2006 Ruling 2005-0155361R3 - interest deductibility - Part XIII

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 212(1)(b)(vii) and GAAR apply where loan to Finco and on-loan to LP and Holdco

Position: Yes and no

Reasons: although preferred shares that Holdco will acquire do not bear dividends, Holdco shares will disappear on subsequent merger immediately after share acquisition

XXXXXXXXXX 							2005-015536

XXXXXXXXXX, 2006

Re: Advance Income Tax Ruling

XXXXXXXXXX.

XXXXXXXXXX

Dear XXXXXXXXXX:

This is in response to your letter dated XXXXXXXXXX, wherein you requested an advance income tax ruling on behalf of the above-noted taxpayers, and your amended ruling request dated XXXXXXXXXX.

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

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

(ii) 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) under objection by the taxpayers or a related person;

(iv) subject to a ruling previously issued to the taxpayers or a related person 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 not expired.

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

(a) "Act" means the Income Tax Act R.S.C. 1985 (5th Supp.), c.1, as amended to the date hereof. Except as otherwise noted, all statutory references in this request for advance income tax rulings are references to the provisions of the Income Tax Act (Canada), R.S.C. 1995 (5th Supplement), as amended;

(b) "Canco A" means XXXXXXXXXX., a corporation incorporated and existing under the laws of the province of XXXXXXXXXX;

(c) "Canco B" means XXXXXXXXXX., a corporation incorporated and existing under the laws of the province of XXXXXXXXXX;

(d) "Canco C" means XXXXXXXXXX., a corporation incorporated and existing under the laws of the province of XXXXXXXXXX. The address and business number of Canco C are XXXXXXXXXX, respectively. Canco C is located within the area served by the XXXXXXXXXX TSO and the XXXXXXXXXX TC;

(e) "Canco D" means XXXXXXXXXX., a corporation incorporated and existing under the Canada Business Corporations Act;

(f) "Canco E" means the corporation referred to in Paragraph 21;

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

(h) "Credit Agreement" means the agreement to be entered into between Finco and the Lenders outlining the terms and conditions of the Credit Facility;

(i) "Credit Facility" means the credit facility in the amount of approximately $XXXXXXXXXX to be made available by XXXXXXXXXX, acting as administrative agent for a lending syndicate, to Finco pursuant to the terms of the Credit Agreement;

(j) "Existing Canco B Indebtedness" means indebtedness of LP in favour of Canco B in the amount of approximately $XXXXXXXXXX;

(k) "Existing Credit Facility" means the XXXXXXXXXX, non-revolving, term facility of LP, established pursuant to the credit agreement dated XXXXXXXXXX between GP, on behalf of LP, Canco A and a syndicate of lenders;

(l) "Existing Partners Indebtedness" means indebtedness of LP in favour of its limited partners in the amount of approximately $XXXXXXXXXX;

(m) "Facility" means the XXXXXXXXXX;

(n) "Finco" means a soon-to-be-created wholly-owned subsidiary of LP to be constituted under the laws of the province of XXXXXXXXXX;

(o) "GAAR" means the general anti-avoidance rule in subsection 245(2) of the Act;

(p) "Holdco" means XXXXXXXXXX., a corporation incorporated and existing under the laws of XXXXXXXXXX;

(q) "Holdco Guarantee" means the agreement or agreements to be entered into by Holdco with the Lenders pursuant to which Holdo will provide to the Lenders a guarantee of the obligations of Finco under the Credit Facility secured by a charge over the assets of Holdco;

(r) "Holdco Loan Amount" means the sum of approximately $XXXXXXXXXX to be advanced by Finco to Holdco pursuant to the Holdco Sub-Loan Agreement using a portion of the funds drawn by Finco from the Credit Facility;

(s) "Holdco Sub-Loan Agreement" means the agreement to be entered into between Finco and Holdco outlining the terms and conditions of the loan by Finco in favour of Holdco of the Holdco Loan Amount;

(t) "Individual" means XXXXXXXXXX., a U.S. resident;

(u) "Lenders" means XXXXXXXXXX, acting as administrative agent for a lending syndicate, together with each member of the lending syndicate, which is expected to include non-residents of Canada for purposes of the Act;

(v) "LP" means XXXXXXXXXX, a limited partnership formed under the laws of XXXXXXXXXX. The address and business number of LP are XXXXXXXXXX, respectively. LP is located within the area served by the XXXXXXXXXX TSO and the XXXXXXXXXX TC;

(w) "LP Agreement" means the limited partnership agreement dated XXXXXXXXXX, as amended, which governs LP;

(x) "LP Operations" means the operations of LP which consists in the XXXXXXXXXX and the ownership of an indirect interest in Canco A and Canco B through Holdco;

