXXXXXXXX., a Taxable Canadian Corporation and a general partner of the Partnership all of whose shares are owned by Holdco;

(m) "GP#2" means XXXXXXXXXX., a Taxable Canadian Corporation, and a general partner of the Partnership, all of whose shares are owned by GP#1;

(n) "Holdco" means XXXXXXXXXX., a Taxable Canadian Corporation, all of whose shares are owned by Sponsor;

(o) "Lenders" means the lenders under the Primary Loan Agreement who will purchase notes to be held directly or by nominees;

(p) "Make-Whole Premium" means a premium payable in respect of the Primary Loan in the event of early repayment of the Primary Loan, calculated as the sum of the present values of each payment of interest and principal that, but for such early redemption, would have been payable on the portion of the Primary Loan being redeemed, assuming no prepayments other than scheduled amortization discounted from the scheduled payment dates to the early redemption date (using the discount rate specified in the Primary Loan Agreement) minus the principal amount of the portion of the Primary Loan being redeemed;

(q) "Non-Resident Lender" means a Lender who is not resident in Canada;

(r) "Operating and Maintenance Contract" means the contract between the Partnership and the Operator pursuant to which the Operator will operate the Project for the Partnership during the Operating Period. (XXXXXXXXXX.);

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

(t) "Operator" means XXXXXXXXXX., an operations and maintenance services contractor which will operate the Project after Substantial Completion;

(u) "Partner" or "Partners" means a Partner or the Partners of the Partnership from time to time;

(v) "Partnership" means the general partnership formed on XXXXXXXXXX, having GP#1 and GP#2 as its initial general partners;

(w) "Primary Loan" means a loan to be made to Finco pursuant to the terms of the Primary Loan Agreement;

(x) "Primary Loan Agreement" means the credit facility agreement between Finco, the Partnership and the Lenders and related agreements;

(y) "Principal Amount" has the meaning assigned by subsection 248(1) of the Act;

(z) "Project" means the XXXXXXXXXX;

(aa) "Proposed Transactions" means the transactions described herein;

(bb) "Province" means the Province of XXXXXXXXXX;

(cc) "Secondary Loan" means an advance made by Finco to the Partnership pursuant to the terms of a credit agreement between Finco and the Partnership;

(dd) "Site" is the land on which the Project will be constructed and operated;

(ee) "Sponsor" means XXXXXXXXXX, a non-resident corporation;

(ff) "Substantial Completion" means the substantial completion of the construction of the Project; and

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

BACKGROUND FACTS

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

1. The Project is a public-private partnership.

2. The Partnership was formed under the XXXXXXXXXX Partnership Act as a general partnership pursuant to a partnership agreement. The Partners are GP#1 and GP#2.

3. GP#1 will have a XXXXXXXXXX% interest in the income and capital of the Partnership. GP#2 will have a XXXXXXXXXX% interest in the income and capital of the Partnership.

4. Contractor and Operator deal at arm's length with each of the Partnership, GP#1, GP#2, Holdco and Sponsor.

5. The aggregate cost of the Project is expected to be approximately $XXXXXXXXXX.

PROPOSED TRANSACTIONS

6. The Partnership has entered into the Concession Agreement with the Province and the Entity. The Contract Period is for XXXXXXXXXX years. There will be two separate periods in the Contract Period. The first period is the Construction Period that includes the design and construction of the Project. The Construction Period ends once a certificate is issued that Substantial Completion has occurred. The second period is the Operating Period. This period runs concurrently with the Construction Period (XXXXXXXXXX) and continues until the end of the Contract Period. The Concession Agreement sets out the obligations of these parties during the Construction Period and the Operating Period. The Partnership is responsible for constructing, completing, commissioning and testing the Project during the Construction Period and operating and maintaining the Project throughout the Operating Period, all in accordance with the requirements set out in the Concession Agreement. 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.

7. The Province owns or has rights to the real property interests comprising the Site. Ownership of the real property interests, fixed assets and improvements will remain with the Province.

