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: Is interest on Subco1 Loan used to pay dividends to Holdco deductible in these particular circumstances?
Position: Yes
Reasons: Particular fact situation
XXXXXXXXXX 2005-015730
XXXXXXXXXX, 2006
Dear XXXXXXXXXX:
Re: Advance Income Tax Ruling
XXXXXXXXXX
We are writing in response to your letter of XXXXXXXXXX, as well as additional information supplied via email, wherein you requested an advance income tax ruling on behalf of the above-named taxpayer. We also acknowledge information provided during various telephone conversations (XXXXXXXXXX).
To the best of your knowledge and that of the taxpayer involved, none of the issues contained in this ruling request are:
(i) dealt with in an earlier return of the taxpayer 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 taxpayer or a related person;
(iii) under objection by the taxpayer or a related person;
(iv) subject to a ruling previously issued by the Income Tax Rulings Directorate to the taxpayer or a related person; or
(v) before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has expired.
STATEMENT OF FACTS
1. XXXXXXXXXX ("Subco1") is a corporation existing under the Canada Business Corporations Act, and is a taxable Canadian corporation for purposes of the Income Tax Act (the "Act"). The mailing address for Subco1 is: XXXXXXXXXX. Subco1 files its tax returns at the XXXXXXXXXX Taxation Centre and is serviced by the XXXXXXXXXX Taxation Services Office. Subco1 has a XXXXXXXXXX year-end for tax and accounting purposes.
2. Subco1 is an indirectly controlled subsidiary of XXXXXXXXXX ("Parentco1"), a XXXXXXXXXX corporation, formerly known as XXXXXXXXXX
3. All of the issued and outstanding shares of Subco1 are owned by XXXXXXXXXX ("Holdco"), a XXXXXXXXXX corporation that is resident in XXXXXXXXXX. Holdco's functional currency for operations, accounting and tax purposes is the XXXXXXXXXX (the "Foreign Currency").
4. All of the issued and outstanding shares of Holdco are owned by XXXXXXXXXX ("Parentco2"), a XXXXXXXXXX corporation. Parentco2's functional currency for operations, accounting and tax purposes is the Foreign Currency. Parentco2 is controlled (though not wholly-owned) by Parentco1.
5. Parentco1 owns all of the shares of XXXXXXXXXX ("Subco3"), a corporation resident in XXXXXXXXXX. Subco3 owns all of the shares of XXXXXXXXXX. ("Canco"), a taxable Canadian corporation incorporated to carry out the transactions described in 7 below.
6. Prior to XXXXXXXXXX, Subco1 owned, directly or indirectly, XXXXXXXXXX Class XXXXXXXXXX shares in the capital stock of XXXXXXXXXX ("Investco"), a XXXXXXXXXX corporation, representing approximately XXXXXXXXXX% of the issued and outstanding shares of Investco. Of this total, XXXXXXXXXX Class XXXXXXXXXX shares were owned by XXXXXXXXXX ("Subco2"), a taxable Canadian corporation and a wholly-owned subsidiary of Subco1.
7. Pursuant to a merger agreement, Subco1 agreed to complete an internal restructuring. The terms of the restructuring were set out in the merger agreement, and were amended and restated in a XXXXXXXXXX agreement XXXXXXXXXX dated as of XXXXXXXXXX. As part of the restructuring, Subco1 agreed to amalgamate with Subco2 (the amalgamated corporation to be known as Subco1), and then to sell the shares of Investco to Canco for a purchase price equal to fair market value of approximately $XXXXXXXXXX (US).
8. The sale of the shares of Investco to Canco was completed on XXXXXXXXXX . The sale of shares resulted in a gain of approximately $XXXXXXXXXX (Cdn) for Subco1. Following completion of this step, Subco1 no longer had an interest in Investco.
9. On XXXXXXXXXX, Parentco1 entered into an agreement with an affiliate of Investco, XXXXXXXXXX ("Buyer"), under which Parentco1 agreed to sell (or cause its applicable subsidiary to sell) the shares of Investco, formerly owned by Subco1, to an affiliate of Investco for a cash purchase price of approximately $XXXXXXXXXX (US). On XXXXXXXXXX, this sale was completed, and Canco sold the Investco shares to Buyer.