(y) "LP Guarantee" means the agreement or agreements to be entered into by LP with the Lenders pursuant to which LP will provide to the Lenders a guarantee of the obligations of Finco under the Credit Facility secured by a charge over the assets of LP;

(z) "LP Loan Amount" means the sum of approximately $XXXXXXXXXX to be advanced by Finco to LP pursuant to the LP Sub-Loan Agreement using a portion of the funds drawn by Finco from the Credit Facility;

(aa) "LP Sub-Loan Agreement" means the agreement to be entered into between Finco and GP, in its capacity as general partner of LP, outlining the terms and conditions of the loan by Finco in favour of LP of the LP Loan Amount;

(bb) "Paragraph" means a numbered paragraph in this advance income tax ruling;

(cc) "Preferred Shares" means the preferred shares of Canco A to be acquired by Holdco from Canco D under the Share Purchase Agreement;

(dd) "Share Purchase Agreement" means the agreement to be entered into between Holdco and Canco D pursuant to which Holdco will agree to acquire the Preferred Shares which are currently held by Canco D for a total consideration of approximately $XXXXXXXXXX payable in cash;

(ee) "Sub Guarantees" means, collectively, the LP Guarantee and the Holdco Guarantee;

(ff) "Sub-Loan Agreements" means, collectively, the LP Sub-Loan Agreement and the Holdco Sub-Loan Agreement;

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

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

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

FACTS

1. Canco C is a taxable Canadian corporation and was formed on XXXXXXXXXX, to act as the general partner of LP. The only issued and outstanding share capital of Canco C consists of a single class of voting common shares, which are all owned by Individual.

2. LP is a limited partnership formed under the laws of XXXXXXXXXX, the sole general partner of which is Canco C. LP has issued and outstanding general partnership units and ordinary limited partnership units. All of the general partnership units issued by LP are owned by Canco C. The ordinary limited partnership units issued by LP, representing approximately XXXXXXXXXX% of all issued and outstanding units of LP, are owned by XXXXXXXXXX

3. The LP Operations includes the ownership of, and the grant of a "head lease" on, the Facility. The head lease has been granted to Canco A. Under the head lease, Canco A has all of the exploitation rights with respect to the Facility.

4. Canco A's business consists of the operation of the Facility. Canco A is a wholly-owned subsidiary of Holdco.

5. LP also owns XXXXXXXXXX% of Holdco which, indirectly through Canco A and Canco B, owns and operates the Facility and XXXXXXXXXX. Canco D owns XXXXXXXXXX% of the common shares of Holdco.

6. Under the LP Agreement, Canco C has the authority to manage the LP Operations, to make all decisions regarding the LP Operations and to bind LP in respect of any such decisions. The powers of Canco C include the authority to arrange for debt financing for LP. Canco C is allocated a share of the income or loss of LP for each fiscal year of LP and is entitled to be reimbursed by LP for costs and expenses incurred by it in the performance of its duties under the LP Agreement.

7. LP currently owes approximately $XXXXXXXXXX under the Existing Credit Facility to the Lenders thereunder. The amounts borrowed by LP under the Existing Credit Facility were used by LP to provide part of the funding necessary for the acquisition of the LP Operations.

8. LP also owes approximately $XXXXXXXXXX and $XXXXXXXXXX under, respectively, the Existing Canco B Indebtedness and the Existing Partners Indebtedness. The amounts borrowed by LP under the Existing Canco B Indebtedness and the Existing Partners Indebtedness were used by LP to provide part of the funding necessary for the acquisition of the LP Operations.

9. Canco C, in its capacity as general partner of LP, has decided to refinance the Existing Credit Facility in order to take advantage of current preferential market conditions.

10. The Lenders deal at arm's length with Canco C and LP, and will deal at arm's length with Finco and Holdco.

PROPOSED TRANSACTIONS

11. Finco will be formed as a direct, wholly-owned subsidiary of LP and will be capitalized with nominal share capital. The only activity of Finco will be the lending of money. Finco's only source of income will be the interest payable by LP and Holdco to Finco under the Sub-Loan Agreements.

12. Finco and the Lenders will enter into the Credit Agreement on or prior to the closing date, which is scheduled for XXXXXXXXXX. On the closing date of the Credit Facility, the Lenders will advance to Finco an amount of approximately $XXXXXXXXXX. Finco will then advance the same amount under the Sub-Loan Agreements.

13. Finco and LP will enter into the LP Sub-Loan Agreement on or prior to the closing date of the Credit Facility, the proceeds of which will be used to repay the portion of the Existing Credit Facility owed by LP, to repay the Existing Canco B Indebtedness and the Existing Partners Indebtedness and to effect a distribution of capital in the amount of approximately $XXXXXXXXXX to its partners (equal to or less than the adjusted cost base to its partners of their partnership interest).