8. The Partnership will enter into the Design-Build Contract with the Contractor and the Operating and Maintenance Contract with the Operator.

9. The amount of the Primary Loan will be about $XXXXXXXXXX. The Lenders will loan the Primary Loan to Finco pursuant to the Primary Loan Agreement.

10. One of the Lenders is not resident in Canada. The financing terms and interest rate payable to all Lenders is the same. None of the funds to be advanced by the non-resident lender to Finco will be received as a loan from Sponsor.

11. Finco will loan the proceeds of the Primary Loan to the Partnership on substantially the same financial terms as those under the Primary Loan, except that the interest rate charged by Finco on the Secondary Loan will be XXXXXXXXXX% higher than the interest rate charged by the Lenders and payable by Finco on the Primary Loan.

12. The Partnership will pay the interest payments on the Secondary Loan to Finco and Finco will pay the Lenders the interest payments on the Primary Loan.

13. Under the terms of the Primary Loan Agreement, Finco may not, under any circumstances, be obligated to pay more than 25% of the principal amount (within the meaning of that term in subsection 248(1) of the Act) of the Primary Loan within five years from the end of the availability period of the Primary Loan during which amounts may be drawn under the Primary Loan, except in the event of a failure or default under the terms of the Primary Loan Agreement (or if the terms of the Primary Loan Agreement or any agreement relating thereto become unlawful or are changed by virtue of legislation or by a court, statutory board or commission). Finco may at its option, prepay the Primary Loan. The Primary Loan Agreement provides that Finco must pay the Make-Whole Premium in the event of early repayment, whether voluntary or as a result of a default.

14. The Primary Loan Agreement provides for certain representations and warranties, covenants and events of default appropriate in the context of the Primary Loan Agreement and the Project. Article XXXXXXXXXX of the Primary Loan Agreement contains events of default. Some of these may be triggered by actions of parties to the Primary Loan Agreement, whereas other events of default may be triggered as the result of actions of parties that are not party to the Primary Loan Agreement. For example:

(a) Article XXXXXXXXXX provides that the abandonment, cancellation or termination of the Project (which could include a cancellation by the Province) will constitute an event of default under the Primary Loan Agreement;

(b) Article XXXXXXXXXX provides that the occurrence of an event of default under the Concession Agreement will constitute an event of default under the Primary Loan Agreement (Article XXXXXXXXXX of the Concession Agreement sets out events of default for the purposes of that agreement); and

(c) Article XXXXXXXXXX provides that GP#1 failing to make the required equity contribution payment under the Equity Contribution Agreement will constitute an event of default under the Primary Loan Agreement.

15. The Primary Loan Agreement also requires that Finco make an offer to repay the Primary Loan if the Project is expropriated, sold or terminated, and that the failure of Finco to make such an offer will constitute an event of default.

PURPOSE OF THE PROPOSED TRANSACTIONS

16. The purpose of the proposed transactions is to enable the Partnership to design, engineer, construct, commission and perform testing of the Project during the Construction Period and to operate and maintain the Project during the Operating Period.

17. The Province will acquire the Project at the end of the Construction Period and have the Project maintained during the Operating Period by the Partnership. The Project will help ease traffic congestion and improve safety.

18. The Primary Loan is being obtained from the Lenders, including the Non-Resident Lenders, for the purpose of (partially) funding the construction and operation of the Project.

19. Finco is being used in the structure to:

(a) facilitate, from a commercial perspective, the entry or exit of partners of the Partnership;

(b) avoid any uncertainty with respect to the application of subparagraph 212(l)(b)(vii) of the Act as it applies to a partnership;

(c) avoid any uncertainty that might arise should a Partner dispose of its interest in the Partnership in the future or should a new Partner be admitted to the Partnership, specifically with respect to whether a new debt obligation might be created as a result of such a disposition; and

(d) to ensure that the subparagraph 212(1)(b)(vii) exemption will not cease to apply if one or more Partners assigns its interest in the Partnership to a new Partner that is not a corporation or, if a corporation, is not a corporation resident in Canada or if a new partner that is not a corporation or, if a corporation, is not a corporation resident in Canada, is admitted to the Partnership.