10. Buyer and Investco deal at arm's length with Parentco1, Canco and Subco1 for purposes of the Act.
11. As at XXXXXXXXXX, Subco1 has retained earnings (computed on an unconsolidated basis with investments accounted for on a cost basis) of approximately $XXXXXXXXXX (Cdn). These retained earnings reflect income/losses from its business operations and income/losses from its investments including the disposition of the shares of Investco described in 8 above. Subco1 will compute the portion of its retained earnings that reflect its accumulated profits as described in paragraph 23 of Interpretation Bulletin IT-533, entitled 'Interest Deductibility and Related Issues' (hereinafter referred to as "Accumulated Profits Amount"). The Accumulated Profits Amount will include income arising from the disposition of the shares of Investco described in 8 above.
PROPOSED TRANSACTIONS
12. The board of directors of Subco1 will declare a dividend payable to its shareholders of record on a record date (the "Record Date") to be specified in the resolution declaring the dividend. The Record Date will be some time after the declaration date.
13. XXXXXXXXXX% of the dividend will be payable in the Foreign Currency (the "Foreign Currency Portion"), as this is the functional currency of Holdco and Parentco2, and XXXXXXXXXX% of the declared dividend will be payable in Canadian dollars (the "Canadian Currency Portion").
14. Concurrently with the declaration of the dividend, Subco1 will enter into a loan agreement with a XXXXXXXXXX (the "Bank"). The Bank is an "authorized foreign bank", as defined in the Act, and all amounts referred to herein that are paid or credited by Subco1 to the Bank are in respect of the Bank's Canadian banking business. Pursuant to the loan agreement, the Bank will make a term loan (the "Loan") to Subco1. The Loan will be denominated in the Foreign Currency. The aggregate principal amount of the Loan will be approximately equal to the Foreign Currency Portion, and will be less than or equal to the Accumulated Profits Amount. Under the loan agreement, the Bank will agree to advance the principal amount of the Loan to Subco1 on the Record Date.
15. On the Record Date, the dividend will be due and payable to Holdco, the sole shareholder of Subco1, and the full principal amount of the Loan will be advanced by the Bank to Subco1 in the Foreign Currency. In order to accomplish the advance, each of the Bank and Subco1 will open a "XXXXXXXXXX" bank account in XXXXXXXXXX.
16. XXXXXXXXXX
17. In order to accomplish the remittance of the dividend, Holdco will also open a "XXXXXXXXXX" bank account in XXXXXXXXXX. The full amount of the Canadian Currency Portion will be remitted by Subco1 to the CRA on account of the non-resident withholding tax payable on the dividend. Such amount will be funded by Subco1 out of non-borrowed cash.
18. On the Record Date, and immediately after receipt of the advance of the principal amount of the Loan from the Bank, Subco1 will remit the full amount so advanced (XXXXXXXXXX) to Holdco in full satisfaction of its obligation to pay the Foreign Currency Portion of the dividend.
19. Holdco will pay a Foreign Currency denominated dividend to Parentco2 approximately equal to the Foreign Currency Portion.
20. On the Record Date, Subco1 will enter into a series of forward exchange contracts with another entity that is an affiliate of the Bank ("Forward Counterparty"). Pursuant to the forward exchange contracts, on each day on which interest is payable under the Loan, Subco1 will be obligated to deliver to the Forward Counterparty a specified amount of Canadian dollars in exchange for a specified amount of the Foreign Currency. The forward exchange contracts will also provide that on the date on which the principal amount of the Loan is due and payable in accordance with the terms thereof (including pursuant to any acceleration), Subco1 will deliver a specified amount of Canadian dollars to the Forward Counterparty in exchange for a specified amount of the Foreign Currency. In this manner, Subco1 will hedge its exposure to foreign currency risk.
21. XXXXXXXXXX. Accordingly, any gain or loss on the forward exchange contracts will be cash settled, with an appropriate payment being made on each interest payment date and on the maturity date from (or to) Subco1 to (or from) the Forward Counterparty. At the time of each such cash settlement payment, Subco1 will deliver Canadian dollars to another affiliate of the Bank resident in XXXXXXXXXX (the "Spot Counterparty") in exchange for the Foreign Currency in a separate spot foreign exchange transaction.