14. Finco and Holdco will enter into the Holdco Sub-Loan Agreement on or prior to the closing date of the Credit Facility, the proceeds of which will be used to acquire the Preferred Shares from Canco D pursuant to the Share Purchase Agreement and to make a pro rata distribution of approximately $XXXXXXXXXX in total of stated capital to each of LP and Canco D, the holders of the common shares of Holdco.

15. Pursuant to the Credit Agreement, Finco will be obliged to pay certain customary costs and fees to the Lenders in respect of the Credit Facility. In addition, the Credit Agreement will include a typical "gross-up" clause which would require

Finco to make additional payments to the Lenders to compensate the Lenders for any withholding taxes, and certain other taxes, that may be exigible in connection with payments made under the Credit Facility.

16. Under the Credit Agreement, Finco will not be obligated to repay more than XXXXXXXXXX% of the principal amount of the loan within XXXXXXXXXX years from the date the advance is made, except upon the occurrence of an event of default, as defined in the Credit Agreement. The events of default under the Credit Agreement will be commercially reasonable and will not be contrived.

17. The Lenders require that the Credit Facility be guaranteed by LP and Holdco. Canco C, in its capacity as general partner of LP, and Holdco will, respectively, enter into the LP Guarantee and the Holdco Guarantee.

18. The loans under the Sub-Loan Agreements will be on substantially the same terms as the terms under which Finco is borrowing under the Credit Facility as to maturity date, principal amount and currency denomination. However, advances under the Sub-Loan Agreements will bear interest at a rate of XXXXXXXXXX% per annum in excess of the interest rates under the Credit Facility.

19. The default provisions under the Sub-Loan Agreements will be subject to the default provisions under the Sub Guarantees. In addition, as a condition of its agreement to make the loans to LP and Holdco under the Sub-Loan Agreements, Finco will require LP and Holdco to reimburse Finco for all of its fees and expenses incurred in connection with the Sub-Loan Agreements and incurred by Finco under the Credit Facility. The advances to LP and Holdco under the Sub-Loan Agreements will be unsecured, but Finco will require, as a condition of agreeing to make loans to LP and Holdco under the Sub-Loan Agreements, that LP and Holdco enter into the Sub Guarantees.

20. Holdco will acquire the Preferred Shares from Canco D for proceeds equal to $XXXXXXXXXX to be paid in cash.

21. Holdco and Canco A will amalgamate to form Canco E.

22. Canco D and LP will transfer their common shares in Canco E to a newly incorporated Canadian corporation in exchange for an equal number of common shares of that newly incorporated Canadian corporation.

PURPOSE OF THE PROPOSED TRANSACTIONS

23. The purpose of the proposed financing under the Credit Facility is to enable Finco to obtain long-term financing at the lowest cost of capital, which financing proceeds will, in turn, be used by Finco to make loans to LP and Holdco in order to allow (i) LP to repay the portion of the Existing Credit Facility owed by LP, to repay the Existing Canco B Indebtedness and the Existing Partners Indebtedness and to effect a distribution of capital to its partners equal to or less than the adjusted cost base to its partners of their partnership interest; and (ii) Holdco to acquire the Preferred Shares and to make a distribution to each of Canco D and LP in the form of a return of capital.

RULINGS

Provided that the above description of Facts, Proposed Transactions and Purpose of the Proposed Transactions are accurate and constitute a complete and accurate disclosure of all of the relevant Facts, Proposed Transactions and Purpose thereof, and provided further that the Proposed Transactions are completed in the manner described above, our rulings are as set forth below:

A. By virtue of the exemption contained in subparagraph 212(1)(b)(vii) of the Act, no tax under Part XIII of the Act will be exigible in respect of any amounts paid or credited to the Lenders as, on account, or in lieu of payment of, or in satisfaction of interest under the Credit Facility, provided that at the time the amount is paid or credited the Lenders deal at arm's length with Finco.

B. Subsection 15(2.3) of the Act will apply with respect to loans made by Finco to LP under the LP Sub-Loan Agreement.

C. Subsection 245(2) of the Act will not apply to redetermine the tax consequences of the proposed transactions confirmed in the ruling given above.

CAVEAT

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 the Proposed Transactions described in Paragraphs 12, 13 and 14 are completed on or before XXXXXXXXXX and provided that the amalgamation referred to in Paragraph 21 occurs immediately after the acquisition of the Preferred Shares by Holdco.

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. In addition, we have not been provided with any of the legal documents or draft legal documents referred to in this advance income tax ruling, and accordingly we have not had the opportunity to consider any information, including the events of default, other than that which is contained in this advance income tax ruling.

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, or

(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 Legislation Branch