OTHER INFORMATION

20. It is anticipated that in the future one or more Partners may sell or otherwise dispose of all or a portion of their interest in the Partnership to a new Partner and/or one or more new Partners will be admitted to the Partnership. Such a new Partner might be a Canadian resident or non-resident corporation, trust, partnership, fund or other entity.

21. It is anticipated that the Lenders may assign their participation in the Primary Loans to other Lenders pursuant to the Primary Loan Agreement. The Primary Loan Agreement provides that no such assignment shall be nor shall it be deemed to be a discharge, rescission, extinguishment, novation or substitution of any portion of the Primary Loan and the portion of the Primary Loan so assigned shall continue to be the same obligation and not a new obligation.

RULINGS GIVEN

Provided that the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, the Proposed Transactions and purpose of the Proposed Transactions, and that the final agreements referred to in this letter are substantially the same as the documents provided to us, and provided further that the Proposed Transactions are completed in the manner described above, our rulings are as set forth below:

A. Interest payments made by Finco to a Non-Resident Lender pursuant to the Primary Loan Agreement will be exempt from withholding taxes under Part XIII pursuant to subparagraph 212(1)(b)(vii) of the Act, provided that at the time of the payment the Non-Resident Lender deals at arm's length with Finco.

B. Provided that the "Make-Whole Premium" as described in the definition and in paragraph 13 of the Proposed Transactions, to be paid to the Lenders does not exceed the value at the time of the payment of the interest that, would have been paid or payable by Finco as interest on the Primary Loan for taxation years ending after that time, such payment will pursuant to paragraphs 18(9.1)(e) and (f) of the Act, be deemed to have been paid by Finco and received by the Lenders as interest on the Primary Loan and accordingly those provisions will deem the "Make-Whole Premium" to be paid to the Non-Resident Lenders who deal at arm's length with Finco as interest payable for purposes of subparagraph 212(1)(b)(vii) of the Act.

C. Neither the disposition by a Partner of its interest in the Partnership nor the admission of a new Partner to the Partnership will, in and of itself, preclude the application of subparagraph 212(1)(b)(vii) of the Act to interest payments made by Finco to a Lender pursuant to the Primary Loan Agreement, regardless of whether a new Partner is a corporation.

D. For purposes of the five year period within which not more than 25% of the principal amount of an obligation can be payable for purposes of subparagraph 212(1)(b)(vii) of the Act, a disposition of an interest by a Partner in the Partnership or the acquisition by a person of an interest as a Partner in the Partnership will not, in and of itself, result in the issuance of a new debt obligation under the Primary Loan Agreement.

E. The assignment by a Lender of its interest in the Primary Loan will not, in and of itself, preclude the application of subparagraph 212(1)(b)(vii) of the Act to interest payments made by Finco to a Lender pursuant to the Primary Loan Agreement.

F. For purposes of the five year period within which not more than 25% of the principal amount of an obligation can be payable for purposes of subparagraph 212(1)(b)(vii) of the Act, the assignment by a Lender of its interest in the Primary Loan will not, in and of itself, result in the issuance of a new debt obligation.

G. The requirements of Finco, pursuant to the Primary Loan Agreement, to make an offer to repay the Primary Loan as described in paragraph 15 will not, in and by themselves, preclude the application of subparagraph 212(1)(b)(vii) of the Act to the interest paid by Finco to Lenders, who for the purposes of the Act are non-residents of Canada and deal at arm's length with the Borrower at the time of the payment.

H. As a result of the Proposed Transactions, in and by themselves, subsection 245(2) of the Act will not be applied to redetermine the tax consequences confirmed in the rulings above.

The above rulings are given subject to the general limitations and qualifications set out in Information Circular 70-6R5 (the "Circular") issued by the CRA on May 17, 2002, and are binding provided that 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.

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