22. The full amount of each interest payment on the Loan and the full amount of the principal repayment at maturity of the Loan will be paid by Subco1 in the Foreign Currency. Specifically, the appropriate amount of the Foreign Currency will be advanced, on each relevant date, by the Spot Counterparty into Subco1's XXXXXXXXXX account and then from Subco1's XXXXXXXXXX account into the Bank's XXXXXXXXXX account. XXXXXXXXXX. Subco1's Bank has confirmed in writing that in accordance with such Bank's internal policies, the interest rate payable on the Loan would be equal to the interest rate that would be payable by any other customer of the Bank with a similar credit rating for a Foreign Currency denominated loan with similar terms, and that such interest rate would reflect prevailing market conditions at the time the Loan is made.
23. The interest rate payable by Subco1 to the Bank under the Loan will be a market rate for a Foreign Currency denominated debt issued by a party having a credit rating similar to Subco1. It is not yet known precisely what the interest rate will be. Had the Loan been advanced on the date the ruling request was submitted, the interest rate would have been approximately XXXXXXXXXX%.
24. Subco1 deals at arm's length with the Bank, the Forward Counterparty and the Spot Counterparty for purposes of the Act and the forward exchange contracts and the spot foreign exchange transactions will reflect arm's length terms.
25. The rate of interest on the Loan will exceed by more than XXXXXXXXXX% the rate of interest that would have been payable by Subco1 had the Loan been denominated in Canadian dollars.
PURPOSE OF THE PROPOSED TRANSACTIONS
26. Subco1 wishes to replace some of its existing capital represented by retained earnings with third party debt. The Loan and dividend have the effect of replacing retained earnings with debt financing. Holdco's and Parentco2's functional currency for operations, accounting and tax purposes is the Foreign Currency, and they want to receive dividends denominated in the Foreign Currency. If the dividends were declared and paid in Canadian dollars, Holdco or Parentco2 would incur additional transaction costs in converting the Canadian dollars into the Foreign Currency in XXXXXXXXXX.
RULINGS
Provided that the preceding statements constitute a complete and accurate disclosure of all of the relevant warranties on page 1 of this advance income tax ruling, as well as all of the relevant facts, proposed transactions and purpose of the proposed transactions, and provided that the proposed transactions are completed in the manner described above, our rulings are as set forth below:
A. Provided that Subco1 has a legal obligation to pay interest on the Loan to the Bank as described in 14, 15, 16, 22 and 23 and that Subco1 uses the proceeds from the Loan to pay the dividend to Holdco, as described in 18, Subco1 will be entitled, pursuant to paragraph 20(1)(c) to deduct the lesser of (i) the interest paid or payable (depending on the method regularly followed by Subco1 in computing its income for purposes of the Act) in respect of the year on the Loan or (ii) a reasonable amount in respect thereof.
B. Subsection 20.3(2) of the Act will not apply to limit the amount of interest that is deductible in calculating Subco1's income in respect of the Loan, nor will subsection 20.3(2) of the Act deem any currency gain or loss on repayment of the Loan to be on income account.
C. Subsection 245(2) will not apply to the proposed transactions, in and by itself, to redetermine the tax consequences confirmed in the rulings given.
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 Canada Revenue Agency ("CRA") on May 17, 2002, and are binding provided the Proposed Transactions above are completed on or before XXXXXXXXXX.
The 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) the determination of the Accumulated Profits Amount of Subco1; or
(iii) any other tax consequences of the proposed transactions or of related transactions or events that are not described herein.
OPINION
You have asked for rulings that any currency gain or loss realized by Subco1 upon repayment of the Loan will be on capital account and that any gain or loss realized by Subco1 upon settlement of its obligations under the forward exchange contract relating to the principal amount of the Loan will be on capital account. As indicated in paragraph 15 of the Circular, we cannot provide rulings where the major issue is whether a transaction should be viewed as being of an income nature or of a capital nature. However, we are prepared to offer the following general comments.
We are generally of the view that if a borrowing transaction is entered into for the purpose of acquiring funds to be used for capital purposes (i.e., to pay dividends), any foreign currency gains or losses realized on the repayment of that debt obligation would be considered to be on capital account. In addition, it is our view that a gain or loss arising on a settlement of a forward contract that is matched to a capital asset or liability will likely be on capital account.
The foregoing comments represent our general views with respect to the subject matter. As indicated in paragraph 22 of the Circular, the above comments do not constitute an income tax ruling and accordingly are not binding on the CRA. Our practice is to make this specific disclaimer in all instances in which we provide an opinion.
Yours truly,
XXXXXXXXXX
for Director
Financial Industries and Exempt Entities Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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